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SECURITIES AND EXCHANGE COMMISSIONWASHINGTON,
D.C. 20549

FORM
20-F

|   |                                                                                                   
|-- | --------------------------------------------------------------------------------------------------
|o  | REGISTRATION
  STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF
  1934
|   |                                                                                                   
|OR
|   |                                                                                                   
|x  | ANNUAL
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934            
|   | FOR THE FISCAL YEAR ENDED
  DECEMBER 31, 2005                                                     
|   |                                                                                                   
|OR
|   |                                                                                                   
|o  | TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934        
|   | FOR THE TRANSITION PERIOD
  FROM __________ TO __________                                         
|   |                                                                                                   
|OR
|   |                                                                                                   
|o  | SHELL
  COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
  OF 1934   
|   | DATE OF EVENT REQUIRING
  THIS SHELL COMPANY REPORT__________                                     

|                                                        
|--------------------------------------------------------
|Commission file number 0-20860                          
|                                                        
|                                                        
|                                                        
|LANOPTICS LTD.                                          
|                                                        
|(Exact
  name of Registrant as specified in its charter)
|                                                        
|Israel                                                  
|                                                        
|(Jurisdiction
  of incorporation or organization)       
|                                                        
|1 Hatamar Street                                        
|PO Box 527                                              
|Yokneam 20692 Israel                                    
|                                                        
|(Address
  of Principal Executive Office)               

SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION
12(b) OF THE ACT:None

SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION
12(g) OF THE ACT:Ordinary Shares,
nominal value NIS 0.02

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: 11,633,771 Ordinary
Shares

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

Yes o   No x

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

Yes o   No x

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

Yes x   No o

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

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

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

Item 17 o   Item
18 x

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

Yes o   No
x

This Form 20-F is being
incorporated by reference into the Registrants Form F-3 Registration
Statements File Nos. 333-112136, 333-121611 and 333-126416 and Form S-8
Registration Statement File No. 33-71822.

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TABLE OF CONTENTS

|       |          |                                                            |   
|------ | -------- | ---------------------------------------------------------- | --
|Part I |          |                                                            | 2 
|       |          |                                                            |   
|       | Item 1.  | Identity of Directors, Senior Management and Advisors      | 2 
|       | Item 2.  | Offer Statistics and Expected Timetable                    | 2 
|       | Item 3.  | Key Information                                            | 2 
|       |          | A. Selected Consolidated Financial Data                    | 2 
|       |          | B. Capitalization and Indebtedness                         | 3 
|       |          | C. Reasons for the Offer and Use of Proceeds               | 3 
|       |          | D. Risk Factors                                            | 4 
|       | Item 4.  | Information On The Company                                 | 13
|       |          | A. History and Development of the Company                  | 13
|       |          | B. Business Overview                                       | 14
|       |          | C. Organizational Structure                                | 25
|       |          | D. Property, Plants and Equipment                          | 25
|       | Item 4A. | Unresolved Staff Comments                                  | 26
|       | Item 5.  | Operating and Financial Review and Prospects               | 26
|       |          | A. Results of Operations                                   | 29
|       |          | B. Liquidity and Capital Resources                         | 34
|       |          | C. Research and Development, Patents and Licenses          | 35
|       |          | D. Trend Information                                       | 36
|       |          | E. Off-Balance Sheet Arrangements                          | 36
|       |          | F. Tabular Disclosure of Contractual Obligations           | 36
|       | Item 6.  | Directors, Senior Management and Employees                 | 37
|       |          | A. Directors and Senior Management                         | 37
|       |          | B. Compensation of Directors and Officers                  | 39
|       |          | C. Board Practices                                         | 40
|       |          | D. Employees                                               | 45
|       |          | E. Share Ownership                                         | 46
|       | Item 7.  | Major Shareholders and Related Party Transactions          | 47
|       |          | A. Major Shareholders                                      | 47
|       |          | B. Related Party Transaction                               | 48
|       |          | C. Interests of Experts and Counsel                        | 48
|       | Item 8.  | Financial Information                                      | 48
|       |          | A. Consolidated Statements and Other Financial Information | 48
|       |          | B. Significant Changes                                     | 49
|       | Item 9.  | Offer and Listing                                          | 49
|       |          | A. Listing Details                                         | 49
|       |          | B. Plan of Distribution                                    | 50
|       |          | C. Markets                                                 | 50
|       |          | D. Selling Shareholders                                    | 50
|       |          | E. Dilution                                                | 50
|       |          | F. Expense of the Issue                                    | 50
|       | Item 10. | Additional Information                                     | 51

i

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|           |           |                                                                                |   
|---------- | --------- | ------------------------------------------------------------------------------ | --
|           |           | A. Share capital                                                               | 51
|           |           | B. Memorandum and Articles of Association                                      | 51
|           |           | C. Material Contracts                                                          | 54
|           |           | D. Exchange Controls                                                           | 54
|           |           | E. Taxation                                                                    | 54
|           |           | F. Dividend and Paying Agents                                                  | 62
|           |           | G. Statement by Experts                                                        | 62
|           |           | H. Documents on Display                                                        | 62
|           |           | I. Subsidiary Information                                                      | 63
|           | Item 11.  | Quantitative and Qualitative Disclosures About Market Risk                     | 63
|           | Item 12.  | Description of Securities Other Than Equity Securities                         | 64
|           |           |                                                                                |   
|Part II    |           |                                                                                | 65
|           | Item 13.  | Defaults, Dividend Arrearages and Delinquencies                                | 65
|           | Item 14.  | Material Modifications to the Rights of Security Holders and Use of
  Proceeds | 65
|           | Item 15.  | Controls and Procedures                                                        | 65
|           | Item 16.  | [Reserved]                                                                     | 65
|           | Item 16A. | Audit Committee Financial Expert                                               | 65
|           | Item 16B. | Code of Ethics                                                                 | 65
|           | Item 16C. | Principal Accounting Fees and Services                                         | 66
|           | Item 16D. | Exemptions from the Listing Requirements and Standards for Audit
  Committee   | 66
|           | Item 16E. | Purchase of Equity Securities by the Issuer and Affiliates and
  Purchasers    | 67
|           |           |                                                                                |   
|Part III   |           |                                                                                | 67
|           | Item 17.  | Financial Statements                                                           | 67
|           | Item 18.  | Financial Statements                                                           | 67
|           | Item 19.  | Exhibits                                                                       | 68
|           |           |                                                                                |   
|Signatures |           |                                                                                | 69

ii

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INTRODUCTION

LanOptics
Ltd. was incorporated as a limited liability company under the laws of the
State of Israel in 1989. Until 1999 our principal business was the development,
manufacturing and marketing of solutions and Internet applications to improve
the connectivity and performance of corporate Local Area Networks, or LANs, and
Wide Area Networks, or WANs. Our business now consists of the development and
marketing of high performance network processors through our independent
business unit, E.Z. Chip Technologies Ltd., or EZchip, an Israeli company in
which we currently have a 60.4% ownership interest. As used in this Annual
Report, the terms we, us, our and our company mean LanOptics and its
EZchip subsidiary taken together, unless otherwise expressly stated. Our
ordinary shares are traded on the NASDAQ Capital Market and on the Tel-Aviv
Stock Exchange under the symbol LNOP.

This
Annual Report includes certain forward-looking statements with respect to the
business, financial condition and results of operations of our company. The
words estimate, project, intend, expect and similar expressions are
intended to identify forward-looking statements within meaning of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
subject to risks and uncertainties that could cause actual results to differ
materially from those contemplated by such forward-looking statements.
Investors are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. We undertake no obligation
to publicly release any revisions to these forward-looking statements to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

Our
consolidated financial statements appearing in this annual report are prepared
in U.S. dollars and in accordance with generally accepted accounting principles
in the United States, or US GAAP. Commencing January 1, 2004 we adopted U.S.
GAAP for the preparation of our consolidated financial statements. Previously,
our consolidated financial statements were prepared in accordance with
generally accepted accounting principles in Israel, or Israeli GAAP, and
included a note describing the major differences between Israeli GAAP and US
GAAP, as applicable to our company. The consolidated financial statements for
all prior periods presented have been restated and are presented in accordance
with U.S. GAAP.

All
references in this Annual Report to dollars or $ are to U.S. dollars and
all references in this annual report to NIS are to New Israeli Shekels. The
representative exchange rate between the NIS and the dollar as published by the
Bank of Israel on December 31, 2005 was NIS 4.603 per $1.00.

Statements
made in this Annual Report concerning the contents of any contract, agreement
or other document are summaries of such contracts, agreements or documents and
are not complete descriptions of all of their terms. If we filed any of these
documents as an exhibit to this annual report or to any registration statement
or annual report that we previously filed, you may read the document itself for
a complete description of its terms.

1

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PART I

|        |                                                      
|------- | -----------------------------------------------------
|ITEM 1. | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
|        |                                                      
|        | Not
  applicable.                                    
|        |                                                      
|ITEM 2. | OFFER STATISTICS AND EXPECTED TIMETABLE              
|        |                                                      
|        | Not
  applicable.                                    
|        |                                                      
|ITEM 3. | KEY INFORMATION                                      

|A. | SELECTED
  CONSOLIDATED FINANCIAL DATA
|-- | --------------------------------------

The
following selected consolidated financial data of our company have been
prepared in accordance with US GAAP, and are derived from our audited
consolidated financial statements and accompanying notes. The selected financial data set forth in the table
below have been derived from our audited historical financial statements for
the years 2001 to 2005. The selected income data for the years 2003, 2004 and
2005, and the selected balance sheet data at December 31, 2004 and 2005, have been derived from our audited
consolidated financial statements set forth in Item 18  Financial
Statements. The selected income data for the years 2001 and 2002, and the
selected balance sheet data at
December 31, 2001, 2002 and 2003, have been derived from our previously
published audited consolidated financial statements, which are not included in
this Annual Report. The
selected 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 included elsewhere in
this Annual Report.

Revenues
from our legacy networking operations have become immaterial. As a result, the
related assets, liabilities and results of operations for the reported periods
have been reclassified as discontinued operations. The reclassification did
not result in any changes to our net assets or net income (loss) for the
reported periods.

2

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|                                                                         |  |                                                   |           |      |   |           |   |      |           |      |   |           |   |   |            |  
|------------------------------------------------------------------------ |  | ------------------------------------------------- | --------- | ---- | - | --------- | - | ---- | --------- | ---- | - | --------- | - | - | ---------- | -
|                                                                         |  | Year Ended December 31,                           |          
|                                                                         |  |                                                   |          
|                                                                         |  | 2001                                              |           | 2002 |   | 2003      |   | 2004 |           | 2005 |  
|                                                                         |  |                                                   |           |      |   |           |   |      |           |      |  
|                                                                         |  | (in thousands, except share and per
  share data) |          
|                                                                        
|Statement of Operations Data:                                            |  |                                                   |           |      |   |           |   |      |           |      |   |           |   |   |            |  
|Revenues                                                                 |  | $                                                 | --        |      | $ | 465       |   | $    | 1,756     |      | $ | 4,746     |   | $ | 5,848      |  
|Operating loss                                                           |  |                                                   | (9,766    | )    |   | (14,992   | ) |      | (9,986    | )    |   | (8,416    | ) |   | (10,126    | )
|Loss from continuing operations                                          |  |                                                   | (8,363    | )    |   | (14,354   | ) |      | (10,404   | )    |   | (9,154    | ) |   | (10,347    | )
|Net loss                                                                 |  |                                                   | (7,570    | )    |   | (14,303   | ) |      | (10,404   | )    |   | (9,154    | ) |   | (10,347    | )
|                                                                         |  |                                                   |           |      |   |           |   |      |           |      |   |           |   |   |            |  
|Per share data:                                                          |  |                                                   |           |      |   |           |   |      |           |      |   |           |   |   |            |  
|Net loss (basic and diluted)                                             |  |                                                   | (1.04     | )    |   | (1.85     | ) |      | (1.23     | )    |   | (0.98     | ) |   | (0.93      | )
|Net loss from continuing operations (basic and
  diluted)                |  |                                                   | (1.15     | )    |   | (1.85     | ) |      | (1.23     | )    |   | (0.98     | ) |   | (0.93      | )
|Net profit from discontinued operations (basic
  and diluted)            |  |                                                   | 0.11      |      |   | --        |   |      | --        |      |   | --        |   |   | --         |  
|Weighted average number of shares used in
  computing net loss per share |  |                                                   | 7,287,715 |      |   | 7,744,593 |   |      | 8,484,120 |      |   | 9,365,181 |   |   | 11,156,250 |  
|                                                                         |  |                                                   |           |      |   |           |   |      |           |      |   |           |   |   |            |  
|Balance Sheet Data:                                                      |  |                                                   |           |      |   |           |   |      |           |      |   |           |   |   |            |  
|Working capital                                                          |  | $                                                 | 19,220    |      | $ | 9,149     |   | $    | 17,990    |      | $ | 25,048    |   | $ | 20,627     |  
|Total assets                                                             |  |                                                   | 24,220    |      |   | 15,515    |   |      | 23,965    |      |   | 31,365    |   |   | 30,871     |  
|Long-term liabilities                                                    |  |                                                   | 990       |      |   | 1,196     |   |      | 2,919     |      |   | 1,985     |   |   | 2,243      |  
|Preferred shares of a subsidiary                                         |  |                                                   | 25,179    |      |   | 20,991    |   |      | 32,423    |      |   | 35,790    |   |   | 38,567     |  
|Shareholders deficiency                                                 |  | $                                                 | (4,361    | )    | $ | (9,688    | ) | $    | (14,320   | )    | $ | (9,891    | ) | $ | (12,193    | )

Exchange Rate Information

The
following tables sets forth, for the periods and dates indicated, certain
information regarding the Bank of Israel representative rate of exchange for
U.S. dollars, expressed in New Israeli Shekels per dollar.

|                                        |  |         |        |      |  |       |  |                 |       |  |  |       | 
|--------------------------------------- |  | ------- | ------ | ---- |  | ----- |  | --------------- | ----- |  |  | ----- | 
|Period                                  |  | Average |        | High |  | Low   |  | At Period
  End |      
|                                        |  |         |        |      |  |       |  |                 |      
|Twelve months ended
  December 31, 2001 |  |         | 4.2056 |      |  | 4.416 |  |                 | 4.041 |  |  | 4.416 | 
|Twelve months ended
  December 31, 2002 |  |         | 4.7378 |      |  | 4.994 |  |                 | 4.416 |  |  | 4.737 | 
|Twelve months ended
  December 31, 2003 |  |         | 4.5483 |      |  | 4.924 |  |                 | 4.283 |  |  | 4.379 | 
|Twelve months ended
  December 31, 2004 |  |         | 4.4823 |      |  | 4.634 |  |                 | 4.308 |  |  | 4.308 | 
|Twelve months ended
  December 31, 2005 |  |         | 4.4878 |      |  | 4.741 |  |                 | 4.299 |  |  | 4.603 | 

|                                    |  |      |       |     |  |       | 
|----------------------------------- |  | ---- | ----- | --- |  | ----- | 
|Period                              |  | High |       | Low | 
|                                    |  |      |       |     | 
|December 2005                       |  |      | 4.662 |     |  | 4.579 | 
|January 2006                        |  |      | 4.658 |     |  | 4.577 | 
|February 2006                       |  |      | 4.725 |     |  | 4.664 | 
|March 2006 (as of March
  29, 2006) |  |      | 4.717 |     |  | 4.658 | 

At
March 29, 2006 the representative rate of exchange was NIS 4.703 = $1.00, as published by the
Bank of Israel.

|   |                                            
|-- | -------------------------------------------
|B. | CAPITALIZATION
  AND INDEBTEDNESS          
|   |                                            
|   | Not
  applicable.                          
|   |                                            
|C. | REASONS FOR
  THE OFFER AND USE OF PROCEEDS
|   |                                            
|   | Not
  applicable.                          

3

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|   |             
|-- | ------------
|D. | RISK FACTORS

Investing
in our ordinary shares involves a high degree of risk and uncertainty. You
should carefully consider the risks and uncertainties described below before
investing in our ordinary shares. Our business, prospects, financial condition
and results of operations could be adversely affected due to any of the
following risks. In that case, the value of our ordinary shares could decline,
and you could lose all or part of your investment.

RISKS RELATING TO OUR BUSINESS

We have had a limited operating history in
the network processor industry and our future financial results are difficult
to predict.

Our
future success will be subject to the risks we will encounter in the network
processor industry. We have a limited operating history in the industry, with
our first product sales in the second quarter of 2002 and total network product
sales through December 31, 2005 of approximately $12.8 million. Our limited
operating history makes it difficult to evaluate the prospects of our business.
Moreover, the network processor industry is constantly evolving and is subject
to technological and competitive forces beyond our control. Our ability to
design and market products to meet customer demand and the revenue and income
potential of our products and business are unproven. As an early stage company
in the developing network processor industry, we face numerous risks and
uncertainties. Some of these risks relate to our ability to:

| |   |                                          
| | - | -----------------------------------------
| |  | expand and enhance our product offerings;
| |   |                                          
| |  | increase our revenues;                   
| |   |                                          
| |  | diversify our sources of revenue;        
| |   |                                          
| |  | respond to technological changes; and    
| |   |                                          
| |  | respond to competitive market conditions.

If we fail
to address these risks and uncertainties, our results of operations will be
adversely affected.

We are dependent on the networking equipment
market for our growth, and if it does not grow then we will not be able to
expand our business.

The
growth of our network processor business depends in part on increased
acceptance and use of networking equipment. In particular, we depend on the
ability of our target customers to develop new products and enhance existing
products for the networking equipment market that incorporate our products and
to introduce and promote their products successfully. The market for networking
equipment depends in part upon the markets acceptance of 10 Gigabit Ethernet
technologies that enable the forwarding of data at a high speed. Ultimately,
the 10 Gigabit Ethernet technologies development rate may be slower than we
anticipate. If the use of networking equipment does not grow as we anticipate,
if our target customers do not incorporate our products into theirs, or if the
products of our target customers that incorporate our network processors are
not commercially successful, our growth will be impeded.

4

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Many of our competitors and potential
competitors are much larger than us, and if we are unable to compete
effectively we could lose our market share and revenues.

The market
for network processors is intensely competitive, rapidly evolving and subject
to rapid technological change. We believe that competition in this market will
become more intense in the future and may cause price reductions, reduce gross
margins and result in loss of market share, any one of which could
significantly reduce our future revenue and increase our losses. Many of our
current and potential competitors have longer operating histories, significantly
greater financial, technical, product development and marketing resources,
greater name recognition and significantly larger customer bases than we do.

Additionally,
many of our competitors also have well-established relationships with our prospective
customers and suppliers. As a result of these factors, many of our competitors,
either alone or with other companies, have significant influence in our target
markets that could outweigh our technological advantage.

Our
products may have defects, which could damage our reputation, decrease market
acceptance of our products, cause us to lose customers and revenue, increase
production costs and result in liability.

Highly
complex products such as network processors may contain hardware or software
defects or bugs. Often, these defects and bugs are not detected until after the
products have been shipped. If any of our products contain defects, or have
reliability, quality or compatibility problems, our reputation might be damaged
significantly and customers might be reluctant to buy our products, which could
result in the loss of or failure to attract customers. In addition, these
defects could interrupt or delay sales. We may have to invest significant
capital and other resources to correct these problems. If any of these problems
are not found until after we have commenced commercial production of a new
product, we might incur substantial additional development costs. If we fail to
provide solutions to the problems, such as software patches, we could also
incur product recall, repair or replacement costs. These problems might also
result in claims against us by our customers or others. In addition, these
problems might divert technical and other resources from other development
efforts. Moreover, we would likely lose, or experience a delay in, market
acceptance of the affected product or products, and we could lose credibility
with our current and prospective customers. This is particularly significant as
we are relatively a new entrant to a market dominated by large,
well-established companies.

We may have to redesign our products to meet
rapidly evolving industry standards and customer specifications, which could
delay our production and increase our operating costs.

We operate
in a market characterized by rapidly evolving industry standards, product
obsolescence, and new manufacturing and design technologies. Many of the
standards and protocols for our products are based on high speed networking
technologies that have not been widely adopted or ratified by one of the
standard setting bodies in our customers industry.

Our
target customers, network equipment manufacturers, are likely to have varying
requirements and may delay or alter their design demands during this standard-setting
process. In response, we may have to redesign our products to suit these
changing demands, which would likely delay the production of our future
products and increase operating costs.

5

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---



Because our products have lengthy design and
development cycles, we could experience delays in generating revenues or
cancellation of customer contracts.

We
may never generate significant revenues from our products after incurring
significant design and development expenditures. A customer may decide to
cancel or change its product plans, which could cause us to generate no revenue
from that customer and adversely affect our results of operations. A delay or
cancellation of a customers plans could significantly adversely affect our
financial results. Even after winning a design contract, a customer may not
begin volume production of our equipment for a period of up to two years, if at
all. Due to this lengthy design and development cycle, a significant period may
elapse from the time we begin incurring expenses until the time we generate
revenue from our products. We have no assurances that our customers will
ultimately market and sell their equipment incorporating our network
processors, or that such efforts by our customers will be successful.

The loss of personnel could affect our
ability to design and market our products.

To
succeed, we must retain and hire technical personnel highly skilled at the
design and test functions used to develop high speed networking products and
related software. The competition for such employees is intense. We, along with
our competitors, customers and other companies in the communications industry,
face intense competition for those employees from competitors and an increasing
number of startup companies which are emerging with potentially lucrative
employee ownership arrangements. Recruiting, hiring and retaining key personnel
can also result in significant monetary costs.

If we are unable to adequately protect our
technology or other intellectual property through patents, copyrights, trade
secrets, trademarks and other measures, our competitors could use our
proprietary information and we could lose our competitive advantage.

To
compete effectively, we must protect our proprietary information. We rely on
and intend to rely on a combination of patents, trademarks, trade secret laws,
confidentiality procedures and licensing arrangements to protect our
intellectual property rights. Our failure to adequately protect our technology
or other intellectual property from use by our competitors could jeopardize our
competitive advantage, and result in a loss of customers. We have a number of
issued patents, however, the patents that have been issued may not provide any
meaningful protection or commercial advantage to us, as they may not be of
sufficient scope or strength, or may not be issued in all countries where our
products can be sold. In addition, our competitors may be able to design around
our patents.

6

---

---



Our products employ technologies that may
infringe on the proprietary rights of third parties, which may expose us to
litigation and prevent us from selling our products.

Vigorous
protection and pursuit of intellectual property rights or positions
characterize the semiconductor industry. This often results in expensive and
lengthy litigation. We, as well as our customers or suppliers, may be accused
of infringing on patents or other intellectual property rights owned by third
parties. An adverse result in any litigation could force us to pay substantial
damages, stop designing or manufacturing, using and selling the infringing
products, spend significant resources to develop non-infringing technology,
discontinue using certain processes or obtain licenses to use the infringing
technology. In addition, we may not be able to develop non-infringing
technology, nor might we be able to find appropriate licenses on reasonably
satisfactory terms.

Because the processes used to manufacture our
products are complex, customized to our specifications and can only be
performed by a limited number of manufacturing facilities, we may experience
delays in production and increased costs.

The
manufacture of processors is a highly complex and technically demanding
process. Defects in design or problems associated with transitions to newer
manufacturing processes or new manufacturers can result in unacceptable
manufacturing yields and performance. These problems are frequently difficult
to detect in the early stages of the production process and can be time-consuming
and expensive to correct once detected. As a result, defects, performance
problems with our products or poor manufacturing yields could adversely affect
our business and operating results.

We depend on third-party manufacturers and
other suppliers to manufacture our network processors.

The
fabrication of our network processors is outsourced to third-party
manufacturers and subcontractors. There are significant risks associated with
our reliance on third-party manufacturers. Most significantly, if our
manufacturing suppliers are unable or unwilling to provide us with adequate
manufacturing capacity, we would have to identify and qualify one or more
substitute suppliers for our products. Our manufacturers may experience
unanticipated events that could inhibit their abilities to provide us with
adequate manufacturing capacity on a timely basis, or at all. Historically,
there have been periods in which there has been a worldwide shortage of
manufacturer capacity for the production of high-performance processors such as
ours. Introducing new products or transferring existing products to a new third
party manufacturer would require significant development time to adapt our
designs to their manufacturing processes and could cause product shipment
delays. In addition, the costs associated with manufacturing our products may
increase if we are required to use a new third party manufacturer. If we fail
to satisfy our manufacturing requirements, our business would be materially
harmed.

7

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Under
a November 2000 agreement, as amended, IBM agreed to manufacture our NP-1 and
NP-1c network processors and related prototypes until December 31, 2007. Under
the agreements terms, IBM may reduce or delay shipment if its ability to
manufacture the NP-1 and NP-1c network processors is constrained. IBM is the
sole manufacturer of the NP-1 and NP-1c network processors. If IBM fails to
deliver these network processors on time or at all, our business could be
severely harmed. If the arrangement with IBM is terminated or amended in a
manner detrimental to us, it could adversely affect our business while we try
to locate a substitute supplier.

We
have entered into arrangements with a third party for manufacturing services
relating to our NP-2 network processor. This third party will coordinate and
assume responsibility for various aspects of the manufacturing process and will
arrange for the manufacture of our NP-2 network processor by Taiwan
Semiconductor Manufacturing Co. (TSMC). These arrangements entail similar
risks. TSMC is the sole manufacturer of the NP-2 network processor. If either
the third party, TSMC or any other subcontractor fails to deliver network
processors or necessary components or services on time or at all, our business
could be severely harmed. If the current manufacturing arrangement between our
third party subcontractor and TSMC is terminated or amended in a manner
detrimental to us, it could adversely affect our business while we try to make
alternative arrangements with substitute suppliers.

These
and other risks associated with our reliance on a third-party manufacturer
could materially and adversely affect our business, financial condition and
results of operations.

If internally generated funds are
insufficient and we are unable to procure funding on favorable terms, we would
not be able to develop and expand our business, which could negatively affect
our revenues.

We
expect that significant funding will be required in order to continue to
develop our products and to expand our business. Given the state of development
of our products and the present economic environment, we believe that we have
sufficient funding resources to finance our operations through the end of 2007.
The capital markets have experienced severe downturns over the last couple of
years, especially relating to technology companies, and access to capital has
at times been both difficult and expensive. If internally generated funds are
insufficient and we do not obtain enough funding to support our future
development when needed, our business will suffer. Even if we are successful in
obtaining funding through the capital markets or otherwise, such funding may
not be on terms favorable to us.

Your ownership interest in LanOptics may be
diluted as a result of anticipated exchanges of our shares for EZchip shares.

We
presently own approximately 60.4% of EZchip. We wish to exchange our shares
from time to time for EZchip shares in order to increase our ownership interest
in EZchip. We will attempt to effect all such exchanges at an exchange ratio
that reflects the relative values of LanOptics and EZchip. If we are required
to issue more LanOptics shares than the number that reflects our value relative
to the value of EZchip, the ownership interests of LanOptics existing
shareholders will be diluted.

8

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The liquidation preference of the preferred
shareholders of EZchip may limit LanOptics return in the event of a sale of
EZchip.

We
hold both ordinary shares and various classes of preferred shares in
EZchip. Most of the other shareholders of EZchip hold only preferred shares,
which provide the holders with preferences upon liquidation. If EZchip were to
be sold, the transaction would likely be a deemed liquidation that would
entitle the preferred shareholders to their liquidation preference before any
distribution to the holders of ordinary shares. This may result in those
shareholders receiving a higher percentage in liquidation than their actual
ownership percentage. Any voluntary liquidation event would require the
approval of our board of directors.

Our share price has been volatile and we
believe that it is likely to continue to be volatile.

The
market price of our ordinary shares has been highly volatile and we believe
that it is likely to continue to be volatile. This is due to the risks and
uncertainties described in this Annual Report, as well as other factors,
including:

| |   |                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------
| |  | general economic conditions, including those that
  specifically relate to network processor and telecom industries;                              
| |   |                                                                                                                                                   
| |  | actual or anticipated fluctuations in our operating
  results;                                                                                    
| |   |                                                                                                                                                   
| |  | changes in expectations as to our future financial
  performance;                                                                                 
| |   |                                                                                                                                                   
| |  | the issuance
  of research reports about our company or industry, or
  changes in analysts opinions about our company;                           
| |   |                                                                                                                                                   
| |  | technological
  innovations by
  us or by our competitors;                                                                                        
| |   |                                                                                                                                                   
| |  | investors
  perceptions about the future of the telecom industry or changes in market
  valuation of
  network processor companies in particular;
| |   |                                                                                                                                                   
| |  | relatively
  low volumes at
  which our shares have been traded
  at in the past and at which they may continue to trade; and                     
| |   |                                                                                                                                                   
| |  | the
  operating and share price performance of comparable
  companies.                                                                            

In
addition, the market prices of equity securities of companies that have a
significant presence in Israel may also be affected by the changing security
situation in the Middle East and particularly in Israel. As a result, these
companies may experience difficulties in raising additional financing required
to effectively operate and grow their businesses. Such failure and the
volatility of the securities market in general, and our share price in
particular, may affect our ability to raise additional financing in the future.
Market and industry fluctuations may adversely affect the trading price of our
ordinary shares, regardless of our actual operating performance.

9

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The implementation of SFAS No. 123(R), which
requires us to record compensation expense in connection with equity share
based compensation, will increase our compensation costs significantly.

On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123 (revised 2004), Share-Based Payment (SFAS No. 123(R)),
which is a revision of SFAS No. 123. Generally, the approach in SFAS 123(R) is
similar to the approach described in Statement 123. However, SFAS No. 123
permitted, but did not require, share-based payments to employees to be
recognized based on their fair values, while SFAS No. 123(R) requires, as to
fiscal years starting after June 15, 2005, that all share-based payments to
employees be recognized based on their fair values. SFAS No. 123(R) also
revises, clarifies and expands guidance in several areas, including measuring
fair value, classifying an award as equity or as a liability and attributing
compensation cost to reporting periods. The adoption of SFAS No. 123(R) will have a
material adverse effect on our results of operations, although it will have no
impact on our overall financial position or cash flows. In addition, the
adoption of SFAS No. 123(R) could also limit our ability to use stock options
as an incentive and retention tool, which could, in turn, hurt our ability to
recruit employees and retain existing employees.

Fluctuations in the exchange rate between the
United States dollar and foreign currencies may affect our operating results.

A
significant portion of the cost of our Israeli operations, mainly personnel and
facility-related, is incurred in NIS. Therefore, our NIS related costs, as
expressed in US dollars, are influenced by the exchange rate between the US
dollar and the NIS. In addition, if the rate of inflation in Israel will exceed
the rate of devaluation of the NIS in relation to the US dollar, or if the
timing of such devaluations were to lag considerably behind inflation, our cost
as expressed in US dollars may increase. NIS linked balance sheet items may
create foreign exchange gains or losses, depending upon the relative dollar
values of the NIS at the beginning and end of the reporting period, affecting
our net income and earnings per share. Although we may use hedging techniques
we may not be able to eliminate the effects of currency fluctuations. Thus,
exchange rate fluctuations could have a material adverse impact on our
operating results and share price.

Compliance with changing regulation of
corporate governance and public disclosure may result in additional expenses.

Changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new Securities and
Exchange Commission regulations and NASDAQ Stock Market rules, are creating
uncertainty for companies such as ours. We are committed to maintaining high
standards of corporate governance and public disclosure. As a result, we intend
to invest reasonably necessary resources to comply with evolving standards, and
this investment may result in increased general and administrative expenses and
a diversion of management time and attention from revenue-generating activities
to compliance activities, which could harm our operating results and business
prospects.

10

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RISKS RELATING TO OUR LOCATION IN ISRAEL

Potential political, economic and military
instability in Israel may disrupt our operations and negatively affect our
sales.

We
are incorporated under the laws of the State of Israel, and our principal
executive offices and principal research and development facilities are located
in Israel. Accordingly, political, economic and military conditions in and
surrounding Israel may directly affect our business. Since the State of Israel
was established in 1948, a number of armed conflicts have occurred between
Israel and its Arab neighbors. Any hostilities involving Israel or the
interruption or curtailment of trade between Israel and its present trading
partners, or a significant downturn in the economic or financial condition of
Israel, could materially adversely affect our operations. Since October 2000
terrorist violence in Israel has increased significantly. Ongoing and revived
hostilities or other Israeli political or economic factors could materially
adversely affect our business, operating results and financial condition.

Additionally,
some of our key employees in Israel are obligated to perform annual reserve
duty in the Israel Defense Forces and are subject to being called for active
military duty at any time in the event of a national emergency. Our operations
could be disrupted by the absence for a significant period of one or more of
our key employees due to military service. Any disruption in our operations
would harm our business.

Changes to tax laws may result in our
receiving fewer benefits than we hope to receive.

Our
facilities in Israel have been granted Approved Enterprise status under the Law
for the Encouragement of Capital Investments, 1959, commonly referred to as the
Investment Law. The Investment Law provides that capital investments in a
production facility (or other eligible assets) may be designated as an Approved
Enterprise. Until recently, the designation required advance approval from the
Investment Center of the Israel Ministry of Industry, Trade and Labor (the
Investment Center). For these programs to be eligible for tax benefits, we must
meet certain conditions, relating principally to adherence to the approved
programs and to periodic reporting obligations. We believe that we are
currently in compliance with these requirements. However, if we fail to meet
these requirements, we would be subject to corporate tax in Israel at the
regular statutory rate. We could also be required to refund tax benefits, with
interest and adjustments for inflation based on the Israeli consumer price
index.

