**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

| (Mark One)                                                                                                                         |                                                                                                    |
|------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ý                                                                                                                             | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|                                                                                                                               | **For the fiscal year ended December 31, 2006**                                                    |
|  ̈                                                                                                                             | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For the transition period from                   to** |

 

**Commission File Number 000-50954**

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**NESS TECHNOLOGIES, INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                    |   | **98-0346908**         |
|---------------------------------|--------|------------------------|
| (State or other jurisdiction of |   | (I.R.S. Employer       |
| incorporation or organization)  |   | Identification Number) |

 

**Ness TowerAtidim High-Tech Industrial ParkBuilding 4Tel Aviv 61580, IsraelTelephone: +972 (3) 766-6800**

(Address of registrant’s principal executive offices and registrant’stelephone number, including area code)

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Securitiesregistered pursuant to Section 12(b) of the Act:

|                                         | **Title of each class** | ** **              |   | ** ** | **Name of each exchange on which  registered** | ** ** |
|-----------------------------------------|-------------------------|-------------------------|--------|------------|------------------------------------------------|------------|
| Common Stock, $0.01 par value per share |                    | The NASDAQ Stock Market |

 

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yesý No

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. o Yes ý No

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. ý Yeso No

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein,and will not be contained,to the best of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

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

Large accelerated filer o         Acceleratedfiler ý         Non-accelerated filer o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). o Yesý No

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the registrant as of June 30,2006 was $385.2 million, based on the closing price of the stock on that date.As of March 2, 2007, 38,962,720 shares of common stock, $0.01 par valueper share, were outstanding.

The registrantintends to file, not later than April 30, 2007, a definitive proxystatement pursuant to Regulation 14A, promulgated under the Securities ExchangeAct of 1934, as amended, to be used in connection with the registrant’s annualmeeting of stockholders. The information required in response to Items 10-14of Part III of this Form 10-K is herebyincorporated by referenceto such proxy statement.

 

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**NESS TECHNOLOGIES,INC. AND SUBSIDIARIES**

**INDEX**

| PART I                                | 3                                                                                                                          |
|--------------------------------------------|----------------------------------------------------------------------------------------------------------------------------|
|                                       | Item 1.  Business                                                                                                          | 3 |
|                                       | Item  1A. Risk Factors                                                                                                     | 23 |
|                                       | Item 1B. Unresolved Staff Comments                                                                                         | 33 |
|                                       | Item 2.  Properties                                                                                                        | 33 |
|                                       | Item  3. Legal Proceedings                                                                                                 | 33 |
|                                       | Item 4. Submission of Matters to a Vote of Security  Holders                                                               | 34 |
| PART II                               | 35                                                                                                                         |
|                                       | Item 5. Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities | 35 |
|                                       | Item  6. Selected Financial Data                                                                                           | 36 |
|                                       | Item 7. Management’s Discussion and Analysis of Financial  Condition and Results of  Operations                       | 38 |
|                                       | Item 7A. Quantitative and Qualitative Disclosure about  Market Risk                                                        | 54 |
|                                       | Item 8. Financial Statements and Supplementary Data                                                                        | 55 |
|                                       | Item 9. Changes in and Disagreements with Accountants  on Accounting and Financial  Disclosure                             | 55 |
|                                       | Item 9A. Controls and Procedures                                                                                           | 55 |
|                                       | Item  9B. Other Information                                                                                                | 57 |
| PART III                              | 59                                                                                                                         |
|                                       | Item 10. Directors, Executive Officers and Corporate  Governance                                                           | 59 |
|                                       | Item 11. Executive Compensation                                                                                            | 59 |
|                                       | Item 12. Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                   | 59 |
|                                       | Item 13. Certain Relationships and Related  Transactions, and Director Independence                                        | 59 |
|                                       | Item 14. Principal Accountant Fees and Services                                                                            | 59 |
| PART IV                               | 60                                                                                                                         |
|                                       | Item 15. Exhibits and Financial Statement Schedules                                                                        | 60 |
| SIGNATURES                                 | 63                                                                                                                         |
| INDEX TO CONSOLIDATED FINANCIAL STATEMENTS | F-1                                                                                                                        |
| EXHIBIT INDEX                              |                                                                                                                       |

 

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**PART I**

**DisclosureStatement**

This Annual Report on Form 10-Kcontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, Section 21E of the SecuritiesExchange Act of 1934 (the “Exchange Act”), as amended, and the PrivateSecurities Litigation Reform Act of 1995, relating to our operations and ourresults of operations that are based on our current expectations, estimates andprojections. Words such as “expects,” “intends,” “plans,” “projects,” believes,”“estimates” and similar expressions are used to identify these forward-lookingstatements. These statements are not guarantees of future performance andinvolve risks, uncertainties and assumptions that are difficult to predict.Forward-looking statements are based upon assumptions as to future events thatmay not prove to be accurate. Actual outcomes and results may differ materiallyfrom what is expressed or forecast in these forward-looking statements. Thereasons for these differences include changes in general economic and politicalconditions, including fluctuations in exchange rates, and the factors discussedbelow under Item 1A “Risk Factors.”

**AvailableInformation**

Our website address is www.ness.com. We make availablefree of charge on the Investor Relations section of our website(investor.ness.com) our Annual Reports on Form 10-K, QuarterlyReports on Form 10-Q, Current Reports on Form 8-K and allamendments to those reports as soon as reasonably practicable after suchmaterial is electronically filed or furnished with the Securities and ExchangeCommission (the “SEC”) pursuant to Section 13(a) or 15(d) of theExchange Act. We also make available through our website other reports filedwith or furnished to the SEC under the Exchange Act, including our proxystatements and reports filed by officers and directors under Section 16(a) ofthat Act, as well as our Code of Business Conduct and Ethics. We do not intendfor information contained in our website to be part of this Annual Report on Form 10-K.

You also may read and copy any materials we file withthe SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW,Washington, DC, 20549. You may obtain information on the operation of thePublic Reference Room by calling the SEC at 1-800-SEC-0330.The SEC maintains an Internet site (www.sec.gov) that contains reports, proxyand information statements, and other information regarding issuers that fileelectronically with the SEC.

In this Annual Report on Form 10-K,we use the terms “Ness,” “we,” “our,” “us” and “the Company” to refer to NessTechnologies, Inc. and its subsidiaries.

***Item 1. Business***

**General**

We are a global provider of information technology, orIT, services and end-to-end business solutions designed to help clients improvetheir competitiveness and effectiveness. End-to-end business solutionsencompass all stages of a client’s business process and incorporate alltechnologies and IT services related to that process. Our portfolio ofsolutions and services includes outsourcing, system integration and applicationdevelopment, software and consulting, and quality assurance and training.

We provide services to a significant number of clientsin the commercial, industrial and government sectors. We have a highly skilledworkforce of experienced IT employees and consulting professionals across ourkey vertical markets. The primary industries, or verticals, we serve includegovernment and defense, financial services, life sciences and healthcare,telecommunications and utilities, and independent software vendors, or ISVs. Wecombine our knowledge of these vertical markets and our clients’ businesses 

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with our technicalexpertise to deliver tailored solutions to our clients, many of whom aresubject to rigorous regulatory requirements.

We have operations in 16 countries across NorthAmerica, Europe and Asia. We combine our deep vertical expertise and strongtechnical capabilities to provide a complete range of high quality services ona global scale. By integrating our local and international personnel in focusedbusiness and project teams, this global delivery model leverages our corporateknowledge and experience, intellectual property and global infrastructure todevelop innovative solutions for clients across the geographies and verticalswe serve. We complement this global delivery model with our offshore deliverycapabilities to achieve meaningful cost reductions or other benefits for ourclients.

We provide services to over 500 clients locatedthroughout the world, including a number of Fortune 1000 and Global 2000companies. We have achieved recurring revenues as a result of our multi-yearcontracts and long-standing relationships with clients such as AT&T,Chordiant, ČEZa.s., Czech Telecom, Franklin Templeton, Israel Aircraft Industries, IsraelDiscount Bank, Lockheed Martin, Orange and Pfizer, which are among the largestclients in each of our verticals, based on revenues. In 2006, existing clientsfrom prior years generated more than 80% of our revenues, with no single clientaccounting for more than 5% of our revenues.

Our services and solutions offerings are strengthenedby our strategic alliances and close relationships with leading global softwareand infrastructure vendors, which allow our clients to benefit from a selectionof technologies and innovation. We maintain the highest level of certificationwith many of our key partners, which allows us to influence their developmentof new products and obtain and offer our clients early access to new productofferings. These certifications are awarded by major ISVs and service providersto those partners that demonstrate high levels of professional and technicalexpertise. Some key alliances and partnerships that are applicable acrossmultiple industry verticals and geographies, and with whom we conduct businessand maintain high levels of certification are EMC Documentum, IBM, Microsoft,SAP and Unisys, as well as various companies for whom we distribute softwareproducts.

Our revenues have grown from $166.6 million in 2002 to$474.3 million in 2006, representing a compounded annual growth rate ofapproximately 30%. During that time, our results of operations have alsoimproved from net income of $0.9 million for 2002 to $29.8 million for 2006.

For 2004, 2005 and 2006, the percentage of our revenuesgenerated by public and private sector clients in Israel was 57%, 52% and 48%,respectively. The percentage of our revenues derived, in aggregate, fromagencies of the government of Israel for the same time periods was 12%, 11% and10%, respectively, while our revenues from these agencies increased steadilyduring the same periods.

Ness Technologies, Inc. was incorporated inDelaware in March 1999 in connection with the acquisition between 1997 and1999 of six Israeli IT companies, which collectively average more than 23 yearsof IT experience. These companies and each company we subsequently acquiredhave been successfully integrated into our corporate structure, and theacquired capabilities, know-how and staff have been assigned to our variousbusiness groups.

Our principal executive office in the United States islocated at 3 University Plaza, Suite 600, Hackensack, New Jersey 07601.Our telephone number there is (201) 488-7222. Our principal executiveoffice in Israel is located at Ness Tower, Atidim High-Tech Industrial Park,Building 4, Tel Aviv 61580, Israel. Our telephone number there is +972 (3) 766-6800.

Ness and V-Ness are our primary trademarks and tradenames. All other trademarks, trade names and service marks used in this reportare the property of their respective owners.

Unless otherwise noted, (1) allreferences to “dollars” or “$” are to United States dollars and all referencesto “NIS” are to New Israeli Shekels, (2) all references to shares of ourcommon stock and per 

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shareinformation have been adjusted to reflect the 0.7193 for one reverse stocksplit effected on September 20, 2004.

**Service Offerings**

We offer a broad suite ofservices, including outsourcing, system integration and applicationdevelopment, software and consulting, and quality assurance, or QA, andtraining.

***Outsourcing***

We have several specific offerings in this category,each of which represents the outsourcing of a core client IT function to us. Weperform these services either locally (at the client’s facilities or ourfacilities) or at our offshore facilities. We offer the following outsourcingservices:

*ManagedLabs for Independent Software Vendors.*   ISVs areincreasingly faced with challenges, including pricing pressures, lower licensesales, increased competition and reduced development budgets. To address thesechallenges, we have developed a managed labs offering to provide ISVs withoutsourced software product research and development centers that supplementthose of the client. These offerings include product development andmaintenance, testing, release automation services and porting services. We haveexperience in successfully providing management consulting, processtransformation, technology solutions and offshore production services. Ourstrong infrastructure and proven processes ensure that our solutions aredeveloped and built offshore and deployed onsite in an efficient and effectivemanner.

Our expertise lies in the design and development ofnew software products, re-development, re-engineering, and maintenance ofexisting products, and global implementation and rollout support for existingproducts. Our labs are specially designed to assist software product companiesthrough all phases of a product’s life cycle. We consider ourselves custodiansof our clients’ intellectual property and accordingly offer them ourbuild-operate-transfer model. We function as a partner with our clients tomanage tactical needs at all phases of the development process. During the “build”phase, we provide strategic consulting to address our clients’ businesschallenges and investment goals. During the “operate” phase, we help ourclients track progress according to their plans. We report and advise ourclients on the work in progress and refine the model in accordance with theirbusiness priorities. We have successfully executed this model with over 30companies worldwide. Typically, after 36 months of operation, we offer ourclients the option of purchasing back the offshore development center assets intheir entirety.

*ITOutsourcing.*   We offer customized IT outsourcingservices, both onsite and off-site. Through our end-to-end service solution, wetake responsibility for all or a portion of client operations and activities,including information security solutions, IT management, applicationdevelopment and maintenance, infrastructure implementation and management,network management, computer and communications hardware, help desk support,and disaster recovery planning, storage and backup solutions. We apply ourproven methodologies, which cover every phase of a project’s lifecycle, withstrong project management, senior staff supervision and QA mechanisms to ensurereliable delivery. We currently provide these services, including support on a24-hour-a-day, seven-day-a-week basis, to approximately 30 clients indiverse fields, representing, we believe, over 100,000 end-users, forsingle-site and multi-site enterprises and organizations.

*OffshoreApplication Development and Maintenance.*   Ouroffshore application development and maintenance services include a wide rangeof technologies and platforms. We customize our services according to eachclient’s needs by employing flexible service models drawn from our experiencehelping our clients outsource software services. Our offshore center inBangalore, India is ISO 9001 certified and accredited at CMMI Level 3, ouroffshore center in Mumbai, India is accredited at CMM Level 5 and our offshorecenter in Hyderabad, India is accredited at CMM Level 4 and is ISO/IEC27001:2005 certified, enabling us to provide low cost, high quality and 24-hourdevelopment cycle capability. ISO 9001 is an 

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international standard forquality management systems maintained by the International Organization ofStandardization. The CMM, or Capability Maturity Model, is a widely acceptedset of practices developed by the Software Engineering Institute at CarnegieMellon aimed at producing defect free software by technical and managementdiscipline, rather than by exhaustive testing. CMM Level 5 accreditation isreserved for organizations with the highest quality of disciplined andrepeatable software development practices. CMMI, or Capability Maturity ModelIntegrated, accreditation measures an organization’s maturity across multiplesoftware development and system engineering practices, consisting of bestpractices that address product development and maintenance covering the product’slife cycle from conception through delivery and maintenance. ISO/IEC 27001(formerly BS 7700) certification formally attests to the rigorousimplementation of the elements of IT security—confidentiality, integrity,availability and legality—in a company’s services and solutions.

To date, we have provided most of our offshoreapplication development services to clients in the financial services, retailand telecommunications verticals. Following development and implementation, weprovide services such as end-to-end application monitoring, scheduled downtimeand maintenance, ad-hoc maintenance activities, application upgrades and legacyapplication integration within and across company firewalls.

We believe our applicationdevelopment and maintenance services are characterized by low cost, highquality and short time-to-market. We create, implement and integrate softwareapplications through a global infrastructure, and we believe we are wellpositioned to support virtually any client anywhere in the world through ourglobal delivery model.

***System Integration and Application Development***

We offer a broad set of IT services to our clients inthe area of system integration and application development, including thefollowing:

*EnterpriseResource Planning and Customer Relationship Management Solutions.*   Enterpriseresource planning, or ERP, and customer relationship management, or CRM, areintegrated application software packages designed to support multiple businessfunctions. For many organizations in the vertical markets we serve, ERP and CRMsystems are the backbone of business transactions and communications. We offera wide range of ERP and CRM solutions and services, including needs analysis,product selection and differentiation analysis, solution design, installationand administration, product adjustment and customization, data transfer fromoriginal information systems, integration with other systems, includingbusiness partner systems, end-user and administrator training, manualproduction and routine operational support, including upgrades and ongoingdevelopment. Our client service teams provide support activities such aslocalization, basis team infrastructure, training and delivery of complementaryproducts. Our solutions and expertise include supply chain management, supplierrelationship management and life cycle management.

We provide these services from many of our deliverycenters for clients around the world. In Israel, we are the sole SAP productdistributor, where we also implement SAP and operate the Israeli SAP usergroup.

*EnterpriseApplication Integration (EAI).*   We offer EAIsolutions focused on building software infrastructure platforms that simplifyconnectivity between diverse applications and dissimilar business systems. Weintegrate and leverage our clients’ investments in current systems whileimproving business efficiency and enabling the sharing of information acrossapplication boundaries. Our integration personnel are proficient in primaryintegration tools and standards.

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*Command and Control andReal-Time Systems.*   We deliver high-end technicalsolutions for protecting the safety of national borders, improving datagathering mechanisms, and enhancing communications channels for both militaryand civilian organizations. These services include:

·       airdefense command and control systems, including simulators, test beds, C4Isystems, planning systems and air traffic control systems;

·       groundcommand and control systems, or GCCS, including strategic and tacticalvisualization systems, digital GCCS systems, and tactical command and controlsystems;

·       surveillancesystems, including mission management systems and unmanned aerial vehicleinterpretation systems;

·       intelligencesystems, including IT solutions for organizations which collect, process anddisseminate large volumes of information, in a demanding environment;

·       missiledefense, including missile defense simulation and theater defense systems; and

·       electronicwarfare systems, including modern human machine interfaces, resourceallocation, parameter management, results acquisition and threats databasemanagement.

*GeographicInformation Systems (GIS).*   We have been activein the field of digital mapping since 1985, developing advanced GIS thatquickly and accurately process and transform large volumes of maps andphotography into various digital and easily readable formats. For example,militaries are in critical need of accurate maps, GIS data, and photographicintelligence for mission planning, operational command and control, and threedimensional mission rehearsal and training. Similarly, emergency responsesystems require accurate road maps, current location display, shortest routedetermination and other GIS capabilities that we provide.

Some of Israel’s national (including military,civilian and commercial) geographic databases were created using software wedeveloped. These systems cover all aspects of cartographic and photogrammetricdata collection, manipulation, storage and retrieval.

*TelecommunicationsSystems.*   We provide industrial, government anddefense organizations with turnkey solutions, including complete systems andspecifically tailored projects designed to facilitate the management oftelecommunications systems and networks. We have developed a wide range ofnetwork management products, including:

·       contactcenters and computer telephony integration systems;

·       largescale integrated network management systems for switching, transmission anddata;

·       telephonedirectory assistance systems; and

·       voiceactivated dialing—telecommunication speech recognition technologies.

*Document Management andKnowledge Management.*   We offer a range ofservices and products designed to help our clients realize value from theircorporate knowledge, including information storage, retrieval and sharing. Ourspecific offerings include:

·       documentmanagement and workflow solutions for facilitating the storage and managementof electronic documents and images.

·       enterprisecontent management—business processes for delivering well-integratedinformation to key decision makers on a timely basis; and

·       enterpriseportals—solutions integrating the necessary components for a knowledge-centricportal infrastructure;

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*Business Intelligence (BI)and Data Warehousing.*   We enable organizations todevelop what we believe to be complete state-of-the-art information systems forturning data into business intelligence. Our end-to-end BI and data warehousingsolutions are designed to ensure accuracy, consistency and timeliness ofinformation storage and retrieval to meet our clients’ business requirements.Recent examples within the life sciences and healthcare vertical include BI anddata warehousing solutions in the following areas:

·       clinicaltrials management systems; and

·       scientificdata management systems utilized in the research and development area.

Other examplesinclude:

·       portfoliomanagement systems, including balanced scorecard systems to measure businessperformance using data from clinical trials, research and development, andsales and marketing; and

·       sales,marketing and financial solutions, which analyze market share/size, revenuesand costs to help increase profitability and produce other metrics relevant tobusiness decisions.

*Proprietary and TurnkeySolutions.*   We have developed software to marketas proprietary turnkey solutions, which are customized applications designedand modified to meet client needs. We provide end-to-end business solutionsfrom design to maintenance and are able to provide specialization according tothe subtle differences within each specific industry. We retain certainintellectual property and rights which allow us to continue to exploitopportunities to market these products. Our turnkey solutions include:

·       AwareNess—anemergency management system;

·       electronictoll collection system, including CRM billing and payment for toll roadsystems;

·       bordercontrol system used for identifying, controlling and registering passagesthrough borders;

·       pensionmanagement system, enabling large organizations and pension funds to manage allaspects of employee pensions;

·       InsureNess—acomprehensive core insurance infrastructure for life and health insurance;

·       businessrules technology software, permitting IT organizations to develop businesssolutions with reduced coding;

·       paperlesscourt system, bringing all court-related documents and communications online toenable electronic case filing.

·       digitalrights management software, enabling broadcasters, television and filmproducers, and media companies and publishers to manage all their authorrights, contracts, and royalties; and

·       air traffic controlsystems, including various software solutions handling all aspects of thecomplicated task of air traffic control.

***Software andConsulting***

We offer a comprehensive range of strategic consultingservices and are able to assess a client’s software needs and recommend and, incertain cases, resell, commercially available software products and systems.

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*ProductRepresentation.*   We select what we believe to bethe best products for our clients by working closely with major internationalvendors who specialize in software product development, integration,localization, marketing, service and maintenance. In this way, we are able toleverage the products and methodologies supplied by our partners in order toprovide our clients with comprehensive value added solutions. Through ourpartner relationships, we resell products, mostly in Israel, Spain, Portugal andAsia Pacific, for over 30 companies, including SAP, EMC Documentum, Sybase,Information Builders, Genesys, Sterling Commerce, Serena, SyncSort andTelcordia.

*Strategic Consulting.*   Weleverage our proven methodologies to help our clients analyze, plan and achieveobjectives at various stages of the business lifecycle. Our expertise, coupledwith product and technology alliances, provides organizations with a one-stopsolution. To deepen our specialization and understanding of our clients’business needs, we have established teams with core competence in particularverticals. Our IT experience, combined with our technology independence,enables us to offer a range of IT solutions for combining business trends andcompany goals with IT implementation. We believe that this blend of IT andbusiness expertise is unique and enables us to unify IT and business needs toenhance our clients’ competitive advantage and growth. We also provide strategicstaff augmentation services for some accounts, as part of our methodology forpenetrating strategic accounts.

***QualityAssurance and Training***

We offer a broad range of QA, testing, user interfaceengineering, training and user assimilation services, all designed to producehigh quality business solutions with broad and rapid user acceptance.

*QualityAssurance, Testing and User Interface Engineering.*   Astechnology platforms have become more complex at each of the application,operating system and hardware levels, there is a growing need to test, analyzeand certify that software and hardware function as designed. Because of thisgrowing complexity, together with reduced IT budgets, many companies outsourcethe testing and QA process to third party vendors. We target this growingmarket with our independent V-Ness software testing and QA service. In order tomeet the needs of our client base, the V-Ness service provides a spectrum ofsolutions including: time to market QA methodology; system integrationperformance and testing; user interface engineering and user experienceengineering; validation and full traceability capabilities that allow us to verifythat the end product meets the initial product specifications; enterprise QAsolutions, such as ERP, CRM and data warehousing; test automation; loadtesting; and quality consulting. Our professionals have extensive experience inQA and testing using our documented and proven work methodologies.

*Trainingand Assimilation.*   We offer clients comprehensivelearning solutions by providing a wide range of training services. Our staffprovides training across a wide range of information, technology andcommunication applications. We customize our training programs based on advancedproprietary training methodologies and evaluation tools satisfying our clients’needs in terms of content, target audience, level of knowledge and trainingtimes. We complement traditional learning methods with learning managementsystems, e-learning platforms, and computer and web based self study kits,enabling end-users to learn at their own pace and level.

In addition to training,we offer assimilation services, designed to help organizations deploy newsolutions rapidly and effectively. We include these services as part of everyproject, and also offer them separately to meet client needs.