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

On
April 1, 2005 an amendment to the Investment Law came into effect, which
revised the criteria for investments qualified to receive tax benefits. An
eligible investment program under the amendment will qualify for benefits as a
Privileged Enterprise (rather than the previous terminology of Approved
Enterprise). Among other things, the amendment provides tax benefits to both
local and foreign investors and simplifies the approval process. The amendment
does not apply to investment programs approved prior to December 31, 2004. The
new tax regime will apply to new investment programs only.

As
a result of the amendment, tax-exempt income generated under the provisions of
the new law 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. We are currently evaluating what impact the amendment will
have on us.

11

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

We
are organized under the laws of the State of Israel. Substantially all of our
executive officers and directors and a substantial portion of our assets and
the assets of these persons are located outside the United States. Therefore,
it may be difficult for an investor, or any other person or entity, to collect
a judgment obtained in the United States against us or any of these persons, or
to effect service of process upon these persons in the United States.

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 articles of association and by
Israeli law. These rights and responsibilities differ in some respects from the
rights and responsibilities of shareholders in typical U.S. corporations. In
particular, a shareholder of an Israeli company has a duty to act in good faith
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 on certain matters. Israeli law provides that these duties are
applicable in shareholder votes on, among other things, amendments to a
companys articles of association, increases in a companys authorized share
capital, mergers and interested party transactions requiring shareholder
approval. In addition, a shareholder who knows that it possesses the power to
determine the outcome of a shareholder vote or to appoint or prevent the
appointment of a director or executive officer in the company has a duty of
fairness toward the company. The Israeli Companies Law also provides that a
breach of the duty of fairness will be governed by the laws governing breach of
contract; 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.

Provisions of Israeli law may delay, prevent
or make difficult a change of control and therefore depress the price of our
shares.

Some
of the provisions of Israeli law could:

| |   |                                                                                                
| | - | -----------------------------------------------------------------------------------------------
| |  | discourage potential acquisition proposals;                                                    
| |   |                                                                                                
| |  | delay or prevent a change in control; and                                                      
| |   |                                                                                                
| |  | limit the price that investors might be willing to pay in the future
  for our ordinary shares.

Israeli
corporate law regulates mergers and acquisitions of shares through tender
offers, requires approvals for transactions involving significant shareholders
and regulates other matters that may be relevant to these types of
transactions. Furthermore, Israel tax law treats stock-for-stock acquisitions
between an Israeli company and a foreign company less favorably than does U.S.
tax law. For example, Israeli tax law may subject a shareholder who exchanges
his ordinary shares for shares in a foreign corporation to immediate taxation
or to taxation before his investment in the foreign corporation becomes liquid.
These provisions may adversely affect the price of our shares.

12

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|        |                           
|------- | --------------------------
|ITEM 4. | INFORMATION ON THE COMPANY

|   |                                         
|-- | ----------------------------------------
|A. | HISTORY AND
  DEVELOPMENT OF THE COMPANY

We
were incorporated as a limited liability company under the laws of the State of
Israel in 1989. Until 1999, our principal business was the development,
manufacturing and marketing of solutions and Internet applications that improve
connectivity and performance of corporate LANs and WANs. Our business now
consists of the development and marketing of high performance network
processors through our independent business unit, E.Z. Chip Technologies Ltd.,
or EZchip, in which we currently have a 60.4% ownership interest. Our principal
executive offices are located at 1 Hatamar Street, P.O. Box 527, Yokneam 20692
Israel, and our telephone number is +972-4-959-6666. Puglisi & Associates,
located at 859 Library Avenue, Suite 204, P.O. Box 885, Newark, Delaware 19715,
serves as our agent for service of process.

Our
business initially consisted of developing, marketing and producing LAN
equipment, such as hubs and switches, based on the Token Ring protocol.
Beginning in 1995 the Ethernet protocol became increasingly dominant in the LAN
market. Products based on the Token Ring protocol, which formed the core of our
business, suffered from declining market share. In response to the changing
market environment, we started to develop Ethernet protocol-based LAN products.
In addition, we started new business initiatives in areas different from our
core business. One of these businesses, which in 1996 we incorporated as
NetXchange, operated in the fax over Internet Protocol market. We decided to
cease the operations of NetXchange in 1998, after sustaining significant
losses. In 1997 we incorporated NetGuard Ltd., which provided Internet security
solutions. During the first quarter of 2001 we closed the operations of
NetGuard Ltd. Our sales levels for the legacy networking products, the
NetXchange products and the NetGuard products have become immaterial. As a
result, the related assets, liabilities and results of operations for the
reported periods were reclassified as discontinued operations. The
reclassification did not result in any changes to our net assets or net income
(loss) for the reported periods

In
mid-1999 we decided to cease the research and development of new switching
products for LANs and instead focus on our internal application-specific
integrated circuit, or ASIC, design team. This team, that had previously
developed ASICs for our products, began work on the development of network
processors. This new business initiative was incorporated as our EZchip
subsidiary in December 1999.

Through
EZchip we are developing high-performance network processors for high speed
networking equipment. EZchips technology enables complex packet processing
without any noticeable degradation in speed. EZchips solutions enable
networking vendors to build powerful products quickly and cost effectively.
EZchips initial product, the NP-1, a 10-Gigabit, seven-layer network
processor, began shipping to customers in April 2002. EZchips second generation
network processor, the NP-1c, an enhancement to our NP-1 product, has been
commercially available since December 2003. In July 2005 EZchip began sampling
of its third generation network processor, dubbed NP-2, which is an enhanced
10-Gigabit network processor offering integrated traffic management. The
Company is continuing its development of high-speed network processors with
exceptionally high levels of integration.

13

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

The Network Processor Industry

Background

In
recent years there has been a significant increase in the bandwidth demands on
communications networks. These networks have experienced major upsurges in the
volume, variety and complexity of communications traffic. The growth in
Internet usage is creating strong demand for bandwidth, and an increasing
proportion of todays communications traffic consists of digital media. The
traffic now includes voice, video and high-speed Internet access, or
triple-play services. The increases that have been achieved in bandwidth have
not kept pace with the exponential growth in the amount of data that is
transmitted over networks. All available bandwidth is often occupied at peak
hours, with the result that critical operations are buffered and remain in a
queue. The lack of available bandwidth is especially problematic in mission
critical applications that require real-time, high-quality transmission of
data, such as voice over IP telephony, multi-media applications and video
conferencing. Various techniques are available to deal with the overload,
including quality of service approaches (which combine bandwidth control with
load balancing applications) and policy-based management of data traffic.

Network
processors play a key role in dealing with bandwidth constraints. Network
processors are programmable integrated circuits that combine the speed
advantages of silicon chips with the intelligence and flexibility of
microprocessors. They can accommodate new Internet and intranet applications,
and new protocols, simply by downloading new or updated software. This
combination of performance, speed and flexibility allows equipment suppliers to
keep pace with changes and extend the lifespan of their products.

Carrier
network equipment is the primary target for network processors, since the
switches and routers that make up these networks are more demanding in features
and performance and are less cost sensitive than enterprise networks. The
carrier network usually consists of three domains, although in some cases there
is an overlap between these domains. The access network aggregates traffic from
individual businesses and residences. A metro area network, or MAN, spans a
metropolitan area, and interconnects the access networks. Metro Ethernet networks
worldwide are growing rapidly to deliver triple-play services on efficient and
flexible networks. The switches that build the metro Ethernet networks must
meet evolving market requirements to provide new services, to provide better
quality of service and to support new protocols  tasks for which programmable
network processors are ideally suited. Metro area networks are connected via
wide area networks, or WAN.

There
are several product categories within the carrier network that represent the target
market for network processors. These products can be grouped into several
segments:

| | Edge
routers   and MSSW (Multi Service Switches) are usually used as MAN/WAN edge devices.
  BRAS (Broadband Remote Access Switches) aggregate traffic from broadband   access
devices such as DSLAMs and cable modem termination systems. These   products are
gradually merging and becoming indistinct.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

14

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| | Metro
  switches that build the MAN  Metro Ethernet switches focus on providing a   large
number of high-speed Ethernet ports to enable migration from the older   SONET to newer
Ethernet infrastructure. Some metro switches support EoS   (Ethernet over SONET) and ADM
(Add Drop Multiplexer) functionality and are   sometimes referred to as MSPP and MSTP
(Multi Service Provisioning/Transport   Platform). Similar o the edge routers, the lines
separating between the   various types of metro switches are blurring. The focus of new
metro switch   designs is to enhance support of Ethernet in terms of new protocols, QoS
and   number of ports per system
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Access
switches consist of IP DSLAMs (DSL Access Multiplexers), CMTS (Cable Modem   Termination
Systems) and various Ethernet aggregation switches such as EPON   and GPON. The bandwidth
requirements of these systems grow hand-in-hand with   end user traffic growth
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Other
market segments, of lesser focus for EZchip, include data center appliances
that perform functions such as security, load balancing and traffic analysis

WAN/MAN
edge devices and metro switches are typically configured in a modular,
expandable, multi-slot chassis that consists of several line cards with many
network ports per line card. Access switches are typically built in a
stand-alone, fixed configuration, flat frame known as a pizza box.

Market Trends

Carrier
network equipment can be designed to incorporate ASICs (Application Specific
Integrated Circuits, i.e. non-programmable switching chips), FPGAs (Field
Programmable Gate Arrays), high-speed network processors, or a combination of
these. The outstanding challenge is to provide an integrated solution that is
both flexible and cost-effective. Most of the existing solutions are inadequate
and fraught with difficulties.

ASICs
are effective from a performance viewpoint, but their drawback is the inability
to program them. This makes them too inflexible for todays rapidly changing
application environment. These chips need to be redesigned to deal with changes
in the applications, and do not provide the flexibility to implement evolving requirements
to support new features and network protocols.

FPGAs
are expensive devices and fail to provide the price points that can effectively
address carrier network price targets.

High-speed
network processors typically strain current silicon technologies to provide
maximum programming flexibility and integration while maintaining high
throughput.

15

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Within
the market for network processors, or NPUs, there are three main distinct
classes:

| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | Access NPUs
  - typically with up to 1-Gigabit throughput and mostly used in access
  equipment.                        
| |   |                                                                                                                         
| |  | Mid-range
  NPUs - typically with up to 2.5-Gigabit throughput and often used in
  multi-service equipment, such as ATM.
| |   |                                                                                                                         
| |  | High-speed
  NPUs - typically with 10-Gigabit throughput and mostly used in metro switches
  and edge routers.          

Because
of the 10-Gigabit throughput they provide, high-speed NPUs are the most
suitable of these three classes for use in edge routers and metro switches. As
these products are built in a modular multi-slot chassis and as each chassis
typically consists of 8-16 line cards, 8-16 NPUs can be used per chassis. Of
these products, metro switches and specifically Ethernet metro switches are the
fastest growing, as carriers worldwide are migrating from older TDM SONET/SDH
based networks to packet Ethernet based networks.

The
access switches are mostly served today by access NPUs. However as packet
services increase the per-user bandwidth requirements, these switches are
gradually migrating to support aggregate throughput of 10-Gigabit and more, and
consequently represent another market segment suitable for high-speed NPUs.

Our Solution

We
design and produce network processors for high-speed networking equipment,
integrating several key functions onto a single chip. Networking equipment
vendors use EZchips network processors to form the silicon core of
next-generation networking equipment, such as switches and routers, for voice,
video and data integration in a variety of applications. We are a fabless
semiconductor company, which means that we do not have our own semiconductor
manufacturing plant but rather utilize outside fabrication facilities.

Our
network processors are single-chip solutions that enable our customers to design
high-density, multi-port line cards. They include processing and classification
engines, traffic managers (in the case of the NP-2) and media access
controllers, or MACs, thus reducing the number of complementary chips required.
This high level of integration benefits networking vendors by reducing the
system price, complexity and amount of space required on the board.

Earlier
generations of network processor solutions required multiple integrated circuit
chips and related hardware and software to perform the requisite designed-in
functions, placing limitations both on the amount of data that could be handled
simultaneously and the speed at which it could be processed. Moreover, most of
these earlier solutions employed generic RISC processors rather than specially
designed processors. EZchips advance over these earlier designs lies in its
integration of processing, classification and traffic management functions.
This is accomplished in part with patented elements and other proprietary
information and consists among other things EZchips Task Optimized Processing
technology, or TOPcore®, through a combination of chip architecture
innovations and through innovative table lookup (search) algorithms. As a
result, systems designed using EZchips products offer equipment vendors the
ability to reduce chip count, power consumption and cost.

16

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Our
first product, which was introduced in April 2002, is the NP-1, a merchant
silicon network processor that forms the core of 10-Gigabit networking
equipment. Although a couple of customers still have product designs based on
our first chip, the NP-1, most of our customers today are using the NP-1c for
their EZchip-based products. The NP-1c is an improved and less expensive
version of the NP-1, and uses a 0.13-micron chip manufacturing process. It has
been commercially available since December 2003.

We
are currently in advanced testing of our NP-2 network processor, EZchips
latest NPU. The NP-2 is based on the same network processing core technology as
the NP-1c, with the addition of traffic management functionality onto a single
chip. By combining both the network processing and traffic management
functions, generally performed by two separate chips, onto a single chip we
hope to offer customers an even more integrated and cost effective solution. We
previously offered a 10-Gigabit traffic manager, the QX-1, that complemented
the NP-1/NP-1c network processors by providing added traffic management
functionality and expanded QoS features. With the introduction of the NP-2
network processor, which integrates this traffic management functionality, we
no longer offer the QX-1 as a stand-alone product. Testing of samples of the
NP-2 family commenced in July 2005and the NP-2 is scheduled to move to
production during the first half of 2006. We assume that a majority of our new
customers will be designing systems based on the NP-2 as opposed to the NP-1c.

The
architecture and features of these EZchip products offer the flexibility,
scalability and price performance that are sought by communications equipment
vendors.

Products

The
NP-1 is a single-chip, full-duplex, 10-Gigabit, seven-layer network processor
with integrated classifiers. It provides fully programmable packet classification,
modification and forwarding.

Continuing
with our development of highly integrated products, in December 2003 we
introduced the NP-1c network processor. Like the NP-1, the NP-1c is a
single-chip, full-duplex, 10-Gigabit network processor that integrates search
engines, yet it offers a significant increase in performance and cost reduction
due to its improved process technology. NP-1c is essentially an improved and
less expensive version of the NP-1 that uses a 0.13-micron chip manufacturing
process and therefore we no longer offer the NP-1.

The
QX-1, a 10-Gigabit traffic manager, was introduced in January 2003. The QX-1
was an optional chip that complemented the NP-1/NP-1c by expanding its QoS
features. With the integration of traffic management functionality into the
NP-2, we no longer offer the QX-1.

17

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The
NP-2, like its predecessor the NP-1c, is a single-chip, full-duplex, 10-Gigabit
network processor. However, in addition to the integration of packet
processing, classification search engines and MACs currently available in the
NP-1c, the NP-2 also includes two traffic managers for improved QoS. Since the
traffic management function is generally performed by complementary chips, by
integrating it directly into the network processor we hope to provide our
customers with a cost-effective network processing solution that reduces power
dissipation and system design costs. The NP-2 network processor is available in
three models for different speeds and feature sets, which will enable the NP-2
to position itself in network processor market segments not reached by the NP-1
and NP-1c.

Whereas
the NP-1c is targeted mainly at service cards in communication applications
with typically one or two of these cards per chassis, the NP-2 address line
card applications, which often have ten or more cards installed per chassis,
and stand-alone pizza box applications. We hope to increase our market share by
expanding into this additional market segment.

Since
all the NP-2 models are software compatible and share the same pin arrangement,
customers may modify their NP-2 designs using the different NP-2 models to
offer a range of products at differing price points. The NP-2 product family is
also software-compatible with the NP-1c, making it possible for existing
customers to port their network-processor applications to NP-2. The NP-2 has
been sampling since July 2005 and is scheduled to move into volume production
during the first half of 2006

Evaluation Boards and Network-processor Based
Systems

In
April 2002, with the arrival of the first NP-1 processors, we began delivering
evaluation boards to customers to enable them to test their NP-1 based systems.
Evaluation boards for NP-1 are available with three different interfaces: eight
ports of 1-Gigabit Ethernet, one 10-Gigabit Ethernet port or one OC-192 port
for Packet over SONET (POS). Evaluation boards for the NP-1c are available with
two different interfaces: ten ports of 1-Gigabit Ethernet or one 10-Gigabit Ethernet
port.

Although
our primary business is selling network processor chips, we offer two systems
based on the NP-1c network processor. These systems serve as evaluation systems
for our current and prospective customers to assess an NP-1c based system, as
well as systems that our customers may adapt and differentiate and then market
as their own products. In November 2003 we announced two new evaluation system
for the NP-1c network processor. The systems use the same hardware and software
environments and are different in their form factor:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | 
| | - | EZ-ATCA
  follows the new Advanced Telecommunications Computing Architecture
  (AdvancedTCA®) and is provided as a blade that can be plugged into
  an AdvancedTCA chassis or as a stand-alone, self-contained box. The EZchip
  board enables ten network-processor driven 1-Gigabit ports on a single
  AdvancedTCA board. AdvancedTCA is the PCI Industrial Computer Manufacturers
  Group (PICMG) specification for Advanced Telecommunications Computing
  Architecture and forms the basis for standard-compliant hardware for next
  generation telecommunications equipment. | 
|
| | - | EZsystem is
  a stand-alone, self-contained box with ten 1-Gigabit ports.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 

18

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Both
systems can be tailored to a wide variety of networking applications. Such
applications may include firewall, intrusion detection, load balancing, network
management, Voice over Internet Protocol gateways, content inspection and
traffic analysis. These systems utilize the NP-1c to accelerate software
solutions that typically run on available off-the-shelf PC based hardware or
proprietary hardware platforms. Through programming of the system, software
vendors can deliver high performance applications without requiring any
hardware design on their part.

In
2005 we developed similar hardware and software platform based on the new NP-2,
named EZ-ATCA2 and EZ-System2. Both systems feature ten 1-Gigabit Ethernet
ports and a complete data plane and control plane solution.

Development Software Toolkits

In
order to facilitate our customers adaptation of our products, we offer
toolkits that assist our customers in creating, verifying and implementing
solutions based on our network processors. These toolkits are used for
customers product development based on all of our network processors models:
NP-1, NP-1c and NP-2.

We
released the first toolkit, EZdesign, in January 2001. It is a comprehensive
software development toolset with a graphical user interface (GUI) for writing,
testing and debugging programs for our network processors to implement a wide
range of applications and reduce time to market of next-generation networking
products. It includes a hardware-software simulator, a library of pre-coded
subroutines, a high-level language compiler and a functional tester. We
continuously release new versions of the EZdesign toolset, providing functional
enhancements. Software versions supporting the NP-2 network processor also
enable the configuration of its integrated traffic manager.

EZdriver
is a toolset that facilitates the development of the control path software for
EZchip-based systems. It enables applications that run on the control CPU to
communicate with our network processors. EZdriver consists of routines that
execute on the control CPU and provide an application program interface (API)
to the network processor. It includes network processor configuration,
microcode loading, creation and maintenance of network-processor lookup
structures, sending and receiving frames to and from the network processor, as
well as configuration and access to the network-processor statistics block.

EZdriver
along with EZdesign provide extensive debugging capabilities, and enable
software-driven debugging features (e.g. breakpoints, single step, register and
memory access) to be performed on both the network processor simulator and the
actual chip.

To
assist our customers in their application development, EZchip also provides
customers with a broad library featuring tested source code for a wide range of
applications. These include MPLS (Multi-Protocol Label Switching), VPLS
(Virtual Private LAN Service) and Draft Martini, IPv4 and IPv6 routing, ACL
(Access Control Lists), Network Address Translation, Server Load Balancing and
URL filtering. New code is periodically added to this library.

19

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Future Products

We
are continuing to develop high-speed network processors with exceptionally high
levels of integration. We will be adding features and modifying our designs
based on customer feedback, accumulated experience gathered from previous
generations of our network processors and our assessment of the prospective
market.

Technology

In
general, a network processor is a programmable integrated circuit used in data
communications that is capable of performing one or more of the following
functions: packet classification (that is, identifying a packet of data based
on known characteristics such as address or protocol), packet modification
(that is, modifying the packet to comply with specified protocols),
queue/policy management (that is, reflecting the organization and
prioritization of the processing of specific packets), and packet forwarding
(that is, transmission and receipt of data and forwarding or routing the packet
to the appropriate address). To perform these functions requires the network
processor device to handle identification, classification and processing tasks
simultaneously.

Our
NPUs integrate many high-speed TOPs (Task Optimized Processors), each
specifically designed and optimized to perform a specific task. Four types of
TOPs  parse, search, resolve and modify  are employed to perform the main
tasks of packet processing, i.e. classification, forwarding and modification.
Each TOP processor type employs a unique architecture with a customized,
function-specific data path and instruction set. This minimizes the number of
clock cycles required for complex packet manipulation and provides
exceptionally fast packet processing. TOP performance is boosted by a
super-scalar architecture in which multiple instances of the TOPs operate in
parallel within each pipeline stage.

Our
NPUs feature embedded search engines (TOPsearch) that perform table lookups
needed for implementing diverse applications. These search engines implement
proprietary and patented lookup algorithms that utilize DRAM memory chips for
storing the lookup tables and reduce the need for more expensive CAM and SRAM
chips.

Our
NP-2 network processors also possess integrated traffic managers for advanced
QoS, which is required by increasingly complex networks. After modification,
packets are put in queues that are managed and controlled by one of two traffic
managers, which provide traffic management capabilities on both the ingress and
egress paths. By integrating this functionality into our network processors,
EZchip eliminates the need for a separate traffic management chip.

We
consider the ability to integrate the main network processing features into a
single chip as one of the primary advantages of our technology. We intend to
continue to provide this high level of integration in future products under
development.

20

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Research and Product Development

Currently,
59 employees, representing about 73% of EZchips employees, are engaged in
research and development. EZchips senior executives devote a substantial
portion of their time in communicating with customers to determine what product
needs should be addressed. Our research and development expenses were
$7,219,000 in 2003, $7,267,000 in 2004 and $8,215,000 in 2005.

Sales and Marketing

Our
objective is to become a leading supplier of high-speed network processors. To
meet this objective, we devote significant resources to securing new customers,
preferably leading networking equipment vendors, and we place an emphasis on
assisting our existing customers in bringing their products to the production
stage.

In
general, it takes a customer one to two years to design a networking product
based on our network processors chips. During this design phase the revenues we
recognize are mostly attributable to the sale of evaluation systems and
development software toolkits, that our customers are using to assist in the
development of their own network processor based products. As they move to
development of their own boards with the network processor, they purchase
sample chips from us for testing purposes. Once their own designs are
completed, they move into production phase where they begin to manufacture
their products. At this point they purchase a limited number of network
processors for the initial production stage. Depending upon the acceptance of
their products in the marketplace and the speed of deployment of projects with
them, the customer may or may not increase production. Volume production of a
customers product is expected to translate into volume sales of our network
processors. EZchip has no direct influence upon the sales and marketing of our
customers products.

Since
we expect the high-speed NPU market to continue to grow, we believe that by
securing more customers and more design wins we are strengthening our market
position and increasing our potential market share. We work closely with
existing and potential customers in their design of systems and equipment where
the capabilities of EZchips products can be exploited. We are targeting
designers, manufacturers and vendors of networking equipment and other
large-scale data processing network devices, such as switches and routers.

To
facilitate marketing efforts, EZchip has built on its extensive industry
exposure through trade shows and similar events and has established sales
offices in California and Massachusetts. In Israel and North America we have
our own direct sales force. Currently, our sales and marketing staff consists
of 11 marketing professionals and administrative personnel. The direct sales
force consists of persons with technical training and significant experience in
the semiconductor industry. Sales efforts are augmented by the direct
involvement of EZchips senior executives, who work closely with customers to
determine product needs. In the rest of the world and parts of North America
our strategy is to work with local marketing channels, including sales agents,
resellers and distributors. These channels are assigned territories of primary
responsibility, with exclusive rights in some cases. We will consider the need
for local sales offices when justified by the circumstances. Our in-house sales
and marketing force and the external marketing channels are also responsible
for providing local technical support. Our marketing activities include:

| | seminar
  programs, trade shows, guest speaker invitations and technical conferences;
|- | -------------------------------------------------------------------------------------

21

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| | public
  relations activities and customer events;
|- | --------------------------------------------------

| | technical
  articles in industry publications and marketing collateral materials; and
|- | -------------------------------------------------------------------------------------

| | communication
  on the Internet.
|- | --------------------------------

We
also work with leading vendors of complementary technologies to provide our
customers with fully interoperable solutions. We provide interoperability with
devices from Ample Communications, AMCC, Broadcom, Dune Networks, Marvell,
PMC-Sierra, TeraChip, and Vitesse.

Customers and Customer Support

As
of December 31, 2005 we had approximately 75 design wins with customers
worldwide, who purchased development kits and started designs of networking
products based on our network processors. Our customers have a total of fifteen
products in production based on our NP-1 or NP-1c. An additional 20 NP-1c
design wins and 40 NP-2 design wins are in various stages of development. We do
not expect that all of our customers will reach production stage, as projects
may be halted, delayed or cancelled and there is also no assurance that
products that have reached production will be successfully accepted in the
marketplace.

Potential
customers typically evaluate our network processor, as well of those offered by
our competitors, for several months before selecting the one best suited to
their project. Once our product is selected, the customer usually purchases the
software tools and evaluation hardware and allocates the personnel to begin
working on the project. Only when the customer has allocated both the financial
and human resources, and we fully believe that there is every intention for the
project to move forward, do we consider it a design win.

Since
some of our larger customers have teams working on several projects, we may
have more than one design win with that customer. In this case, the customer
would purchase only one set of software tools.

Customer
support is provided from our Israeli headquarters as well as our two offices in
the United States. The primary business center in the United States is located
on the West Coast in the Silicon Valley area, and a Boston-area office services
the Eastern United States and Europe.

EZchip
offers training courses to provide its customers with a complete understanding
of its products and toolsets.

22

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Competition

The
semiconductor market, particularly the high-performance semiconductor market,
is highly competitive and subject to rapid technological change, price erosion
and heightened international competition. Especially in an area such as network
processors, where technology has not been standardized and where applications
are in early stages of development, competitive pressures can be intense. There
are currently three vendors providing high-speed network processors that target
the metro and access switches, and edge routers: EZchip, Sandburst Corporation
(which was acquired by Broadcom Corporation in January 2006) and Xelerated,
Inc. In addition, Broadcom Corporation, Greenfield Networks, Inc. and Marvell
Technology Group Ltd. have released switch ASICs (non-programmable chips) that
target these market segments as well. Agere Systems Inc., Applied Micro
Circuits Corporation and Intel Corporation also previously targeted the
10-Gigabit network processor market, but are now more focused on lower speed
applications.

Many
of our competitors or potential competitors are larger, have significantly
greater sales, have greater financial resources and are better known.

We
believe that the principal elements of competition in the market for advanced
network processors are integration, flexibility and price. Integration reduces
the chip count (that is, the number of chips needed in a given application to
achieve the system manufacturers design goals), power usage (that is, the
watts of electric power required to operate the chip) and ultimately the
overall price of a system solution. Flexibility implies ability to address
changing market processing requirements through programming and downloading of
new code to the network processor.

Our
research and development effort seeks to maximize integration and programming
flexibility while minimizing production costs. Our ability to compete in this
emerging market depends largely upon our ability to offer better design and
performance than our competitors.

All
of our network processor competitors currently-announced products use separate
chips for processing and traffic management. Traffic managers are typically
separate chips, placed alongside the network processor on the board, which
enable the control of the flow of traffic and implementation of Quality of
Service features. The NP-2 is the only announced 10-Gigabit, full-duplex,
network processor that integrates traffic managers into the network processor
chip.

Some
of our competitors offer a 20-Gigabit full-duplex network processor while
others offer only a 10-Gigabit half-duplex network processor, but we believe
that our network processors provide greater programming flexibility. When
compared to the non-programmable ASIC solutions, we believe that our network
processors bring flexibility that addresses customers needs to support new
applications at a reasonable price differential when compared to the price of
ASIC solutions.

23

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While
we believe that the NP-1, NP-1c and NP-2 chips surpass the known products of
our competitors in these characteristics, there can be no assurance that our
products will retain their differentiation or competitive edge for any specific
period of time.

Intellectual Property Rights

We
rely primarily on a combination of trade secrets and employee and third-party
nondisclosure agreements to protect our intellectual property, as well as
limiting access to the distribution of proprietary information. We cannot
assure you that the steps taken to protect our intellectual property rights
will be adequate to prevent misappropriation of our technology or to preclude
competitors from independently developing such technology. Furthermore, we
cannot assure you that, in the future, third parties will not assert
infringement claims against us or with respect to our products.

As
a general matter, the semiconductor industry is characterized by substantial
litigation regarding patent and other intellectual property rights. Third
parties may claim that we are infringing their intellectual property rights. We
have certain indemnification obligations to customers with respect to the
infringement of third party intellectual property rights by our products. There
can be no assurance that infringement claims by third parties or claims for
indemnification by customers or end users of our products resulting from
infringement claims will not be asserted in the future or that such assertions,
if proven to be true, will not materially adversely affect our business,
financial condition or operating results. In the event of any adverse ruling in
any such matter, we could be required to pay substantial damages, which could
include treble damages, cease the manufacturing, use and sale of infringing
products, discontinue the use of certain processes or obtain a license under
the intellectual property rights of the third-party claiming infringement.
There can be no assurance that a license would be available on reasonable terms
or at all. Any limitations on our ability to market our products, any delays
and costs associated with redesigning our products or payments of license fees
to third parties or any failure by us to develop or license a substitute technology
on commercially reasonable terms could have a material adverse effect on our
business, financial condition and operating results.

We
hold four United States patents, No. 6,532,457, No. 6,594,655, No. 6,625,612
and No. 6,778,534. There can be no assurance that others will not develop
technologies that are similar or superior to our technology, or design around
any patents issued to us. Despite our efforts to protect our proprietary
rights, unauthorized parties may copy aspects of our products or obtain and use
information that we regard as proprietary. Policing any of such unauthorized
uses of our products is difficult, and although we are unable to determine the
extent to which piracy of our software products exists, software piracy can be
expected to be a persistent problem. In addition, the laws of some foreign
countries do not protect proprietary rights as fully as do the laws of the
United States or Israel. There can be no assurance that our efforts to protect
our proprietary rights will be adequate or that our competitors will not
independently develop similar technology.

24

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Manufacturing

While
we engineer and design our products, we do not own or operate a semiconductor
fabrication facility and we do not have the resources to manufacture our
products internally. In November 2000 we entered into an agreement with IBM to
manufacture our NP-1 and NP-1c network processors.

The
NP-1 network processors were manufactured using IBMs SA-27E 0.18-micron ASIC
technology, while NP-1c network processors utilize IBMs 0.11-micron Cu-11 ASIC
template. Use of this new manufacturing technology enables enhanced performance
while reducing manufacturing costs significantly. Taiwan Semiconductor
Manufacturing Co. (TSMC) manufactures our NP-2 line of products using the 0.13
micron process. This fabless manufacturing model enables us to focus on our
engineering and design strengths, minimize fixed costs on capital expenditures
and still have access to high-volume manufacturing capacity.

We
expect that all of our products will be single sourced from fabrication
facilities and any late delivery or failure to deliver products could result in
delays in satisfying customer demand, increased costs and loss of revenues.

C. ORGANIZATIONAL STRUCTURE

In
mid-1999 we decided to focus on our internal application-specific integrated
circuit (ASIC) team to start a new business initiative. This new business
initiative was incorporated as E.Z. Chip Technologies Ltd. in December 1999.
Through EZchip we are engaged in the development and marketing of high
performance network processors. Since its inception EZchip has raised $61
million in three private financing rounds, with $24 million of that amount
invested by LanOptics (or by investors who exchanged their EZchip shares with
LanOptics) and the balance by EZchip minority shareholders. We currently have a
60.4% ownership interest in EZchip. We intend to seek to increase our ownership
position in EZchip through the exchange of our shares for EZchip shares.

D. PROPERTY, PLANTS AND EQUIPMENT

We
do not own any real property. Our principal development, marketing and
administrative facilities occupy approximately 25,000 square feet of a building
in Yokneam, Israel which is leased through January 2007.

EZchip,
which conducts its sales operations through two locations in the United States,
leases office space in California and Massachusetts under six-month renewable
leases, and it currently maintains three sales people in each office.

Our
principal capital expenditures to date have been the purchase of equipment and
other fixed assets used in our business, mainly in Israel. These purchases
totaled $265,000 in 2003, $206,000 in 2004 and $217,000 in 2005. Our capital
expenditures in 2003, 2004 and 2005 were spent primarily for the procurement of
EZchip research and development hardware equipment and software tools.

25

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|                  |                                             
|----------------- | --------------------------------------------
|ITEM 4A.          | UNRESOLVED STAFF COMMENTS                   
|                  |                                             
|Not
  applicable.
|                  |                                             
|ITEM 5.           | OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The
following discussion and analysis should be read in conjunction with Item 3.
Key Information and the Consolidated Financial Statements and notes thereto
included herein.