**Industry Overview**

The IT services industry is highly fragmented and hasevolved from simply supporting business functions to enabling their expansionand transformation. To succeed in this transformation, companies must respondrapidly to market trends, create new business models and improve productivity.In this dynamic, competitive environment, decisions with respect to technologyhave become increasingly 

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important. Also, due tothe 2002 to 2004 global economic downturn as well as the lack of compelling ITinitiatives, such as Year 2000 and Euro conversion, companies substantiallyreduced their IT services spending, resulting in hardship for many IT servicevendors. According to industry analysts, however, the IT services market isagain in a period of growth. Based on our review of publicly availableinformation, the global IT services market will grow from $629 billion in 2005to $856 billion in 2010, a compounded annual growth rate of approximately 6.4%.

Companies are increasingly seeking cost effectivealternatives to acquire high quality IT services. The use of offshore vendorsis increasingly common among larger corporations. Based on our review ofpublicly available information, we believe IT services provided offshoretotaled between $20 billion and $24 billion in 2006, representing slightly over3% of the total IT services market, and India has captured the bulk of thisrevenue. Other offshore IT service countries are gaining market share. Based onour review of publicly available information, we project an annual growth ratefor offshore IT services of 25% to 30%, making offshore IT services aparticularly high growth market. Offshore business processing outsourcingservices are projected to grow even faster, with an estimated annual growthrate as high as 60%.

These factors reflect abusiness opportunity for global IT services vendors with established verticalpractices, effective global delivery mechanisms and limited reliance onlong-term staff relocation from offshore locations to client locations in theUnited States and around the world.

**CompetitiveStrengths**

We believe our competitive strengths include:

*Ourvertical expertise.*   Since our inception, we haveachieved leading positions in a number of the verticals in which we compete. Wemaintain a staff of highly skilled industry experts in each of these verticalsand use this expertise on our engagements to provide a range of end-to-endbusiness solutions.

*Ourglobal delivery model.*   We have operations in 16countries in North America, Europe and Asia. We provide services to our clientsthrough a comprehensive global delivery model that integrates both local andglobal resources in a cost-effective manner. Our fully operational offshoreoutsourcing centers, including our CMM level 4 and 5 accredited, CMMI level 3accredited and ISO/IEC 27001:2005 certified offshore facilities in India,enable us to minimize the difficulties other outsourcing vendors now face inusing foreign employees in the United States on a temporary basis due to thetightening of immigration policies.

*Ourproven track record.*   By consistently providinghigh quality services, we have achieved a track record of project successesthrough the completion of numerous engagements around the world. Part ofour success is attributable to our focus on methodology and repeatable highquality practices, which are ISO 9001 certified.

*Ourfocus on quality.*   We believe strongly in qualitythroughout our organization. We maintain independent quality assurancecapabilities in geographies where we operate. We also provide QA, testing andaudit services to some of our clients on QA engagements through our independentV-Ness subsidiary.

*Ourfocus on innovation.*   Our employees possess alevel of business and technical knowledge that enables us to be innovative whenon assignment. Utilizing both our practical understanding of our clients’ needsand our technical expertise, we strive to provide innovative solutions to ourclients’ problems. Examples of such innovation include the creation of ourmanaged labs extended development center offering, which supplements andextends the research and development facilities of ISVs for core productdevelopment and other activities; and the creation of sophisticatedintellectual property in the defense and homeland security sector, which weincorporate in systems we deliver and which we market on a stand-alone basis.

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*Ourbreadth of service offerings.*   Our broad range ofservice offerings distinguishes us from many of our competitors. We believethat with these offerings, we are a one-stop shop, providing robust and comprehensivebusiness solutions to meet the needs of our clients in the key verticals wecover.

*Ourlong-term relationships with a diverse client base.*   Wehave long-term relationships with many of our clients, who frequently retain usfor additional projects after an initial successful engagement. In 2006,existing clients from prior years generated more than 80% of our revenues.Moreover, our client base is diverse and we are not dependent on any singleclient. In 2006, no client accounted for more than 5% of our revenues and ourlargest twenty clients together accounted for approximately 29% of ourrevenues. Agencies of the government of Israel, in aggregate, represented 10%of our revenues in 2006.

*Ourproven ability to scale.*   We have growncontinuously and successfully since inception, and we have demonstrated theability to expand our teams and facilities to meet the needs of our clients.For example, over the past two and a half years we have expanded our Indianheadcount from approximately 1,100 to over 2,300 employees in response to ourclients’ rapidly growing offshore development needs, and we have expanded ouremployee base in Europe from approximately 350 to over 800.

*Ourorganizational and business flexibility.*   Our flexibleorganizational structure, business culture and technological abilities haveallowed us to adapt to rapidly changing economic conditions, as well assignificant changes in our clients’ needs, enabling us to continue to grow andimprove our performance during economic growth periods as well as duringeconomic downturns. During the economic downturn of 2002 to 2004, we increasedour revenues, number of employees, geographic footprint and profitability.Additionally, our strong vertical alignment, the industry and technicalexperience of our employees, our operational efficiency, our ability to secureand retain key clients and the effective use of our global delivery modelhelped insulate us from many of the hardships experienced by our competitors.

*Our abilityto integrate acquired companies.*   We have grownpartly through acquisitions since our inception. Due in part to our significantfocus on the abilities of the senior management of acquired firms, we have beenable to retain the senior management of each of these companies. We havesuccessfully integrated each acquired company into our corporate structure andculture, working together with existing management, employees and clients tofacilitate an efficient and productive transition.

*Ourability to retain and educate employees.*   We havemaintained a relatively low attrition rate despite traditionally high turnoverin the IT services industry. We believe that our ability to retain ouremployees is due in part to our commitment to rewarding qualified employees andto our advanced continuing education and training courses.

*Our well-establishedinternal infrastructure.*   We utilize anenterprise resource planning system and a CRM system, embodying our bestpractices, corporate methodologies and financial controls.

**Business Strategy**

Our goal is to further solidify and enhance ourposition as a global IT services and solutions provider on the basis of ourquality, professionalism, vertical expertise, reliability and technicalinnovation. We hold the leading market position in Israel based on revenuesfrom IT services. We intend to extend that geographic and vertical reach throughthe following strategic initiatives:

*Furtherpenetrate the North American market as well as emerging markets such as EasternEurope and Asia.*   We were formed in 1999 andquickly established a leading market position in the Israeli IT servicesmarket. In the last five years we expanded outside Israel with acquisitions inNorth America, Europe and Asia, and have achieved organic growth in each. Wegenerated approximately $23.0 million, or 14% of our revenues, in North Americain 2002, which we expanded over five-fold to $120.8 million, or 25% of ourrevenues, by 2006. During the same period, we grew our European revenue overnine-fold from approximately $11.0 million, or 7% of our revenues, to $104.4million, or 22% of our revenues. We intend 

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to focus considerably onexpanding our revenues in North America, both organically and throughacquisitions. Based on our review of publicly available information, in 2006,the North American market alone represented approximately 44% of totalworldwide IT services spending, which concentration is expected to continue inthe future. We intend to penetrate specific niches in that market utilizing ourvertical products and technical expertise. Our acquisition strategy will alsocontinue to target these markets, such as financial services, as well asemerging markets in which we believe growth and potential profitability arehigher, such as Eastern Europe and Asia.

*Be amarket leader in key verticals.*   In NorthAmerica, we presently focus on several verticals: life sciences, ISVs, defenseand financial services. In Europe, we are focused on the financial services,retail, telecommunications and utilities verticals. In Israel, we have a strongfocus on several verticals, including government and defense, financialservices and telecommunications. We intend to further solidify our position ineach of these verticals through internal growth based on complementary offshoreofferings and key partnerships, and external growth through acquisitions. Ourgoal is to establish ourselves in North America as a leading provider inoutsourcing and offshore services for life sciences, ISVs and homelandsecurity.

*Maintaina high proportion of long-term and recurring revenues through outsourcing andoffshore services.*   We intend to maintain a highproportion of revenues generated from long-term, recurring contracts byfocusing on long-term engagements, outsourcing, life-cycle services and othermulti-year services, including offshore services. Our goal is to maximize ourrecurring revenue, both in North America and in Europe, where outsourcing andoffshore services are gaining acceptance, and to maintain our high percentageof revenue from existing clients in prior years.

*Enhancebrand visibility.*   We intend to continue todevelop our brand identity including through the exposure provided by our 2004initial public offering. Our efforts include media and industry analyst events,sponsorship of and participation in targeted industry conferences, trade shows,recruiting efforts, community outreach, public relations and investorrelations.

*Pursuestrategic alliances.*   We intend to continue todevelop alliances that complement our core competencies. Our alliance strategyis targeted at leading business advisory companies and at leading technologyproviders, which allows us to take advantage of emerging technologies in amutually beneficial and cost-competitive manner.

*Continue to strengthen ourleading position in the Israeli IT services market.*   Weintend to retain and enhance our leading market position in Israel with acontinued focus on the government and defense, financial services andtelecommunications verticals. We also intend to leverage our ISV relationshipsto drive additional reselling and professional services revenues.

**Vertical Focus**

We operate in a significant number of commercial andindustrial sectors and in many areas of government operations. As a result ofour deep understanding of the different markets and environments in which ourclients operate, and our ability to understand our clients’ needs and tailorsolutions to meet those needs, we have developed a strong reputation fordelivering systems to businesses that are subject to regulatory supervision,government control or other rigorous operational requirements. We are active inall of the following sectors, each influenced by fluctuating market conditions,as well as regulatory and oversight environments:

*Governmentand Defense.*   Government agencies areincreasingly required to modernize their traditional operating processes andmodels in order to improve and accelerate delivery of services to citizens. Wehave developed a track record in the public sector for helping government agenciesdeliver IT 

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services to the publicmore effectively and efficiently. In Israel, we are a leading provider ofintegrated solutions for the government and defense sector.

The defense and homeland security industry faces amultitude of challenges, including protecting the safety of national borders,improving command and control and intelligence gathering mechanisms, enhancingcommunications channels throughout the military and performing scenarioanalysis. We possess extensive experience in delivering high-end technicalsolutions and intellectual property (some of which is confidential) to thedefense and homeland security industry to help surmount these challenges.

*FinancialServices.*   The financial services industry, whichis the industry having the greatest worldwide demand for IT services, operatesin a highly regulated environment, which creates significant demand forservices such as ours. Financial services organizations must strategicallyemploy advanced technology in order to maximize their operational excellenceand provide the best possible services to their clients. We combine advancedsolutions, industry best practices, and the products and services of businesspartners to help our clients streamline their business processes and ensurelong-term success in this fast-paced environment. We provide services to anumber of segments of this vertical including: retail, private and investmentbanks; credit card companies; insurance and reinsurance companies; consumerfinance organizations; and pension funds. Services we provide includeimplementations of our reference data management product suite and our transferagency solution, IT outsourcing, offshore services, turnkey solutions, customdevelopment and system integration.

*Telecommunicationsand Utilities.*   Competitive pressures are causingtelecommunications companies to find ways to reduce costs and make moreinformed decisions about their IT investments. We deliver reliabletelecommunications systems and portals that help carriers reduce operating costsand increase revenue, while helping telecommunications companies evaluate theimpact of new technologies and make informed planning decisions about their ITinvestments. We offer innovative information system solutions for improvingtime-to-market and enhancing telecommunications service delivery, addressingthe specific needs of operators of all sizes from traditional wireline towireless and internet service provider to broadband. Our services include ERPsolutions, internet protocol telephony, configuration management, contactcenters, interactive voice response systems, Operational Support Systems-based,or OSS-based, complex network management systems, management of common channelsignaling systems, service assurance, mediation devices and consultingservices.

Globalization, escalating market competition andderegulation throughout the world are forcing utility companies to modify theirIT strategies and adopt advanced solutions. We provide high-end e-businessservices in areas such as CRM, ERP, e-procurement, asset management andmetering solutions.

*LifeSciences and Healthcare.*   Effectively managingand improving the efficiency of a life sciences business requires innovativecross functional information management solutions. Our expertise lies in improvingtime-to-market of new products through clinical trial optimization, safety andadverse event tracking, knowledge management, BI and data warehousing,strategic planning and budgeting. We have been delivering business performanceoriented data and document management solutions to large pharmaceutical andbiotechnology firms for many years.

Increased government regulations and rising costsrequire healthcare organizations to address complex patient informationmanagement needs and share information across various hospitals and facilitiesmore effectively. We help healthcare organizations remain competitive withservices designed to simplify their administrative processes, reduce costs andimprove the quality of care.

*High-Techand Independent Software Vendors.*   Softwarecompanies need to focus on their core competencies of developing software andother technology products. By utilizing our offshore capabilities, expertiseand experience in developing complementary IT solutions, we enable our clientsto meet this need through our managed labs offering to provide ISVs withoutsourced software product research and 

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development centers thatsupplement those of the client. Our expertise lies in the design anddevelopment of new software products, re-development, re-engineering, andmaintenance of existing products, and global implementation and rollout supportfor existing products. We function as a partner with our clients to managetactical needs at all phases of the development process.

*Manufacturingand Transportation.*   We continually monitoremerging technologies to help clients evaluate the benefits and costs ofadopting these new technologies. Our services enable clients to improve supplychain management, enhance their partner and client relations, enhance enterpriseresource planning and optimize product quality. Intelligent transportationsystems use a variety of technologies in order to facilitate the movement ofpeople and goods via highways and public transportation systems. We havedeveloped a wide range of services specifically tailored for clients within thetransportation industry, including emergency management systems, electronictoll collection and traffic management solutions.

*Retail, Media,Entertainment and Publishing.*   As the retailingindustry moves through a period of significant transformation, with majorchains expanding their presence throughout the world and exposing their brandsto new markets, retailers need to run their IT systems more cost effectively.Our services enable retailers to deliver consistent customer service (throughstore sales, call centers and internet websites) and to develop and extendtheir technology infrastructures. We have worked with a variety of media,entertainment and publishing companies to develop systems for managing andprotecting content and digital assets. We possess the implementation expertiserequired to gather, analyze and distribute information for delivering thetechnical proficiency needed to develop new market opportunities. Our softwaresolution for intellectual rights management has been chosen and implemented bysome of the top market participants from the entertainment, publishing andadvertising industries.

**Global DeliveryModel**

We have local and offshore delivery facilities inNorth America, Europe and Asia, with a range of industry expertise, softwarelanguage and product focuses, and also with varying costs. Each facility has ahigh level of management skill, vertical expertise, IT services capabilitiesand quality at each location.

In each of the 16 countries in which we operate, weapply our expertise to serve both our local clients and our clients throughoutthe world as part of our global delivery model. As expertise in certaintechnologies, skills or verticals is needed, we have the capability to assembleteams spanning several of our locations around the world. By doing this, wereduce or eliminate the need to carry potentially non-billable staff at eachlocation to handle unanticipated needs or surge capacity, which results inlower costs on average.

For example, we completed a sophisticated web-baseddocument management and workflow solution for a large, internationalbio-pharmaceutical firm based in Switzerland, using teams from Switzerland, theUnited States and Israel. We provided SAP system integration and projectservices to a large, global law firm using resources from the United Kingdomand India. Similarly, we executed regional European SAP projects formulti-national corporations using resources from the Czech Republic, Slovakia, Romania,Israel and Switzerland. In these and virtually all other projects staffed usingour global delivery model, the teams work in their home locations except forperiodic travel to the client location for knowledge transfer, client meetingsand implementation work. This model also means that we are substantially lessaffected by changing immigration regulations than other well-known offshorevendors. In our model, the team that remains at the client site throughout theengagement comprises our local resources, complementing our local presence withour strong vertical experience to the engagement from inception throughcompletion. Our global delivery model is optimized by a worldwide proprietaryknowledge management system that enables our employees to communicate and shareknowledge. In addition, we continually host internal training courses.

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Other benefits gained byclients from our global delivery model are 24-hour delivery and supportcapabilities; built-in redundancy, both in terms of people and facilities; andthe availability of a global knowledge base of business and technicalinformation that is populated, maintained and leveraged by our employees aroundthe globe.

As of December 31,2006, we employed approximately 7,515 employees worldwide, includingapproximately 3,430 in Israel, 2,330 in India, 545 in North America, 835 inEurope and 375 in the Asia Pacific region.

**Sales and Marketing**

We market our services tolarge organizations in North America, Europe and Asia. We have a leading marketpresence in Israel and a growing presence in North America and Europe. We selland market our services from sales offices located in 16 countries. We manageour business and results of operations as part of a global sales and marketingstrategy. As of December 31, 2006, we had approximately 200 direct salespersons and account managers.

Our sales and marketingstrategy focuses on increasing awareness of and gaining new business fromtarget clients and promoting client loyalty and repeat business among existingclients. We constantly seek to expand the nature and scope of our engagementswith existing clients by increasing the volume of our business and extendingthe breadth of services offered. Members of our executive management team areactively involved in business development and in managing key clientrelationships through targeted interaction with our clients’ senior management.

For each prospectiveproject, we assemble a team of our senior employees, drawn from variousdisciplines within our company. The team members assume certain roles in aformalized process, using their combined knowledge and experience to understandthe client’s needs, design a solution, identify key decision makers andmaximize the strength of our bid. This approach allows for a smooth transitionto execution once the sale is completed. We typically bid against other ITservices providers in response to requests for proposals.

Oursales and marketing teams work with our technical team as the sales processmoves closer to the client’s selection of an IT service provider. The durationof the sales process varies depending on the type of service, ranging fromapproximately two months to over one year. Throughout the process, the accountmanager or sales executive works with the technical team to:

·       definethe scope, deliverables, assumptions and execution strategies for a proposed project;

·       developproject estimates;

·       preparepricing and margin analysis; and

·       finalizesales proposals.

Management reviews andapproves proposals, which are then presented to the prospective clients. Oursales and account management personnel remain actively involved in the projectthrough the execution phase. We focus our marketing efforts on businesses withextensive information processing needs. We maintain what we believe to be astate-of-the-art prospect/client database that is continuously updated and usedthroughout the sales cycle from prospect qualification to close. As a result ofthis marketing system, we are able to pre-qualify sales opportunities anddirect sales representatives are able to minimize the time spent on prospectqualification. In addition, substantial emphasis is placed on client retentionand expansion of services provided to existing clients. In this regard, ouraccount managers play an important marketing role by leveraging their ongoingrelationships with each client to identify opportunities to expand anddiversify the type of services provided to that client.

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**Clients**

We presently serve over500 clients in a wide range of industries. Our clients vary in size and includea number of Fortune 1000 and Global 2000 companies. For 2006, no clientrepresented more than 5% of our annual revenues, and our largest twenty clientstogether represented approximately 29% of our revenues, compared to 32% in2005. Agencies of the government of Israel, in aggregate, represented 10% ofour revenue in 2006, versus 11% in 2005.

Thepercentage of our revenues derived from Israeli clients has been steadilydecreasing as we have expanded our global presence. Our revenues for theperiods presented, broken down by geographic area, are as follows:

| ** **            | ** ** | **Year ended December 31,** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|
| ** **            | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| Israel                |       |                                       | 93         | % |   |   | 80 | % |   |   | 68 | % |   |   | 57 | % |   |   | 52 | % |   |   | 48 | % |   |
| United States         |       |                                       | 3          |   |   |   | 14 |   |   |   | 16 |   |   |   | 25 |   |   |   | 22 |   |   |   | 25 |   |   |
| Europe                |       |                                       | 4          |   |   |   | 7 |   |   |   | 13 |   |   |   | 13 |   |   |   | 19 |   |   |   | 22 |   |   |
| Asia and the Far East |       |                                       | —     |   |   |   | — |   |   |   | 3 |   |   |   | 5 |   |   |   | 5 |   |   |   | 4 |   |   |
| Others                |       |                                       | —     |   |   |   | — |   |   |   | 1 |   |   |   | 1 |   |   |   | 1 |   |   |   | 1 |   |   |
| Total                 |       |                                       | 100        | % |   |   | 100 | %* |   |   | 100 | %* |   |   | 100 | %* |   |   | 100 | %* |   |   | 100 | % |   |

----

*                    Due torounding, the aggregate percentage for this period does not appear to equal100%.

Thepercentage of our revenues derived from outsourcing (including offshoredevelopment) has significantly increased. Based on estimates derived frominternal management operating data, the proportion of our revenues by type ofservice for the periods presented is:

| ** **                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| Outsourcing (including  offshore development)   |       |                                       | 17         | % |   |   | 16 | % |   |   | 31 | % |   |   | 47 | % |   |   | 45 | % |   |   | 43 | % |   |
| System Integration and  Application Development |       |                                       | 55         |   |   |   | 46 |   |   |   | 35 |   |   |   | 30 |   |   |   | 31 |   |   |   | 32 |   |   |
| Software and Consulting                         |       |                                       | 19         |   |   |   | 18 |   |   |   | 16 |   |   |   | 14 |   |   |   | 16 |   |   |   | 15 |   |   |
| Quality Assurance and  Training                 |       |                                       | 5          |   |   |   | 16 |   |   |   | 11 |   |   |   | 5 |   |   |   | 5 |   |   |   | 7 |   |   |
| Other                                           |       |                                       | 4          |   |   |   | 4 |   |   |   | 7 |   |   |   | 4 |   |   |   | 3 |   |   |   | 2 |   |   |
| Total                                           |       |                                       | 100        | % |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |   | 100 | %* |   |

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*                    Due torounding, the aggregate percentage for this period does not appear to equal100%.

Our client base includesleading worldwide and regional entities. The clients listed alphabeticallybelow are among our largest clients, based on revenues, in each of ourverticals:

*Government andDefense*

·       CzechOffice for Surveying, Mapping and Cadastre

·       IsraelAircraft Industries

·       IsraelAirport Authority

·       IsraelCourt Authority

·       IsraelMinistry of Defense

·       IsraelMinistry of Finance

·       IsraelMinistry of Justice

·       IsraeliPolice

·       LockheedMartin

·       SingaporePolice

·       Štatistickýúrad Slovenskej republiky

·       TadiranSystems

·       Tel-AvivMunicipality

*Financial Services*

·       AchmeaZorg

·       Amvescap

·       BankHapoalim

·       BankLeumi

·       BanquePrivée Edmond de Rothschild

·       CashAmerica

·       CIBC

·       Citibank

·       ClalInsurance

·       CreditSuisse First Boston

·       DBSBank, Singapore

·       FirstInternational Bank of Israel

·       FranklinTempleton

·       GeneraliGroup

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·       IndustrialDevelopment Bank of Israel Ltd.

·       INGInvestments

·       IsraelDiscount Bank Ltd.

·       KomerčníBanka

·       M&TBank

·       Menzis

·       Mizrahi-TefahotBank

·       PhoenixInsurance

·       Standard &Poor’s

·       ThailandStock Exchange

·       WaldviertlerSparkasse

*Telecommunicationsand Utilities*

·       AT&T

·       Bezeq

·       Cellcom

·       ČEZ,a.s.

·       CingularWireless

·       CzechTelecom

·       Electrica

·       Eurotel

·       IsraelElectric Company

·       Orange

·       SlovakTelecom

·       SlovenskéElektrárne

·       TelusCommunications

·       Vodafone

·       YES

*Life Sciences andHealthcare*

·       AssutaMedical Centers

·       ClalitHealth Services

·       IdenixPharmaceuticals

·       KaiserPermanente

·       Pfizer

·       QuintilesTransnational Corporation

·       Sanofi-Aventis

·       ScheringPlough

·       Teva

·       VITAS

·       WockhardtUSA

·       Wyeth

*High-Tech andIndependent Software Vendors*

·       BusinessObjects

·       Cartesis

·       Chordiant

·       Cisco

·       CobaltGroup

·       Comverse

·       Corrillian

·       DoradoCorporation

·       EMCDocumentum

·       Fortent

·       Google

·       IBM

·       IndusInternational

·       InfoVista

·       PayPal

·       PortalSoftware

·       PulsicLtd.