General

We
design, develop, manufacture, market and support network processors, through
our subsidiary, EZchip. For the past five and a half years, we have focused our
efforts on the network processor market and ceased our investment in research
and development for LAN switching products. We also closed the operations of
our Internet applications business segment principally comprised of the
operations of NetGuard and NetXchange. Our resources are now focused
exclusively on EZchip. Due to this shift in focus, our sales, which until 2002
were comprised solely of our legacy LanOptics and NetGuard products, decreased
significantly after fiscal year 1999. Our sales have increased in the last few
fiscal years as EZchip has begun to generate revenues.

We
maintain our accounts in U.S. dollars. Because the U.S. dollar is the currency
of the primary economic environment in which our operations are conducted. We
hold most of our cash, cash equivalents and marketable securities in US
dollars, sales prices are quoted in U.S. dollars and the majority of purchases
of materials and components are quoted invoiced and paid in U.S. dollars. In
addition, a majority of other expenses, principally R&D engineering
services and marketing expenses, are incurred outside Israel in U.S. dollars or
paid in U.S. dollars. Nevertheless, a significant portion of the cost of our
Israeli operations, mainly personnel related, is incurred in NIS. See Note 2b
to our Consolidated Financial Statements.

Commencing
January 1, 2004 we adopted generally accepted accounting principles in the
United States (U.S. GAAP) for the preparation of our consolidated financial
statements. Previously, our consolidated financial statements were prepared in
accordance with generally accepted accounting principles in Israel, or Israeli
GAAP, and included a note describing the major differences between Israeli GAAP
and US GAAP, as applicable to our company. The consolidated financial
statements for all prior periods presented have been restated and are presented
in accordance with U.S. GAAP.

Critical Accounting Policies

The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
On an on-going basis, management evaluates its estimates and judgments.
Management bases its estimates and judgments on historical experience and on
various other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from other sources. Under different assumptions or conditions, actual results
may differ from these estimates.

26

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Management
believes the following critical accounting policies, among others, affect its
more significant judgments and estimates used in the preparation of our
consolidated financial statements:

Revenue Recognition

We
generate our revenues mainly from sales of network processor chips and to a
lesser extent from the sales of network-processor based systems, software tools
and maintenance and support services, through EZchip and its wholly owned
subsidiary EZchip Inc.

In
general, it takes one to two years to design a networking product based on
EZchip network processors. During this design phase the revenues we recognize
are mostly attributable to the sale of evaluation systems and development
software tools, which our customers use to assist in the development of their
own network processor based products. As they move to development of their own
boards with the network processor, they purchase sample chips from us for
testing purposes. Once their own designs are completed, they move into
production phase where they begin to manufacture their products. At this point,
they purchase a limited number of network processors chips for the initial
production stage. Depending upon the acceptance of their products in the
marketplace and the speed of deployment of projects with them, the customer may
or may not increase production. Volume production of customers products is
expected to translate into volume sales of our network processors. EZchip has
no direct influence upon the sales and marketing of our customers products.

Revenues
from network processor chips and network processor-based systems are recognized
upon shipment in accordance with Staff Accounting Bulletin No. 104 Revenue
Recognition in Financial Statements (SAB 104), when persuasive evidence of an
agreement exists, delivery of the product has occurred, the fee is fixed or
determinable and collectibility is probable. Generally, the Company does not
have any significant obligations after delivery. The Company does not grant a
right of return to its customers. In addition, if a sale does not meet all of
the criteria, the sale is deferred until all criteria are met.

Revenues
from sales of software tools and maintenance services which are sold separately
from other products are recognized in accordance with statement of Position
97-2, Software Revenues Recognition (SOP 97-2). The company uses the
residual method when Vendor Specific Objective Evidence (VSOE) of fair value
only exists for the maintenance.

In
certain instances, the Company sells network processor-based systems together
with software tools and maintenance and support services. In these cases, the
Company complies with the requirements set forth in EITF 00-21, Revenue
Arrangements with Multiple Deliverables, relating to the separation of
multiple deliverables into individual accounting units with determinable fair
values.

27

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Inventory Valuation

We
are required to state our inventories at the lower of cost or market price. In
assessing the ultimate realization of inventories, we are required to make
judgments as to future demand requirements and compare that with the current or
committed inventory levels. Inventory write-offs are provided for slow-moving
items or technological obsolescence and are recorded in the consolidated
statement of operation. Once inventory is written down, a new cost basis is
established for future periods.

Legal Contingencies

When
the likelihood of the incurrence of losses related to our legal proceedings is
probable and management has the ability to estimate such costs, we provide for
estimates of probable losses through charges to our Consolidated Statements of
Operations. These estimates have been based on our assessment of the facts and
circumstances at each balance sheet date and are subject to change based upon
new information and intervening events.

We
are not currently involved in any significant legal proceedings and are not
required to assess the likelihood of any specific adverse judgments or outcomes
of such proceedings or of any potential ranges of probable losses.

Allowance for Doubtful Debts

Management
continually reviews the collectibility of trade accounts receivable and the
adequacy of the allowance for doubtful debts against the trade accounts
receivable. Management specifically analyzes customer accounts, account
receivable aging reports, history of bad debts and the business or industry
sector to which they belong, customer concentrations, customer credit
worthiness, current economic trends and any other pertinent factors. Management
is able to make reasonably objective judgments on the adequacy of other
provisions relating to trade accruals.

Goodwill and other intangible assets

We
follow SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No.
142, goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but are subject to periodic impairment tests in accordance
with the Statement. Goodwill impairment is deemed to exist if the net book
value of a reporting unit exceeds its estimated fair value. The total purchase
price of business acquisitions accounted for using the purchase method is
allocated first to identifiable assets and liabilities based on estimated fair
values. The excess of the purchase price over the fair value of net assets of
purchased businesses is recorded as goodwill.

We
perform an annual impairment test during the fourth quarter of each fiscal
year, or more frequently if impairment indicators are present. We operate in
one operating segment, and this segment comprises our only reporting unit. As
of December 31, 2005 no impairment charges were required.

28

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|   |                        
|-- | -----------------------
|A. | RESULTS OF
  OPERATIONS

The
following table presents, for the periods indicated, information concerning the
Companys results of operations (dollars in thousands).

Income Statement Data:

|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|------------------------------------------------------------------------------ |  | ----------------------- | ------ | ---- | - | ------- | - | ---- | ------- | ---- | - | ------ | - | - | ------- | -
|                                                                               |  | Year Ended December 31, |       
|                                                                               |  |                         |       
|                                                                               |  | 2001                    |        | 2002 |   | 2003    |   | 2004 |         | 2005 |  
|                                                                               |  |                         |        |      |   |         |   |      |         |      |  
|Revenues                                                                       |  |                         | --     |      | $ | 465     |   | $    | 1,756   |      | $ | 4,746  |   | $ | 5,848   |  
|Costs of revenues                                                              |  |                         | --     |      |   | 163     |   |      | 624     |      |   | 1,889  |   |   | 2,350   |  
|Amortization of developed technology                                           |  |                         | --     |      |   | 90      |   |      | 239     |      |   | 241    |   |   | 291     |  
|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Gross profit                                                                   |  |                         | --     |      |   | 212     |   |      | 893     |      |   | 2,616  |   |   | 3,207   |  
|Operating expenses:                                                            |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Research & development cost, net                                               |  |                         | 7,434  |      |   | 8,075   |   |      | 7,219   |      |   | 7,267  |   |   | 8,215   |  
|In-process research and development write-off                                  |  |                         | --     |      |   | 3,928   |   |      | --      |      |   | --     |   |   | 1,475   |  
|Selling, general and administrative, net                                       |  |                         | 2,332  |      |   | 3,201   |   |      | 3,660   |      |   | 3,765  |   |   | 3,643   |  
|Total operating expenses                                                       |  |                         | 9,766  |      |   | 15,204  |   |      | 10,879  |      |   | 11,032 |   |   | 13,333  |  
|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Operating loss                                                                 |  |                         | (9,766 | )    |   | (14,992 | ) |      | (9,986  | )    |   | (8,416 | ) |   | (10,126 | )
|Financial and other income (expenses), net *)                                  |  |                         | 1,293  |      |   | 638     |   |      | (418    | )    |   | (738   | ) |   | (312    | )
|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Loss from continuing operations before minority
  interest                     |  |                         | (8,443 | )    |   | (14,354 | ) |      | (10,404 | )    |   | (9,154 | ) |   | (10,438 | )
|Minority interest in loss of a subsidiary                                      |  |                         | 80     |      |   | --      |   |      | --      |      |   | --     |   |   | 206     |  
|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Loss from continuing operations                                                |  |                         | (8,363 | )    |   | (14,354 | ) |      | (10,404 | )    |   | (9,154 | ) |   | (10,232 | )
|Income from discontinued operations of a segment
  of a business               |  |                         | 793    |      |   | 51      |   |      | --      |      |   | --     |   |   | --      |  
|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Net loss                                                                       |  |                         | (7,570 | )    |   | (14,303 | ) |      | (10,404 | )    |   | (9,154 | ) |   | (10,232 | )
|Cumulative effect of change in accounting
  principle.                         |  |                         | --     |      |   | --      |   |      | --      |      |   | --     |   |   | (115    | )
|Net loss after cumulative effect of change in
  accounting principle           |  |                         | (7,570 | )    |   | (14,303 | ) |      | (10,404 | )    |   | (9,154 | ) |   | (10,347 | )
|                                                                               |  |                         |        |      |   |         |   |      |         |      |   |        |   |   |         |  
|Net loss per share (basic and diluted)                                         |  |                         | (1.04  | )    |   | (1.85   | ) |      | (1.23   | )    |   | (0.98  | ) |   | (0.92   | )
|Net loss per share from continuing operations
  (basic and diluted)            |  |                         | (1.15  | )    |   | (1.85   | ) |      | (1.23   | )    |   | (0.98  | ) |   | (0.92   | )
|Net earnings per share from discontinued
  operations (basic and diluted)      |  |                         | 0.11   |      |   | --      |   |      | --      |      |   | --     |   |   | --      |  
|Net loss per share after cumulative effect of
  change in accounting principle |  |                         | (1.04  | )    |   | (1.85   | ) |      | (1.23   | )    |   | (0.98  | ) |   | (0.93   | )

|                | 
|--------------- | 
|               
|*) reclassified

29

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Years Ended December 31, 2005 and 2004

Revenues

We
generate our revenues mainly from sales of network processors chips and to a
lesser extent from the sales of network processor-based systems, software tools
and maintenance and support services. For the twelve months ended December 31,
2005, revenues increased by $1,102,000, or 23%, to $5,848,000 from $4,746,000
in the same period in 2004. This increase is mainly attributable to increased
purchases by several of our customers that entered into their production stage
for networking products incorporating our network processors chips, as well as
to the growth in our customer base.

Cost of Revenues

Cost
of revenues consists primarily of the cost of network processor chips purchased
from our contract manufacturers and to a lesser extent from the cost of network
processor-based systems, labor costs associated with maintenance and support
services as well as other production management and facilities related costs.
For the twelve months ended December 31, 2005, our cost of revenues increased
by $461,000, or 24%, to $2,350,000 (40% of revenues) from $1,889,000 (40% of
revenues) in the same period in 2004, primarily as a result of the increase in
revenues.

Gross Profit

For
the twelve months ended December 31, 2005, gross profit increased by $591,000,
or 23%, to $3,207,000 (55% of revenues) from $2,616,000 (55% of revenues) in
the same period in 2004, primarily as a result of the increase in revenues.

Research and Development Cost, Net

Research
and development costs consist mainly of the salary and benefits of engineers
and costs related to external engineering design services. The reported figures
consist entirely of EZchips research and development costs. For the year ended
December 31, 2005, research and development costs increased by $948,000, or
13%, to $8,215,000 from $7,267,000 in the 2004 period. This increase is
attributable primarily to the substantial external engineering design expenses
associated with the final stage of the design and tape-out of our NP-2 network
processor.

In-Process Research and Development Write-Off

In-process
research and development write-off in the amount of $1,475,000 was recorded in
connection with the purchase of EZchip shares in an exchange transaction that
occurred in June 2005. See note 3 to the financial statements.

30

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---



Selling, General and Administrative Expenses

Selling,
general and administrative expenses consist primarily of salaries,
participation in trade shows and travel expenses as well as legal, accounting
and other administrative costs. For the twelve months ended December 31, 2005,
these expenses decreased by $122,000, or 3%, to $3,643,000 from $3,765,000 in
the same period in 2004. There was no material change in the mix or type of
expenses between 2004 and 2005.

Financial and Other Income (Expenses), Net

Financial
and other income/(expenses) reflects the income or expenses both from
traditional investment income or financing expenses and from exchange rate fluctuations
and currency translation. For the twelve months ended December 31, 2005, net
financial expenses decreased by $426,000, or 58%, to $312,000 from net
financial expenses of $738,000 in the same period in 2004. This decrease is
primarily attributable to higher interest income in 2005, resulting from higher
interest rates and a higher average cash balance. In addition, in August 2004,
we repaid a loan in the principal amount of $1,500,000 which resulted in lower
interest expense during 2005. Most of our financial expenses (in both periods) are
composed of non-cash interest accruals on EZchips Series C Preferred shares.
The EZchip Series C Preferred shares were issued during March 2003 ($11.2
million to minority holders), March 2004 ($2.6 million to minority holders) and
July 2005 ($3.0 million to minority holders) and bear 6% annual interest.

Minority Interest in Loss of a Subsidiary

Minority
interest in loss of a subsidiary reflects the share of EZchips minority holders of ordinary shares in
EZchips loss. The amount of $206,000 represents proceeds received during 2005 from the exercise of stock options in
EZchip.

Cumulative Effect of Change in Accounting
Principle

See note 2k to
the  financial statements.

Years Ended December 31, 2004 and 2003

Revenues

For
the twelve months ended December 31, 2004, revenues increased by $2,990,000, or
170%, to $4,746,000 from $1,756,000 in the same period in 2003. This increase
is mainly attributable to purchases by several of our customers that entered
into their production stage for networking products incorporating our network
processors chips. EZchip first network processors became commercially available
during the second quarter of 2002. Therefore, the majority of our revenues generated
in 2003 resulted from customers in their product design phase that purchased
sample chips, evaluation systems and software tools, enabling the development
of new networking products based on our network processor chips. The majority
of our 2004 revenues were derived from sales of network processor chips to
several of those customers who completed the design phase and entered
production during 2004.

31

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---



Cost of Revenues

For
the twelve months ended December 31, 2004, our cost of revenues increased by
$1,265,000, or 203%, to $1,889,000 (40% of revenues) from $624,000 (36% of
revenues) in the same period in 2003. The increase in cost of revenues is the
result of the increase in revenues. The increase in cost of revenues as a
percentage of revenues is the result of the increased volume production orders,
characterized by lower unit prices and a change in the mix of our sales, with a
higher contribution from the sale of chips and other hardware products compared
to software and services in the 2004 period.

Gross Profit

For
the twelve months ended December 31, 2004, gross profit increased by
$1,723,000, or 193%, to $2,616,000 (55% of revenues) from $893,000 (51% of
revenues) in the same period in 2003. This increase was primarily attributable
to the increase in revenues.

Research and Development Cost, Net

Research
and development costs consist mainly of the salary and benefits of engineers
and costs related to external engineering design services. Reported figures
consist entirely of EZchips research and development costs. For the year ended
December 31, 2004, research and development costs increased by $48,000, or
0.7%, to $7,267,000 from $7,219,000 in the 2003 period.

Selling, General and Administrative Expenses

Selling,
general and administrative expenses consist primarily of salaries,
participation in trade shows and travel expenses as well as legal, accounting
and other administrative costs. For the twelve months ended December 31, 2004,
these expenses increased by $105,000, or 3%, to $3,765,000 from $3,660,000 in
the same period in 2003.

Financial and Other Income (Expenses), Net

Financial
and other income/(expenses) reflects the income or expenses both from
traditional investment income or financing expenses and from exchange rate
fluctuations and currency translation. For the twelve months ended December 31,
2004, net financial expenses increased by $320,000, or 77%, to $738,000 from
net financial expenses of $418,000 in the same period in 2003. This increase is
mostly attributable to a longer period and a higher amount of interest accruals
on EZchips Series C Preferred shares during the 2004 period. EZchip Series C
Preferred shares were issued during March 2003 ($11.2 million to minority
holders) and during March 2004 ($2.6 million to minority holders) and bear
non-cumulative dividends at the rate of 6% per annum.

32

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---



Effective Corporate Tax Rate

Israeli
companies were generally subject to corporate tax at the rate of 34% of their
taxable income in 2005. Pursuant to tax reform legislation that came into
effect in 2003, the corporate tax rate is to undergo staged reductions to 25%
by the year 2010. In order to implement these reductions, the corporate tax
rate is scheduled to decline to 31% in 2006, 29% in 2007, 27% in 2008, and 26%
in 2009. However, because we have elected to participate in the alternative
package of tax benefits for our current approved enterprise, the income derived
from that enterprise will be exempt from Israeli corporate tax for a specified
benefit period (except to the extent that dividends are distributed during the
tax-exemption period other than upon liquidation) and subject to reduced
corporate tax rates for an additional period. The period of tax benefits for EZchips
approved enterprise expires in 2013. Certain investment income derived by
EZchip from investments may not be regarded by the Israeli tax authorities as
income from its approved enterprise and consequently may be taxed at the
regular statutory rate in Israel.

We
and EZchip have tax loss carryforwards resulting from the years up to and
including 2005 amounting to approximately $60.6 million which may be carried
forward indefinitely.

EZchip
Inc. is subject to U.S. income taxes and has a loss carryforward resulting from
the years up to and including 2005 amounting to approximately $4.2 million.

Utilization
of the U.S. net operating losses may be subject to substantial annual
limitation due to the change in ownership provisions of the Internal Revenue
Code of 1986 and similar state provisions. The annual limitation may result in
the expiration of net operating losses before utilization. In addition, we have
accumulated capital losses in the amount of $21.7 million. We have not
established a deferred tax asset resulting from temporary differences between
the basis of assets for financial and tax reporting purposes, as it has been
determined that it is more likely than not that such deferred tax assets will
not be realized.

Impact of Currency Fluctuation and of
Inflation

A
significant portion of the cost of our Israeli operations, mainly personnel and
facility-related, is incurred in NIS. Therefore, our NIS related costs, as
expressed in US dollars, are influenced by the exchange rate between the US
dollar and the NIS. In addition, if the rate of inflation in Israel will exceed
the rate of devaluation of the NIS in relation to the US dollar, or if the
timing of such devaluations were to lag considerably behind inflation, our cost
as expressed in US dollars may increase. NIS linked balance sheet items, may
also create foreign exchange gains or losses, depending upon the relative
dollar values of the NIS at the beginning and end of the reporting period,
affecting our net income and earnings per share. Although we may use hedging
techniques, we may not be able to eliminate the effects of currency
fluctuations. Thus, exchange rate fluctuations could have a material adverse
impact on our operating results and share price. The caption Financial income
(expenses), net in our Financial Statements includes the impact of these
factors as well as traditional interest income or expense. See note 15 to the
 financial statements.

33

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---



The
following table sets forth, for the periods indicated, (i) devaluation of the
NIS against the most important currencies for our business, the U.S. dollar,
and (ii) inflation as reflected in changes in the Israeli consumer price index.

|                                     |  |  |                           |   |      |     |      |  |      |    |      |      |    |  |     |  
|------------------------------------ |  |  | ------------------------- | - | ---- | --- | ---- |  | ---- | -- | ---- | ---- | -- |  | --- | -
|                                     |  |  | Year Ended
  December 31,
|                                     |  |  |                          
|                                     |  |  | 2001                      |   | 2002 |     | 2003 |  | 2004 |    | 2005
|                                     |  |  |                           |   |      |     |      |  |      |    |     
|Devaluation of NIS vs.
  U.S. Dollar |  |  | 9.3                       | % |      | 7.3 | %    |  | (7.6 | )% |      | (1.6 | )% |  | 6.8 | %
|Israeli Consumer Price
  Index       |  |  | 1.4                       | % |      | 6.5 | %    |  | (1.9 | )% |      | 1.4  | %  |  | 2.4 | %

Because
exchange rates between the NIS and the dollar fluctuate continuously, exchange
rate fluctuations, particularly larger periodic devaluations, may have an
impact on our profitability and period-to-period comparisons of our results. We
cannot assure you that in the future our results of operations may not be
materially adversely affected by currency fluctuations.

Seasonality

Our
operating results are generally not characterized by a seasonal pattern.

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

Historically
we have satisfied our financial requirements primarily through equity
investments, funds provided by operations and, through research and development
grants. EZchips research and development has not been funded by Israels
Office of Chief Scientist, but rather has been funded through the proceeds of
third party investments, combined with contributions by LanOptics.

In
2000 we conducted two rounds of financing for EZchip, raising $27.2 million
through the private placement of EZchips Series A and B Preferred shares, of
which we invested $2 million. The amount of investments by third parties was
recorded as preferred shares of a subsidiary in our financial statements. In
addition, we made a $2 million investment in EZchip during 2000.

In
early 2003 EZchip raised $13.5 million in a private placement of Series C
Preferred shares, of which amount we invested $2.3 million. In addition, EZchip
obtained a $3 million credit facility, of which $1.5 million was drawn down. In
September 2004 the $1.5 million was repaid.

Under
the terms of the Series C Preferred share financing EZchip could raise an
aggregate additional amount of up to $8 million at one or more additional
closing to be initiated within 24 months of the initial investment of $13.5
million On March 9, 2004, EZchip raised the additional $8 million, of which we
invested $5.3 million.

In
July 2005 EZchip raised an additional $10.0 million in a private placement of
Series C Preferred shares, including a $6.9 million investment by LanOptics.

34

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On
December 16, 2003 we concluded a $6 million private placement of our ordinary
shares to Deutsche Bank AG, London Branch. $5.3 million of the proceeds were
used to fund the exercise of our option to purchase EZchip Series C Preferred
shares, which increased our ownership interest in EZchip to 53.4%. The
investors in this private placement were granted warrants to purchase 187,500
Ordinary shares at an exercise price of $11.39 per share with an exercise
period of five years

On
November 26, 2004 we concluded a $14.3 million private placement of our
ordinary shares to several institutional investors. The private placement was
undertaken to strength our balance sheet and insure our control over EZchip in
the event of additional private investment in EZchip, as well as for other
general corporate purposes. The investors in this private placement were
granted warrants to purchase 478,800 Ordinary shares at an exercise price of
$15.5 per share with an exercise period of five years

As
of December 31, 2005 we had $20.6 million in working capital and $19.6 million
in cash, cash equivalents and marketable securities. Our cash, cash equivalents
and marketable securities balance decreased by approximately $6.0 million in
2005 as a result of the following:

| |   |                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------
| |  | Approximately
  $9.0 million was used in operating activities.                                                               
| |   |                                                                                                                              
| |  | Financing
  activities provided approximately $3.2 million as a result of the Series C
  financing raised from third parties.
| |   |                                                                                                                              
| |  | Approximately
  $0.2 million was used for the purchase of property and equipment.                                            

We
believe that our unused cash, cash equivalents and marketable securities
balances will provide sufficient cash resources to finance our operations at
least through the end of 2007. However, if we grow more rapidly than currently
anticipated or, if we do not generate sufficient revenues, it is possible that
we would require additional funds before the end of such period.

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

Currently,
59 employees, representing about 73% of EZchips employees, are engaged in
research and development. EZchips senior executives devote a substantial
portion of their time in communicating with customers to determine what product
needs should be addressed.

The
following table sets forth research and development costs for the periods
indicated:

|                          |       |      |   |       |  |   |       | 
|------------------------- | ----- | ---- | - | ----- |  | - | ----- | 
|Year Ended
  December 31,
|                          |      
|2003                      |       | 2004 |   | 2005  | 
|                          |       |      |   |       | 
|(in
thousands)           
|$                         | 7,219 |      | $ | 7,267 |  | $ | 8,215 | 

35

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We
rely primarily on a combination of trade secrets and employee and third-party
nondisclosure agreements to protect our intellectual property, as well as
limiting access to the distribution of proprietary information. We cannot
assure you that the steps taken to protect our intellectual property rights
will be adequate to prevent misappropriation of our technology or to preclude
competitors from independently developing such technology. Furthermore, we
cannot assure you that, in the future, third parties will not assert
infringement claims against us or with respect to our products.

We
hold four United States patents:

| |    |                                                      
| | -- | -----------------------------------------------------
| | 1. | 6,532,457:
  Look-ahead tree structure               
|
| | 2. | 6,594,655: Wildcards in radix search tree structures.
|
| | 3. | 6,625,612:
  Deterministic search algorithm.         
|
| | 4. | 6,778,534: High-performance network processor.       

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

Our
2005 revenues increased 23% to $5.8 million, up from $4.7 million in 2004.
These revenues still reflected orders from only a handful of our 15 NP-1c
customers that are already in production. An additional 20 NP-1c customers are
still in their design phase and we expect most of them to enter production
during 2006. Our NP-2 customers have not yet contributed to revenues and we
expect the first NP-2 customers to enter production during the second half of
2006. Our chips go into communication equipment that average about two years
from design win to product, and volume orders can be expected only after the
customers equipment enters production. Consequently, we have not yet realized
the potential of our design wins and we expect that our quarterly revenues will
continue to fluctuate. We do not expect that all of our customers will reach
production stage, as projects may be halted, delayed or cancelled and there is
also no assurance that products that have reached production will be
successfully accepted in the marketplace. Our future revenue ramp-up will
continue to depend on the success of our customers new products that
incorporate our network processors, on market acceptance of these products, and
on the pace of recovery in the telecommunications and related markets

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

We
are not a party to any material off-balance sheet arrangements. In addition, we
have no unconsolidated special purpose financing or partnership entities that
are likely to create material contingent obligations.

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

The
following table summarizes our minimum contractual obligations and commercial
commitments, including obligations of discontinued operations, as of December
31, 2005 and the effect we expect them to have on our liquidity and cash flow
in future periods.

36

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|                                                                          |  |       |            |                    |                        |           |  |           |            |                    |   |           |  |  |    | 
|------------------------------------------------------------------------- |  | ----- | ---------- | ------------------ | ---------------------- | --------- |  | --------- | ---------- | ------------------ | - | --------- |  |  | -- | 
|                                                                          |  |       |            |                    | Payments due by period |          
|                                                                          |  |       |            |                    |                        |          
|Contractual
  Obligations                                                 |  | Total |            | Less than 1
  year |                        | 13 years |  | 3-5 years |            | More than5
  years |  
|                                                                          |  |       |            |                    |                        |           |  |           |            |                    |  
|Operating lease obligation                                                |  | $     | 1,057,000  |                    | $                      | 782,000   |  | $         | 275,000    |                    |   | --        |  |  | -- | 
|Other long-term liabilities reflected on the companys balance
  sheet(1) |  | $     | 18,882,000 |                    |                        | --        |  | $         | 15,151,000 |                    | $ | 3,731,000 |  |  | -- | 
|                                                                          |  |       |            |                    |                        |           |  |           |            |                    |   |           |  |  |    | 
|Total                                                                     |  | $     | 19,939,000 |                    | $                      | 782,000   |  | $         | 15,426,000 |                    | $ | 3,731,000 |  |  | -- | 



---

(1) During
March 2003 and during March 2004, EZchip issued to LanOptics and to third
parties 26,345,092 Series C Preferred shares, in consideration of $21,500,000.
The net amount of $13,491,000, which was invested by third parties, was
recorded as redeemable preferred shares in a subsidiary. After four years from
the issuance date and subject to the request of the majority holders of Series
C Preferred shares, EZchip may be required to redeem the Series C Preferred
shares at a price per share equal to the greater of (i) the original Series C
Preferred share issue price plus an amount equal to any accrued and unpaid
dividends thereon plus 6% coupon interest compounded annually or (ii) the fair
market value of such shares. The amount specified represents the original
Series C Preferred share issue price plus 6% accrued interest.


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

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

Set
forth below are the names of all directors and senior management of our
company:

Dr.
Meir D. Burstin, 63, is Chairman of the Board of Directors of the Company as
well as the Chairman of the Board of Directors of the Companys subsidiary,
E.Z. Chip Technologies Ltd. (EZchip). In addition, he is the Chairman of
Sivron, a security trade software company, and Director of Negev Software, a
communication monitoring company. Dr. Burstin was the Chairman and founder of
ART Advanced Recognition Technologies Inc., a speech and handwriting
recognition company, recently acquired by Scansoft (Now Nuance). He was a
founder and chairman of the Board of Ornet, a data switching company founded in
1996 and acquired by Siemens two years later. Dr. Burstin was a director of
several other high-tech companies and the Chairman of the Jerusalem Software
Greenhouse. In 1969, Dr. Burstin was a founder of Advanced Technology Ltd.
(ATL), one of Israels largest software companies at the time, and served as
its president until 1982. From 1982 to 1984, Dr. Burstin was a Visiting Scholar
at the Computer Science Department at UCLA and Vice President Technologies of
Tadiran U.S. In this position, he was in charge of the acquisition of
technologies and technology companies for Tadiran. Upon his return to Israel in
1984, he became a Corporate Vice President of Tadiran Ltd., then one of
Israels largest electronics companies, and President of Tadirans Systems
Division. In 1986, he also became President of Elisra Systems, an electronic
warfare company acquired by Tadiran, and organized the acquisition. In
addition, Dr. Burstin served as a Chairman or Director of several Tadiran
subsidiaries. Dr. Burstin holds a Ph.D. in Information Systems and Computers
from Tel-Aviv University. He received B.Sc. degrees in Physics and Mathematics
and an M.Sc. in Physics from the Hebrew University of Jerusalem.

37

---

---



Eli
Fruchter, 50, is the President and Chief Executive Officer of EZchip, a position
that he has held since EZchips inception, and has been a director of our
company since its inception. He served as General Manager of our company from
its inception until May 1999, and as President, Chief Executive Officer and
General Manager from May 1999 through September 1999. From March 1995 until
September 1999, he was the Chairman of the Board of Directors of our company.
Mr. Fruchter was among the founders of Adacom Technologies Ltd., a manufacturer
of data communications products for the IBM 3270 environment. From April 1985
until December 1987, he served as a research and development manager at Adacom,
and from January 1988 until November 1989, he was the Manager of Adacoms
Marketing Department. Before helping to found Adacom in 1985 Mr. Fruchter was
Manager - Research and Development Group of Fibronics Ltd., a manufacturer of
data communications and fiber optics systems. Mr. Fruchter holds a B.Sc. degree
in Electrical Engineering from the Technion - Israel Institute of Technology.

Benjamin
(Benny) D. Gaon, 70, has been a director of the Company since 1995. Mr. Gaon is
President and Chairman of Israel-registered B. Gaon Holdings Ltd., whose
activities encompass three main sectors: financial and other services;
agro-industries; and wholesale and retail. Previously, Mr. Gaon served as
President and Chief Executive Officer of Koor Industries Ltd., Israels largest
industrial enterprise. Mr. Gaon is an active Chairman and Board member of
various companies in Israel, including Yakhin Hakal Holdings Ltd., Hamashbir
Holdings (1999) Ltd., H&O Fashion Ltd., Ahava Holdings Ltd., Dead Sea
Laboratories Ltd., B. Gaon Holdings Ltd., Or Assaf Investments Ltd., Genius
Technologies (1999) Ltd., B. Gaon Investments (1998) Ltd., Gaon Agro Industries
Ltd., Middle East Tube Company Ltd., Gaon Investment in Capital Markets Ltd.,
Gaon Capital Markets Ltd., B. Gaon Productions and Contents Ltd., Gaon
Communication Investments (2001) Ltd., Tal Sky Ltd., Tel-Ad Jerusalem Studios
Ltd., ACE Marketing Chains  Consumer Products Ltd. And Auto Depot (1992) Ltd.
He was the Chairman of the Board of Co-Op Blue Square Consumers Cooperative
Society Ltd. and of Delek Israel Fuel Corporation Ltd. Among his other public
positions, Mr. Gaon serves as chairman of Israel Management Center Ltd.
(HAMIL), Chairman of Moshe David Gaon Center for Ladino Studies in Ben-Gurion
University, President of the Israel Cancer Association. He also serves on the
Board of Trustees of the Hebrew University of Jerusalem and of Tel-Aviv
University.

Dr.
Ran Giladi, 51, has been a director of our company since December 2001. Dr.
Giladi is a faculty member at Ben-Gurion University of the Negev, Beersheba,
where he founded and was the Head of the Department of Communication Systems
Engineering from 1992 until 2000. Dr. Giladi is also the active Chairman of
DiskSites, Inc. and of InfoCyclone Inc., a company he co-founded in September
2000, which produces storage appliances for owners of massively accessed
repositories and of which he was President and Chief Executive Officer from
2000 until 2002. Dr. Giladi taught at the Business School and at the Electrical
Engineering Department of Tel-Aviv University from 1987 until 1993. Dr. Giladi
co-founded Ramir Ltd., which was later acquired by Harris-Adacom, and served as
Vice President Research & Development in both companies from 1984 until
1986. Dr. Giladi also founded the Israeli Consortia for research on network
management systems (NMS), and served as the Chairman of the Consortia Board of
Directors. His research interests include computer and communications systems
performance, data networks and communications, and network management systems.
Dr. Giladi received a B.A. in Physics and an M.Sc. in Biomedical Engineering
from the Technion - Israel Institute of Technology, and a Ph.D. in Computers
and Information Systems from Tel-Aviv University.