·       Retalix

*Manufacturing andTransportation*

·       Coca-Cola

·       ELAL Airlines

·       IsraeliChemicals Ltd. (ICL)

·       Mitsubishi

·       Philips

·       Strauss-Elite

·       Toyota

·       Vítkovice

*Retail, Media,Entertainment, Publishing & Other*

·       Cushman &Wakefield

·       FremantleMedia Services

·       HollywoodMedia Corp.

·       Israel’sYellow Pages

·       KurtSalmon Associates

·       Long &Foster

·       Plan

·       Ringier

·       SuperSol

 

**Business Partnersand Alliances**

We have strategic alliances and partnerships withleading global software, infrastructure and consulting vendors, therebyexpanding the variety of technologies and capabilities we offer to our clients.We continuously evaluate partnership opportunities and add new partners toensure that we are positioned to deliver what we believe to be the mosteffective and advanced solutions to our clients. We also maintain the highestlevel of certification with many of our key partners in order to obtain earlyaccess to new product offerings and to influence the development of newproducts and offerings. We take great pride in being “technology independent”in that we approach each project we undertake with no preconceived notions regardingthe technology that will ultimately be deployed, and we recommend what webelieve to be the most effective technology for our clients’ needs.

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Wehave many alliances and partnerships around the world. Some alliances arespecific to certain verticals and others are specific to certain markets inwhich we operate. Some key alliances and partnerships that are applicableacross multiple industry verticals and across multiple geographies, and withwhom we conduct business, are described in the chart below.

| **Alliance Partner**          | ** ** | **Alliance Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|-------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Business Objects              |       | We partner with Business  Objects to provide professional services and deliver business intelligence  solutions to their customers worldwide.                                                                                                                                                                                                                                                                                                                                                    |
| Chordiant                     |       | We provide  professional services to Chordiant’s customers through our worldwide  partnership, including the implementation of systems to automate and manage  operational business processes for service-driven global organizations in  retail banking, card services, lending, insurance and telecommunications.                                                                                                                                                                         |
| Deloitte                      |       | We partner with  Deloitte as a Tier 1 provider of IT services at locations across North  America and Asia, spanning a range of verticals and service offerings.                                                                                                                                                                                                                                                                                                                                  |
| EMC                           |       | We partner with  EMC worldwide to deliver robust, validated and high performing *Documentum* document and content  management systems and workflow solutions to our clients. In addition, we are  the sole sales channel in Israel of Documentum enterprise content management  solutions. We also provide customized storage solutions to enterprise  clients.                                                                                                                                  |
| IBM                           |       | We work with IBM  around the world to offer a broad array of scalable solutions built on IBM  software and hardware platforms. We also work with IBM with IBM to provide  ISVs with re-platforming services, enabling them to migrate existing  applications to open standards-based IBM platforms and to stay current with  IBM platform changes. In addition, we have supplier agreements with IBM in  the United States, Asia Pacific, India and Israel for services, software and  hardware. |
| Kurt Salmon Associates  (KSA) |       | We support the  retail and consumer products industries through a business alliance with KSA,  a leading management consulting firm. We work as an integral component of  KSA’s teams at several North American and European consumer products  retailers and suppliers.                                                                                                                                                                                                                    |
| Hewlett Packard               |       | We partner with  Mercury Interactive, which was acquired by Hewlett Packard, as their  certified partner for the implementation and deployment of testing and QA  enterprise projects around the world.                                                                                                                                                                                                                                                                                          |
| Microsoft                     |       | We work with  Microsoft around the world to offer a broad array of scalable solutions built  on Microsoft’s .NET enterprise platform and other Microsoft platforms. We are  a global Microsoft Gold Partner with certifications on many platforms and  products, and we have won numerous Microsoft awards for our solutions.                                                                                                                                                               |
| SAP                           |       | We partner with  SAP in Israel as the sole product and professional services arm of SAP in the  country. We also partner with SAP worldwide to deliver innovative ERP  solutions.                                                                                                                                                                                                                                                                                                                |
| Unisys                        |       | We partner with Unisys  as their sole distributor for the Unisys ES7000 enterprise server platform in  Israel, providing solutions for server consolidation, business intelligence  and disaster recovery planning projects.                                                                                                                                                                                                                                                                     |

 

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While we are notsubstantially dependent on any one of these partnerships, we believe theycollectively represent a significant competitive advantage for us. Throughthese partnerships and alliances, we:

·       performjoint engagements;

·       gainaccess to additional opportunities and engagements;

·       influencethe products and services of our partners, through participation in advisoryand/or steering committees;

·       inseveral cases, enhance and extend the products of our partners;

·       gainearly access to new technologies and products, both for us and for our clients,as well as enhanced support for their products and platforms; and

·       furtherdemonstrate our qualifications for leading technologies and key verticals.

In addition to these benefits, the relationshipsenhance our ability to: deliver a broad range of IT services outsourcing;provide us channels to sell additional services to our clients, such as qualityassurance and training; and make us a more attractive employer, based on ouremployees’ use of these advanced platforms and access to our partners.

Some of the certification levels our partners requireare difficult to attain, requiring the demonstration of significant technicalexpertise, high levels of training and certification, the influencing of acertain amount of product sales for the partner, certain levels of investmentin the products and technologies of our partners, or other factors. Ourrelationships with these partners are long-term, unlike typical vendorrelationships.

We have written agreementswith some, but not all, of our partners and alliances. The terms of theagreements vary. In some cases our partners are restricted from using othercompanies to provide similar services in certain markets. Some of our partnersrequire that we achieve certain minimum sales levels to maintain our partnerstatus level. We have oral contracts and working arrangements with theremainder of our partners and alliances. Although these oral contracts and otherarrangements may be terminated by either party at any time without penalty,they also afford greater flexibility to our partners and alliances as well asto us.

**Competition**

The IT servicesmarket has become increasingly competitive in recent years as a result of theeconomic downturn and associated decline in IT service spending during 2002 to2004. While some vendors have not survived, others have become more aggressiveand some low-cost offshore vendors have entered new markets traditionallydominated by large multinational consultancy firms. The IT services vendorswith whom we compete include:

·        consultingfirms, such as Accenture Ltd., BearingPoint, Inc. and Cap Gemini;

·        divisionsof large multinational technology firms, such as Hewlett Packard Company andIBM;

·        IToutsourcing firms, such as Computer Sciences Corporation, Electronic DataSystems Corporation and Keane, Inc.;

·        US-basedoffshore IT services firms, such as Cognizant Technology Solutions Corp.,Covansys Corp., Syntel Inc., HCL Technologies and Perot Systems;

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·        largeIndian IT services firms, such as Infosys Technologies Limited, Satyam ComputerServices Limited, Tata Consultancy Services and Wipro Limited and smaller firmssuch as MindTree Consulting, Patni, Persistent Systems, Sonata Software andSymphony;

·        regionalIT services firms in certain geographic markets, such as Matrix, Malam, Elbitand Teldor in Israel, Logica, T-Systems and Atos Origin in Europe, and FirstConsulting Group in the United States; and

·        insome cases, internal IT departments of our clients.

Some of these competitors are more established, enjoygreater market recognition and have significantly greater financial, technicaland marketing resources than we do. Moreover, the IT services industry isexperiencing rapid changes, primarily consolidation, that are affecting thecompetitive landscape. These changes may result in a greater number ofcompetitors with significantly larger resources than ours. In addition, some ofour competitors have added cost competitive offshore capabilities to theirservice offerings, which may adversely affect our ability to competesuccessfully against these competitors. We expect competition to intensify inthe future as current competitors enhance their service offerings and new competitorspenetrate the market due to low barriers to entry. Existing or futurecompetitors may develop or offer services and products that provide significantperformance, price or other advantages over those we offer.

Our future successwill depend in part on our ability to develop and market new or enhancedservices that adequately address changes in technology, industry standards andclient requirements and gain commercial acceptance. Any delay or failure todevelop new services or to adapt our services to technological change andmarket requirements could have a material adverse effect on our competitiveposition. We believe that the principal competitive factors in our businessinclude the ability to:

·        provideand leverage deep industry vertical expertise, and integrate this expertisewith superior system integration, software development, QA and supportabilities to deliver tailored, high quality business solutions that generatehigh returns on investments;

·        deliversolutions quickly and cost effectively, using an integrated global deliverymodel with industry leading methodologies and practices and appropriate SEIcertification levels;

·        attractand retain experienced, high-quality IT professionals;

·        workeffectively with leading partners and alliances to offer superior solutions anddrive additional business;

·        respondrapidly to meet the challenging demands of each engagement; and

·        growand thrive in challenging economic times, so that client needs and expectationscan be met reliably and continuously.

We believe we competefavorably based on these factors, and we possess significant competitiveadvantages. See “—Competitive Strengths.”

**IntellectualProperty**

Our intellectual property rights are important to ourbusiness. We rely on a combination of copyright, trademark and design laws,trade secrets, confidentiality procedures and contractual provisions to protectour intellectual property. We currently have no issued patents. We requireemployees, independent contractors and, whenever possible, vendors to enterinto confidentiality agreements upon the commencement of their relationshipswith us. These agreements generally provide that any confidential orproprietary information developed by us or on our behalf be kept confidential.These agreements also provide that any confidential or proprietary informationdisclosed to third parties in the course of our 

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business be keptconfidential by such third parties. However, our clients usually own theintellectual property in the software we develop for them.

We regard our trade name, trademarks, service marksand domain names as important to our success. We rely on the law to protect ourproprietary rights to them and we have taken steps to enhance our rights byfiling trademark applications where appropriate. We have registered our keybrand “Ness” as a trademark in both Israel and in the United States.

Third parties may assertinfringement claims against us or claim that we have violated theirintellectual property rights. We are obligated under some client contracts toindemnify our clients if claims are made against us alleging that we infringeon the proprietary rights of third parties. These claims, regardless of meritor ultimate outcome, could result in significant legal and other costs, harm toour reputation and a distraction to management. In particular, growth in thenumber of business method and software patents issued to others may greatlylimit the solutions we are able to offer our clients.

**Employees**

As of December 31, 2006, we employed approximately7,515 employees, including approximately 6,600 IT professionals. None of ouremployees is represented by a labor union and we have not experienced anystrikes or work stoppages. We believe our relations with our employees aregood.

Our employees in Israel are subject to Israeli laborlaws and regulations and other special practices and employment customs. Thelaws and regulations principally concern matters such as paid annual vacation,paid sick days, the length of the workday, payment for overtime and severancepay. Israeli law generally requires severance pay equal to one month’s salaryfor each year of employment upon the retirement or death of an employee ortermination of employment without a valid legal reason. Furthermore, Israeliemployees and employers are required to pay predetermined sums to the NationalInsurance Institute, which is similar to the U.S. Social SecurityAdministration. Since January 1, 1995, these amounts also include paymentsfor national health insurance. Our payments to the National Insurance Instituteamount to approximately 15% of wages up to a specified amount, of which theemployee contributes two-thirds and the employer contributes one-third.

In addition, by order of the Israeli Ministry of Laborand Welfare, the provisions of a collective bargaining agreement between theHistadrut (the General Federation of Labor in Israel) and the IndustrialistsAssociation in Israel may be applicable to our employees in Israel. Thiscollective bargaining agreement principally concerns cost of living increases,vacation and holiday pay, length of the workday, wage tariffs, termination andseverance payments. We provide our employees with benefits and workingconditions that are at least as favorable as the conditions specified in thecollective bargaining agreement.

Our employees are our most important asset. We believethat the quality and level of service that our professionals deliver are amongthe highest in the global IT services industry. We believe we provide achallenging, entrepreneurial and empowering work environment that demandsdedication and a strong work ethic.

Our training, continuing education and careerdevelopment programs are primarily designed to ensure our IT professionalsenhance their skill-sets in alignment with their respective roles. Wecontinually provide our IT professionals with challenging assignments andexposure to new skills, technologies and global opportunities. We have anappraisal program that incorporates a feedback system, recognizing highperformers and providing constructive feedback and coaching to underperformers. Leadership development is also a key part of our training programs.

We believe that our ITprofessionals receive competitive salaries and benefits and are eligible toparticipate in our stock option plans. We have also adopted a performancelinked compensation program that links compensation to both the employee’s andour performance.

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**Corporate History**

Ness Technologies, Inc. was incorporated inDelaware in March 1999 in connection with the acquisition of six IsraeliIT companies and their consolidation into a single operating structure. ComproSoftware Industries, a privately-held Israeli software consulting companyfounded in 1985, was acquired by our founders in December 1997 and by usin April 1999. At the time of its acquisition, Compro had a staff ofapproximately 170 people.

We subsequentlyacquired five Israeli IT services companies:

·        GiladSoftware and Systems Integration, a privately-held Israeli integration andnetworking company founded in 1990 that we acquired in April 1999. At thetime of its acquisition, it had approximately 340 employees.

·        Contahal,a publicly-traded Israeli IT services company (traded on the Tel Aviv StockExchange), founded in 1970. We acquired Contahal in May 1999 and took itprivate in February 2000. At the time of its acquisition, it hadapproximately 310 employees.

·        AdvancedTechnology, or ATL, a publicly-traded Israeli IT services company (traded onthe Tel Aviv Stock Exchange), founded in 1969 and engaged in systemsintegration, application development and consulting, with main lines ofbusiness of IS implementation, military and real time systems. We acquired ATLin August 1999, and took it private in December 1999. At the time ofits acquisition, it had approximately 650 employees.

·        IPEX,a privately-held Israeli systems integration company founded in 1992 that weacquired in November 1999. At the time of its acquisition, it hadapproximately 350 employees.

·        IPEXISI, a privately-held Israeli software development company founded in 1996 thatwe acquired in November 1999. At the time of its acquisition, it hadapproximately 40 employees.

Followingcompletion of these acquisitions, all the acquired companies (six Israelicompanies in total) were consolidated into a single operating structure. Theconsolidation, which commenced in the second quarter of 2000 and was completedin the second quarter of 2001, involved a major reorganization effort andassociated investment, including:

·        rationalizationof facilities;

·        creationof a new organizational structure;

·        developmentof a new brand and identity;

·        creationand staffing of a new cross functional sales force;

·        developmentand installation of a new ERP system (SAP comprehensive business solution);

·        upgradeand consolidation of delivery methodologies and QA practices;

·        organicgrowth through hiring;

·        trainingof our staff on new internal systems and methodologies;

·        inceptionof a research and development function;

·        creationof our corporate knowledge sharing infrastructure; and

·        creationof a legal department.

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Towards the end of2001, and after becoming a leading IT services company in Israel, we embarkedon our global expansion strategy. The following material acquisitions were madeas part of that strategy:

·        NessU.S.A. Inc., a subsidiary formed to acquire substantially all of the internetbased computer solutions assets and liabilities of Blueflame Inc., a companyfounded in 1985, out of Blueflame’s Chapter 11 bankruptcy proceeding in November 2001.At the time of its acquisition, it had 120 employees and annual revenues ofapproximately $18 million.

·        APPGroup CEE B.V., a privately-held IT services firm in the Czech Republic andSlovakia specializing in CRM, ERP, EAI, enterprise asset management ande-commerce solutions in the utilities, telecommunication, finance, governmentand manufacturing sectors. APP was established in 1990 and we acquired it in September 2002.At the time of its acquisition, it had approximately 180 employees. The WarburgPincus entities that collectively are principal stockholders of ours were alsoprincipal stockholders of APP at the time of the acquisition.

·        AparHolding Corp., a privately-held U.S./Indian IT services company, founded in1998 and providing a wide range of advanced ERP, CRM and EAI software servicesto the financial services, manufacturing, telecom, retail sales and logisticssectors, as well as sophisticated offshore software engineering developmentservices for large software product companies. In addition to Apar’s U.S.headquarters, Apar has operations in the United Kingdom, India and Singapore,and offices in Canada, Australia, Japan and Malaysia. At the time of itsacquisition, effective in June 2003, it had approximately 1,200 employees.The Warburg Pincus entities that collectively are principal stockholders ofours were also principal stockholders of Apar at the time of the acquisition.

·        Threeprivately-held providers of IT services and solutions in Eastern Europe, aspart of our growth strategy in Eastern Europe’s emerging market for ITservices: Radix Company SA, based in Romania, a provider of ERP, contentmanagement, decision support and workflow management solutions; DeltaElectronic Services a.s., based in Slovakia, a provider of ERP and customenterprise solutions; and Efcon a.s., a provider of document management, ERPand workflow systems. The acquisitions closed during the second through fourthquarters of 2005.

·        OlasSoftware Solutions, Inc., d/b/a Innova Solutions, a privately-held IT servicesprovider and system integrator based in California and India, offering aportfolio of offshore and on-site IT services and solutions, with a focus onfinancial services. Innova commenced operations in 1998 and we acquired it in February 2006.At the time of its acquisition, it had approximately 765 employees.

·        SelestaEspaña, an IT software distribution and systems integration company based inSpain and Portugal, as part of the international expansion of our NessProGlobal product representation business. The acquisition closed in December 2006.

The acquired companies were integrated into ourcorporate structure, with capabilities and staff assigned to the variousdivisions and business groups.

We are continuouslyseeking to acquire new companies and businesses in order to expand our globalpresence and improve our position in our targeted verticals and geographies.

***Item 1A.Risk Factors***

*Investing in our common stock involves risks. Youshould carefully consider the following risk factors and other information inthis report before purchasing our common stock. Any of the risks describedbelow could result in a material adverse effect on our business, results ofoperations and financial condition. The trading*

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*price of our common stock may decline due to any ofthese risks, and you could lose all or part of your investment.*

***Risks Relating to Our Business***

**If we fail tomanage our growth, our business could be disrupted and our profitability willlikely decline.**

We have experiencedrapid growth in recent periods through both acquisitions and organic growth.The number of our employees increased from approximately 2,240 as of December 31,2001 to approximately 7,515 as of December 31, 2006. We expect our growthto continue to significantly strain our management and other operational andfinancial resources. In particular, continued growth increases the integrationchallenges involved in:

·       recruiting,training and retaining skilled technical, marketing and management personnel;

·       maintaininghigh quality standards;

·       preservingour corporate culture, values and entrepreneurial environment;

·       developingand improving our internal administrative infrastructure, particularly ourfinancial, operational, communications and other internal controls; and

·       maintaininghigh levels of client satisfaction.

The rapid executionnecessary to exploit the market for our business model requires an effectiveplanning and management process. Our systems, procedures or controls may not beadequate to support the growth in our operations, and our management may not beable to achieve the rapid execution necessary to exploit the market for ourbusiness model. Our future operating results will also depend on our ability toexpand our development, sales and marketing organizations. If we are unable tomanage growth effectively, our profitability will likely decline.

**We may engage in acquisitions, strategic investments,partnerships, alliances or other ventures that are not successful, or fail tointegrate acquired businesses into our operations, which may adversely affectour competitive position and growth prospects.**

We have in the past engaged in acquisitions, strategicinvestments, partnerships and alliances. Since our last annual report weacquired two additional companies. We may acquire or make strategic investmentsin complementary businesses, technologies, services or products, or enter intostrategic partnerships or alliances with third parties in the future in orderto expand our business. We may be unable to identify suitable acquisition,strategic investment or strategic partnership candidates, or if we do identifysuitable candidates, we may not complete those transactions on termscommercially favorable to us or at all, which may adversely affect ourcompetitive position and our growth prospects.

If we acquireanother business, we may face difficulties, including:

·       integratingthat business’ personnel, products, technologies or services into ouroperations;

·       retainingthe key personnel of the acquired business;

·       failingto adequately identify or assess liabilities of that business;

·       failureof that business to fulfill its contractual obligations;

·       failureof that business to achieve the forecasts we used to determine the purchaseprice; and

·       divertingour management’s attention from normal daily operations of our business.

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These difficulties coulddisrupt our ongoing business and increase our expenses. As of the date of thisreport, we have no agreements to enter into any material acquisition,investment, partnership, alliance or other joint venture transaction.

**Because we derive a significant portion of ourrevenues from the Israeli government, a reduction of government spending inIsrael on IT services would reduce, possibly materially, our revenues andprofitability; and any delay in its annual budget approval process wouldnegatively impact our cash flows.**

We perform work for a widerange of Israeli governmental agencies, including defense, education, justiceand finance, which collectively represented approximately 10% of our revenuesin 2006. The Israeli economy experienced a recession through 2004. Although ourrevenues derived from agencies of the Israeli government grew each year duringthat period, the size of the overall Israeli IT services market decreased,putting pressure on our revenue growth rates. Israel is once again in a periodof economic growth, and we do not expect any additional short-term decrease.However, any future reduction in Israeli government spending for political oreconomic reasons would reduce, possibly materially, our revenues and profitability.In addition, the government of Israel has experienced significant delays in theapproval of its annual budget in recent years. Such delays in the future couldmaterially and negatively affect our cash flows by delaying receipt of paymentfrom the government of Israel for services performed.

**Quarterlyfluctuations in our results of operations could cause our stock price todecline or fluctuate.**

We haveexperienced, and expect to continue to experience, significant fluctuations inour quarterly results of operations. During the past eight quarters, our netincome ranged from approximately $4.0 million to approximately $9.6 million. Infuture periods, our operating results could be below public expectations, whichwould likely cause the market price of our common stock to decline. Numerousfactors, some of which are beyond our control, may affect our quarterly resultsof operations, including:

·       thesize, timing and terms and conditions of significant projects;

·       variationsin the duration, size and scope of our projects;

·       contractterminations or cancellation or deferral of projects;

·       ourability to manage costs, including personnel and support services costs, andinvestments required by us to maintain our existing operations and supportfuture growth;

·       currencyexchange fluctuations;

·       changesin pricing policies by us or our competitors;

·       theintroduction of new services by us or our competitors;

·       acquisitionand integration costs related to possible acquisitions of other businesses; and

During recent periods, our quarterly results havefluctuated as a result of the number of working days in each period and theseasonality of client demand in the IT services industry. Typically our fourthquarter is strongest, when client demand is greatest, and the second quarter isweakest, when the number of working days in the quarter is lowest in Israel,currently our largest employee location. We expect these factors to continue tobe significant in the future, although we believe that the impact of the numberof working days on our results of operations will decrease as our internationalbusiness continues to grow.

Our clients typicallyretain our services for set engagements pursuant to contracts that may beterminated by them with little or no notice and without termination fees. Thetermination, cancellation or deferral of one or more significant projects couldmaterially and adversely affect our operating results in any fiscal quarter. Inaddition, we base our current and future expense levels on our internal operatingplans and sales forecasts, and our near-term operating costs are, therefore, toa large extent, fixed. As a 

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result,we may not be able to sufficiently reduce our costs on a timely basis in anyquarter to compensate for an unexpected near-term shortfall in revenues.