38

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Karen
Sarid, 55, has been a director of the Company since December 2001. Ms. Sarid
has served as a General Manager of Orex Computed Radiography Ltd., a Kodak
Company focusing on radiography systems for the digital x-ray market. Prior to
this and since September 2000, she held the position of Chief Operating Officer
and Chief Financial Officer at Orex. From September 1999 until September 2000
she was Chief Financial Officer and a member of the Board of Directors of
Forsoft Ltd., a software solutions provider and a subsidiary of the Formula
Group. From 1996 until August 1999 Ms. Sarid was Chief Financial Officer and a
member of the Board of Directors of ESC Medical Systems Ltd., a medical laser
manufacturer that is traded on the NASDAQ Stock Market. She was Chief Financial
Officer of our company from 1993 through 1996. Ms. Sarid also serves as a
director of Oridion Systems Ltd. and Gilat Satellite Networks Ltd. Ms. Sarid
received a B.A. in Economics and Accounting from Haifa University, and was
awarded the CFO of the Year award in 1998 by the Association of Chief Financial
Officers in Israel.

David
Schlachet, 60, has been a director of our company since September 2005. Mr.
Schlachet has served as chief executive officer of Syneron Medical Ltd. since
November 2005, after having served as chief financial officer of Syneron
Medical Ltd. since July 2004. From 2000 to June 2004 Mr. Schlachet served as
Managing Partner of Biocom, a venture capital fund specializing in the life
sciences area. From 1995 to 2000, Mr. Schlachet served as a senior Vice
President and Chief Financial Officer of Strauss Elite Holdings, a packaged
food group. He also served as an active Chairman of Elite Industries Ltd. From
1988 to 1995 Mr. Schlachet served first as CEO of Yeda, the Weizmann Institute
technology transfer company, and later as Vice President of Finance and
Administration of the Weizmann Institute of Science. Mr. Schlachet serves as a
director and chair of audit committee for NASDAQ listed companies Pharmos Inc.
and Compugen Ltd., and is a director of Israel Discount Bank. Mr. Schlachet
holds a B.Sc. degree in chemical engineering and an M.B.A. from Tel-Aviv University.

Senior Management

In
addition to Mr. Fruchter and Dr. Burstin, with respect to whom information is
provided above under Directors, Dror Israel is the other executive officer of the
Company.

Dror
Israel, 37, has been our Chief Financial Officer since June 2001. Prior to that
he was our financial controller from January 2000 through May 2001 and a
financial analyst from August 1997 through December 1999. Prior to joining
LanOptics Mr. Israel was employed by Hi Group, a holdings company, as a
financial analyst. Mr. Israel holds a B.A. degree in economics from Haifa
University and an M.B.A. cum laude from the Technion - Israel Institute of
Technology.

There
are no family relationships between any of our directors and executive officers.

|   |                                         
|-- | ----------------------------------------
|B. | COMPENSATION
  OF DIRECTORS AND OFFICERS

The
aggregate amount of compensation paid during 2005 to all of our directors and
executive officers as a group for services in all capacities was approximately
$338,000. The aggregate amount set aside or accrued during 2005 to provide
pension, retirement or similar benefits for directors and officers of our
company, pursuant to any existing plan provided or contributed to by us, was
approximately $6,000.

39

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

Appointment of Directors and Term of Office

Our
directors, other than our outside directors as described below, are appointed
by our shareholders at our annual general meeting and hold office until the
next annual general meeting. Our annual general meetings are held at least once
every calendar year, but not more than fifteen months after the last preceding
annual general meeting. In the intervals between our annual general meetings,
the board of directors may appoint new directors to fill vacancies. Our officers
serve at the discretion of the board of directors, subject to the terms of any
agreement between them and us and the provisions of the Israeli Companies Law.

Alternate Directors

Our
articles of association provide that any director may, by written notice to us,
appoint another person to serve as an alternate director. Under the Israeli
Companies Law, any person eligible to serve as a director (other than a
director or an existing alternate director) may act as an alternate director.
An alternate director may be appointed for one meeting or for another specified
period or until notice is given of the cancellation of the appointment. To our
knowledge, no director currently intends to appoint any other person as an
alternate director, except if the director is unable to attend a meeting of the
board of directors.

Outside And Independent Directors

In
accordance with the Israeli Companies Law and the regulations promulgated under
the Companies Law, the Company must have two outside directors. The outside
directors must meet certain statutory requirements of independence. The term of
office of an outside director is three years, which can be extended for one
additional term of three years (there are no prescribed terms of service for the
other directors of the company). An outside director can be removed from office
only under very limited circumstances. Both of the outside directors must serve
on the companys statutory audit committee, and at least one outside director
must serve on each committee of the board of directors. Benjamin (Benny) D.
Gaon and David Schlachet serve as our outside directors under the Israeli
Companies Law.

Pursuant
to the current listing requirements of the NASDAQ Stock Market, we are required
to have at least three independent directors on our board of directors. Our
independent directors who meet these requirements are Messrs. Gaon, Giladi and
Shlachet and Ms. Sarid.

40

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Audit Committee

The
Israeli Companies Law requires public companies to appoint an audit committee.
The responsibilities of the audit committee include identifying irregularities
in the management of the companys business and approving related party
transactions as required by law. An audit committee must consist of at least
three directors including both of the outside directors. The chairman of the
board of directors, any director employed by or otherwise providing services to
the company, and a controlling shareholder or any relative of a controlling
shareholder may not be a member of the audit committee.

Under
Israeli law, an audit committee may not approve an action or a transaction with
a controlling shareholder, or with an office holder, unless at the time of
approval two outside directors are serving as members of the audit committee
and at least one of the outside directors was present at the meeting in which
an approval was granted.

Pursuant
to the current listing requirements of the NASDAQ Stock Market, we are required
to establish an audit committee, at least a majority of whose members are
independent of management. Pursuant to the Sarbanes-Oxley Act of 2002 and the
NASDAQ corporate governance rules that have been applicable to us since July
31, 2005, we are required to have an audit committee consisting of at least
three independent members, all of whom are financially literate and one whom
has accounting or related financial management expertise.

The
new NASDAQ rules implement two basic criteria for determining independence:
(i) audit committee members are barred from accepting any consulting,
advisory or other compensatory fee from the issuer or an affiliate of the
issuer, other than in the members capacity as a member of the board of
directors and any board committee, and (ii) audit committee members may
not be an affiliated person of the issuer or any subsidiary of the issuer
apart from his or her capacity as a member of the board and any board
committee.

Our
Audit Committee currently consists of Benjamin D. Gaon, Karen Sarid and David
Shclachet. We believe that these appointments comply with the requirements of
the Companies Law and with the SEC and NASDAQ rules, and that Karen Sarid
qualifies to serve as the audit committees financial expert as required by the
SEC and NASDAQ.

Our
Audit Committee reviewed our audited financial statements for the year ended
December 31, 2005 and members of the Committee met with both management and our
external auditors to discuss those financial statements. Management and the
external auditors have represented to the Audit Committee that the financial
statements were prepared in accordance with the generally accepted accounting
principles. Members of the Audit Committee have received from and discussed
with the external auditors their written disclosure and letter regarding their
independence from our company as required by Independence Standards Board
Standard No. 1. Members of the Audit Committee also discussed with the external
auditors any matters required to be discussed by Statement on Auditing
Standards No. 61. Based upon these reviews and discussions, the Audit Committee
has recommended to the Board of Directors that the audited financial statements
be included in our Annual Report on Form 20-F for the year ended December 31,
2005.

41

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Approval of Certain Transactions; Obligations
Of Directors, Officers and Shareholders

The
Israeli Companies Law codifies the fiduciary duties that office holders,
including directors and executive officers, owe to a company. An office
holders fiduciary duties consist of a duty of care and a duty of loyalty. The
duty of loyalty includes avoiding any conflict of interest between the office
holders position in the company and such persons personal affairs, avoiding
any competition with the company, avoiding exploiting any corporate opportunity
of the company in order to receive personal advantage for such person or
others, and revealing to the company any information or documents relating to
the companys affairs which the office holder has received due to his position
as an office holder.

Under
the Israeli Companies Law, all arrangements as to compensation of office
holders who are not directors require approval of the board of directors unless
the articles of association provide otherwise. Arrangements regarding the
compensation of directors also require audit committee and shareholder
approval. The Israeli Companies Law requires that an office holder promptly
disclose any personal interest that he or she may have and all related material
information known to him or her, in connection with any existing or proposed
transaction by the company. In addition, if the transaction is an extraordinary
transaction, the office holder must also disclose any personal interest held by
the office holders specified relatives, or by any corporation in which the
office holder is a five percent or greater shareholder, director or general
manager or in which the office holder has the right to appoint at least one
director or the general manager. An extraordinary transaction is defined as a
transaction not in the ordinary course of business, a transaction that is not
on market terms, or a transaction that is likely to have a material impact on
the companys profitability, assets or liabilities.

In
the case of a transaction that is not an extraordinary transaction, after the
office holder complies with the above disclosure requirement, only board
approval is required unless the articles of association of the company provide
otherwise. Such approval must determine that the transaction is not adverse to
the companys interest. If the transaction is an extraordinary transaction,
then in addition to any approval required by the articles of association, it
also must be approved by the audit committee and by the board and, under
specified circumstances, by a meeting of the shareholders. An Israeli company
whose shares are publicly traded shall not be entitled to approve such a
transaction unless, at the time the approval was granted, two members of the
audit committee were outside directors and at least one of them was present at
the meeting at which the audit committee decided to grant the approval. An
office holder who has a personal interest in a matter that is considered at a
meeting of the board of directors or the audit committee generally may not be
present at this meeting or vote on this matter.

The
Israeli Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which includes a shareholder that holds 25% or
more of the voting rights if no other shareholder owns more than 50% of the
voting rights in the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and
the terms of compensation of a controlling shareholder who is an office holder,
require the approval of the audit committee, the board of directors and the
shareholders of the company. The shareholder approval must either include at
least one-third of the votes of disinterested shareholders who are present, in
person or by proxy, at the meeting or, alternatively, the total shareholdings
of the disinterested shareholders who vote against the transaction must not
represent more than one percent of the voting rights in the company.

42

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Under
the Israeli Companies Law, a shareholder has a duty to act in good faith
towards the company and other shareholders and refrain from abusing his or her
power in the company, including, among other things, voting in the general
meeting of shareholders on the following matters:

| | any
  amendment to the articles of association;
|- | -----------------------------------------------

| | an
increase   of the companys authorized share capital;
|- | --------------------------------------------------------

| | a
merger; or
|- | ------------

| | approval
of   related party transactions that require shareholder approval.
|- | ---------------------------------------------------------------------------

In
addition, any controlling shareholder, any shareholder who can determine the
outcome of a shareholder vote and any shareholder who, under the companys
articles of association, can appoint or prevent the appointment of an office
holder, is under a duty to act with fairness towards the company. The Israeli
Companies Law also provides that a breach of the duty of fairness will be
governed by the laws governing breach of contract; however, the Israeli
Companies Law does not describe the substance of this duty.

Indemnification of Directors and Officers;
Limitations on Liability

Our
articles of association allow us to indemnify, exculpate and insure our office
holders to the fullest extent permitted under the Israeli Companies Law,
provided that procuring this insurance or providing this indemnification or
exculpation is approved by the audit committee and the board of directors, as
well as by the shareholders if the office holder is a director.

Under the Israeli
Companies Law, a company may indemnify an office holder against any monetary
liability incurred in his or her capacity as an office holder whether imposed on him or her or incurred by him or
her in favor of another person pursuant to a judgment, a settlement or an
arbitrators award approved by court. A company also can indemnify an office
holder against reasonable litigation expenses including attorneys fees,
incurred, whether or not paid by him or her in his or her capacity as an office
holder, in proceedings instituted against him or her by the company, on its
behalf or by a third-party, in connection with criminal proceedings in which
the office holder was acquitted, or as a result of a conviction for a crime
that does not require proof of criminal intent, or in which an indictment was
not brought against the office holder.

In
addition, a company may indemnify an office holder against reasonable legal
fees, including attorneys fees, incurred, whether or not paid by him, by him
or her in consequence of an investigation or proceeding instituted against him
or her by an authority that is authorized to conduct such investigation or
proceeding, and that was resolved without an indictment against him or her and
without imposing on him or her financial obligation as an alternative of a
criminal proceeding, or that was resolved without filing an indictment against
him or her but with the imposition on him or her of a financial obligation as
an alternative to a criminal proceeding in respect of an offense that does not
require the proof of criminal intent.

43

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

A
company may obtain insurance for an office holder against liabilities incurred
in his or her capacity as an office holder. These liabilities include a breach
of duty of care to the company or a third-party, including a breach arising out
of negligent conduct of the office holder, a breach of duty of loyalty and any
monetary liability imposed on the office holder in favor of a third-party. A
company may also exculpate an office holder from a breach of duty of care in
advance of that breach. Our articles of association provide for exculpation
both in advance or retroactively, to the extent permitted under Israeli law. A
company may not exculpate an office holder from a breach of duty of loyalty towards
the company or from a breach of duty of care concerning dividend distribution
or a purchase of the companys shares by the company or other entities
controlled by the company.

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

Our
audit committee, board of directors and shareholders have resolved to indemnify
our directors and officers to the extent permitted by law and by our articles
of association for liabilities not covered by insurance, that are of certain
enumerated types of events, and subject to limitations as to amount.

Internal Auditor

The
Israeli Companies Law also requires the board of directors of a public company
to appoint an internal auditor nominated by the audit committee. A person who
does not satisfy the Companies Laws independence requirements may not be
appointed as an internal auditor. The role of the internal auditor is to
examine, among other things, the compliance of the companys conduct with applicable
law and orderly business practice. Fahn Kanne Control Management Ltd., a member
of the Grant Thornton network, serves as our internal auditor.

44

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NASDAQ Marketplace
Rules and Home Country Practices

Under
NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private issuers, such as
our company, are permitted to follow certain home country corporate governance
practices instead of certain provisions of Rule 4350, without the need to seek
individual exemptions from NASDAQ. A foreign private issuer that elects to
follow a home country practice instead of any of such provisions of Rule 4350,
must submit to NASDAQ, in advance, a written statement from an independent
counsel in such issuers home country certifying that the issuers practices
are not prohibited by the home countrys laws.

On
July 27, 2005, we provided NASDAQ with a notice of non-compliance with Rule
4350. In practice, we do not comply with the NASDAQ requirements regarding the
director nominations process, the establishment of a compensation committee and
the distribution of annual reports. Instead, we follow Israeli law and practice
in accordance with which our directors are recommended by our board of
directors for election by our shareholders, our board sets executive
compensation and we post our Annual Report or Form 20-F on our website. See
above in this Item 6C. Directors, Senior Management and Employees - Board
Practices - Election of Directors.

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

On
March 30, 2006 we had 82 employees, of whom three are LanOptics employees and
79 are EZchip employees. Six of EZchips employees who are involved in sales
and marketing are in the U.S. Fifty-nine of EZchips employees are engaged in
research and development. We believe that our company has good relations with
its employees and we have never experienced a labor dispute, strike or work
stoppage.

| |                     |  |                      |    |      |  |      |  |  |    | 
| | ------------------- |  | -------------------- | -- | ---- |  | ---- |  |  | -- | 
| |                     |  | As of
  December 31, |   
| |                     |  |                      |   
| |                     |  | 2003                 |    | 2004 |  | 2005 | 
| |                     |  |                      |    |      |  |      | 
| | LanOptics employees |  |                      | 3  |      |  | 3    |  |  | 3  | 
| | EZchip employees    |  |                      | 78 |      |  | 77   |  |  | 79 | 
| |                     |  |                      |    |      |  |      |  |  |    | 
| | Total employees     |  |                      | 81 |      |  | 80   |  |  | 82 | 

Israeli
labor laws are applicable to our companys employees in Israel. Such laws
principally concern the length of the workday and the workweek, minimum wages
for workers, minimum annual leave, insurance for work-related accidents,
procedures for dismissing employees and determination of severance pay. Israeli
employers are also required to make payments to Israels National Insurance
Institute with respect to employees. In addition, certain provisions of the
collective bargaining agreements between the Histadrut (Israels General
Federation of Labor) and the Israeli Coordinating Bureau of Economic
Organization apply to the Companys employees in Israel pursuant to
administrative orders extending them to all private sector employees. According
to such administrative orders, all Israeli employers are required to provide
certain escalations of the wages in relation to the increases in the Israeli
consumer price index as well as to provide minimum annual payments so as to
cover vacation expenses. All of our employees are covered by comprehensive life
and pension insurance policies.

45

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All
our officers, key employees and certain of our other employees are party to
individual employment agreements. We have entered into a non-disclosure and
non-competition agreement with each of our executive officers and key
employees.

Pursuant
to Israeli law, we are legally required to pay severance benefits upon certain
circumstances, including the retirement or death of an employee or the
termination of employment of an employee without due cause. All of our
employees are covered by life and/or pension insurance policies providing
customary benefits to employees, including retirement and severance benefits.
We contribute between 13.3% of base wages to such plans and employees
contribute between 5.0% to 5.5% of base wages. We also contribute between 5.0%
and 7.5% of base wages to certain professional advancement funds for
managers, engineers and others and such employees contribute 2.5% of base
wages. Our contribution is limited to the maximum amounts that are not
considered taxable income to the employee. Israeli employers and employees are
required to pay predetermined sums to the National Insurance Institute, which
is similar to the United States Social Security Administration. In the fiscal
year ended December 31, 2005 the aggregate payments to the National Insurance
Institute amounted to approximately 14.5% of base wages, with the employee
contributing 9% (of which approximately 4.3% relates to payments for national
health insurance) and the employer contributing the remainder.

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

Beneficial Ownership of Executive Officers
and Directors

As
of March 30, 2006 all the directors and executive officers as a group
beneficially held 911,585 of our ordinary shares (approximately 7.3% of our
outstanding shares). This figure includes 610,596 shares beneficially owned by
Eli Fruchter, representing approximately 5.2% of our outstanding shares. Mr.
Fruchter is the only director or officer who holds 1% or more of our
outstanding shares as of March 30, 2006.

Stock Option Plans

LanOptics Option Plans

Since
1993 LanOptics has granted options to purchase ordinary shares to key
employees, directors and shareholders pursuant to the LanOptics 1992 Stock
Option Plan as an incentive to attract and retain qualified personnel. Under
the terms of these grants, options, generally, become exercisable ratably over
a four-year period commencing with the date of grant. The options generally
expire no later than six years from the date of the grant, and are non-transferable,
except under the laws of succession. LanOptics 1992 Israeli Stock Option Plan
expired in November 2002. There were approximately 140,000 options for ordinary
shares that remained unissued upon the expiration of the 1992 Plan.

46

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On
October 2003 LanOptics adopted the 2003 Israeli Share Option Plan (the 2003
Israel Plan), under which a total of 90,000 ordinary shares of the Company
were reserved and authorized for the purpose of the option plan. The 2003
Israel Plan is administered by the Board of Directors, which has broad
discretion, subject to certain limitations, to determine the persons entitled
to receive options, the terms and conditions on which options are granted and
the number of shares subject to each grant. Options under the 2003 Israel Plan
are issued to Israeli employees, directors, consultants, advisers and service
providers of the Company and its subsidiaries. In accordance with the terms and
conditions imposed by Section 102 of the Israel Income Tax Ordinance, grantees
who receive options under the 2003 Israel Plan are afforded certain tax
benefits (excluding controlling shareholders of the Company or those who are
not employees or directors of the Company). The Company has elected the
benefits available under the capital gains alternative. There are various
conditions that must be met in order to qualify for these benefits, including
registration of the options in the name of a trustee for each of the employees
who is granted options. Each option, and any ordinary shares acquired upon the
exercise of the option, must be held by the trustee for a period commencing on
the date of grant and ending no earlier than 24 months after the end of the tax
year in which the option was granted and deposited in trust with the trustee. The
2003 Israel Plan provides for the options granted to have a maximum exercise
period of ten years from the date of grant. Options granted under the 2003
Israel Plan are generally exercisable over four years. Options that are not
exercised will become available for further grant by the Board under the 2003
Israel Plan.

As of March
30, 2006 there were outstanding options to purchase 305,239 ordinary shares.
All of these options were exercisable at exercise prices ranging from $2.50 to
$6.93 per share. The number of options held by directors and officers of the
Company as a group was 300,989, including options to purchase 194,739 ordinary
shares held by Mr. Burstin.

Ezchip Option Plans

Since
2000 EZchip has granted options to purchase its ordinary shares to key
employees, shareholders and directors pursuant to the Israeli and the U.S.
stock option plans (the 2000 Section 102 Share Option Plan, the 2003 Section
102 Share Option Plan and the 2001 U.S. Stock Option Plan), as an incentive
to attract and retain qualified personnel. Under these plans a total of
11,500,000 ordinary shares of EZchip are reserved and authorized for issuance.
Under the terms of these grants, options generally become exercisable over a
four-year period, commencing with the date of grant. The options generally
expire 7 to 10 years from the date of the grant, and are non-transferable,
except under the laws of succession. As of March 30, 2006 there were
outstanding options to purchase ordinary shares of EZchip representing approximately
11.9% of the share capital of EZchip on an as converted and fully diluted
basis. Approximately 20% of these options were held by directors and officers
of our company.

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

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

The
following table sets forth certain information as of March 30, 2005 concerning
the only persons or entities known to us to own beneficially more than 5% of
our companys outstanding ordinary shares:

|                                                                 |  |                        |         |         |  |  |    
|---------------------------------------------------------------- |  | ---------------------- | ------- | ------- |  |  | ---
|Name                                                             |  | Number of
Shares(1)(2) |         | Percent | 
|                                                                 |  |                        |         |         | 
|Eli Fruchter                                                     |  |                        | 610,596 |         |  |  | 5.2
|All directors and
  executive officers as a group (6 persons)(3) |  |                        | 911,585 |         |  |  | 7.3

|    |                                                                                                                                                                                                                                                                                                                                                                                    
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | The number of ordinary
  shares beneficially owned includes the shares issuable pursuant to stock options
  that are exercisable within 60 days of March 30, 2006. Shares issuable
  pursuant to stock options are deemed outstanding for computing the
  percentage of the person holding such options but are not outstanding for
  computing the percentage of any other person.
|   
|(2) | Based on the most recent
  13G and 13D filings.                                                                                                                                                                                                                                                                                                                                    
|   
|(3) | As of March 30, 2006 all
  directors and executive officers as a group (7 persons) held vested options
  exercisable into 300,989 Ordinary Shares at exercise prices ranging from
  $4.15 to $6.93. These options expire between November 2006 and December
  20013.                                                                                                               

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According
to our transfer agent, as of March 30, 2006 there were 45 holders of record of
our ordinary shares, including 32 holders of record residing in the United
States holding 10,542,586 ordinary shares, or 87.1% of the aggregate 12,102,627
ordinary shares outstanding as of such date. We believe that as of such date we
had approximately 5,500 beneficial shareholders.

|   |                           
|-- | --------------------------
|B. | RELATED PARTY TRANSACTIONS

In
May 2003 LanOptics executed an agreement with all of EZchips major
shareholders. Pursuant to the agreement, EZchips four major shareholders were
granted the right to exchange all their shares in EZchip for ordinary shares of
LanOptics, subject to the fulfillment of certain conditions (as fully describe
in Note 3 to our consolidated financial statements). The exchange ratio will be
calculated according to a formula determined by the parties, and will apply to
all series of EZchips shares without regard to any preferences of such shares.
The exchange right will expire upon the earlier of an initial public offering
of EZchips securities and the sale of all or substantially all of EZchips
assets or securities. As of March 30, 2006 none of the major shareholders have elected
to exercise their right.

In
early 2003 EZchip raised $13.5 million in a private placement of Series C
Preferred shares, of which amount we invested $2.3 million. The terms of the
Series C Preferred share financing also provided the investors in the private
placement with an option to invest up to another $8 million in the future. This
option was exercised on March 9, 2004, resulting in a follow-on Series C
Preferred share investment in EZchip in the amount of $8 million, of which we
invested $5.3 million. In July 2005 EZchip raised an additional $10.0 million
in a private placement of Series C Preferred shares, including a $6.9 million
investment by LanOptics.

|   |                                   
|-- | ----------------------------------
|C. | INTERESTS OF
  EXPERTS AND COUNSEL
|  
|   | Not
  applicable.                 

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

|   |                                                          
|-- | ---------------------------------------------------------
|A. | CONSOLIDATED
  STATEMENTS AND OTHER FINANCIAL INFORMATION

The
financial statements included under Item 18. Financial Statements and
Exhibits are incorporated herein by reference.

The
Financial Statement Schedules listed under the Rules of the Securities and
Exchange Commission but not included herein are omitted either because they are
not applicable, they are not required under the provisions of Regulation S-X or
the required information is included in the Consolidated Financial Statements
or the related notes thereto.

Export Sales

See
note 14b. to the financial statements

Legal Proceedings

We
are not a party to any litigation, other than litigation in the ordinary course
of business, which in the aggregate is not material to the business of our
company, and we are not aware of any threatened litigation, which in the
aggregate would be material to the business of the company.

48

---

---



Dividend Policy

We
anticipate that we will retain any future earnings to support operations and to
finance the growth and development of our business. In addition, tax-exempt
income attributable to our status as an approved enterprise under Israeli tax
law can be distributed to shareholders without subjecting us to taxes only upon
the complete liquidation of our company. Tax will be levied if we decide to
distribute such income in the future. Currently, we intend to reinvest the
amount of our tax-exempt income.

|   |                    
|-- | -------------------
|B. | SIGNIFICANT CHANGES

Except
as otherwise disclosed in this Annual Report, there has been no material change
in our financial position since December 31, 2005.

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

|   |                  
|-- | -----------------
|A. | LISTING
  DETAILS

Our
ordinary shares are quoted on the NASDAQ Capital Market (prior to April 14,
2003, the Companys ordinary shares were traded on The NASDAQ National Market)
and on the Tel Aviv Stock Exchange under the symbol LNOP. Our listing on the
Tel Aviv Stock Exchange was accomplished pursuant to special dual listing rules
applicable to companies that are traded on NASDAQ.

Set
forth below for each of the years indicated are the range of high and low
NASDAQ sales prices for our ordinary shares as reported by NASDAQ, and the high
and low sales prices (in U.S. dollars) on the Tel-Aviv Stock Exchange since
April 1, 2002. Stock prices on the Tel Aviv Stock Exchange are quoted in New
Israeli Shekels (NIS); the stock prices set forth below in U.S. dollars reflect
the translation into U.S. dollars based on the rate of exchange published by
the Bank of Israel on the dates in question.

|     |  |        |       |                           |   |      |  |     |       |  |   |      | 
|---- |  | ------ | ----- | ------------------------- | - | ---- |  | --- | ----- |  | - | ---- | 
|     |  | NASDAQ |       | TEL AVIV
  STOCK EXCHANGE |  
|     |  |        |       |                           |  
|Year |  | High   |       | Low                       |   | High |  | Low |      
|     |  |        |       |                           |   |      |  |     |      
|2000 |  | $      | 43.75 |                           | $ | 5.50 |  |     | --    |  |   | --   | 
|2001 |  | $      | 19.25 |                           | $ | 2.70 |  |     | --    |  |   | --   | 
|2002 |  | $      | 16.45 |                           | $ | 3.97 |  | $   | 14.86 |  | $ | 6.16 | 
|2003 |  | $      | 11.20 |                           | $ | 3.88 |  | $   | 11.10 |  | $ | 4.78 | 
|2004 |  | $      | 15.17 |                           | $ | 4.77 |  | $   | 14.79 |  | $ | 5.22 | 
|2005 |  | $      | 14.90 |                           | $ | 4.56 |  | $   | 14.41 |  | $ | 4.93 | 

49

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---



QUARTERLY STOCK INFORMATION

The
following table sets forth, for each of the full financial quarters in the
years indicated, the range of high ask and low bid prices of our ordinary
shares on the NASDAQ Stock Market and the Tel-Aviv Stock Exchange:

|                          |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|------------------------- |  | ------ | ----- | ----------------------- | - | ---- |  |  | - | ----- |  |  |  | - | ---- |  | 
|                          |  | NASDAQ |       | TEL AVIV STOCK EXCHANGE |  
|                          |  |        |       |                         |  
|2003                      |  |        |       |                         |   |      |  |  |   |       |  |  | 
|First quarter             |  | $      | 6.2   |                         | $ | 3.88 |  |  | $ | 6.86  |  |  |  | $ | 4.78 |  | 
|Second quarter            |  |        | 8.33  |                         |   | 4.47 |  |  |   | 8.17  |  |  |  |   | 4.86 |  | 
|Third quarter             |  |        | 9.8   |                         |   | 6.41 |  |  |   | 10.05 |  |  |  |   | 7.23 |  | 
|Fourth quarter            |  |        | 11.20 |                         |   | 8.50 |  |  |   | 11.10 |  |  |  |   | 8.94 |  | 
|                          |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|2004                      |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|First quarter             |  | $      | 15.17 |                         | $ | 7.11 |  |  | $ | 12.12 |  |  |  | $ | 7.95 |  | 
|Second quarter            |  |        | 8.90  |                         |   | 4.77 |  |  |   | 9.58  |  |  |  |   | 5.55 |  | 
|Third quarter             |  |        | 9.80  |                         |   | 6.41 |  |  |   | 6.77  |  |  |  |   | 5.22 |  | 
|Fourth quarter            |  |        | 11.20 |                         |   | 8.50 |  |  |   | 11.10 |  |  |  |   | 8.94 |  | 
|                          |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|2005                      |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|First quarter             |  | $      | 14.90 |                         | $ | 6.62 |  |  | $ | 14.41 |  |  |  | $ | 7.60 |  | 
|Second quarter            |  |        | 9.49  |                         |   | 6.60 |  |  |   | 9.37  |  |  |  |   | 6.86 |  | 
|Third quarter             |  |        | 8.69  |                         |   | 6.04 |  |  |   | 8.41  |  |  |  |   | 6.94 |  | 
|Fourth quarter            |  |        | 7.34  |                         |   | 4.56 |  |  |   | 7.05  |  |  |  |   | 4.93 |  | 
|                          |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|MONTHLY STOCK INFORMATION |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|                          |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|2005                      |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|October                   |  | $      | 7.34  |                         | $ | 5.83 |  |  | $ | 7.05  |  |  |  | $ | 6.29 |  | 
|November                  |  |        | 6.17  |                         |   | 4.56 |  |  |   | 6.30  |  |  |  |   | 4.83 |  | 
|December                  |  |        | 5.60  |                         |   | 4.85 |  |  |   | 5.35  |  |  |  |   | 4.93 |  | 
|                          |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|2006                      |  |        |       |                         |   |      |  |  |   |       |  |  |  |   |      |  | 
|January                   |  | $      | 6.84  |                         | $ | 5.02 |  |  | $ | 6.80  |  |  |  | $ | 5.25 |  | 
|February                  |  |        | 5.90  |                         |   | 5.15 |  |  |   | 6.16  |  |  |  |   | 5.36 |  | 
|March (thru March 29)     |  |        | 8.20  |                         |   | 5.68 |  |  |   | 7.89  |  |  |  |   | 5.95 |  | 

|   |                       
|-- | ----------------------
|B. | PLAN OF
  DISTRIBUTION
|   |                       
|   | Not
  applicable      
|   |                       
|C. | MARKETS               
|   |                       
|   | See A. above.         
|   |                       
|D. | SELLING SHAREHOLDERS  
|   |                       
|   | Not applicable.       
|   |                       
|E. | DILUTION              
|   |                       
|   | Not applicable.       
|   |                       
|F. | EXPENSE OF THE ISSUE  
|   |                       
|   | Not
  applicable.     

50

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

|   |                                         
|-- | ----------------------------------------
|A. | SHARE
  CAPITAL                         
|   |                                         
|   | Not
  applicable.                       
|   |                                         
|B. | MEMORANDUM
  AND ARTICLES OF ASSOCIATION

Objects and Purposes of the Company

We
are registered under the Israel Companies Law as a public company with the name
LanOptics Ltd. and registration number 52-003806-8. The objective stated in our
memorandum of association is to engage in any lawful activity.

Powers of the Directors

Pursuant
to the Israeli Companies Law and our articles of association, a director is
generally not permitted to participate in the discussion of, or to vote on, a
proposal, arrangement or contract in which he has a personal interest. Also,
the directors may not vote compensation to themselves or any members of their
body without the approval of our audit committee and our shareholders at a
general meeting. The requirements for approval of certain transactions are set
forth above in Item 6. Directors, Senior Management and Employees; Directors
and Senior Management; Approval of Certain Transactions. The power of our
directors to enter into borrowing arrangements on our behalf is limited to the
same extent as any other transaction by us.

Rights Attached to Ordinary Shares

Our
authorized share capital consists of 30,000,000 ordinary shares, par value NIS
0.02 per share. Holders of ordinary shares have one vote per share, and are
entitled to participate equally in the payment of dividends and share
distributions and, in the event of our liquidation, in the distribution of
assets after satisfaction of liabilities to creditors. No preferred shares are
currently authorized. All outstanding ordinary shares are validly issued and
fully paid. The rights of our ordinary shares may be cancelled, added to,
restricted, amended or otherwise altered with a vote of the holders of at least
75% of the outstanding ordinary shares voting at a duly convened shareholders
meeting.

Transfer of Shares and Notices

Fully
paid ordinary shares are issued in registered form and may be freely
transferred under our articles of association unless the transfer is restricted
or prohibited by another instrument. Under Israeli law and our articles of
association, each shareholder of record is entitled to receive at least 21
days prior notice of any shareholders meeting. For purposes of determining
the shareholders entitled to notice and to vote at such meeting, the Board of
Directors may fix the record date, which shall be not more than forty nor less
than four days prior to the date of the meeting.

51

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Dividend and Liquidation Rights

We
may declare a dividend to be paid to the holders of ordinary shares according
to their rights and interests in our profits. In the event of our liquidation,
after satisfaction of liabilities to creditors, our assets will be distributed to
the holders of ordinary shares in proportion to the nominal value of their
holdings. This right may be affected by the grant of preferential dividend or
distribution rights to the holders of a class of shares with preferential
rights that may be authorized in the future. Pursuant to Israels securities
laws, a company registering its shares for trade on the Tel Aviv Stock Exchange
may not have more than one class of shares for a period of one year following
registration, after which it is permitted to issue preferred shares, if the
preference of those shares is limited to a preference in the distribution of
dividends and these preferred shares have not voting rights. Under the Israeli
Companies Law, the declaration of a dividend does not require the approval of
the shareholders of the company, unless the companys articles of association
require otherwise. Our articles of association provide that the board of
directors may declare and distribute interim dividends without the approval of
the shareholders, but the payment of a final dividend requires shareholder
approval.

Annual and Extraordinary General Meetings

We
must hold our annual general meeting of shareholders each year no later than 15
months from the last annual meeting, at a time and place determined by the
board of directors, upon at least 21 days prior notice to our shareholders. A
special meeting may be convened by request of two directors or by written
request of one or more shareholders holding at least 5% of our issued share capital
and 1% of the voting rights or one or more shareholders holding at least 5% of
the voting rights. Shareholders requesting a special meeting must submit their
proposed resolution with their request.

The
quorum required for a meeting of shareholders consists of at least two
shareholders present in person or by proxy who hold at least 50% of the issued
share capital. A meeting adjourned for lack of a quorum generally is adjourned
to the same day in the following week at the same time and place or any time
and place as the Chairman may determine with the consent of the holders of a
majority of the voting power represented at the meeting in person or by proxy
and voting on the question of adjournment. At the reconvened meeting, the
required quorum consists of any two members present in person or by proxy.

Voting Rights

Our
ordinary shares do not have cumulative voting rights in the election of
directors. As a result, the holders of ordinary shares that represent more than
50% of the voting power represented at a shareholders meeting have the power to
elect all of our directors, except the outside directors whose election
requires a special majority.

Holders
of ordinary shares have one vote for each Ordinary Share held on all matters
submitted to a vote of shareholders. Shareholders may vote in person or by
proxy. These voting rights may be affected by the grant of any special voting
rights to the holders of a class of shares with preferential rights that may be
authorized in the future.

Under
the Companies Law, all shareholders meetings require prior notice of at least
21 days. Our articles of association provide that most decisions may be made by
a simple majority, although certain resolutions, referred to as special resolutions
(for example, changes to the articles of association) require approval of at
least 75% of the shares present and voting on the matter. See Item 6.
Directors, Senior Management and Employees; Directors and Senior Management;
Approval of Certain Transactions; Obligations of Directors, Officers and
Shareholders above for certain duties of shareholders towards the company.

52

---

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Limitations on The Rights to Own Securities

The
ownership or voting of ordinary shares by non-residents of Israel is not
restricted in any way by our articles of association or the laws of the State
of Israel, except that nationals of countries which are, or have been, in a
state of war with Israel may not be recognized as owners of ordinary shares.

Anti-Takeover Provisions Under Israeli Law

The
Israeli Companies Law provides that an acquisition of shares in a public
company must be made by means of a tender offer if as a result of the
acquisition the purchaser would hold more than 25% of the voting rights in the
company, unless there is already another shareholder of the company with 25% or
more of the voting rights. Similarly, the Israeli Companies Law provides that
an acquisition of shares in a public company must be made by means of a tender
offer if as a result of the acquisition the purchaser would hold more than 45%
of the voting rights in the company, unless there is a shareholder with 45% or
more of the voting rights in the company. These rules do not apply if the
acquisition is made by way of a merger. Regulations promulgated under the
Companies Law provide that these tender offer requirements do not apply to
companies whose shares are listed for trading outside of Israel if, according
to the law in the country in which the shares are traded, including the rules
and regulations of the stock exchange or which the shares are traded, either:

|  |                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------
| | there is a
  limitation on acquisition of any level of control of the company; or                                    
|  |                                                                                                                      
| | the
  acquisition of any level of control requires the purchaser to do so by means
  of a tender offer to the public.

Finally,
in general, Israeli tax law treats stock-for-stock acquisitions less favorably
than does U.S. tax law. Israeli tax law has been amended to provide for tax
deferral in specified acquisitions, including transactions where the
consideration for the sale of shares is the receipt of shares of the acquiring
company. Nevertheless, Israeli tax law may subject a shareholder who exchanges
his ordinary shares for shares in a foreign corporation to immediate taxation
or to taxation before his investment in the foreign corporation becomes liquid.

Exemption From NASDAQ Corporate Governance
Rules

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

53

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|   |                     
|-- | --------------------
|C. | MATERIAL
  CONTRACTS
|   |                     
|   | Not
  applicable.   
|   |                     
|D. | EXCHANGE CONTROLS   

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

Until
May 1998 Israel imposed extensive restrictions on transactions in foreign
currency. These restrictions were largely lifted in May 1998. Since January 1,
2003 all exchange control restrictions have been eliminated (although there are
still reporting requirements for foreign currency transactions). Legislation
remains in effect, however, pursuant to which currency controls can be imposed
by administrative action at any time.

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

ISRAELI TAX CONSIDERATIONS

The
following is a summary of the principal Israeli tax laws applicable to us, of
the Israeli Government programs from which we benefit, and of Israeli foreign
exchange regulations. This section also contains a discussion of material
Israeli tax consequences to our shareholders who are not residents or citizens
of Israel. This summary does not discuss all 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 investors subject to special treatment
under Israeli law include residents of Israel, traders in securities, or
persons who 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 new tax legislation that
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 consequences.

You
are urged to consult your own tax advisor as to the Israeli and other tax
consequences of the purchase, ownership and disposition of our ordinary shares,
including, in particular, the effect of any non-Israeli, state or local taxes.

General
corporate tax structure in Israel

Israeli
companies were generally subject to corporate tax at the rate of 34% of their
taxable income in 2005. Pursuant to tax reform legislation that came into
effect in 2003, the corporate tax rate is to undergo further staged reductions
to 25% by the year 2010. In order to implement these reductions, the corporate
tax rate is scheduled to decline to 31% in 2006, 29% in 2007, 27% in 2008, and
26% in 2009.

54

---

---



As
discussed below, however, the rate is effectively reduced for income derived
from an Approved Enterprise.

Law
for the Encouragement of Capital Investments, 1959

Our
facilities in Israel have been granted Approved Enterprise status under the Law
for the Encouragement of Capital Investments, 1959, commonly referred to as the
Investment Law. The Investment Law provides that capital investments in a
production facility (or other eligible assets) may be designated as an Approved
Enterprise. Until recently, the designation required advance approval from the
Investment Center of the Israel Ministry of Industry, Trade and Labor (the
Investment Center). Each certificate of approval for an Approved Enterprise
relates to a specific investment program, delineated both by the financial
scope of the investment and by the physical characteristics of the facility or
the asset.

A
company that owns an Approved Enterprise is eligible for governmental grants,
but may elect to receive an alternative package comprised of tax benefits
(Alternative Track). Under the alternative package, a companys undistributed
income derived from an Approved Enterprise is exempt from corporate tax for an
initial period (two to ten years, depending on the geographic location of the
Approved Enterprise within Israel). The exemption begins in the first year that
the company realizes taxable income from the Approved Enterprise.

After
expiration of the initial tax exemption period, the company is
eligible for a reduced corporate tax rate of 10% to 25% for the following five to eight years, depending on the
extent of foreign investment in the company (as shown in the table below). The
benefits period is limited to 12 years from completion of the investment under
the approved plan or 14 years from the date of the approval, whichever is
earlier. A company in which more than 25% of the shareholders are non-residents
of Israel, defined in the Investment Law as a Foreign Investors Company, may be
eligible for benefits for an extended period of up to ten years.

The tax
benefits derived from any certificate of approval relate only to taxable income
attributable to the specific Approved Enterprise. To the extent we have more
than one approval or only a portion of our capital investments are approved,
our effective tax rate will be the result of a weighted combination of the
applicable rates.

|                               |  |                       |  |                    |  |                    
|------------------------------ |  | --------------------- |  | ------------------ |  | -------------------
|Percent of
  Foreign Ownership |  | Rate of
  Reduced Tax |  | Reduced Tax Period |  | Tax ExemptionPeriod
|                               |  |                       |  |                    |  |                    
|0-25%                          |  | 25%                   |  | 5 years            |  | 2 years            
|25-49%                         |  | 25%                   |  | 8 years            |  | 2 years            
|49-74%                         |  | 20%                   |  | 8 years            |  | 2 years            
|74-90%                         |  | 15%                   |  | 8 years            |  | 2 years            
|90-100%                        |  | 10%                   |  | 8 years            |  | 2 years            

If a
company distributes dividends from tax-exempt Approved Enterprise income, the
company will be taxed on the otherwise exempt income at the same reduced
corporate tax rate that applies to it after the initial exemption period. Distribution
of dividends derived from Approved Enterprise income that was taxed at reduced
rates, but not tax exempt, does not result in additional tax consequences to
the company. Shareholders who receive dividends derived from Approved
Enterprise income are generally taxed at a rate of 15%, which is withheld and
paid by the company paying the dividend, if the dividend is distributed during
the benefits period or within the following 12 years (but the 12-year
limitation does not apply to a Foreign Investors Company).

55

---

---



Currently,
we have one Approved Enterprise program under the alternative track of the
Investment Law. We have derived, and expect to continue to derive, a
substantial portion of our operating income from our Approved Enterprise facilities.
We are therefore eligible for a tax exemption for a limited period on
undistributed Approved Enterprise income, and an additional subsequent period
of reduced corporate tax rates ranging between 10% and 25%, depending on the
level of foreign ownership of our shares. The tax benefits attributable to our
current Approved Enterprises are scheduled to expire by 2013. We intend to
continue to apply for Approved Enterprise programs, but we cannot assure you
that we will do so or that we will be successful. We intend to reinvest the
entire amount of our tax-exempt income and not to distribute this income as a
dividend.

The
benefits available to an Approved Enterprise are conditioned upon terms
stipulated in the Investment Law and the related regulations (which include
making specified investments in property and equipment, and financing a
percentage of these investments with share capital), and the criteria set forth
in the applicable certificate of approval. If we do not fulfill these
conditions in whole or in part, the benefits can be cancelled and we may be
required to refund the amount of the benefits, linked to the Israeli consumer
price index plus interest. We believe that our Approved Enterprise programs
currently operate in compliance with all applicable conditions and criteria,
but we cannot assure you that they will continue to do so.

On April 1,
2005 an amendment to the Investment Law came into effect, in which it revised
the criteria for investments qualified to receive tax benefits. An eligible
investment program under the amendment will qualify for benefits as a
Privileged Enterprise (rather than the previous terminology of Approved
Enterprise). Among other things, the amendment provides tax benefits to both
local and foreign investors and simplifies the approval process. The amendment
does not apply to investment programs approved prior to December 31, 2004. The
new tax regime will apply to new investment programs only.

As a result
of the amendment, tax-exempt income generated under the provisions of the new
law 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. As of December 31, 2005, the Company had not generated any
income under the provisions of the new law.

Law
for the Encouragement of Industry (Taxes), 1969

We believe
that we currently qualify as an Industrial Company within the meaning of the
Law for the Encouragement of Industry (Taxes), 1969 (the Industrial
Encouragement Law). The Industrial Encouragement Law defines an Industrial
Company as a company that is resident in Israel and that derives at least 90%
of its income in any tax year, other than income from defense loans, capital
gains, interest and dividends, from an enterprise whose major activity in a
given tax year is industrial production.

The
following are the principal corporate tax benefits that are available to
Industrial Companies:

| |  | amortization
of the cost of purchased know-how and patents over an   eight-year period for tax
purposes,
| | - | --------------------------------------------------------------------------------------------------------

56

---

---



| |  | accelerated
depreciation rates on equipment and buildings,
| | - | ----------------------------------------------------------

| |  | under
specified conditions, an election to file consolidated tax   returns with related Israeli
Industrial Companies, and
| | - | -------------------------------------------------------------------------------------------------------------------------

| |  | expenses
related to a public offering are deductible in equal amounts   over three years.
| | - | -----------------------------------------------------------------------------------------

Eligibility
for the benefits under the Industry Encouragement Law is not subject to receipt
of prior approval from any governmental authority. We cannot assure you that we
qualify or will continue to qualify as an Industrial Company or that the
benefits described above will be available in the future.

Special
provisions relating to taxation under inflationary conditions

We
measure our taxable income in accordance with the Income Tax Law (Inflationary
Adjustments), 1985, or the Inflationary Adjustments Law, which represents an
attempt to overcome the problems presented to a traditional tax system by an
economy undergoing rapid inflation. Results of the Company for tax purposes are
measured in terms of earning in NIS after certain adjustments for changes in
the Israeli consumer price index. The Inflationary Adjustments Law is highly
complex.

Stamp
tax

Under
Israels Stamp Tax on Documents Law, certain documents are subject to stamp
tax. In 2004, however, the tax authorities began an enforcement campaign
involving extensive audits of companies compliance with the stamp tax
obligation with respect to all agreements which had been signed since June
2003. The Company has received legal advice that there are a variety of
defenses relating to the obligation to pay stamp tax or to the amount to be
paid. The Companys management believes that applicable provision in the
financial statements as of December 31, 2005 is adequate to cover probable
costs arising from this matter.

Effective
January 1, 2006, stamp tax has been cancelled.

Taxation
of non-Israeli shareholders on receipt of dividends

Under
Israeli tax law, a distribution of dividends from income attributable to an
Approved Enterprise will be subject to tax in Israel at the rate of 15%, which
is withheld and paid by the company paying the dividend, if the dividend is
distributed during the benefits period or within the following 12 years (but
the 12-year limitation does not apply to a Foreign Investors Company). Any
distribution of dividends from income that is not attributable to an Approved
Enterprise will be subject to tax in Israel at the rate of 25%, except that dividends
distributed on or after January 1, 2006 to an individual who is deemed a
non-substantial shareholder will be subject to tax at the rate of 20%.

Under the
United States-Israel tax treaty, the maximum tax on dividends paid to a holder
of the ordinary shares who is a United States resident is 25%. Dividends
received by a United States company that holds at least 10% of our voting
rights will be subject to withholding tax at the rate of 12.5%, provided
certain other conditions in the tax treaty are met (or at the tax rate of 15%
in respect of dividends paid from income attributable to our Approved
Enterprises).

57

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Capital
gains taxes applicable to non-Israeli shareholders

Capital
gains from the sale of our ordinary shares by non-Israeli shareholders are
exempt from Israeli taxation, provided that the capital gain is not derived
from a permanent establishment in Israel. In addition, the United States-Israel
tax treaty exempts United States residents who hold less than 10% of our voting
rights, and who held less than 10% of our voting rights during the 12 months
prior to a sale of their shares, from Israeli capital gains tax in connection
with such sale.

Foreign
exchange regulations

Dividends,
if any, paid to the holders of our ordinary shares, and any amounts payable
upon our dissolution, liquidation or winding up, as well as the proceeds of any
sale in Israel of our ordinary shares to an Israeli resident, may be paid in
non-Israeli currency. If these amounts are paid in Israeli currency, they may
be converted into freely repatriable U.S. dollar at the rate of exchange
prevailing at the time of conversion. In addition, the statutory framework for
the potential imposition of exchange controls has not been eliminated, and may
be restored at any time by administrative action.

U.S. FEDERAL INCOME TAX CONSIDERATIONS

The
following summary sets forth the material U. S. federal income tax consequences
applicable to the following persons who purchase, hold or dispose of the ordinary
shares (U.S. Shareholders): (i) citizens or residents (as defined for U.S.
federal income tax purposes) of the United States; (ii) corporations, or other
entities taxable as corporations for U.S. federal income tax purposes, created
or organized in or under the laws of the United States or any political
subdivision thereof; (iii) estates, the income of which is subject to U. S.
federal income taxation regardless of its source; and (iv) trusts, if (a) a
U.S. court is able to exercise primary supervision over its administration and
(b) one or more U.S. persons have the authority to control all of its
substantial decisions. This discussion is based on the provisions of the U. S.
Internal Revenue Code of 1986, as amended, or the Code, U. S. Treasury Regulations
promulgated thereunder and administrative and judicial interpretations thereof,
all as in effect as of the date of this Annual Report, and all of which are
subject to change either prospectively or retroactively. This discussion
generally considers only U.S. Shareholders that will hold the ordinary shares
as capital assets for U.S. federal income tax purposes and does not consider
(a) all aspects of U.S. federal income taxation that may be relevant to
particular U.S. Shareholders by reason of their particular circumstances
(including potential application of the alternative minimum tax), (b) U.S.
Shareholders subject to special treatment under the U.S. federal income tax
laws, such as financial institutions, insurance companies, broker-dealers, tax-exempt
organizations, (c) U.S. Shareholders owning, directly or by attribution, 10% or
more of the LanOptics outstanding voting shares, (d) U.S. Shareholders who
hold the ordinary shares as part of a hedging, straddle or conversion
transaction, or appreciated financial position, (e) U.S. Shareholders who
acquire their ordinary shares in a compensatory transaction, (f) U.S.
Shareholders whose functional currency is not the U.S. dollar, or (g) any
aspect of state, local or non-U. S. tax law.

If
a partnership or an entity treated as a partnership for U.S. federal income tax
purposes owns ordinary shares, the U.S. federal income tax treatment of a
partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
ordinary shares.

58

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THE
FOLLOWING SUMMARY DOES NOT ADDRESS THE IMPACT OF A U.S. SHAREHOLDERS
INDIVIDUAL TAX CIRCUMSTANCES. ACCORDINGLY, EACH U.S. SHAREHOLDER SHOULD CONSULT
HIS OR HER TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO HIM OR HER OF
AN INVESTMENT IN THE ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE
STATE, LOCAL OR NON-U.S. TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.

Distributions Paid on the Ordinary Shares

A
U.S. Shareholder generally will be required to include in gross income as
dividend income, the amount of any distributions paid in respect of the
ordinary shares (including the amount of any Israeli taxes withheld therefrom)
to the extent that such distributions are paid out of the LanOptics current or
accumulated earnings and profits as determined for U.S. federal income tax
purposes. Distributions in excess of such earnings and profits will be treated
first as a non-taxable return of capital reducing the U.S. Shareholders tax
basis in the ordinary shares to the extent of the distributions, and then as
capital gain from a sale or exchange of such ordinary shares. Such dividends
will generally not qualify for the dividends received deduction available to
corporations. The amount of any cash distribution paid in NIS will equal the
U.S. dollar value of the distribution, calculated by reference to the spot
exchange rate in effect on the date of the distribution, regardless of whether
the payment is in fact converted into U.S. dollars on that day. A U.S.
Shareholder generally will recognize foreign currency gain or loss (which is
treated as ordinary income or loss from sources within the United States) upon
the subsequent disposition of the NIS.

Subject
to certain conditions and complex limitations, any Israeli tax withheld or paid
with respect to dividends on the ordinary shares will generally be eligible for
credit against a U.S. Shareholders U. S. federal income tax liability at such
U.S. Shareholders election. The Code provides limitations on the amount of
foreign tax credits that a U.S. Shareholder may claim, including extensive
separate computation rules under which foreign tax credits allowable with
respect to specific categories of income cannot exceed the U. S. federal income
taxes otherwise payable with respect to each such category of income. U.S.
Shareholders that do not elect to claim a foreign tax credit may instead claim
a deduction for Israeli income tax withheld or paid, but only for a year in
which such U.S. Shareholders elect to do so for all non-U.S. income taxes.
Dividends with respect to the ordinary shares will generally be classified as
foreign source passive income for the purpose of computing a U.S.
Shareholders foreign tax credit limitations for U.S. foreign tax credit
purposes. U.S. Shareholders should note that recently enacted legislation
eliminates the financial services income category with respect to taxable
years beginning after December 31, 2006. Under this legislation, the foreign
tax credit limitation categories will be limited to passive category income and
general category income. Further, there are special rules for computing the
foreign tax credit limitation of a taxpayer who receives dividends subject to a
reduced tax rate, see discussion below. The rules relating to foreign tax
credits are complex, and each U.S. Shareholder should consult his or her tax
advisor to determine whether he or she would be entitled to this credit.

59

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Subject
to certain limitations, qualified dividend income received by a noncorporate
U.S. Holder in tax years beginning on or before December 31, 2008 will be
subject to tax at a reduced maximum tax rate of 15 percent. Distributions
taxable as dividends paid on the ordinary shares should qualify for the 15
percent rate provided that either: (i) LanOptics is entitled to benefits under
the income tax treaty between the United States and Israel (the Treaty) or
(ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that LanOptics is entitled to benefits under the Treaty and that the ordinary
shares currently are readily tradable on an established securities market in
the United States. However, no assurance can be given that the ordinary shares
will remain readily tradable. The rate reduction does not apply unless certain
holding period requirements are satisfied. With respect to the ordinary shares,
the U.S. Holder must have held such shares for at least 61 days during the
121-day period beginning 60 days before the ex-dividend date. The rate
reduction also does not apply to dividends received from passive foreign
investment companies, see discussion below, or in respect of certain hedged
positions or in certain other situations. The legislation enacting the reduced
tax rate contains special rules for computing the foreign tax credit limitation
of a taxpayer who receives dividends subject to the reduced tax rate. U.S.
Holders of ordinary shares should consult their own tax advisors regarding the
effect of these rules in their particular circumstances.

Sale, Exchange or Other Disposition of the
Ordinary Shares

The
sale, exchange or other disposition of ordinary shares will generally result in
the recognition of capital gain or loss in an amount equal to the difference
between the amount realized on the sale or exchange and the U.S. Shareholders
tax basis in the ordinary shares (determined in U.S. dollars). Such gain or
loss generally will be long-term capital gain or loss if the U.S. Shareholders
holding period of the ordinary shares exceeds one year at the time of the
disposition. Gain or loss recognized by a U.S. Shareholder on a sale or
exchange of ordinary shares generally will be treated as U.S. source gain or
loss for U.S. foreign tax credit purposes. Under the United States- Israel Tax
Treaty, gain derived from the sale, exchange or other disposition of ordinary
shares by a holder who is a resident of the United States for purposes of the
treaty and who sells the ordinary shares within Israel may be treated as foreign
source income for U.S. foreign tax credit purposes.

In
the case of a cash basis U.S. Shareholder who receives NIS in connection with
the sale or disposition of ordinary shares, the amount realized will be based
on the U.S. dollar value of the NIS received with respect to the ordinary
shares as determined on the settlement date of such exchange. A U.S.
Shareholder who receives payment in NIS and converts NIS into United States
dollars at a conversion rate other than the rate in effect on the settlement
date may have a foreign currency exchange gain or loss that would be treated as
ordinary income or loss.

An
accrual basis U.S. shareholder may elect the same treatment required of cash
basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue
Service. In the event that an accrual basis U.S. Shareholder does not elect to be
treated as a cash basis taxpayer (pursuant to the Treasury regulations
applicable to foreign currency transactions), such U.S. Shareholder may have a
foreign currency gain or loss for U.S. federal income tax purposes because of
differences between the U.S. dollar value of the currency received prevailing
on the trade date and the settlement date. Any such currency gain or loss would
be treated as ordinary income or loss and would be in addition to gain or loss,
if any, recognized by such U.S. Shareholder on the sale or disposition of such
ordinary shares.

Passive Foreign Investment Company Status

For
U.S. federal income tax purposes, a foreign corporation will be classified as a
passive foreign investment company, or a PFIC, if, for any taxable year, either
(i) 75% or more of its gross income in the taxable year is passive income, or
(ii) 50% or more of the average value of its gross assets in the taxable year,
calculated quarterly by value, produce or are held for the production of,
passive income. For this purpose, passive income includes dividends, interest,
royalties, rents, annuities and the excess of gain over losses from the
disposition of assets, which produce passive income.

60

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Although
not free from doubt, based on our current and projected income, assets and
activities, we believe that we are not currently a PFIC nor do we expect to
become a PFIC in the foreseeable future. However, there can be no assurance
that we will not in fact be considered to be a PFIC for our current taxable
year or any other subsequent year because (i) the determination of whether or
not we are a PFIC will be based on the composition of our income and assets and
can be definitively made only after the end of each taxable year, (ii) the
value of our stock has been volatile historically, (iii) we own substantial
amount of assets such as cash and marketable securities which are considered as
passive asset for purposes of the PFIC rules and (iv) the legal and financial
analysis to determine whether a company is a PFIC is not entirely clear.
Therefore, there is no assurance that our belief regarding PFIC status will not
be challenged by the U.S. Internal Revenue Service, or the IRS, or that a court
will not sustain such challenge.

If
we were a PFIC for any taxable year during a U.S. Shareholders holding period,
and the U.S. Shareholder did not timely elect to treat the Company as a
qualified electing fund under Section 1295 of the Code or elect to mark to
market the ordinary shares (each as discussed below), a U.S. Shareholder would
be subject to special tax rules on the receipt of an excess distribution on
the ordinary shares (generally, a distribution to the extent it exceeds 125% of
the average annual distributions in the prior three years) and on gain from the
disposition of the ordinary shares. Under these rules, the excess distribution
and any gain would be allocated ratably over the U.S. Shareholders holding
period in the ordinary shares, the amount allocated to the current taxable year
and any taxable year prior to the first taxable year in which we are a PFIC
would be taxed as ordinary income, the amount allocated to each of the other
taxable years would be subject to tax at the highest marginal rate in effect
for the applicable class of taxpayer for that year, and an interest charge for
the deemed deferral benefit would be imposed on the resulting tax allocated to
such other taxable years. The tax liability with respect to amounts allocated
to years prior to the year of the disposition or excess distribution would
not be offset by any net operating losses. Additionally, if we are deemed to be
a PFIC, a U.S. Shareholder who acquires our ordinary shares from a decedent
generally will be denied the normally available step-up in tax basis to fair
market value for the ordinary shares at the date of the death, and instead will
have a tax basis equal to the decedents tax basis if lower than fair market
value.

U.S.
Shareholders may avoid taxation under the rules described above by making (i) a
qualified electing fund election for the first taxable year in which we are a
PFIC to include such U.S. Shareholders share of our ordinary earnings and net
capital gain on a current basis or (ii) a deemed sale election in a
subsequent year, along with a qualified electing fund election, if we are still
classified as a PFIC. A qualified electing fund election remains in effect
until revoked by the IRS. You will not be to make a qualified electing fund
election unless we comply with certain applicable information reporting
requirements.

61

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U.S.
Shareholders holding marketable stock (which we consider our ordinary shares
to be) in a PFIC may make an election to mark-to-market the ordinary shares
annually, rather than be subject to the above-described rules. Under such
election, the U.S. Shareholder will include in income each year any excess of
the fair market value of the PFIC stock at the close of each taxable year over
the U.S. Shareholders adjusted basis in such stock. The U.S. Shareholder will
generally be allowed an ordinary deduction for the excess, if any, of the
adjusted basis of the PFIC stock over its fair market value 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. Shareholder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
amounts included in income pursuant to a mark-to-market election, as well as
gain on the actual sale or other disposition of the PFIC stock, are treated as
ordinary income. Ordinary loss treatment also applies to any loss recognized on
the actual sale or disposition of PFIC stock to the extent that the amount of
such loss does not exceed the net mark-to-market gains previously included with
respect to such stock. Gain or loss from the disposition of ordinary shares (as
to which a mark-to-market election was made) in a year in which we are no
longer a PFIC, will be capital gain or loss. An election to mark-to-market
generally will apply to the taxable year in which the election is made and all
subsequent taxable years.

If
a U.S. Shareholder makes one of these two elections, distributions and gain
generally will not be recognized ratably over the U.S. Shareholders holding
period or be subject to an interest charge as described above. Further, the
denial of basis step-up at death described above generally will not apply. A U.S.
Shareholder making one of these two elections may experience current income
recognition, even if no cash is distributed by us.

We
will notify U.S. Shareholders in the event that we conclude that we will be
treated as a PFIC for any taxable year and will provide these U.S. Shareholders
with such information as is necessary to enable these U.S. Shareholders to
elect to treat us as a qualified electing fund for U.S. federal income tax
purposes or to elect to mark-to-market the ordinary shares.

BOTH
ELECTIONS ARE SUBJECT TO A NUMBER OF SPECIFIC RULES AND REQUIREMENTS, AND U.S.
SHAREHOLDERS ARE STRONGLY URGED TO CONSULT THEIR TAX ADVISORS CONCERNING THESE
ELECTIONS IF WE BECOME A PFIC.

Backup Withholding and Information Reporting

Under
certain circumstances, U.S information reporting and/or backup withholding of
U.S. federal income tax (currently at the rate of 28%) on dividends received
on, and the proceeds of the dispositions of, the ordinary shares may apply to
U.S. Shareholders. A backup withholding tax may apply to such payments if the
beneficial owner fails to provide a correct taxpayer identification number to
the paying agent and to comply with certain certification procedures or
otherwise establish an exemption from backup withholding. Backup withholding
tax will be allowed as a refund or credit against the U.S. Shareholders U.S.
federal income tax liability, provided that certain required information is
furnished to the IRS.

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

62

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We
are subject to certain of the information reporting requirements of the
Securities and Exchange Act of 1934, as amended. As a foreign private issuer,
we are exempt from the rules and regulations under the Securities Exchange Act
prescribing the furnishing and content of proxy statements, and our officers,
directors and principal shareholders are exempt from the reporting and
short-swing profit recovery provisions contained in Section 16 of the
Securities Exchange Act, with respect to their purchase and sale of the
ordinary shares. In addition, we are not required to file reports and financial
statements with the Securities and Exchange Commission as frequently or as
promptly as U.S. companies whose securities are registered under the Securities
Exchange Act. However, we will file with the Securities and Exchange Commission
an annual report on Form 20-F containing financial statements audited by an independent
accounting firm. We will also furnish quarterly reports on Form 6-K containing
unaudited financial information after the end of each of the first three
quarters. We post our Annual Report on Form 20-F on our Website
(www.lanoptics.com) promptly following the filing of our Annual Report with the
Securities and Exchange Commission.

This
report and other information filed or to be filed by us can be inspected and
copied at the public reference facilities maintained by the Securities and Exchange
Commission at:

| |                         
| | ------------------------
| | 100 F
  Street, NE      
| | Public
  Reference Room 
| | Washington,
  D.C. 20549

Copies
of these materials can also be obtained from the Public Reference Section of
the Securities and Exchange Commission, 100 F Street, NE, Washington, D.C.
20549, at prescribed rates.

The
Securities and Exchange Commission maintains a Web site at www.sec.gov that
contains reports, proxy and information statements, and other information
regarding registrants that make electronic filings with the Securities and
Exchange Commission using its EDGAR system.

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

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

General

The
currency of our primary economic environment is the dollar. However, we have
balances and activities in other currencies, mainly NIS. We are therefore
exposed to market risks arising from changes in currency exchange rates. We are
also exposed to market risks arising from changes in interest rates.

Exchange Rate Risk Management

Our
functional currency and that of EZchip is the dollar. Accordingly, we attempt
to protect ourselves against exposure arising from the difference between
assets and liabilities in NIS and the dollar, or Balance Sheet Exposure. We
strive to limit our exposure through natural hedging, i.e., attempting to
maintain similar levels of assets and liabilities in any given currency, to the
extent possible. However, this method of natural hedging is not always
achievable.

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Interest Rate Risk Management

Due
to the existence of assets with different interest rates and maturity dates, we
are exposed to changes in interest rates. Currently Our portfolio is composed
mainly of (i) fixed income assets, including U.S. Government and Corporate
Obligations, rated A-AAA and bearing annual interest rates in the range of 2.5%
- 3.5%, with maturities in the range of 3 to 12 months; and (ii) short term
managed liquidity funds bearing annual interest rates in the range of 3.0% -
4.0%.

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

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PART II

|         |                                                                             
|-------- | ----------------------------------------------------------------------------
|ITEM 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                             
|         |                                                                             
|         | None                                                                        
|         |                                                                             
|ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
|         |                                                                             
|         | Not
  applicable.                                                           
|         |                                                                             
|ITEM 15. | CONTROLS AND PROCEDURES                                                     

Our
management, including our chief executive officer and chief financial officer,
evaluated the effectiveness of our disclosure controls and procedures (as
defined in Exchange Act Rule 13a-15(e)) as of the end of the period
covered by this annual report on Form 20-F. Based upon that evaluation,
our chief executive officer and chief financial officer have concluded that, as
of such date, our disclosure controls and procedures were effective to ensure
that information required to be disclosed by our company in reports that we
file or submit under the U.S. Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms and that such
information was made known to them by others within the company, as appropriate
to allow timely decisions regarding required disclosure.