**If we fail to attract and retain highly skilled ITprofessionals, we may not have the necessary resources to properly staffprojects.**

Our success dependslargely on the contributions of our employees and our ability to attract andretain qualified personnel, including technology, consulting, engineering,marketing and management professionals. Competition for qualified personnel inthe IT services industry, in the markets in which we operate, particularly inIndia, is intense and, accordingly, we may not be able to retain or hire all ofthe personnel necessary to meet our ongoing and future business needs. If weare unable to attract and retain the highly skilled IT professionals we need,we may have to forego projects for lack of resources or be unable to staffprojects optimally. In addition, the competition for highly skilled employeesmay require us to increase salaries of highly skilled employees, and we may beunable to pass on these increased costs to our clients, which would reduce ourprofitability.

**If our clients terminate significant contractedprojects or choose not to retain us for additional projects, or if we arerestricted from providing services to our clients’ competitors, our revenuesand profitability may be negatively affected.**

Our clientstypically retain us on a non-exclusive basis. Many of our client contracts,including those that are on a fixed price, fixed timeframe basis, can beterminated by the client with or without cause upon 90 days’ notice or less andgenerally without termination-related penalties. Additionally, our contractswith clients are typically limited to discrete projects without any commitmentto a specific volume of business or future work and may involve multiplestages. In addition, the increased breadth of our service offerings may resultin larger and more complex projects for our clients that require us to devoteresources to more thoroughly understand their operations. Despite theseefforts, our clients may choose not to retain us for additional stages or maycancel or delay planned or existing engagements due to any number of factors,including:

·       financialdifficulties of a current client;

·       achange in strategic priorities;

·       ademand for price reductions; and

·       adecision by our clients to utilize their in-house IT capacity or work with ourcompetitors.

These potentialterminations, cancellations or delays in planned or existing engagements couldmake it difficult for us to use our personnel efficiently. In addition, some ofour client contracts restrict us from engaging in business with certaincompetitors of our clients during the term of the agreements and for a limitedperiod following termination of these agreements. Any of the foregoing factorsmay negatively impact our revenues and profitability.

**If we fail to meet our clients’ performanceexpectations, our reputation may be harmed, causing us to lose clients orexposing us to legal liability.**

As an IT services provider, our ability to attract andretain clients depends to a large extent on our relationships with our clientsand our reputation for high quality professional services and integrity. As aresult, if a client is not satisfied with our services or solutions, includingthose of subcontractors we engage, our reputation may be damaged. In addition,a number of our contracts provide for incentive based or other pricing termspursuant to which some of our fees are contingent on our ability to meetrevenue enhancement, cost-saving or other contractually defined performancegoals. Our failure to meet these goals or a client’s expectations in suchperformance-based contracts may result in a less profitable or an 

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unprofitable engagement.Moreover, if we fail to meet our clients’ performance expectations, we may loseclients and be subject to legal liability, particularly if such failure has aconsequential adverse impact on our clients’ businesses.

In addition, many of ourprojects are critical to the operations of our clients’ businesses. Ourexposure to legal liability may be increased in the case of outsourcingcontracts in which we become more involved in our clients’ operations. Whileour contracts typically include provisions designed to limit our exposure tolegal claims relating to our services and the solutions we develop, these provisionsmay not adequately protect us or may not be enforceable in all cases. Thegeneral liability insurance coverage that we maintain, including coverage forerrors and omissions, is subject to important exclusions and limitations. Wecannot be certain that this coverage will continue to be available onreasonable terms or will be available in sufficient amounts to cover one ormore large claims, or that the insurer will not disclaim coverage as to anyfuture claim. A successful assertion of one or more large claims against usthat exceeds our available insurance coverage or changes in our insurancepolicies, including premium increases or the imposition of large deductible orco-insurance requirements, could adversely affect our profitability.

**We may be required to be responsible for theperformance of business partners we do not control, which could lower ourmargins and reduce profitability.**

In connection with some ofour more complex engagements, we have been required, and may in the future berequired, to assume contingent responsibility for the performance of businesspartners. Our being required to perform the third party obligations of thesecommitments could have a material adverse affect on our margins andprofitability because we would be required to incur additional costs, possiblywithout any corresponding recovery against the third parties. While we willcontinue to manage liabilities or risks through rigorous transaction review, weexpect that clients may require us to assume certain additional contractualobligations and potential liabilities when we are responsible for theperformance of business partners we do not control.

**If we fail to complete fixed price contracts on budgetand on time, our reputation may be harmed, causing us to lose clients andnegatively affecting our profitability.**

We offer a portion of ourservices on a fixed price basis, rather than on a time-and-materials basis. In2004, 2005 and 2006, revenues from fixed price projects accounted forapproximately 19%, 22% and 27% of our total revenues, respectively. Under thesecontractual arrangements, we bear the risk of cost overruns, completion delaysand wage inflation. If we fail to estimate accurately the resources and timerequired to complete a project or fail to complete our contractual obligationswithin the scheduled timeframe, our profitability may suffer. Historically, wehave not had any cost overruns that have had a material impact on ourprofitability. However, we cannot be certain that this will continue to be the case.

**Our success depends in part upon the senior members ofour management team, and our inability to attract and retain them could have anegative effect on our ability to operate our business.**

We are highly dependent onthe senior members of our management team. We do not maintain key man lifeinsurance for any of the senior members of our management team. Competition forsenior management in our industry is intense, and we may not be able to retainour senior management personnel or attract and retain new senior managementpersonnel in the future. The loss of one or more members of our seniormanagement team could have a negative effect on our ability to attract andretain clients, execute our business strategy and otherwise operate ourbusiness, which could reduce our revenues, increase our expenses and reduce ourprofitability.

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**Our CEO and CFO transitions during the first quarterof 2007 could negatively affect our revenues and profitability.**

By the end of the firstquarter of 2007 we expect to complete the transition of our Chief ExecutiveOfficer (CEO) and Chief Financial Officer (CFO). While a new CEO and CFO weretimely appointed, and are already employed by the company in an overlap andtransition process, there is no guarantee that the process will be seamless. Ifwe are unable to complete the transitions smoothly, or if we experiencedisruptions in our business, loss of key clients or loss of other seniorexecutives during the transitions, our revenues and profitability could bematerially affected.

**Disruptions in our telecommunications infrastructurecould harm our ability to operate and to deliver our services effectively,which could result in client dissatisfaction and a reduction of our revenuesand results of operations.**

A significant element ofour global delivery model is to continue to leverage and expand our globaldevelopment centers. Our global development centers are linked with a networkarchitecture that uses multiple telecommunication service providers and variouslinks with alternate routing, including some routing via virtual privatenetworks on the internet. We may not be able to maintain active voice and datacommunications between our various global development centers and between ourglobal development centers and our clients’ sites at all times. Any significantloss or impairment of our ability to communicate could result in a disruptionin our business, which could hinder our performance or our ability to completeclient projects on time. This, in turn, could lead to client dissatisfactionand have a material adverse effect on our operations.

**Our inability toprotect our intellectual property rights may force us to incur unanticipatedcosts.**

Our success will depend, in part, on our ability toobtain and maintain protection in the United States and other countries forcertain intellectual property incorporated into our software solutions and ourproprietary methodologies. We may be unable to obtain patents relating to ourtechnology. Even if issued, patents may be challenged, narrowed, invalidated orcircumvented, which could limit our ability to prevent competitors frommarketing similar solutions that limit the effectiveness of our patentprotection and force us to incur unanticipated costs. In addition, existinglaws of some countries in which we provide services or solutions may offer onlylimited protection of our intellectual property rights.

While we attempt to retainintellectual property rights arising from client engagements, our clients oftenhave the contractual right to such intellectual property. For intellectualproperty that we own, we rely upon a combination of trade secrets,confidentiality, nondisclosure and other contractual arrangements. Thesemeasures may not adequately prevent or deter infringement or other misappropriationof our intellectual property, and we may not be able to detect unauthorized useof, or take appropriate and timely steps to enforce, our intellectual propertyrights.

**If we are unable to secure necessary additionalfinancing, we may not be able to fund our operations or strategic growth.**

In order to achieve ourstrategic business objectives, we may be required to seek additional financing.For example, future acquisitions may require additional equity and/or debtfinancing. In addition, we may require further capital to continue to developour technology and infrastructure and for working capital purposes. Thesefinancings may not be available on acceptable terms, or at all. Our failure tosecure additional financing could prevent us from completing acquisitions,developing new technologies and competing effectively, all of which would havea negative impact on our continued development and growth.

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**Our clients’ complex regulatory requirements mayincrease our costs, which could negatively impact our profits.**

Many of our clients,particularly those in the financial services, life sciences, healthcare anddefense verticals, are subject to complex and constantly changing regulatoryrequirements. On occasion, these regulatory requirements change unpredictably.These regulations may increase our potential liabilities if our services arefound to contribute to a failure by our clients to comply with the requirementsapplicable to them and may increase compliance costs as regulatory requirementsincrease or change. These increased costs could negatively impact our profits.

**We will be exposed to risks relating to evaluations ofinternal control over financial reporting required by Section 404 of theSarbanes-Oxley Act of 2002.**

We spend a substantialamount of management time and resources to comply with changing laws,regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations andNasdaq Global Select Market rules. In particular, Section 404 of theSarbanes-Oxley Act of 2002 requires management’s annual review and evaluationof our internal control systems, and attestations as to the effectiveness ofthese systems by our independent registered public accounting firm. We have expendedand expect to continue to expend significant resources and management timedocumenting and testing our internal control systems and procedures. Thisprocess has been complicated by the decentralized nature of our operations andinformation systems. If we fail to maintain the adequacy of our internalcontrols, as such standards are modified, supplemented or amended from time totime, we may not be able to ensure that we can conclude on an ongoing basisthat we have effective internal control over financial reporting in accordancewith Section 404 of the Sarbanes-Oxley Act. Failure to maintain aneffective internal control environment could have a material adverse effect onthe market price of our stock.

***Risks Relating to Our International Operations***

**Our international operations subject us to risksinherent in doing business on an international level, any of which couldincrease our costs and hinder our growth.**

We currentlyoperate in 16 countries and intend to further penetrate key markets, primarilyin North America and Europe, while establishing offshore development centers inlower-cost Asian markets. We expect to devote significant resources to thiseffort but may not be successful in this regard. Risks inherent in ourinternational business activities include:

·       difficultiesin staffing international projects and managing international operations;

·       difficultiesin collecting accounts receivable;

·       localcompetition, particularly in North America and Europe;

·       impositionof public sector controls;

·       tradeand tariff restrictions;

·       priceor exchange controls;

·       limitationson repatriation of earnings;

·       foreigntax consequences; and

·       theburdens of complying with a wide variety of foreign laws and regulations.

One or more of thesefactors may have a material adverse effect on our business, financial conditionor results of operations.

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**If we fail to achieve planned growth in our offshorefacilities, our ability to fulfill client commitments profitably or to fulfillthem at all may be compromised.**

Our growth strategy reliesin part on the expansion of our offshore development centers. If we fail toretain needed employees in India and other offshore locations, or to managegrowth in these regions, our business, financial condition and results ofoperations may be adversely affected. Employee attrition rates in India aresignificantly higher than in other geographies. Wage costs in India havehistorically been significantly lower than wage costs in North America andWestern Europe for comparably skilled professionals; however, wages in Indiaare currently increasing at a faster rate than in North America and WesternEurope, which could result in increased costs for IT professionals,particularly project managers and other mid-level professionals. We may need toincrease the levels of our employee compensation more rapidly than in the pastto remain competitive. Compensation increases may hinder our planned growth andcould materially adversely affect our business, financial condition and resultsof operations.

**Regional instability in Israel and India may adverselyaffect business conditions in those regions, which may disrupt our operationsand negatively affect our revenues and profitability.**

We generated approximately 48% of our revenues inIsrael in 2006. In addition, our principal offices and a substantial portion ofour employees are located in Israel. Therefore, political, economic andmilitary conditions in Israel directly affect our operations. Since theestablishment of the State of Israel in 1948, a number of armed conflicts havetaken place between Israel and its Arab neighbors. We cannot predict the effecton our business of any increase in the degree of violence by the Palestiniansagainst Israel or the effect of military action elsewhere in the Middle East.The future of peace efforts between Israel and its Arab neighbors remainsuncertain. Any future armed conflicts or political instability in the regionwould likely negatively affect business conditions and adversely affect ourresults of operations. Furthermore, several countries restrict or prohibitbusiness with Israel or companies that do business in Israel. These restrictivelaws and policies may severely limit our ability to provide services in thosecountries.