All
internal control systems no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective may not
prevent or detect misstatements and can provide only reasonable assurance with
respect to financial statement preparation and presentation. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.

|          |                                 
|--------- | --------------------------------
|ITEM 16.  | [RESERVED]                      
|          |                                 
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT

Our
Board of Directors has determined that Karen Sarid meets the definition of an
audit committee financial expert, as defined in Item 401 of Regulation S-K.

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

We
have adopted a code of ethics that applies to our chief executive officer and
all senior financial officers of our company, including the chief financial
officer, chief accounting officer or controller, or persons performing similar
functions. Written copies are available upon request. If we make any
substantive amendment to the code of ethics or grant any waivers, including any
implicit waiver, from a provision of the codes of ethics, we will disclose the
nature of such amendment or waiver on our website.

65

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|          |                                       
|--------- | --------------------------------------
|ITEM 16C. | PRINCIPAL ACCOUNTING FEES AND SERVICES

Fees Paid To Independent Public Accountants

The
following table sets forth the fees billed by our independent public
accountants for professional services rendered during each of the years
indicated and the percentage of each of the fees out of the total amount paid
to the accountants.

|                    |  |                         |        |             |  |      |     |             |  |   |         |  |  |  |     |   | 
|------------------- |  | ----------------------- | ------ | ----------- |  | ---- | --- | ----------- |  | - | ------- |  |  |  | --- | - | 
|                    |  | Year Ended December 31, |       
|                    |  |                         |       
|                    |  | 2004                    |        | 2005        | 
|                    |  |                         |        |             | 
|Services
  Rendered |  | Fees                    |        | Percentages |  | Fees |     | Percentages | 
|                    |  |                         |        |             |  |      |     |             | 
|Audit (1)           |  | $                       | 48,000 |             |  |      | 71  | %           |  | $ | 68,000  |  |  |  | 53  | % | 
|Audit-related
  (2) |  |                         | 20,000 |             |  |      | 29  | %           |  |   | 42,000  |  |  |  | 33  | % | 
|Tax (3)             |  |                         |       |             |  |      |    |             |  |   | 18,000  |  |  |  | 14  | % | 
|Total               |  |                         | 68,000 |             |  |      | 100 | %           |  |   | 128,000 |  |  |  | 100 | % | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Audit fees
  consist of services that would normally be provided in connection with
  statutory and regulatory filings or engagements, including services that
  generally only the independent accountant can reasonably provide.                                                                                                                                                                                          
|    |                                                                                                                                                                                                                                                                                                                                                                                                                             
|(2) | Audit-related
  fees relate to assurance and associated services that traditionally are
  performed by the independent accountant, including: attest services that are
  not required by statute or regulation; accounting consultation and audits in
  connection with mergers, acquisitions and divestitures; employee benefit plans
  audits; and consultation concerning financial accounting and reporting
  standards.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                             
|(3) | Tax fees
  relate to services performed by the tax division for tax compliance,
  planning, and advice.                                                                                                                                                                                                                                                                                                                     

Pre-Approval Policies and Procedures

Our
audit committee has adopted a policy and procedures for the pre-approval of
audit and non-audit services rendered by our independent public accountants,
Kost, Forer, Gabbay & Kasierer. Pre-approval of an audit or non-audit
service may be given as a general pre-approval, as part of the audit
committees approval of the scope of the engagement of our independent auditor,
or on an individual basis. Any proposed services exceeding general pre-approved
levels also require specific pre-approval by our audit committee. The policy
prohibits retention of the independent public accountants to perform the
prohibited non-audit functions defined in Section 201 of the Sarbanes-Oxley Act
or the rules of the SEC, and also requires the audit committee to consider
whether proposed services are compatible with the independence of the public
accountants.

|          |                                                           
|--------- | ----------------------------------------------------------
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
|          |                                                           
|          | Not
  applicable.                                         

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|          |                                                                          
|--------- | -------------------------------------------------------------------------
|ITEM 16E. | PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATES AND PURCHASERS

Issuer Purchase Of Equity Securities

There
were no shares purchased by us or on our behalf or by any affiliated purchaser
during 2005.

PART III

|         |                                             
|-------- | --------------------------------------------
|ITEM 17. | FINANCIAL STATEMENTS                        
|         |                                             
|         | Not
  applicable.                           
|         |                                             
|ITEM 18. | FINANCIAL STATEMENTS                        
|         |                                             
|         | See pages
  F-1 to F-33 incorporated herein.

67

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Item 19. Exhibits

| |             |  |                                                                                                                                              
| | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit No. |  | Description of Exhibit                                                                                                                       
| |             |  |                                                                                                                                              
| | 1.1         |  | Memorandum of Association of the
  Registrant(1)                                                                                             
| | 1.2         |  | Articles of Association of the
  Registrant(2)                                                                                               
| | 4.1         |  | Ordinary Share Purchase Agreement dated
  June 22, 2005 among the Registrant and the Investors therein(3)                                    
| | 12.1        |  | Certification of Chief Executive Officer
  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
  as amended.       
| | 12.2        |  | Certification of Chief Financial Officer
  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
  as amended.       
| | 13.1        |  | Certification of Chief Executive Officer
  pursuant to18 U.S.C. 1350, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 2002.
| | 13.2        |  | Certification of Chief Financial Officer
  pursuant to18 U.S.C. 1350, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 2002.
| | 15.1        |  | Consent of Kost Forer Gabbay &
  Kasierer, a member of Ernst & Young Global.                                                                 

|    |                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Filed as Exhibit 3.1 to the registrants Registration
  Statement on Form F-1, registration number 33-52676, and incorporated herein
  by reference.                    
|   
|(2) | Filed as Exhibit 3.2 to Amendment No. 1 of the
  registrants Registration Statement on Form F-1, registration number
  33-52676, and incorporated herein by reference. 
|   
|(3) | Filed as Exhibit 4.3 to Amendment No. 3 of the
  Registrants Registration Statement on Form F-3, registration number
  333-126416 and incorporated herein by reference.

68

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005

IN U.S. DOLLARS

INDEX

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

F-1

---

---



(EARNST&YOUNG LOGO)

REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

LANOPTICS
LTD.

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

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

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

|                 |                                 
|---------------- | --------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 30, 2006   | A Member of Ernst & Young Global

F-2

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|------------------------------------------------------------------------------------------------------------------------ |  | ---- | - | ---- | ------------ | ------ |  | - | ------ | 
|                                                                                                                         |  |      |   |      | December 31, |       
|                                                                                                                         |  |      |   |      |              |        | 
|                                                                                                                         |  | Note |   | 2005 |              | 2004   | 
|                                                                                                                         |  |      |   |      |              |        | 
|ASSETS                                                                                                                   |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|CURRENT ASSETS:                                                                                                          |  |      |   |      |              |        |  |   |        | 
|Cash and cash equivalents                                                                                                |  |      |   |      | $            | 14,115 |  | $ | 13,504 | 
|Marketable securities                                                                                                    |  |      | 4 |      |              | 5,437  |  |   | 12,115 | 
|Trade receivables, net of allowance for
  doubtful accounts of $49 and $47 at December 31, 2005 and 2004,
  respectively |  |      |   |      |              | 931    |  |   | 781    | 
|Other accounts receivable and prepaid
  expenses                                                                         |  |      | 5 |      |              | 300    |  |   | 703    | 
|Inventories                                                                                                              |  |      | 6 |      |              | 2,098  |  |   | 1,279  | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|Total current assets                                                                                                     |  |      |   |      |              | 22,881 |  |   | 28,382 | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|LONG-TERM INVESTMENTS:                                                                                                   |  |      |   |      |              |        |  |   |        | 
|Prepaid development and production costs,
  net                                                                          |  |      | 7 |      |              | 381    |  |   | 476    | 
|Severance pay fund                                                                                                       |  |      |   |      |              | 1,564  |  |   | 1,489  | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              | 1,945  |  |   | 1,965  | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|PROPERTY AND EQUIPMENT, NET                                                                                              |  |      | 8 |      |              | 351    |  |   | 384    | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|DEVELOPED TECHNOLOGY, NET                                                                                                |  |      | 9 |      |              | 861    |  |   | 634    | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|GOODWILL                                                                                                                 |  |      | 3 |      |              | 4,833  |  |   | -      | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 
|Total assets                                                                                                             |  |      |   |      | $            | 30,871 |  | $ | 31,365 | 
|                                                                                                                         |  |      |   |      |              |        |  |   |        | 

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

F-3

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE
SHEETSU.S. dollars in thousands

|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | ---- | ------------ | ------- | - | - | ------- | -
|                                                                                                                                                                      |  |      |    |      | December 31, |        
|                                                                                                                                                                      |  |      |    |      |              |         |  
|                                                                                                                                                                      |  | Note |    | 2005 |              | 2004    |  
|                                                                                                                                                                      |  |      |    |      |              |         |  
|LIABILITIES AND SHAREHOLDERS
DEFICIENCY                                                                                                                              |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|CURRENT LIABILITIES:                                                                                                                                                  |  |      |    |      |              |         |   |   |         |  
|Trade payables                                                                                                                                                        |  |      |    |      | $            | 338     |   | $ | 856     |  
|Other accounts payable and
  accrued expenses                                                                                                                         |  |      | 10 |      |              | 1,916   |   |   | 2,478   |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|Total current liabilities                                                                                                                                             |  |      |    |      |              | 2,254   |   |   | 3,334   |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|LONG-TERM LIABILITIES:                                                                                                                                                |  |      |    |      |              |         |   |   |         |  
|Accrued severance pay                                                                                                                                                 |  |      |    |      |              | 1,990   |   |   | 1,985   |  
|Warrants to redeemable preferred shares in
  EZchip                                                                                                                   |  |      | 2k |      |              | 253     |   |   | -       |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|Total long-term liabilities                                                                                                                                           |  |      |    |      |              | 2,243   |   |   | 1,985   |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|REDEEMABLE PREFERRED SHARES
  IN A EZchip                                                                                                                             |  |      |    |      |              | 18,499  |   |   | 14,946  |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|PREFERRED SHARES IN EZchip                                                                                                                                            |  |      |    |      |              | 20,068  |   |   | 20,991  |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|SHAREHOLDERS DEFICIENCY:                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|Share capital                                                                                                                                                         |  |      |    |      |              |         |   |   |         |  
|Ordinary shares of NIS 0.02 par value -                                                                                                                               |  |      | 12 |      |              |         |   |   |         |  
|Authorized: 30,000,000 shares at December
  31, 2005 and 2004; Issued and outstanding: 11,633,771 and 10,626,285 shares
  at December 31, 2005 and 2004, respectively |  |      |    |      |              | 75      |   |   | 70      |  
|Additional paid-in capital                                                                                                                                            |  |      |    |      |              | 61,185  |   |   | 53,193  |  
|Accumulated other
  comprehensive loss                                                                                                                                |  |      |    |      |              | (36     | ) |   | (84     | )
|Accumulated deficit                                                                                                                                                   |  |      |    |      |              | (73,417 | ) |   | (63,070 | )
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|Total shareholders deficiency                                                                                                                                        |  |      |    |      |              | (12,193 | ) |   | (9,891  | )
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  
|Total liabilities and shareholders
  deficiency                                                                                                                      |  |      |    |      | $            | 30,871  |   | $ | 31,365  |  
|                                                                                                                                                                      |  |      |    |      |              |         |   |   |         |  

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

F-4

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED
STATEMENTS OF OPERATIONS
U.S. dollars in thousands (except share and per share data)

|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|--------------------------------------------------------------------------------- |  | ---- | -- | ---- | ----------------------- | ---------- | - | ---- | --------- | - | - | --------- | -
|                                                                                  |  |      |    |      | Year ended December 31, |           
|                                                                                  |  |      |    |      |                         |           
|                                                                                  |  | Note |    | 2005 |                         | 2004       |   | 2003 |          
|                                                                                  |  |      |    |      |                         |            |   |      |          
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Revenues                                                                          |  |      | 14 |      | $                       | 5,848      |   | $    | 4,746     |   | $ | 1,756     |  
|Costs of revenues                                                                 |  |      |    |      |                         | 2,350      |   |      | 1,889     |   |   | 624       |  
|Amortization of developed
  technology                                            |  |      |    |      |                         | 291        |   |      | 241       |   |   | 239       |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Gross profit                                                                      |  |      |    |      |                         | 3,207      |   |      | 2,616     |   |   | 893       |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Operating expenses:                                                               |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Research and development,
  net                                                   |  |      |    |      |                         | 8,215      |   |      | 7,267     |   |   | 7,219     |  
|In-process research and
  development                                             |  |      |    |      |                         | 1,475      |   |      | -         |   |   | -         |  
|Selling and marketing, net                                                        |  |      |    |      |                         | 2,245      |   |      | 2,309     |   |   | 2,191     |  
|General and administrative                                                        |  |      |    |      |                         | 1,398      |   |      | 1,456     |   |   | 1,469     |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Total operating expenses                                                          |  |      |    |      |                         | 13,333     |   |      | 11,032    |   |   | 10,879    |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Operating loss                                                                    |  |      |    |      |                         | (10,126    | ) |      | (8,416    | ) |   | (9,986    | )
|Financial and other
  expenses, net                                               |  |      | 15 |      |                         | (312       | ) |      | (738      | ) |   | (418      | )
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Loss before minority interest                                                     |  |      |    |      |                         | (10,438    | ) |      | (9,154    | ) |   | (10,404   | )
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Minority interest in losses of EZchip                                             |  |      |    |      |                         | 206        |   |      | -         |   |   | -         |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Net loss before cumulative effect of change
  in accounting principle             |  |      |    |      |                         | (10,232    | ) |      | (9,154    | ) |   | (10,404   | )
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Cumulative effect of change in accounting
  principle                             |  |      | 2k |      |                         | (115       | ) |      | -         |   |   | -         |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Net Loss                                                                          |  |      |    |      | $                       | (10,347    | ) | $    | (9,154    | ) | $ | (10,404   | )
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Net loss per share
  before cumulative effect of change in accounting principle   |  |      |    |      | $                       | (0.92      | ) | $    | (0.98     | ) | $ | (1.23     | )
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                 
|Net Loss per share                                                                |  |      |    |      | $                       | (0.93      | ) | $    | (0.98     | ) | $ | (1.23     | )
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  
|Weighted average number of
  ordinary shares used in computing net loss per share |  |      |    |      |                         | 11,156,250 |   |      | 9,365,181 |   |   | 8,484,120 |  
|                                                                                  |  |      |    |      |                         |            |   |      |           |   |   |           |  

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

F-5

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

|                                                 
|-------------------------------------------------
|STATEMENTS OF CHANGES IN SHAREHOLDERS DEFICIENCY
|                                                 
|U.S. dollars in thousands (except share data)    

|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|---------------------------------------------------- |  | -------- | ---------- | ------- | - | ------- | ---------- | ------ | ------------- | ----------- | ----- | ------------- | - | ------------- | ------- | ----- | - | ------- | - | - | ------- | -
|                                                     |  |          |            |         |   |         |            |        |               | Accumulated |       |               |   |               |         |       |   |         |   |  
|                                                     |  |          |            |         |   |         |            |        |               |             | other |               |   |               |         |       |   |         |   |  
|                                                     |  |          |            |         |   |         | Additional |        | comprehensive |             |       |               |   | Total         |         | Total |  
|                                                     |  | Ordinary |            | Share   |   | paid-in |            | income |               | Accumulated |       | comprehensive |   | shareholders |        
|                                                     |  | shares   |            | capital |   | capital |            | (loss) |               | deficit     |       | loss          |   | deficiency    |        
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |        
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Balance as of January 1, 2003                        |  |          | 8,465,535  |         | $ | 60      |            | $      | 33,743        |             | $     | 21            |   | $             | (43,512 | )     |   |         |   | $ | (9,688  | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Issuance of shares, net                              |  |          | 750,000    |         |   | 4       |            |        | 5,637         |             |       | -             |   |               | -       |       |   |         |   |   | 5,641   |  
|Exercise of stock options                            |  |          | 35,000     |         |   | *)  -   |            |        | 93            |             |       | -             |   |               | -       |       |   |         |   |   | 93      |  
|Compensation related to options granted to employees |  |          | -          |         |   | -       |            |        | 43            |             |       | -             |   |               | -       |       |   |         |   |   | 43      |  
|Comprehensive loss:                                  |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Unrealized losses on available-for-sale
securities   |  |          | -          |         |   | -       |            |        | -             |             |       | (5            | ) |               | -       |       | $ | (5      | ) |   | (5      | )
|Net loss                                             |  |          | -          |         |   | -       |            |        | -             |             |       | -             |   |               | (10,404 | )     |   | (10,404 | ) |   | (10,404 | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Total comprehensive loss                             |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       | $ | (10,409 | ) |   |         |  
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Balance as of December 31, 2003                      |  |          | 9,250,535  |         |   | 64      |            |        | 39,516        |             |       | 16            |   |               | (53,916 | )     |   |         |   |   | (14,320 | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Issuance of shares, net                              |  |          | 1,368,000  |         |   | 6       |            |        | 13,465        |             |       | -             |   |               | -       |       |   |         |   |   | 13,471  |  
|Exercise of stock options                            |  |          | 7,750      |         |   | *)  -   |            |        | 40            |             |       | -             |   |               | -       |       |   |         |   |   | 40      |  
|Compensation related to options granted to employees |  |          | -          |         |   | -       |            |        | 172           |             |       | -             |   |               | -       |       |   | -       |   |   | 172     |  
|Comprehensive loss:                                  |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Unrealized losses on available-for-sale
securities   |  |          | -          |         |   | -       |            |        | -             |             |       | (100          | ) |               | -       |       | $ | (100    | ) |   | (100    | )
|Net loss                                             |  |          | -          |         |   | -       |            |        | -             |             |       | -             |   |               | (9,154  | )     |   | (9,154  | ) |   | (9,154  | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Total comprehensive loss                             |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       | $ | (9,254  | ) |   |         |  
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Balance as of December 31, 2004                      |  |          | 10,626,285 |         |   | 70      |            |        | 53,193        |             |       | (84           | ) |               | (63,070 | )     |   |         |   |   | (9,891  | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Issuance of shares, net                              |  |          | 1,006,486  |         |   | 5       |            |        | 7,951         |             |       | -             |   |               | -       |       |   |         |   |   | 7,956   |  
|Exercise of stock options                            |  |          | 1,000      |         |   | *)  -   |            |        | 3             |             |       | -             |   |               | -       |       |   |         |   |   | 3       |  
|Compensation related to options granted to employees |  |          | -          |         |   | -       |            |        | 38            |             |       | -             |   |               | -       |       |   |         |   |   | 38      |  
|Comprehensive loss:                                  |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Unrealized income on available-for-sale
securities   |  |          | -          |         |   | -       |            |        | -             |             |       | 48            |   |               | -       |       |   | 48      |   |   | 48      |  
|Net loss                                             |  |          | -          |         |   | -       |            |        | -             |             |       | -             |   |               | (10,347 | )     |   | (10,347 | ) |   | (10,347 | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Total comprehensive loss                             |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       | $ | (10,299 | ) |   |         |  
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  
|Balance as of December 31, 2005                      |  |          | 11,633,771 |         | $ | 75      |            | $      | 61,185        |             | $     | (36           | ) | $             | (73,417 | )     |   |         |   | $ | (12,193 | )
|                                                     |  |          |            |         |   |         |            |        |               |             |       |               |   |               |         |       |   |         |   |   |         |  

|   |                
|-- | ---------------
|*) | Less than
  $1.

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

F-6

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|                                                                              |  |                         |         |      |   |         |   |   |         |  
|----------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                                              |  | Year ended December 31, |        
|                                                                              |  |                         |        
|                                                                              |  | 2005                    |         | 2004 |   | 2003    |  
|                                                                              |  |                         |         |      |   |         |  
|Cash flows from operating activities:                                         |  |                         |         |      |   |         |   |   |         |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|Net loss                                                                      |  | $                       | (10,347 | )    | $ | (9,154  | ) | $ | (10,404 | )
|Adjustments to reconcile
  net loss to net cash used in operating activities: |  |                         |         |      |   |         |   |   |         |  
|Depreciation and
  amortization                                               |  |                         | 625     |      |   | 661     |   |   | 918     |  
|In-process research and
  development                                         |  |                         | 1,475   |      |   | -       |   |   | -       |  
|Interest and amortization
  of premium of marketable securities               |  |                         | 152     |      |   | 275     |   |   | (126    | )
|Realized loss related to
  sale of marketable securities                      |  |                         | 9       |      |   | 5       |   |   | -       |  
|Accrued interest on
  Redeemable Preferred shares in EZchip                   |  |                         | 890     |      |   | 804     |   |   | 504     |  
|Capital loss (gain) from
  sale of property and equipment                     |  |                         | (3      | )    |   | (1      | ) |   | 3       |  
|Accrued severance pay, net                                                    |  |                         | (70     | )    |   | 209     |   |   | 30      |  
|Accretion of discount on
  long-term loan                                     |  |                         | -       |      |   | 88      |   |   | 59      |  
|Stock-based compensation
  related to options granted to employees            |  |                         | 38      |      |   | 172     |   |   | 43      |  
|Minority interest in losses of EZchip                                         |  |                         | (206    | )    |   | -       |   |   | -       |  
|Cumulative effect of change
  in accounting principle                         |  |                         | 115     |      |   | -       |   |   | -       |  
|Change in fair value of
  warrants to redeemable preferred shares             |  |                         | (9      | )    |   | -       |   |   | -       |  
|Increase in trade
  receivables                                               |  |                         | (151    | )    |   | (343    | ) |   | (76     | )
|Decrease (increase) in
  other accounts receivable and prepaid expenses       |  |                         | 403     |      |   | (350    | ) |   | 179     |  
|Increase in inventory                                                         |  |                         | (819    | )    |   | (875    | ) |   | (27     | )
|Increase (decrease) in
  trade payables                                       |  |                         | (518    | )    |   | 654     |   |   | (304    | )
|Increase (decrease) in
  other accounts payable and accrued expenses          |  |                         | (562    | )    |   | (87     | ) |   | 55      |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|Net cash used in operating
  activities                                       |  |                         | (8,978  | )    |   | (7,942  | ) |   | (9,146  | )
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|Cash flows from investing
  activities:                                       |  |                         |         |      |   |         |   |   |         |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|Investment in marketable
  securities debt                                    |  |                         | -       |      |   | (10,820 | ) |   | (6,493  | )
|Proceeds from sale and
  redemption marketable securities debt                |  |                         | 6,566   |      |   | 3,739   |   |   | 7,844   |  
|Purchase of property and
  equipment                                          |  |                         | (217    | )    |   | (206    | ) |   | (265    | )
|Proceeds from sale of
  property and equipment                                |  |                         | 14      |      |   | 11      |   |   | 10      |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  
|Net cash provided by (used
  in) investing activities                         |  |                         | 6,363   |      |   | (7,276  | ) |   | 1,096   |  
|                                                                              |  |                         |         |      |   |         |   |   |         |  

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

F-7

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|                                                         |  |                         |        |      |   |        |   |   |        | 
|-------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | - | - | ------ | 
|                                                         |  | Year ended December 31, |       
|                                                         |  |                         |       
|                                                         |  | 2005                    |        | 2004 |   | 2003   |  
|                                                         |  |                         |        |      |   |        |  
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Cash flows from financing
  activities:                  |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Issuance of shares, net                                  |  |                         | (11    | )    |   | 13,471 |   |   | 5,641  | 
|Issuance of Redeemable
  Preferred shares in EZchip, net |  |                         | 3,028  |      |   | 2,563  |   |   | 10,928 | 
|Proceeds from exercise of
  options                      |  |                         | 3      |      |   | 40     |   |   | 93     | 
|Proceeds from exercise of
  options in EZchip            |  |                         | 206    |      |   | -      |   |   | -      | 
|Proceeds from long-term
  loan                           |  |                         | -      |      |   | -      |   |   | 1,324  | 
|Repayment of long-term loan                              |  |                         | -      |      |   | (1,500 | ) |   | -      | 
|Proceeds from issuance of
  warrants by EZchip           |  |                         | -      |      |   | -      |   |   | 176    | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Net cash provided by
  financing activities              |  |                         | 3,226  |      |   | 14,574 |   |   | 18,162 | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Increase (decrease) in cash
  and cash equivalents       |  |                         | 611    |      |   | (644   | ) |   | 10,112 | 
|Cash and cash equivalents
  at the beginning of the year |  |                         | 13,504 |      |   | 14,148 |   |   | 4,036  | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Cash and cash equivalents
  at the end of the year       |  | $                       | 14,115 |      | $ | 13,504 |   | $ | 14,148 | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Supplemental disclosure of
  cash flows activities:      |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Cash paid during the year
  for:                         |  |                         |        |      |   |        |   |   |        | 
|Interest                                                 |  | $                       | -      |      | $ | 56     |   | $ | 54     | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Non-cash activities:                                     |  |                         |        |      |   |        |   |   |        | 
|EZchip shares acquisition (see note 3c)                  |  |                         |        |      |   |        |   |   |        | 
|EZchips Preferred A, B, C and Ordinary
  Shares         |  |                         | 1,142  |      |   | -      |   |   | -      | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Intangible assets acquired:                              |  |                         |        |      |   |        |   |   |        | 
|Developed Technology                                     |  |                         | 517    |      |   | -      |   |   | -      | 
|Goodwill                                                 |  |                         | 4,833  |      |   | -      |   |   | -      | 
|In-process research and development                      |  |                         | 1,475  |      |   | -      |   |   | -      | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|                                                         |  |                         |        |      |   |        |   |   |        | 
|Issuance of shares                                       |  | $                       | 7,967  |      | $ | -      |   | $ | -      | 
|                                                         |  |                         |        |      |   |        |   |   |        | 

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

F-8

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 1:    | GENERAL                                                                                                                                                                                      
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | a.                                                                                                                                                                                            | LanOptics Ltd. (the
  Company) was incorporated as a limited liability company under the laws of
  the State of Israel in 1989. The Company is now operating in the segment of
  network processors, through its business unit, EZchip Technologies Ltd.,
  (EZchip), which is engaged in the development of high performance network
  processors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                                                                                                                                                                               | EZchip was established in
  December 1999 as a wholly-owned subsidiary of the Company. Over the years
  Ezchip raised funds from third party investors while diluting the Companys
  holding. As of December 31, 2005, the Company holds 60.4% of EZchip shares
  and of the voting rights.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                                                                                                                                                                               | EZchips technology
  provides packet processing, classification and traffic management on a single
  chip at wire speed. EZchips single-chip solutions are used for building
  networking equipment with extensive savings in chip count, power and cost.
  Highly flexible processing enables a wide range of applications for metro,
  carrier-edge and core-enterprise. During 2001, EZchip established a
  wholly-owned subsidiary, EZchip Inc., in the United States, which is engaged
  in the marketing of EZchips products.                                                                                                                                                                                                                                                                                                                                      
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | b.                                                                                                                                                                                            | The Companys Ordinary
  shares are traded on the NASDAQ SmallCap Market under the symbol LNOP and
  on the Tel-Aviv Stock Exchange. Prior to April 14, 2003, the Companys
  Ordinary shares were traded on the NASDAQ National Market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | c.                                                                                                                                                                                            | All of the
  Companys network processors chips are manufactured by third party
  subcontractors. While these subcontractors have been able to adequately meet
  the demands of the Companys increasing business, the Company is and will
  probably continue to be dependent upon such subcontractor to achieve
  acceptable manufacturing yields, quality levels and costs, and to allocate to
  the Company sufficient capacity to meet the Companys needs in a timely
  manner. Revenues could be materially and adversely affected should these
  subcontractors fail to meet the Companys demand for products due to a
  shortage of production capacity, process difficulties, low yield rates or
  financial instability. For the year ended December 31, 2005 the one major
  subcontractor accounted for approximately 59% of the Companys cost of
  revenues.
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES                                                                                                                                                              
|            |                                                                                                                                                                                              
|            | The consolidated financial
  statements were prepared in accordance with United States generally accepted
  accounting principles (U.S. GAAP) applied on a consist basis, are as
  follows:
|            |                                                                                                                                                                                              
|            | a.                                                                                                                                                                                            | Use of
  estimates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                                                                                                                                                                               | The
  preparation of financial statements in conformity with generally accepted
  accounting principles requires management to make estimates and assumptions
  that affect the amounts reported in the financial statements and accompanying
  notes. Actual results may differ from those estimates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

F-9

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | -------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES(CONT.)
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | b.                                     | 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. Most of the revenues
  are denominated and earned in dollars, most purchases of materials and
  components are made in dollars, Financing and investing activities, including
  equity transactions and cash investments, are made in U.S. dollars and most
  of its assets are denominated in dollars. Thus, the functional and reporting currency
  of the Company and EZchip is the U.S. dollar.                                                                                                                                                                                                                                                           
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | Accordingly,
  monetary accounts maintained in currencies other than the dollar are
  remeasured into U.S. dollars in accordance with the Statement of Financial
  Accounting Standard Board No. 52, Foreign Currency Translation (SFAS No.
  52). All transaction gains and losses of the remeasured monetary balance
  sheet items are reflected in the statement of operations as financial income
  or expenses, as appropriate.                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | c.                                     | Basis consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | The
  consolidated financial statements include the accounts of the Company and its
  subsidiaries. Intercompany balances and transactions have been eliminated
  upon consolidation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | d.                                     | Cash equivalents:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | The Company considers all highly liquid
  investments that are convertible to cash with maturities of three months or
  less at their acquisition date as cash equivalents.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | e.                                     | Marketable securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | The Company
  accounts for its investments in marketable securities using SFAS No. 115,
  Accounting for Certain Investments in Debt and Equity Securities.
  Management determines the classification of marketable securities at the time
  of purchase and reevaluates such designations as of each balance sheet date.
  As of December 2005 and 2004, all marketable securities were designated as
  available-for-sale. Available-for-sale securities are carried at fair value,
  with the unrealized gains and losses, reported as a separate component of
  shareholders equity, accumulated other comprehensive income (loss). Realized
  gains and losses on sales of investments, as determined on a specific
  identification basis, are included in the consolidated statements of
  operations.
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | f.                                     | Inventories:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | Inventories
  are stated at the lower of cost or market value. Inventory write-offs are
  provided for slow-moving items or technological obsolescence. Cost is
  determined as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | Raw
  materials - using the weighted average method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        | Work in
  progress and finished products  using the weighted average method and calculated
  manufacturing costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

F-10

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                        |                                                                                                                                                                                      
|----------- | -------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES(CONT.)
|            |                                        |                                                                                                                                                                                      
|            | g.                                     | Property and equipment:                                                                                                                                                              
|            |                                        |                                                                                                                                                                                      
|            |                                        | Property and
  equipment are stated at cost, less accumulated depreciation. Depreciation is
  calculated by the straight-line method over the estimated useful lives of the
  assets.
|           
|            |                                        | The annual
  depreciation rates are as follows:                                                                                                                                      

| |                                                |  |   |                                                     | 
| | ---------------------------------------------- |  | - | --------------------------------------------------- | 
| |                                                |  | % |                                                    
| |                                                |  |   |                                                    
|
| | Office furniture and
  equipment               |  |   | 6                                                   | 
| | Computers, software and
  electronic equipment |  |   | 33                                                  | 
| | Motor vehicles                                 |  |   | 15                                                  | 
| | Leasehold improvements                         |  |   | Over the less than term of the lease or useful life | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | h. | Impairment of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The Companys long-lived assets and certain
  identifiable intangibles are reviewed for impairment in accordance with SFAS
  No. 144 Accounting for the Impairment or Disposal of Long Lived Assets,
  whenever events or changes in circumstances indicate that the carrying amount
  of an asset may not be recoverable. Recoverability of assets to be held and
  used is measured by a comparison of the carrying amount of an asset to the
  future undiscounted cash flows expected to be generated by the assets. If
  such assets are considered to be impaired, the impairment to be recognized is
  measured by the amount by which the carrying amount of the assets exceeds the
  fair value of the assets. Assets to be disposed of are reported at the lower
  of the carrying amount or fair value less costs to sell. During the years 2005, 2004 and 2003,
  no impairment losses have been identified.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | i. | Goodwill and
  Developed Technology:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Goodwill
  reflects the excess of the purchase price of business acquired over the fair
  value of net assets acquired.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The Company
  adopted Statement of Financial Accounting Standards No. 142, Goodwill and
  Other Intangible Assets (SFAS No. 142). Under SFAS No. 142, goodwill is not
  amortized but instead is tested for impairment at least annually (or more
  frequently if impairment indicators arise).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | SFAS No. 142
  prescribes a two-phase process for impairment testing of goodwill. The first
  phase screens for impairment while the second phase (if necessary) measures
  impairment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | In the first
  phase of impairment testing, goodwill attributable the reporting unit is
  tested for impairment by comparing the fair value of the reporting unit with
  its carrying value. As of December 31, 2005, no instances of impairment were
  found.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Developed
  technology is amortized over its useful live using a method of amortization
  that reflects the pattern in which the economic benefits of the developed
  technology is consumed or otherwise used up, in accordance with SFAS No. 142.
  The Company amortizes its developed technology on a straight line basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-11

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | -------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES(CONT.)
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | j.                                     | Redeemable
  Preferred shares in EZchip and Preferred shares in EZchip:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | The
  investment by third parties in Redeemable Preferred shares in EZchip and
  Preferred shares in EZchip is presented as a separate component in the
  balance sheet.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | The
  Redeemable Preferred shares bear annual interest at the rate of 6%. Such interest
  is accrued to the statement of operations and will be paid only upon
  redemption of such shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | k.                                     | Warrants to
  Redeemable Preferred shares in EZchip:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | In April 2003, EZchip granted a warrant to purchase Preferred C
  shares in connection with a Loan Agreement with a third party. The Loan was
  repaid in August 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | EZchip
  accounts for such warrants in accordance with FASB Staff Position FASB
  Statement No. 150 Accounting for certain financial Instruments with
  Characteristics of both liabilities and Equity (FSP FAS-150-5). Under FSP
  FAS-150-5 these warrants are classified as liabilities and are carried at
  their fair value. The guidance of this FSP was applied in the first interim
  period beginning after June 30, 2005 and resulted a cumulative affect of a
  change in accounting principles of $115.                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | Changes
  in fair value of these warrants are charged to the statements of operations
  in each reporting period. The fair value of the warrants was determined using
  the Black  Scholes option pricing model, with the following assumptions as
  of December 31, 2005: risk free interest rate of 3.72%, dividend yield of 0%,
  expected life of 5.75 years and expected volatility of 80%. As of December
  31, 2005 the Company recorded expenses related to the change in fair value of
  these warrants in the amount of $9.                                                                                                                                                                                                                                                                                                                                                                
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | l.                                     | Research
  and development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | Research and development costs are charged to expenses as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | m.                                     | Severance
  pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | The
  liability of the Company and its subsidiary for severance pay is calculated
  pursuant to Israels Severance Pay Law based on the most recent salary of the
  employees multiplied by the number of years of employment, as of the balance
  sheet date and is presented on an undiscounted basis. Employees are entitled
  to one months salary for each year of employment or a portion thereof. The
  liability for all of the employees is fully provided by monthly deposits with
  insurance policies and by an accrual. The value of these policies is recorded
  as an asset in the Companys balance sheet. The deposited funds may be
  withdrawn only upon the fulfillment of the obligation, pursuant to the
  Severance Pay Law or labor agreements. The value of the deposited funds is
  based on the cash surrendered value of these policies, and includes
  immaterial profits.
|            |                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                        | Severance
  expense for the years ended December 31, 2005, 2004 and 2003 were $(156),
  $193 and $18, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

F-12

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------- | ----------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES
  (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | n.                                        | Income taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                           | The Company and its affiliates account for
  income taxes in accordance with SFAS No.109, Accounting for Income Taxes (SFAS
  No.109). This Statement prescribes the use of the liability method whereby
  deferred tax assets and liability account balances are determined based on
  differences between financial reporting and tax bases of assets and
  liabilities and are measured using the enacted tax rates and laws that will
  be in effect when the differences are expected to reverse. The Company and
  its subsidiaries provide a valuation allowance, if necessary, to reduce
  deferred tax assets to their estimated realizable value.                                                        
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | o.                                        | Net loss per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                           | Basic net
  loss per share is computed based on the weighted average number of ordinary
  shares outstanding during each year. Diluted net earnings per share are
  computed based on the weighted average number of Ordinary shares outstanding
  during each year, plus dilutive potential Ordinary shares considered
  outstanding during the year, in accordance with Statement of Financial
  Accounting Standard No. 128 Earnings Per share (SFAS No. 128).                                                                                                                                                                                                                                                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                           | For the
  years ended December 31, 2005, 2004 and 2003, all outstanding stock options
  and warrants have been excluded from the calculation of the diluted net loss
  per Ordinary share because all such stock options were antidilutive. The
  total weighted average number of Ordinary shares related to options and
  warrants excluded from the calculation of diluted net loss per share were
  971,539, 572,539 and 268,215 for the years ended December 31, 2005, 2004 and
  2003, respectively.                                                                                                                                                                                                             
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | p.                                        | Accounting for stock based
  compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                           | The Company has
  elected to follow Accounting Principles Board Opinion No. 25, Accounting for
  Stock Issued to Employees (APB 25) and FASB Interpretation No. 44,
  Accounting for Certain Transactions Involving Stock Compensation (FIN 44)
  in accounting for its employee stock option plans. Under APB 25, when the
  exercise price of the Companys stock options is less than the market price
  of the underlying shares on the date of grant, compensation expense is
  recognized over the vesting period.                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                           | The Company
  applies SFAS No. 123, Accounting for Stock-Based Compensation
  (SFAS 123) and EITF 96-18, Accounting for Equity Instruments That are
  Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
  Goods or Services with respect to options issued to non-employees.                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                           | SFAS No.123
  requires use of an option valuation model to measure the fair value of the
  options on the date of grant. Under SFAS No. 123, pro forma information
  regarding net income (loss) and net earnings (loss) per share is required,
  and has been determined as if the Company had accounted for its employee
  stock options under the fair value method. The fair value for these options
  was estimated at the date of grant using the Black-Scholes valuation model
  with the following assumptions for 2003: risk-free interest rates of 2.98%
  dividend yields of 0%; expected life for an option of four years and excepted
  volatility of 83.6%. No options were granted during 2004 and 2005.

F-13

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                           |                                                                                                                                                                                                                 
|----------- | ----------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES
  (Cont.)
|            |                                           |                                                                                                                                                                                                                 
|            | p.                                        | Accounting for stock based
  compensation (cont.):                                                                                                                                                              
|            |                                           |                                                                                                                                                                                                                 
|            |                                           | The fair
  value for options granted in 2003, 2004 and 2005 is amortized over their vesting
  period and estimated at the date of grant using the Black-Scholes pricing
  model, with the following assumptions:

| |                        |  |                         |         |      |  |         |  |  |         | 
| | ---------------------- |  | ----------------------- | ------- | ---- |  | ------- |  |  | ------- | 
| |                        |  | Year ended December 31, |        
| |                        |  |                         |        
| |                        |  | 2005                    |         | 2004 |  | 2003    | 
| |                        |  |                         |         |      |  |         | 
| |                        |  |                         |         |      |  |         |  |  |         | 
| | Dividend yield         |  |                         | 0%      |      |  | 0%      |  |  | 0%      | 
| | Expected volatility    |  |                         | 80%     |      |  | 50%     |  |  | 50%     | 
| | Risk-free interest     |  |                         | 4.28%   |      |  | 3.08%   |  |  | 2.98%   | 
| | Expected life of up to |  |                         | 6 years |      |  | 4 years |  |  | 4 years | 

| |                                       |  |  |  |  |  |  |  |  |  | 
| | ------------------------------------- |  |  |  |  |  |  |  |  |  | 
| | Pro forma information under SFAS 123: |  |  |  |  |  |  |  |  |  | 

| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
| | ----------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------- | - | - | ------- | -
| |                                                                                           |  | Year ended December 31, |        
| |                                                                                           |  |                         |        
| |                                                                                           |  | 2005                    |         | 2004 |   | 2003    |  
| |                                                                                           |  |                         |         |      |   |         |  
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
| | Net loss as reported                                                                      |  | $                       | (10,347 | )    | $ | (9,154  | ) | $ | (10,404 | )
| | Add: stock-based employee
  compensation expense determined under fair value based method |  |                         | (568    | )    |   | (1,219  | ) |   | (387    | )
| | Deduct: stock-based
  employee compensation expense included in reported net loss         |  |                         | 38      |      |   | 172     |   |   | 43      |  
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
| | Pro forma net loss                                                                        |  | $                       | (10,877 | )    | $ | (10,201 | ) | $ | (10,748 | )
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
| | Net loss per share, as reported                                                           |  | $                       | (0.93   | )    | $ | (0.98   | ) | $ | (1.23   | )
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  
|
| | Pro forma net loss per share                                                              |  | $                       | (0.98   | )    | $ | (1.09   | ) | $ | (1.27   | )
| |                                                                                           |  |                         |         |      |   |         |   |   |         |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | q. | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The Company
  generates its revenues mainly from sales of network processors chips and to a
  lesser extent from the sales of network-processor based systems, software
  tools and maintenance and support services, through EZchip and its wholly
  owned subsidiary EZchip Inc.                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Revenues
  from network processors chips and network processors based systems are
  recognized upon delivery in accordance with Staff Accounting Bulletin No. 104
  Revenue Recognition (SAB 104), when persuasive evidence of an agreement
  exists, delivery of the product has occurred, the fee is fixed or
  determinable and collectibility is probable. The Company does not have any
  significant obligations after delivery.

F-14

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----------- | ----------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES
  (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | The Company
  does not grant a right of return to its customers. In addition if a
  transaction sale does not meet all the criteria the revenue is deferred until
  all criteria are met.                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | q.                                        | Revenue
  recognition (cont.):                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | Revenues
  from sales of software tools and maintenance and support services which are
  sold separately from other products, are recognized in accordance with
  Statement of Position 97-2, Software Revenues Recognition (SOP 97-2). The
  Company uses the residual method when Vendor Specific Objective Evidence
  (VSOE) of fair value only exists for the maintenance.                                          
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | In certain
  instances, the Company sells network processors based systems together with
  software tools and maintenance and support services. In those cases the
  Company comply with the requirements set forth in EITF 00-21 Revenue
  Arrangements with multiple Deliverables, relating to the separation of
  multiple deliverables into individual accounting units with determinable fair
  values.                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | r.                                        | Advertising expenses:                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | Advertising
  expenses are charged to the statement of operations, as incurred. Advertising
  expenses for the years ended December 31, 2005, 2004 and 2003 amounted to
  $120, $142 and $169, respectively.                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | s.                                        | Concentrations
  of credit risk:                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | Financial
  instruments that potentially subject the Company and its subsidiaries to
  concentrations of credit risk consist principally of cash and cash
  equivalents, marketable securities and trade receivables.                                                                                                                                                                                                           
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | The
  Companys cash and cash equivalents are mainly invested in major banks in Israel
  and the United States. Such deposits in U.S. banks may be in excess of
  insured limits and are not insured in other jurisdictions. Management
  believes that the financial institutions that hold the Companys investments
  are financially sound, and accordingly, minimal credit risk exists with
  respect to these investments.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | The trade
  receivables of the Company are derived from sales to customers located mainly
  in North America, the Far East and Israel. The Company performs ongoing
  credit evaluations of its customers, and to date has not experienced any
  material losses. An allowance for doubtful accounts is determined with
  respect to those amounts that the Company has determined to be doubtful of
  collection.              
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | The
  Companys marketable securities include investments in U.S. corporations and
  government debts securities. Management believes that those corporations are
  financially sound, the portfolio is well diversified, and accordingly,
  minimal credit risk exists with respect to these marketable securities.                                                                                                            
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           | The Company
  and its subsidiaries have no off-balance-sheet concentrations of credit risk
  such as foreign exchange contracts, option contracts or other foreign hedging
  arrangements.                                                                                                                                                                                                                                      

F-15

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- | ----------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES
  (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | t.                                        | Fair value
  of financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The
  following methods and assumptions were used by the Company and its
  subsidiaries in estimating their fair value disclosures for financial
  instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The carrying
  amounts of cash and cash equivalents, trade receivables, other accounts
  receivable, trade payables, other accounts payable and accrued expenses
  approximate their fair value due to the short-term maturity of such
  instruments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The fair
  value of marketable securities is based on quoted market prices. If the
  market value is lower than the amortized cost for an other-than-temporary
  period, then the marketable securities are amortized to their market value.
  As for the fair value of the marketable securities see Note 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | u.                                        | Impact of recently issued
  accounting standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | In May 2005,
  the FASB issued Statement of Financial Accounting Standard No. 154 (SFAS No.
  154), Accounting Changes and Error Corrections, a replacement of APB No.
  20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in
  Interim Financial Statements. SFAS No. 154 provides guidance on the
  accounting for and reporting of accounting changes and error corrections. APB
  No. 20 previously required that most voluntary changes in accounting
  principles be recognized by including in net income for the period of change
  the cumulative effect of changing to the new accounting principle. SFAS No. 154
  requires retroactive application to prior periods financial statements of a
  voluntary change in accounting principles unless it is impracticable. SFAS
  No. 154 is effective for accounting changes and corrections of errors made in
  fiscal years beginning after December 15, 2005.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | On
  December16, 2004, the FASB issued FASB Statement No. 123R (revised 2004),
  Share Based Payment (SFAS 123R), which is revision of FASB Statement No.
  123, Accounting for Stock Based Compensation. SFAS 123R supersedes APB
  Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB
  Statement No. 95, Statement of Cash Flow. Generally, the approach in SFAS
  123R is similar to the approach described in Statement 123. However, SFAS
  123R requires all share-based payments to employees, including grants of
  employee stock options, to be recognized in the income statement based on
  their fair value.                                                                                                                                                                                                                                                                                        
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | Pro forma
  disclosure is no longer an alternative. The Company expects to adopt
  statement 123R on the first interm period beginning after January 1, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | SFAS 123R
  permits public companies to adopt its requirement using one of the two
  methods:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | A modified
  prospective method in which compensation cost is recognized beginning with
  the effective date (a) based on the requirements of SFAS 123R for all
  share-based payments granted after the effective date and (b) based on the
  requirements of SFAS 123 for all awards granted to employees prior to the
  effective date of SFAS 123R that remain unvested in the effective date.

F-16

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                    
|----------- | ----------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES
  (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                    
|            | u.                                        | Impact of recently issued
  accounting standards (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                    
|            |                                           | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | A modified
  retrospective method which includes the requirements of the modified
  prospective method described above, but also permits entities to restate
  based on the amounts previously recognized under SFAS 123 for purposes of pro
  forma disclosures for all prior periods presented.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                    
|            |                                           | The Company
  plans to adopt SFAS 123R using the modified prospective method. As permitted
  by SFAS 123, the Company currently accounts for share based payments to
  employees using APB 25s intrinsic value method and, as such, generally
  recognizes no compensation cost for employee stock options. Accordingly, the
  adoption of SFAS 123Rs fair value method will have a significant impact in
  our result of operations. The impact of adoption of SFAS 123R cannot be
  predicted at this time because it will depend on levels of share based
  payments granted in the future. However, had the Company adopted SFAS 123R in
  prior periods, the impact of that Standard would have approximated the impact
  of SFAS 123 as described in the disclosure of pro forma net loss and net loss
  per share in note 2 (o).
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | In March
  2005, the SEC released SEC Staff Accounting Bulletin No. 107, Share Based
  Payment (SAB 107). SAB 107 provides the SECs staff position regarding the
  application of FAS 123(R) and contains interpretive guidance relating to the
  interaction between FAS 123(R) and certain SEC rules and regulations, and
  also provides the SEC staffs view regarding the valuation of share-based
  payment arrangements for public companies. SAB 107 highlights the importance
  of disclosures made relating to the accounting for share-based payment
  transactions.                                                                                                                                                                                                                                                     
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|NOTE 3:    | INVESTMENT IN EZCHIP                     
|            |                                          
|            | a.                                        | During March
  2003, EZchip signed an investment agreement (Investment Agreement) upon
  which EZchip was expected to raise up to $21,500 in return for the issuance
  of up to 26,345,092 Redeemable Preferred C shares at a price per share of
  $0.8161. The funding consisted of an initial equity investment of $13,500. In
  addition EZchip shall be entitled according to the Investment Agreement to
  raise an aggregate additional amount of up to $8 million within 24 month of
  the initial investment of $13,500.                                                                                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | In March
  2003, EZchip issued to the Company and to third parties 16,542,267 Series C
  Redeemable Preferred shares, in consideration of $13,500 (First
  investment). The net amount of $10,928, which was invested by third parties,
  was recorded as Redeemable Preferred shares in EZchip.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           | During March
  2004, in the framework of the Investment Agreement dated March 2003. EZchip
  issued 9,802,825 Series C Redeemable Preferred Shares to the Company and to
  third parties (Second Investment). Out of the total consideration of $8,000
  that was invested in EZchip in March 2004, third parties invested a net
  amount of $2,563. This amount was recorded as Redeemable Preferred shares in
  EZchip.                                                                                                                                                                                                                                                                                                                                                                                                              

F-17

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                               
|----------- | ---------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 3:    | INVESTMENT IN EZCHIP (CONT.)
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | In July
  2005, EZchip issued additional 12,253,531 Series C Redeemable Preferred
  Shares to the Company and to third parties (Third Investment). Out of the
  total consideration of $10,000 that was invested in EZchip in this financing
  round, third parties invested a net amount of $3,028. This amount was
  recorded as Redeemable Preferred shares in EZchip.                                                                                                                                                                                                                                                                          
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | Shareholders
  of series C Redeemable Preferred may request redemption of the shares after
  four years. The shares will be redeemed at a price per share equal to the
  greater of (a) the original Series C per share issued price plus an amount
  equal to any accrued and unpaid dividends thereon plus 6% coupon interest
  compounded annually or (b) the fair market value of such shares. Since the
  shareholders may request redemption after four years, the net amount that was
  invested by third parties was recorded as Redeemable Preferred shares in
  EZchip as a mezzanine account (between liabilities and shaholders equity).
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | b.                           | In May 2003,
  the Company executed an agreement with the four largest minority shareholders
  of EZchip (The Major Shareholders), upon which the Company offered to the
  Major Shareholders the right to exchange all their shares in EZchip for
  Ordinary shares of LanOptics. The exchange right is contingent upon the following
  conditions:                                                                                                                                                                                                                                                                                               
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | At least two
  of the Major Shareholders must elect to exchange their EZchipss preferred
  shares for the Companys ordinary shares in accordance with the agreed terms.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | If at least
  two of the four Major Shareholders elect to exchange their preferred shares
  to the Companys ordinary shares, than all of the holders of the EZchips
  preferred shares will be offered to participate in exchange at the same
  terms.                                                      
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                               
|            |                              | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | If at least
  three out of the four Major Shareholders in EZchip elect to exchange their
  preferred shares to the Companys ordinary shares than the fourth Major
  Shareholder will be compelled to participate in the exchange transaction.                                                                
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                               
|            |                              | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Under the
  agreement, the exchange ratio will be calculated according to a formula
  determined between the Company and the Major Shareholders in good faith
  taking into consideration the business situation applicable at the time of
  exchange with no differences between the series of EZchip shares.
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                               
|            |                              | The exchange
  right is valid by the Major Shareholder until the earlier of the (1) Initial
  Public Offering (IPO) of EZchip s securities (2) sale of substantially all
  of EZchip assets or securities. To date none of the Major Shareholder have
  exercised its right.                                                                                                                                                                                                                                                                                                                                                                      
|            |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | c.                           | On June 23,
  2005, the Company acquired 2,378,924 ordinary shares, 831,667 Preferred A
  shares, 110,619 Preferred B shares and 245,070 Preferred C shares of EZchip,
  in consideration of the issuance of 1,006,486 Ordinary shares of the Company.
  The total fair value of the Ordinary shares issued for the acquisition was
  $7,967. The acquisition was accounted for according to the purchase method of
  accounting, in accordance with SFAS No. 141, and accordingly, the purchase
  price was allocated to the assets acquired and liabilities assumed based upon
  their estimated fair values at the date of acquisition.           

F-18

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                              |                                               
|----------- | ---------------------------- | ----------------------------------------------
|NOTE 3:    | INVESTMENT IN EZCHIP (CONT.)
|            |                              |                                               
|            |                              | The purchase
  price allocation is as follows:

| |                                                         |  |   |                            | 
| | ------------------------------------------------------- |  | - | -------------------------- | 
| |                                                         |  |   | Purchase 
price
allocation | 
| |                                                         |  |   |                           
| |                                                         |  |   |                            | 
| | EZchips
  Preferred A,B,C and Ordinary Shares acquired |  | $ | 1,142                      | 
| | Intangible assets acquired:                             |  |   |                            | 
| | In-process research and development (1)                 |  |   | 1,475                      | 
| | Developed technology (2)                                |  |   | 517                        | 
| | Goodwill (3)                                            |  |   | 4,833                      | 
| |                                                         |  |   |                            | 
| |                                                         |  |   |                            | 
| |                                                         |  |   |                            | 
| | Total consideration                                     |  | $ | 7,967                      | 
| |                                                         |  |   |                            | 

|            |                                                                                                           |     |                                                                                                                                                                                                                   
|----------- | --------------------------------------------------------------------------------------------------------- | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            |                                                                                                           | (1) | the Company
  recorded a charge of $1,475 related to in process research and development
  for projects which have not yet reached technological feasibility and which
  have no alternative future use.          
|            |                                                                                                           |     |                                                                                                                                                                                                                   
|            |                                                                                                           | (2) | The
  developed technology is amortized using the straight-line method over the
  useful life of the technology, which is five years. (See Note 9).                                                               
|            |                                                                                                           |     |                                                                                                                                                                                                                   
|            |                                                                                                           | (3) | Goodwill in
  the amount of $4,833 represents the access of the purchase price over the
  fair value of the assets acquired. Goodwill will not be amortized and will be
  tested for impairment at least annually.
|            |                                                                                                           |     |                                                                                                                                                                                                                   
|NOTE 4:    | MARKETABLE SECURITIES                                                                                    
|            |                                                                                                          
|            | As of December 31, 2005
  and 2004 all of the Companys securities were classified as available-for-sale.

| |                     |  |                   |       |                             |  |                |   |                  |       |                             |   |                |  |   |     |   |   |        | 
| | ------------------- |  | ----------------- | ----- | --------------------------- |  | -------------- | - | ---------------- | ----- | --------------------------- | - | -------------- |  | - | --- | - | - | ------ | 
| |                     |  | December 31, 2005 |       | December 31, 2004           | 
| |                     |  |                   |       |                             | 
| |                     |  | Amortized
  cost  |       | Gross
  unrealized
  losses |  | Market
  value |   | Amortized
  cost |       | Gross
  unrealized
  losses |   | Market
  value | 
| |                     |  |                   |       |                             |  |                |   |                  |       |                             |   |                | 
| | Available-for-sale: |  |                   |       |                             |  |                |   |                  |       |                             |   |                |  |   |     |   |   |        | 
| |                     |  |                   |       |                             |  |                |   |                  |       |                             |   |                |  |   |     |   |   |        | 
| | Corporate debts     |  |                   | 1,951 |                             |  | (24            | ) |                  | 1,927 |                             | $ | 5,745          |  | $ | (39 | ) | $ | 5,706  | 
| | US government debts |  |                   | 3,522 |                             |  | (12            | ) |                  | 3,510 |                             |   | 6,454          |  |   | (45 | ) |   | 6409   | 
| |                     |  |                   |       |                             |  |                |   |                  |       |                             |   |                |  |   |     |   |   |        | 
| |                     |  |                   |       |                             |  |                |   |                  |       |                             |   |                |  |   |     |   |   |        | 
| | Total               |  |                   | 5,473 |                             |  | (36            | ) |                  | 5,437 |                             | $ | 12,199         |  | $ | (84 | ) | $ | 12,115 | 
| |                     |  |                   |       |                             |  |                |   |                  |       |                             |   |                |  |   |     |   |   |        | 

| |                     |  |                  |       |                |   |       | 
| | ------------------- |  | ---------------- | ----- | -------------- | - | ----- | 
| |                     |  | 2005             |      
| |                     |  |                  |      
| |                     |  | Amortized
  Cost |       | Market
  value |  
| |                     |  |                  |       |                |  
| | Available-for-sale: |  |                  |       |                |   |       | 
| | Matures in one year |  | $                | 5,473 |                | $ | 5,437 | 
| |                     |  |                  |       |                |   |       | 

| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | For the
  years ended December 31, 2005, 2004 and 2003, the unrealized gain (losses)
  amounted to $48, $(100) and $(5), respectively.

F-19

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 4:    | MARKETABLE SECURITIES (CONT.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | For the year
  ended December 31, 2005, unrealized losses in the Companys investments in
  U.S. government institutions and corporate bonds are mainly attributed to
  increase in market interest rate increases. As the Company has the ability to
  hold these investments until maturity, it is expected that these securities
  would not be settled at a price less than the amortized cost of the Companys
  investment. Therefore, the bonds were not considered to be other than
  temporarily impaired at December 31, 2005.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|NOTE 5:    | OTHER ACCOUNTS RECEIVABLE AND
  PREPAID EXPENSES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| |                        |  |              |     |      |   |     | 
| | ---------------------- |  | ------------ | --- | ---- | - | --- | 
| |                        |  | December 31, |    
| |                        |  |              |    
| |                        |  | 2005         |     | 2004 |  
| |                        |  |              |     |      |  
| |                        |  |              |     |      |   |     | 
| | Government authorities |  | $            | 64  |      | $ | 149 | 
| | Prepaid expenses       |  |              | 204 |      |   | 503 | 
| | Others                 |  |              | 32  |      |   | 51  | 
| |                        |  |              |     |      |   |     | 
| |                        |  |              |     |      |   |     | 
| | Total                  |  | $            | 300 |      | $ | 703 | 
| |                        |  |              |     |      |   |     | 

|            |            
|----------- | -----------
|NOTE 6:    | INVENTORIES

| |                   |  |              |       |      |   |       | 
| | ----------------- |  | ------------ | ----- | ---- | - | ----- | 
| |                   |  | December 31, |      
| |                   |  |              |      
| |                   |  | 2005         |       | 2004 |  
| |                   |  |              |       |      |  
| | Raw materials     |  | $            | 202   |      | $ | 173   | 
| | Work in progress  |  |              | 69    |      |   | 166   | 
| | Finished products |  |              | 1,827 |      |   | 940   | 
| |                   |  |              |       |      |   |       | 
| |                   |  |              |       |      |   |       | 
| | Total             |  | $            | 2,098 |      | $ | 1,279 | 
| |                   |  |              |       |      |   |       | 

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                           | 
|----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------- | 
|NOTE 7:    | PREPAID DEVELOPMENT AND PRODUCTION
  COSTS, NET                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | During 2000, the Company
  recorded prepaid development and production costs in the amount of $2,134
  pursuant to an agreement signed between EZchip and IBM. According to the
  agreement, EZchip issued to IBM fully vested non-forfeitable Ordinary shares
  and is also obligated to future payments according to achievements of
  milestones and production quantities, in consideration of development and
  production services to be provided by IBM, which consists of the following:                     
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | (a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | Development
  - Access to unique semiconductor communications cores and technologies, and
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                          
|            | (b)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | Production -
  IBM agreed to develop specialized high-performance embedded DRAM cores,   
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                          
|            | which meet the
  requirements of EZchips 10-Gigabit wire-speed processing. The fair value of
  these services was measured in accordance with EITF 96-18 Accounting for
  Equity Investments That Are Issued to Other Than Employees for Acquiring or
  in Conjunction with Selling, Goods or Services (EITF 96-18) and recorded
  as an asset in accordance with EITF 00-18  Accounting Recognition for
  Certain Transactions involving Equity Instruments Granted to Other Than
  Employees (EITF 00-18).

F-20

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 7:    | PREPAID DEVELOPMENT AND PRODUCTION
  COSTS, NET (CONT.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | The Ordinary
  shares that were issued were valued in accordance with EZchips fair value at
  the date of this agreement based on a valuation performed by the Companys
  CFO. In addition, the Company performed a valuation of the development
  services, based on estimations performed by the Companys CEO of the scope of
  the anticipated efforts involved, using his best judgment and experience, as
  well as his acquaintance with the market price for similar development
  services. As support for the CEOs estimation, the Company also reviewed
  negotiations for comparable transactions, which indicated similar prices for
  IBMs development services. The remainder of the value of the shares issued
  to IBM was allocated to production services. Accordingly, prepaid costs
  totaling $2,134, were allocated between prepaid development services of
  $1,500, and prepaid production services of $634. Development costs are
  amortized upon achievement of milestones determined in the agreement. As of
  December 31, 2003 the development costs were fully amortized.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Production
  costs are included in cost of sales based on quantities produced. The
  production costs are amortized according to the ratio of units produced and
  the estimated units to be manufactured.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | For the
  years ended December 31, 2005, 2004 and 2003, amortization expenses related
  to the development costs amounted to $0, $0 and $122, respectively and the
  amortization expenses related to the production cost amounted to $95, $47 and
  $12, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE 8:    | PROPERTY AND EQUIPMENT, NET                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

| |                                                |  |              |       |      |   |       | 
| | ---------------------------------------------- |  | ------------ | ----- | ---- | - | ----- | 
| |                                                |  | December 31, |      
| |                                                |  |              |      
| |                                                |  | 2005         |       | 2004 |  
| |                                                |  |              |       |      |  
| | Cost:                                          |  |              |       |      |   |       | 
| |                                                |  |              |       |      |   |       | 
| | Office furniture and
  equipment               |  | $            | 10    |      | $ | 6     | 
| | Computers, software and
  electronic equipment |  |              | 3,394 |      |   | 2,981 | 
| | Motor vehicles                                 |  |              | -     |      |   | 41    | 
| | Leasehold improvements                         |  |              | 56    |      |   | 52    | 
| |                                                |  |              |       |      |   |       | 
| |                                                |  |              |       |      |   |       | 
| | Total cost                                     |  |              | 3,460 |      |   | 3,080 | 
| |                                                |  |              |       |      |   |       | 
| |                                                |  |              |       |      |   |       | 
| | Accumulated depreciation:                      |  |              |       |      |   |       | 
| |                                                |  |              |       |      |   |       | 
| | Office furniture and
  equipment               |  |              | 2     |      |   | 1     | 
| | Computers, software and
  electronic equipment |  |              | 3,079 |      |   | 2,649 | 
| | Motor vehicles                                 |  |              | -     |      |   | 26    | 
| | Leasehold improvements                         |  |              | 28    |      |   | 20    | 
| |                                                |  |              |       |      |   |       | 
| |                                                |  |              |       |      |   |       | 
| | Total accumulated depreciation                 |  |              | 3,109 |      |   | 2,696 | 
| |                                                |  |              |       |      |   |       | 
| |                                                |  |              |       |      |   |       | 
| | Depreciated cost                               |  | $            | 351   |      | $ | 384   | 
| |                                                |  |              |       |      |   |       | 

| |                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------
| | Depreciation
  expenses for the years ended December 31, 2005, 2004 and 2003, amounted to
  $239, $376 and $545, respectively.

F-21

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                          
|----------- | -------------------------
|NOTE 9:    | DEVELOPED TECHNOLOGY, NET

| |                          |  |              |       |      |   |       |  
| | ------------------------ |  | ------------ | ----- | ---- | - | ----- | -
| |                          |  | December 31, |      
| |                          |  |              |      
| |                          |  | 2005         |       | 2004 |  
| |                          |  |              |       |      |  
| | Cost:                    |  |              |       |      |   |       |  
| | Developed technology     |  | $            | 1,720 |      | $ | 1,203 |  
| |                          |  |              |       |      |   |       |  
| | Accumulated amortization |  |              | (859  | )    |   | (569  | )
| |                          |  |              |       |      |   |       |  
| |                          |  |              |       |      |   |       |  
| | Amortized cost           |  | $            | 861   |      | $ | 634   |  
| |                          |  |              |       |      |   |       |  

| |                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------
| | Amortization
  expenses for the years ended December 31, 2005, 2004 and 2003, amounted to
  $291, $241 and $239, respectively.
| |                                                                                                                               
| | Following is
  the estimated amortization expenses in respect of identifiable intangible
  assets:                            

Year ended December 31,2006

$
3442007

$
2562008

$
1032009

$
1032010

$
55


|            |                                              
|----------- | ---------------------------------------------
|NOTE 10:   | OTHER ACCOUNTS PAYABLE AND ACCRUED
  EXPENSES

| |                                |  |              |       |      |   |       | 
| | ------------------------------ |  | ------------ | ----- | ---- | - | ----- | 
| |                                |  | December 31, |      
| |                                |  |              |      
| |                                |  | 2005         |       | 2004 |  
| |                                |  |              |       |      |  
| |                                |  |              |       |      |   |       | 
| | Employees and payroll accruals |  | $            | 1,225 |      | $ | 1,308 | 
| | Accrued expenses               |  |              | 585   |      |   | 915   | 
| | Deferred revenues              |  |              | 106   |      |   | 255   | 
| |                                |  |              |       |      |   |       | 
| |                                |  | $            | 1,916 |      | $ | 2,478 | 
| |                                |  |              |       |      |   |       | 

|            |                                          |                    |                                                                                                                                                                                                            
|----------- | ---------------------------------------- | ------------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:   | COMMITMENTS AND CONTINGENT
  LIABILITIES
|            |                                         
|            | a.                                       | Lease commitments:
|            |                                          |                   
|            |                                          | 1.                 | The Company and its
  subsidiaries lease their facilities under operating lease agreements, which
  will expire in 2007. The minimum lease payments under non-cancelable
  operating leases are as follows:

Year ended December 31,2006

$
3392007


28$
367


F-22

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

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

| |    |                            |                                                                                                                                                                                                                                                                            
| | -- | -------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Lease commitments (cont.):
| |    |                           
| |    |                            | In case the Company will
  decide to terminate the operating lease agreement earlier, the Company will
  pay compensation in an amount of $20. EZchip leases two offices in the U.S. under lease
  agreement, which it renews every six months for a monthly payment of $7.
| |    |                            |                                                                                                                                                                                                                                                                            
| |    |                            | Total rent expenses for
  the Company and for its subsidiaries, for the years ended December 31, 2005,
  2004 and 2003, amounted to $368, $363 and $370, respectively.                                                                                                    
| |    |                            |                                                                                                                                                                                                                                                                            
| |    | 2.                         | The Company and EZchip
  lease motor vehicles under
  operating lease agreements, which will expire in 2008. The minimum lease
  payments under non-cancelable operating leases are as follows:                                                                            

| |                           |  |   |     | 
| | ------------------------- |  | - | --- | 
| | Year ended
  December 31, |  |   |    
| |                           |  |   |     | 
|
| | 2006                      |  | $ | 443 | 
| | 2007                      |  |   | 198 | 
| | 2008                      |  |   | 49  | 
| |                           |  |   |     | 
| |                           |  | $ | 690 | 
| |                           |  |   |     | 

| |  |  |                                                                                                                                          
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Lease motor vehicles
  expenses for the years ended December 31, 2005, 2004 and 2003, amounted to
  $ 605, $ 572 and $ 443, respectively.

|            |                         
|----------- | ------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY

| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | ------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Companys
  shares:
| |    |                    
| |    | 1.                  | Ordinary shares confer on
  their holders the right to receive notice to participate and vote in general
  meetings of the Company, the right to a share in the excess of assets upon
  liquidation of the Company, and the right to receive dividends, if declared.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | 2.                  | On November
  24, 2004, the Company signed an Investment Agreement (Investment Agreement)
  with investors pursuant to which the Company issued 1,368,000 Ordinary shares
  for a net total consideration of $13,471. In addition, the investors were
  granted warrants to purchase 478,800 Ordinary shares at an exercise price of
  $15.5 per share with an exercise period of five years. According to the
  Investment Agreement the Company was required to effect a registration
  statement permitting the resale of the shares underlying the Investment
  Agreement and to keep such registration effective until 2009. Any delay in
  registration and/or effectiveness will result in liquidated damages (and not
  penalty, as stated in the Agreement), to be paid in cash to the investors.
  The Company classified the warrants as equity according to EITF 00-19
  Accounting for Derivative Financial Instruments Indexed to and potentially
  settled in a Companys own stock (EITF 00-19). In December 2004, the
  Company filed a Form F-3 registration statement registering the underlying
  shares, including the underlying shares related to the warrants, which was
  declared effective within the time period required in the Investment
  Agreement.
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                    

F-23

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                 
|----------- | --------------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY (CONT.)

| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -- | ---------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Companys
  shares (cont.):                                                       
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | In December 2003, the
  Company issued 750,000 Ordinary shares for a net total consideration of
  $5,641. In addition, the Company granted the investor warrants to purchase up
  to 187,500 Ordinary shares at an exercise price of $11.39 per Ordinary share. The warrants are
  exercisable until December 2008. In January 2004, the Company filed a
  Form F-3 registration statement registering the underlying shares, including
  the underlying shares related to the warrants, which was declared effective
  within the time period. Under the agreement the Company is required to keep
  such registration effective until 2008.
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | b. | EZchips shares:                                                                  
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | The rights, preferences
  and restrictions of the shares of EZchip are as follows:
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | 1.                                                                                 | The Preferred shares
  confer on their holders all of the rights conferred by the Ordinary shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | 2.                                                                                 | Voting rights:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | Every
  holder of Preferred shares shall have one vote for each Ordinary share into
  which the Preferred shares held by him could be converted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | 3.                                                                                 | Conversion:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | Each
  Preferred share shall be convertible at the option of the holder into
  EZchips Ordinary shares on a 1:1 basis subject to adjustment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | The
  Preferred shares shall automatically be converted into EZchip Ordinary shares
  on a 1:1 basis, subject to adjustment upon a qualified IPO or by decision of
  the holders of a majority of the outstanding Preferred shares at any time.                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | 4.                                                                                 | Dividend preference:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | Each
  holder of Preferred shares shall be entitled to receive, when and if
  declared, non-cumulative dividends at the rate of 6% per annum from the
  original purchase price, prior and in preference to any declaration or
  payment of any dividend to the holders of Ordinary shares.                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | The
  dividend preference shall be allocated on a pro-rata basis between the
  holders of Series A Preferred shares, the holders of Series B Preferred
  shares, and the holders of Series C Preferred shares.                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | 5.                                                                                 | Anti-dilution:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                    | In
  the event that at any time after the original issuance date of Preferred A, B
  and C shares, EZchip issues additional shares at a price which reflects a
  price per share that is lower than the price of the Preferred A or Preferred
  B or Preferred C shares, then the conversion price for each Preferred share
  shall be adjusted to reflect such price reduction, in accordance with
  determined formula for each Series of Preferred shares.                                                                                                                                                                                

F-24

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                 
|----------- | --------------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY (CONT.)

| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------
| |  | 6. | Liquidation preference:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |    | The liquidation preference
  of the preferred shares include the following: (a) First, each Series C
  Preferred share shall entitle its holder to the original Series C per share
  issue price; (b) second, each Series B Preferred share shall entitle its
  holder to the original Series B per share issue price; (c) third, each Series
  A Preferred share  shall entitle its
  holder to the original Series A per share issue price; (d) fourth, each
  Series C Preferred share shall entitle its holder to one and a half times the
  original Series C per share issue price; (e) fifth, each Series B
  Preferred share shall entitle its holder to one and a half times the Original
  Series B per share issue price and, (f) sixth, in the event that the assets
  available for distribution shall equal or exceed the amount necessary to pay
  the full Series C, B and A liquidation preference, then after those
  distributions, all of the remaining assets shall be distributed to the
  holders of Series A, B and C Preferred shares and Ordinary shares in
  proportion to the respective percentage holdings, assuming all of the
  outstanding Preferred shares have been converted into Ordinary shares.
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |    | Each holders of Series C
  Preferred and or Series B Preferred Shares shall receive, with respect to
  each Series C Preferred and or Series B Preferred Shares held by such holder,
  the greater of (1) the C Preference or B Preference as applicable to such
  Preferred Shares, or (2) the amount that such holder would receive pursuant
  to the abovementioned distribution. The holders of Series A Preferred shares
  shall not be entitled to receive the A Preference if upon a distribution of
  the assets of the Company pursuant to the abovementioned distribution,
  without giving effect to the A Preference, such holder would receive, in
  respect of each Series A Preferred share an amount equal to or greater than three
  times the original A issue price.                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  | 7. | Redemption:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |    | At the request of the
  majority holders of Series C Preferred shares after four years from the
  issuance date, EZchip will be required to redeem the Series C Preferred
  shares at a price per share equal to the greater of (a) the original Series C
  per share issue price plus an amount equal to any accrued and unpaid
  dividends thereon plus 6% coupon interest compounded annually or (b) the fair
  market value of such shares. EZchip will be required to redeem Preferred C
  Shares subject to approval of a majority of Series C Preferred shareholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | 8. | Required consent:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  |    | EZchips articles of
  incorporation require approval by a simple majority of its board of directors
  or shareholders actions in the ordinary course of business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  |    | The consent of holders of
  a majority of Series C Preferred shares shall be required to:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |    | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Change the rights and
  terms of the Series C Preferred shares;                                                                     
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  |    | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Issue any security either
  senior to or on a parity with the Series C Preferred shares;                                            
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  |    | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Sell or merge EZchip (or
  any other corporate reorganization) or sell or exclusively license a
  substantial portion of its assets;
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  |    | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Pay any dividend to or
  redeem any existing Preferred shares or Ordinary shares;                                                   
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                     
| |  |    | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Change EZchips by-laws or
  articles of incorporation.                                                                             

F-25

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                 
|----------- | --------------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY (CONT.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c. | Stock option
  plans:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | Since 1993,
  LanOptics has granted options to purchase ordinary shares to key employees,
  directors and shareholders pursuant to the LanOptics 1992 Stock Option Plan
  as an incentive to attract and retain qualified personnel. Under the terms of
  these grants, options, generally, become exercisable ratably over a four-year
  period commencing with the date of grant. The options generally expire no later than six
  years from the date of the grant, and are non-transferable, except under the
  laws of succession. LanOptics 1992 Israeli Stock Option Plan expired in
  November 2002. There were approximately 140,000 options for ordinary shares
  that remained unissued upon the expiration of the 1992 Plan.            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | On October
  2003 the Company adopted the 2003 Israeli Share Option Plan (the 2003 Israel
  Plan), under which a total of 90,000 ordinary shares of the Company were
  reserved and authorized for the purpose of the option plan. Options under the
  2003 Israel Plan are issued to Israeli employees, directors, consultants,
  advisers and service providers of the Company and its subsidiaries. The 2003
  Israel Plan provides for the options granted to have a maximum exercise
  period of ten years from the date of grant. Options granted under the 2003
  Israel Plan are generally exercisable over four years. Options that are not
  exercised will become available for further grant by the Board under the 2003
  Israel Plan.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | Transactions related to the grant of options to employees under the
  above plans during the years ended December 31, 2005, 2004 and 2003, were as
  follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 
| | ------------------------------------ |  | ----------------------- | ------- | ---------------------------------- | - | ---------------- |  | ---------------------------------- | ------- | ---------------- | - | ---------------------------------- |  |  | ------- | - | - | ---- | 
| |                                      |  | Year ended December 31, |        
| |                                      |  |                         |        
| |                                      |  | 2005                    |         | 2004                               |   | 2003             | 
| |                                      |  |                         |         |                                    |   |                  | 
| |                                      |  | Numberof options        |         | Weighted
  average
  exerciseprice |   | Numberof options |  | Weighted
  average
  exerciseprice |         | Numberof options |   | Weighted
  average
  exerciseprice | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    | 
|
| | Outstanding at
  beginning of year   |  |                         | 306,239 |                                    | $ | 4.99             |  |                                    | 313,989 |                  | $ | 5.00                               |  |  | 258,739 |   | $ | 4.01 | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 
| | Granted                              |  |                         | -       |                                    | $ | -                |  |                                    | -       |                  | $ | -                                  |  |  | 90,250  |   | $ | 6.93 | 
| | Exercised                            |  |                         | (1,000  | )                                  | $ | 2.50             |  |                                    | (7,750  | )                | $ | 5.21                               |  |  | (35,000 | ) | $ | 2.68 | 
| | Forfeited                            |  |                         |         |                                    |   |                  |  |                                    | -       |                  | $ | -                                  |  |  | -       |   | $ | -    | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 
| | Outstanding at end
  of year         |  |                         | 305,239 |                                    | $ | 5.00             |  |                                    | 306,239 |                  | $ | 4.99                               |  |  | 313,989 |   | $ | 5.00 | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 
| | Exercisable options
  at end of year |  |                         | 295,239 |                                    | $ | 4.77             |  |                                    | 266,239 |                  | $ | 5.74                               |  |  | 238,989 |   | $ | 4.45 | 
| |                                      |  |                         |         |                                    |   |                  |  |                                    |         |                  |   |                                    |  |  |         |   |   |      | 

F-26

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                 
|----------- | --------------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY (CONT.)

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

| |                  |  |                                                  |         |                                                  |  |                                                   |  |  |         | 
| | ---------------- |  | ------------------------------------------------ | ------- | ------------------------------------------------ |  | ------------------------------------------------- |  |  | ------- | 
| | Exercise
  price |  | Options
  outstandingas of
  December 31,
  2005 |         | Weighted
  averageremaining
  contractual
  life |  | Options
  exercisableas of 
  December 31,
  2005 | 
| |                  |  |                                                  |         |                                                  |  |                                                   | 
| |                  |  |                                                  |         | Years                                            |  |                                                   | 
| |                  |  |                                                  |         |                                                  |  |                                                   | 
| |                  |  |                                                  |         |                                                  |  |                                                   | 
| | $       2.5      |  |                                                  | 4,250   |                                                  |  | 1.32                                              |  |  | 4,250   | 
| | $     4.15       |  |                                                  | 16,250  |                                                  |  | 0.87                                              |  |  | 16,250  | 
| | $   4.234        |  |                                                  | 194,739 |                                                  |  | 4.00                                              |  |  | 194,739 | 
| | $     6.93       |  |                                                  | 90,000  |                                                  |  | 7.84                                              |  |  | 80,000  | 
| |                  |  |                                                  |         |                                                  |  |                                                   |  |  |         | 
| |                  |  |                                                  |         |                                                  |  |                                                   |  |  |         | 
| |                  |  |                                                  | 305,239 |                                                  |  | 4.93                                              |  |  | 295,239 | 
| |                  |  |                                                  |         |                                                  |  |                                                   |  |  |         | 

| |  |                                                                                                                                                                                    
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Weighted
  average fair values and weighted average exercise prices of options whose
  exercise price is equal to the market price of the shares at date of grant
  are as follows:

| |                                                |  |                         |   |      |   |      |  |   |      | 
| | ---------------------------------------------- |  | ----------------------- | - | ---- | - | ---- |  | - | ---- | 
| |                                                |  | Year ended December 31, |  
| |                                                |  |                         |  
| |                                                |  | 2005                    |   | 2004 |   | 2003 | 
| |                                                |  |                         |   |      |   |      | 
| |                                                |  |                         |   |      |   |      |  |   |      | 
| | Weighted average exercise price                |  | $                       | - |      | $ | -    |  | $ | 6.93 | 
| |                                                |  |                         |   |      |   |      |  |   |      | 
| | Weighted average fair value on date of
  grant |  | $                       | - |      | $ | -    |  | $ | 3.43 | 

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Stock options of EZchip:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | Since 2000, EZchip has
  granted options to purchase its ordinary shares to key employees,
  shareholders and directors pursuant to the Israeli and the U.S. stock option
  plans (the 2000 Section 102 Share Option Plan, the 2003 Section 102 Share
  Option Plan and the 2001 U.S. Stock Option Plan), as an incentive to
  attract and retain qualified personnel. Under these plans a total of
  11,500,000 ordinary shares of EZchip are reserved and authorized for
  issuance. Under the terms of these grants, options generally become
  exercisable over a four-year period, commencing with the date of grant. The
  options generally expire 7 to 10 years from the date of the grant, and are
  non-transferable, except under the laws of succession.
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | During 2005, 2004 and 2003, EZchip decided
  to extend the exercise period for certain grants. The extension was accounted
  for in accordance with FIN 44, by applying a new measurement date, which
  resulted in additional compensation expenses for the years ended December 31,
  2005, 2004 and 2003 amounted to $ 43, $ 172 and $ 38, respectively.                                                                                                                                                                                                                                                                                                                                                                                                               

F-27

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                 
|----------- | --------------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY (CONT.)

| |  |                                                                                                                  
| |  | -----------------------------------------------------------------------------------------------------------------
| |  | The following table is a
  summary of activity (except options to consultants) for EZchips stock option
  plans:

| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 
| | ------------------------------------ |  | ----------------------- | ---------- | ---------------------------------- | - | ---------------- |  | ---------------------------------- | ---------- | ---------------- | - | ---------------------------------- |  |  | --------- | - | - | ---- | 
| |                                      |  | Year ended December 31, |           
| |                                      |  |                         |           
| |                                      |  | 2005                    |            | 2004                               |   | 2003             | 
| |                                      |  |                         |            |                                    |   |                  | 
| |                                      |  | Numberof options        |            | Weighted
  average
  exerciseprice |   | Numberof options |  | Weighted
  average
  exerciseprice |            | Numberof options |   | Weighted
  average
  exerciseprice | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    | 
|
| | Outstanding at
  beginning of year   |  |                         | 10,655,411 |                                    | $ | 0.67             |  |                                    | 8,180,474  |                  | $ | 0.71                               |  |  | 5,475,024 |   | $ | 0.66 | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 
| | Granted                              |  |                         | 231,500    |                                    | $ | 0.79             |  |                                    | 2,522,625  |                  | $ | 0.80                               |  |  | 2,810,732 |   | $ | 0.82 | 
| | Exercised                            |  |                         | (278,750   | )                                  | $ | 0.72             |  |                                    | -          |                  |   |                                    |  |  | (26,250   | ) | $ | 1.00 | 
| | Forfeited                            |  |                         | (400,094   | )                                  | $ | 0.81             |  |                                    | (47,688    | )                | $ | 0.81                               |  |  | (79,032   | ) | $ | 0.94 | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 
| | Outstanding at end
  of year         |  |                         | 10,208,067 |                                    | $ | 0.67             |  |                                    | 10,655,411 |                  | $ | 0.73                               |  |  | 8,180,474 |   | $ | 0.71 | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 
| | Exercisable options
  at end of year |  |                         | 8,128,806  |                                    | $ | 0.71             |  |                                    | 6,516,475  |                  | $ | 0.67                               |  |  | 4,653,275 |   | $ | 0.60 | 
| |                                      |  |                         |            |                                    |   |                  |  |                                    |            |                  |   |                                    |  |  |           |   |   |      | 

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

| |                  |  |                                                  |            |                                                  |       |                                                   |  |  |           | 
| | ---------------- |  | ------------------------------------------------ | ---------- | ------------------------------------------------ | ----- | ------------------------------------------------- |  |  | --------- | 
| | Exercise
  price |  | Options
  outstandingas of
  December 31,
  2005 |            | Weighted
  averageremaining
  contractual
  life |       | Options
  exercisableas of 
  December 31,
  2005 | 
| |                  |  |                                                  |            |                                                  |       |                                                   | 
| |                  |  |                                                  |            |                                                  | Years |                                                   |  |  |          
| |                  |  |                                                  |            |                                                  |       |                                                   |  |  |          
| |                  |  |                                                  |            |                                                  |       |                                                   |  |  |           | 
| | $0.4             |  |                                                  | 2,930,938  |                                                  |       | 1.34                                              |  |  | 2,930,938 | 
| | $0.72            |  |                                                  | 156,344    |                                                  |       | 1.51                                              |  |  | 156,344   | 
| | $0.78            |  |                                                  | 103,500    |                                                  |       | 9.84                                              |  |  | -         | 
| | $0.80            |  |                                                  | 2,336,750  |                                                  |       | 8.66                                              |  |  | 1,144,922 | 
| | $0.82            |  |                                                  | 2,582,012  |                                                  |       | 6.68                                              |  |  | 1,826,892 | 
| | $1.00            |  |                                                  | 2,098,523  |                                                  |       | 3.47                                              |  |  | 2,069,710 | 
| |                  |  |                                                  |            |                                                  |       |                                                   |  |  |           | 
| |                  |  |                                                  |            |                                                  |       |                                                   |  |  |           | 
| |                  |  |                                                  | 10,208,067 |                                                  |       | 4.89                                              |  |  | 8,128,806 | 
| |                  |  |                                                  |            |                                                  |       |                                                   |  |  |           | 

F-28

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                 
|----------- | --------------------------------
|NOTE 12:   | SHAREHOLDERS DEFICIENCY (CONT.)

| |  |                                                                                                                                                                                    
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Weighted
  average fair values and weighted average exercise prices of options whose
  exercise price approximate the market price of the shares at date of grant
  are as follows:

| |                                                |  |                         |      |      |   |      |  |   |      | 
| | ---------------------------------------------- |  | ----------------------- | ---- | ---- | - | ---- |  | - | ---- | 
| |                                                |  | Year ended December 31, |     
| |                                                |  |                         |     
| |                                                |  | 2005                    |      | 2004 |   | 2003 | 
| |                                                |  |                         |      |      |   |      | 
| | Weighted average exercise price                |  | $                       | 0.79 |      | $ | 0.80 |  | $ | 0.82 | 
| | Weighted average fair value on date of
  grant |  | $                       | 0.44 |      | $ | 0.34 |  | $ | 0.35 | 

| |  |                                                                                       
| |  | --------------------------------------------------------------------------------------
| |  | EZchips
  outstanding options to consultants as of December 31, 2005, are as follows:

| |               |  |                              |        |                              |  |                       |  |                       |        |  |          |  | 
| | ------------- |  | ---------------------------- | ------ | ---------------------------- |  | --------------------- |  | --------------------- | ------ |  | -------- |  | 
| | Issuance date |  | Number of
  options
  grants |        | Exercise
  price per
  share |  | Options
  exercisable |  | Exercisable
  through |       
| |               |  |                              |        |                              |  |                       |  |                       |       
| |               |  |                              |        |                              |  |                       |  |                       |        |  |          |  | 
| | May 2000      |  |                              | 15,000 |                              |  | $   0.72              |  |                       | 15,000 |  | May 2007 | 

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Reduction in
  Israeli tax rates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Until
  December 31, 2003, the regular tax rate applicable to income of companies
  (which are not entitled to benefits due to Approved Enterprise, as
  described above) was 36%. In June 2004 and in July 2005, the Knesset
  (Israeli parliament) passed amendments to the Income Tax Ordinance (No. 140
  and Temporary Provision), 2004 and (No. 147), 2005 respectively, which
  determine, among other things, that the corporate tax rate is to be gradually
  reduced to the following tax rates: 2004 - 35%, 2005 - 34%, 2006 - 31%, 2007
  - 29%, 2008 - 27%, 2009 - 26% and 2010 and thereafter - 25%.                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | b. | Measurement of taxable
  income under the Income Tax (Inflationary Adjustments) Law, 1985:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Results for tax purposes are measured in terms of earnings in NIS
  after certain adjustments for increases in Israels Consumer Price Index
  (CPI). As explained in Note 2b, the financial statements are measured in
  U.S. dollars. The difference between the annual change in Israels CPI and in
  the NIS/dollar exchange rate causes a further difference between taxable
  income and the income before taxes shown in the financial statements. In
  accordance with paragraph 9(f) of SFAS No. 109, the Company has not provided
  deferred income taxes on the difference between the functional currency and
  the tax bases of assets and liabilities.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | c. | Tax benefits under the Law
  for the Encouragement of Capital Investments, 1959 (the Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | In 2000, EZchip LTD was granted the Approved Enterprise status
  under the Law.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

F-29

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                          
|----------- | -------------------------
|NOTE 13:   | TAXES
  ON INCOME (CONT.)

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | According to the provisions of the Law, the Company has chosen to
  enjoy the Alternative Benefits track and, accordingly, its income from the
  Approved Enterprise is tax-exempt for a period of ten years, commencing in
  the first year the Company has taxable income. Due to the reported losses,
  the benefit period has not commenced. The period of tax benefits is subject
  to limits of the earlier of 12 years from the commencement of production, or
  14 years, from the approval date. Given the aforementioned conditions, the
  period of tax benefits will terminate 2013. The entitlement to the above
  benefits is conditional upon EZchip fulfilling the conditions stipulated by
  the above Law, regulations published thereunder and the letters of approval
  for the specific investments in Approved Enterprises. In the event of failure
  to comply with these conditions, the benefits may be canceled and EZchip may
  be required to refund the amount of the benefits, in whole or in part
  including interest.                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | As of December 31, 2005, management believes that EZchip is meeting
  all of the aforementioned conditions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | In the event of a distribution of cash dividends from income that is
  tax-exempt as mentioned above, EZchip would have to pay income tax equal to
  10% to 25% of the amount distributed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | The tax-exempt income attributable to the Approved Enterprise can
  be distributed to shareholders without subjecting EZchip to taxes only upon
  the complete liquidation of EZchip. EZchip currently has no plans to
  distribute dividends and intends to retain future earnings to finance the
  development of its business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Should the Company derive income from sources other than the
  Approved Enterprise during the relevant period of benefits, such income
  will be taxable at the regular corporate tax rate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | 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 Companys
  existing Approved Enterprise 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 and the Company may be required to record
  deferred tax liability with respect to such tax-exempt income. As of December
  31, 2005, the Company did not generate income under the provision of the new
  law.

F-30

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------- | ----------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:   | TAXES ON INCOME (CONT.)
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                   
|            | d.                      | Net operating losses
  carryforward:                                                                                                                                                                                                                                                                                                                                                                              
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                         | As of December 31,
  2005, the Company and EZchip Ltd. has a tax loss carryforwards amounted to
  approximately $60,641. These net operating losses may be carried forward
  indefinitely and may be offset against future taxable income. The Company
  expects that during the period in which these tax losses are utilized its income
  would be substantially tax-exempt.                                    
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                         | The carryforward tax
  losses through December 31, 2005, of
  EZchips subsidiary in the U.S amounted to approximately $4,229. These
  losses may be offset against any future U.S. taxable income of the U.S.
  subsidiary for periods of up to 20 years. In light of the U.S. subsidiary
  recent history of operating losses, the Company has recorded a valuation
  allowance for all its deferred tax assets.
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                         | Utilization
  of the U.S. net operating losses may be subject to substantial annual
  limitation due to the change in ownership provisions of the Internal
  Revenue Code of 1986 and similar state provisions. The annual limitation may
  result in the expiration of net operating losses before utilization.                                                                                                
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                   
|            | e.                      | Loss before taxes is
  comprised as follows:                                                                                                                                                                                                                                                                                                                                                                      

| |                   |  |                         |        |      |   |       |  |   |        | 
| | ----------------- |  | ----------------------- | ------ | ---- | - | ----- |  | - | ------ | 
| |                   |  | Year ended December 31, |       
| |                   |  |                         |       
| |                   |  | 2005                    |        | 2004 |   | 2003  | 
| |                   |  |                         |        |      |   |       | 
|
| | Domestic (Israel) |  | $                       | 9,452  |      | $ | 8,150 |  | $ | 9,121  | 
| | Foreign           |  |                         | 895    |      |   | 1,004 |  |   | 1,283  | 
| |                   |  |                         |        |      |   |       |  |   |        | 
| |                   |  |                         |        |      |   |       |  |   |        | 
| |                   |  | $                       | 10,347 |      | $ | 9,154 |  | $ | 10,404 | 
| |                   |  |                         |        |      |   |       |  |   |        | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | f. | 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. The Company and its
  subsidiaries deferred tax assets are comprised of operating loss
  carryforwards and other temporary differences. Significant components of the
  Company and its subsidiaries deferred tax assets are as follows:

| |                                                  |  |                |        |      |   |        |  
| | ------------------------------------------------ |  | -------------- | ------ | ---- | - | ------ | -
| |                                                  |  | December
  31, |       
| |                                                  |  |                |       
| |                                                  |  | 2005           |        | 2004 |  
| |                                                  |  |                |        |      |  
| |                                                  |  |                |        |      |   |        |  
| | Reserves and allowances                          |  | $              | 23     |      | $ | 26     |  
| | Loss carryforward                                |  |                | 1480   |      |   | 1,167  |  
| |                                                  |  |                |        |      |   |        |  
| |                                                  |  |                |        |      |   |        |  
| |                                                  |  |                |        |      |   |        |  
| | Deferred tax assets before valuation
  allowance |  |                | 1,503  |      |   | 1,234  |  
| | Less - valuation allowance                       |  |                | (1,503 | )    |   | (1,234 | )
| |                                                  |  |                |        |      |   |        |  
| |                                                  |  |                |        |      |   |        |  
| | Net deferred tax assets                          |  | $              | -      |      | $ | -      |  
| |                                                  |  |                |        |      |   |        |  

F-31

---

---



LANOPTICS LTD. AND ITS SUBSIDIARIES

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

|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------- | ----------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 13:   | TAXES ON INCOME (CONT.)            
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | f.                                  | Deferred taxes (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                     | The
  Companys U.S. subsidiary has provided valuation allowances in respect of
  deferred tax assets resulting from operating loss carryforward and other
  temporary differences. Management currently believes that since the Company
  and its subsidiaries have a history of losses it is more likely than not that
  the deferred tax regarding the loss carryforward and other temporary
  differences will not be realized in the foreseeable future.
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | g.                                  | Reconciliation of the
  theoretical tax expense (benefit) to the actual tax expense (benefit):                                                                                                                                                                                                                                                                                                                                                               
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                     | The main
  reconciling items between the statutory tax rate of the Company and the
  effective tax rate are the non-recognition of tax benefits from accumulated
  net operating losses carryforward among the Company and various subsidiaries due to the
  uncertainty of the realization of such tax benefits and the effect of
  approved enterprise.                                                                                                    
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE 14:   | SEGMENTS AND GEOGRAPHIC INFORMATION
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | a.                                  | Segment
  information:                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                     | The Company
  manages its business on the basis of one reportable segment. See Note 1a for
  a brief description of the Companys business.                                                                                                                                                                                                                                                                                                                  
|            |                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | b.                                  | Total revenues are
  attributed to geographic areas based on location of end customers. The
  following presents total revenues for the years ended December 31, 2005, 2004
  and 2003 and long-lived assets as of December 31, 2005, 2004 and 2003:                                                                                                                                                                                                         

| |               |  |               |       |                  |   |               |  |                  |       |               |   |                  |  |   |       |  |   |       | 
| | ------------- |  | ------------- | ----- | ---------------- | - | ------------- |  | ---------------- | ----- | ------------- | - | ---------------- |  | - | ----- |  | - | ----- | 
| |               |  | 2005          |       | 2004             |   | 2003          | 
| |               |  |               |       |                  |   |               | 
| |               |  | Totalrevenues |       | Long-livedassets |   | Totalrevenues |  | Long-livedAssets |       | Totalrevenues |   | Long-livedassets | 
| |               |  |               |       |                  |   |               |  |                  |       |               |   |                  | 
|
| | Israel        |  | $             | 2,414 |                  | $ | 6,425         |  | $                | 1,503 |               | $ | 1,491            |  | $ | 271   |  | $ | 1,955 | 
| | Far East      |  |               | 1,843 |                  |   | -             |  |                  | 1,065 |               |   | -                |  |   | 993   |  |   | -     | 
| | North America |  |               | 1,390 |                  |   | 1             |  |                  | 2,157 |               |   | 3                |  |   | 434   |  |   | 4     | 
| | Others        |  |               | 201   |                  |   | -             |  |                  | 21    |               |   | -                |  |   | 58    |  |   | -     | 
| |               |  |               |       |                  |   |               |  |                  |       |               |   |                  |  |   |       |  |   |       | 
| |               |  |               |       |                  |   |               |  |                  |       |               |   |                  |  |   |       |  |   |       | 
| |               |  | $             | 5,848 |                  | $ | 6,426         |  | $                | 4,746 |               | $ | 1,494            |  | $ | 1,756 |  | $ | 1,959 | 
| |               |  |               |       |                  |   |               |  |                  |       |               |   |                  |  |   |       |  |   |       | 

| |    |                                                         
| | -- | --------------------------------------------------------
| | c. | Major
  customer data as a percentage of total revenues:

| |            |  |                           |   |      |    |      |  |    |   | 
| | ---------- |  | ------------------------- | - | ---- | -- | ---- |  | -- | - | 
| |            |  | Year ended
  December 31, |  
| |            |  |                           |  
| |            |  | 2005                      |   | 2004 |    | 2003 | 
| |            |  |                           |   |      |    |      | 
| |            |  |                           |   |      |    |      | 
| | Customer A |  | 28                        | % |      | 41 | %    |  | -  |   | 
| | Customer B |  | -                         |   |      | -  |      |  | 13 | % | 
| | Customer C |  | -                         |   |      | -  |      |  | 22 | % | 
| | Customer D |  | 8                         | % |      | 11 | %    |  | -  |   | 
| | Customer E |  | 10                        | % |      | -  |      |  | -  |   | 

F-32

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LANOPTICS
LTD. AND ITS SUBSIDIARIES

|            |                                  
|----------- | ---------------------------------
|NOTE 15:   | FINANCIAL AND OTHER EXPENSES, NET

| |                                                     |  |                           |      |      |   |        |   |   |      |  
| | --------------------------------------------------- |  | ------------------------- | ---- | ---- | - | ------ | - | - | ---- | -
| |                                                     |  | Year ended
  December 31, |     
| |                                                     |  |                           |     
| |                                                     |  | 2005                      |      | 2004 |   | 2003   |  
| |                                                     |  |                           |      |      |   |        |  
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| | Income:                                             |  |                           |      |      |   |        |   |   |      |  
| | Interest income                                     |  | $                         | 578  |      | $ | 270    |   | $ | 207  |  
| | Foreign currency
  translation adjustments          |  |                           | 26   |      |   | -      |   |   | 3    |  
| | Other income                                        |  |                           | 12   |      |   | 1      |   |   | -    |  
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| | Total income                                        |  |                           | 616  |      |   | 271    |   |   | 210  |  
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| | Expenses:                                           |  |                           |      |      |   |        |   |   |      |  
| | Interest and bank charges                           |  |                           | (37  | )    |   | (36    | ) |   | (8   | )
| | Foreign currency
  translation adjustments          |  |                           | -    |      |   | (25    | ) |   | -    |  
| | Amortization of discount on
  long-term loan        |  |                           | -    |      |   | (88    | ) |   | (59  | )
| | Interest on a long-term
  loan                      |  |                           | -    |      |   | (56    | ) |   | (54  | )
| | Interest on Redeemable
  Preferred shares in EZchip |  |                           | (891 | )    |   | (804   | ) |   | (504 | )
| | Other expenses                                      |  |                           | -    |      |   | -      |   |   | (3   | )
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| | Total expenses                                      |  |                           | (928 | )    |   | (1,009 | ) |   | (628 | )
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| |                                                     |  |                           |      |      |   |        |   |   |      |  
| | Net financial and other expenses                    |  | $                         | (312 | )    | $ | (738   | ) | $ | (418 | )
| |                                                     |  |                           |      |      |   |        |   |   |      |  

F-33

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SIGNATURES

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

| |                                     
| | ------------------------------------
| | LANOPTICS
  LTD.                    
| |                                     
| | By:                                 
| |                                     
| | /s/ Meir D. Burstin                 
| |                                     
| | Dr.
  Meir D. Burstin               
| | Chairman
  of the Board of Directors

Dated: March 30,
2006

69

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