Some of our employees in Israel are currentlyobligated to perform up to 36 days, depending on rank and position, of militaryreserve duty annually and are subject to being called for active duty at anytime under emergency circumstances. If a military conflict or war arises, theseindividuals could be required to serve in the military for extended periods oftime. Our operations could be disrupted by the absence for a significant periodof one or more of our executive officers or key employees or a significantnumber of other employees due to military service. Any consequent disruption inour operations could adversely affect our profitability.

We also generatesignificant revenues from services we deliver from India. India has from timeto time experienced instances of civil unrest and hostilities with Pakistan. Inrecent years, there have been military confrontations between India andPakistan that have occurred in the region of Kashmir and along theIndia-Pakistan border. Although the relations between the two countries arecurrently improving, military activity or terrorist attacks in the future couldadversely affect the Indian economy by disrupting communications and makingtravel more difficult, which may have a material adverse effect on our abilityto deliver services from India.

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**Wage inflation inIndia and Israel could reduce our profitability.**

Annual wage inflation forIT professionals in India over the past several years has exceeded world-wideaverages significantly. Based on our review of publicly available information,we believe that this trend will continue for the foreseeable future. Similarly,wage inflation for IT professionals in Israel has exceeded world-wide averagesin the last several years. If we are unable to provide adequately for such wageincreases in our contracts with our customers, or if unexpectedly large wageincreases occur, we may experience a material adverse effect on ourprofitability.

**Our international operations subject us to currencyexchange fluctuations, which could negatively impact our profitability.**

To date, most of our saleshave been denominated in NIS and dollars, while a significant portion of ourexpenses is incurred in the local currencies of countries in which we operate.For financial reporting purposes, we translate all non-United Statesdenominated transactions into dollars in accordance with United Statesgenerally accepted accounting principles. Despite our use of certain forwardforeign currency exchange contracts to hedge our exposure against foreigncurrencies, we may be exposed to the risk that fluctuations in the value ofthese currencies relative to the dollar could increase the dollar cost of ouroperations and therefore have an adverse effect on our profitability.

**Potential anti-outsourcing legislation could impairour ability to service our clients.**

Over the past severalyears, the issue of outsourcing of services abroad by American companies hasbecome a topic of political discussions in the United States. Measures aimed atlimiting or restricting outsourcing by United States companies are underdiscussion in Congress and in as many as one-half of the state legislatures.While no substantive anti-outsourcing legislation has been introduced to date,given the intensifying debate over this issue, the introduction of such legislationis possible. If introduced, such measures are likely to fall within twocategories: (1) measures that extend restrictions on outsourcing byfederal government agencies and on government contracts with firms thatoutsource services directly or indirectly, and (2) measures that affectprivate industry, such as tax disincentives or intellectual property transferrestrictions. If any of these measures become law, our ability to service ourclients could be impaired.

**Terrorist attacks or a war could negatively affect ourfinancial results and prospects.**

Terrorist attacks, such asthe attacks of September 11, 2001 in the United States, and other acts ofviolence or war, like the recent conflict in Iraq, could affect us or ourclients by disrupting normal business practices for extended periods of timeand reducing business confidence. In addition, these attacks may make travelmore difficult and may effectively curtail our ability to serve our clients’needs, any of which could negatively affect our financial results andprospects.

**Restrictions on immigration may affect our ability tocompete for and provide services in our clients’ countries, which could hamperour growth and cause our revenues to decline.**

A portion of our revenuesis derived from offshore outsourcing, which requires some personnel from ouroffshore locations in India and elsewhere to travel to client sites forrotational assignments. The ability of those IT professionals to work in NorthAmerica, Europe and in other countries depends on their ability to obtain thenecessary visas and work permits. The United States has recently reduced thenumber of H-1B visas authorized annually, and has also increased thelevel of scrutiny in granting H-1B, L-1 and ordinary businessvisas. A number of European countries are considering changes in immigrationpolicies as well. The inability of key project personnel to obtain necessaryvisas could delay or prevent our fulfillment of client projects, which couldhamper our growth and cause our revenues to decline.

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**If the government of India were to reduce or withdrawtax benefits and other incentives it provides to us, our net income willdecrease.**

Currently, we benefit fromthe tax benefits that India provides to the export of IT services. Thesebenefits provide a complete exemption from corporate income tax for exported ITservices, compared to an ordinary corporate tax rate of approximately 34%. As aresult of these incentives, our operations in India have been subject torelatively low tax rates. If these tax benefits are eliminated on March 31,2009 as currently scheduled, or if they are eliminated or reduced earlier asthe result of political or other changes in India, our tax expense willincrease, reducing our profitability.

***RisksRelating to Our Stock***

**Our stock price islikely to be highly volatile and could drop unexpectedly.**

The market price ofour stock may fluctuate significantly in response to a number of factors,including the following, several of which are beyond our control:

·       changesin financial estimates or investment recommendations by securities analystsrelating to our stock;

·       changesin market valuations of IT service providers and other high technologycompanies;

·       announcementsby us or our competitors of significant contracts, acquisitions, strategicpartnerships, joint ventures or capital commitments;

·       lossof a major client or changes in our employee utilization rate;

·       unfavorablelegal or arbitration judgments; and

·       changesin key personnel.

In the past, securitiesclass action litigation has often been brought against a company followingperiods of volatility in the market price of its securities. We could be thetarget of similar litigation in the future. Securities litigation, regardlessof merit or ultimate outcome, would likely cause us to incur substantial costs,divert management’s attention and resources, harm our reputation in theindustry and the securities markets and reduce our profitability.

**Your ability to influence corporate decisions may belimited because our executive officers, directors and affiliated majorstockholders beneficially own approximately 18.5% of our common stock.**

Our executive officers,directors and stockholders who beneficially own 5% or more of our outstandingcommon stock and are or were affiliated with Ness beneficially own, in theaggregate, shares representing approximately 18.5% of our outstanding commonstock. As a result of their stock ownership, if these stockholders were tochoose to act together, they may be able to influence the outcome on matterssubmitted to our stockholders for approval, including the election of directorsand approval of any merger, consolidation or sale of all or substantially allof our assets. This concentration of voting power could delay or prevent anacquisition of our company on terms that other stockholders may desire.

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**Provisions in our charter documents and under Delawarelaw may prevent or delay a change of control of us and could also limit themarket price of our common stock.**

Provisions of ourcertificate of incorporation and bylaws, as well as provisions of Delawarecorporate law, may discourage, delay or prevent a merger, acquisition or otherchange in control of our company, even if such a change in control would bebeneficial to our stockholders. These provisions may also prevent or frustrateattempts by our stockholders to replace or remove our management. Theseprovisions include:

·       prohibitingthe stockholders from fixing the number of our directors;

·       authorizingour board of directors to designate the terms of and issue new series ofpreferred stock without additional stockholder approvals;

·       limitingthe individuals who may call a special meeting to our chairman, chief executiveofficer, the majority of our board of directors or the majority of our stockholders;

·       requiringadvance notice for stockholder proposals and nominations; and

·       prohibitingstockholders from acting by written consent, unless unanimous.

We are subject to the provisions of Section 203of the Delaware General Corporation Law, which limits business combinationtransactions with stockholders of 15% or more of our outstanding voting stockthat our board of directors has not approved. These provisions and othersimilar provisions make it more difficult for stockholders or potential acquirersto acquire us without negotiation. These provisions may apply even if somestockholders may consider the transaction beneficial to them.

These provisions couldlimit the price that investors are willing to pay in the future for shares ofour common stock. These provisions might also discourage a potentialacquisition proposal or tender offer, even if the acquisition proposal ortender offer is at a premium over the then current market price for our commonstock.

***Item1B. Unresolved Staff Comments***

None.

***Item 2. Properties***

Our principal executive office is located in leasedpremises of approximately 255,000 square feet in Tel Aviv, Israel. Ourprincipal office in the United States is located in leased premises ofapproximately 21,000 square feet in Hackensack, New Jersey. We have offices ofvarious sizes at approximately 30 locations in 16 countries totalingapproximately 875,000 square feet, all of which are leased, includingapproximately 450,000 square feet in India, primarily in Bangalore, Hyderabadand Mumbai.

We believe that there issufficient office space available at favorable leasing terms both to replaceexisting office space and to satisfy any additional needs we may have as aresult of future expansion.

***Item 3. LegalProceedings***

We are periodically a party to routine litigationincidental to our business. We do not believe that we are a party to anypending legal proceeding that is likely to have a material adverse effect onour business, financial condition or results of operations.

One of our Israelisubsidiaries is currently in a dispute with one of its clients, an Israeliinsurance company, regarding the terms and conditions of a software developmentcontract (the “Contract”). The insurance company claims that we have materiallybreached the Contract by not timely delivering the required software. Theinsurance company has issued a contract termination notice, has collected 

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autonomousguarantees provided by our subsidiary in the amount of about $2 million, and isdemanding payment of the amounts paid so far, as well as damages. Furthermore,this termination could affect our reputation and impair our relations withanother client as well as with additional prospects for the software. Webelieve that we have not materially breached the Contract and that the delayswere caused by the insurance company’s actions. However, we do not contest theinsurance company’s right to terminate the contract for convenience, subject tocertain provisions including proper settlement of payments, as per theContract. The Contract provides for mandatory arbitration, which commenced in January 2007,in which we intend to vigorously defend our position. The insurance company andour subsidiary have both issued their respective claims to the arbitrator, aswell as responses to the other party’s claims. The total scope of the projectis approximately $9 million. With respect to this contract, approximately $3million is included in our accounts receivable and $2 million is included inother accounts receivable and prepaid expenses. We can give no assurance at thepresent time of the exposure, if any, for these claims. We believe that ourliability insurance policy, which has a cap of $5 million per claim, shouldcover such exposure. At this stage we can not estimate the result of thearbitration and we expect that the arbitration process may be protracted. Ifthe outcome of the dispute is not in our favor and not in line with ourposition described above, it may adversely affect our financial position,results of operations and cash flows.

***Item 4. Submissionof Matters to a Vote of Security Holders***

No matters were submitted to a vote of securityholders during the fourth quarter of 2006.

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**PART II**

***Item 5.****           Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities*

Ourcommon stock is quoted on the Nasdaq Global Select Market under the symbol “NSTC.”The following table shows the high and low per share sale prices of our commonstock, as reported on the Nasdaq Global Select Market. These prices reflectinter-dealer prices, without retail mark-up, mark-down or commission, and maynot necessarily represent actual transactions.

| ** **                                         | ** ** | **Price Range** | ** ** |
|----------------------------------------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **High**             | ** ** | **Low** | ** ** |
| **2004**                                           |       |                 |       |   |   |
| Third Quarter (commencing September 29, 2004) |       | $                    | 12.89      |   | $ | 11.90 |   |
| Fourth Quarter                                     |       | $                    | 15.60      |   | $ | 11.30 |   |
| **2005**                                           |       |                 |       |   |   |
| First Quarter                                      |       | $                    | 14.95      |   | $ | 11.40 |   |
| Second Quarter                                     |       | $                    | 12.65      |   | $ | 8.64 |   |
| Third Quarter                                      |       | $                    | 10.63      |   | $ | 8.25 |   |
| Fourth Quarter                                     |       | $                    | 11.20      |   | $ | 8.65 |   |
| **2006**                                           |       |                 |       |   |   |
| First Quarter                                      |       | $                    | 12.88      |   | $ | 9.65 |   |
| Second Quarter                                     |       | $                    | 13.00      |   | $ | 9.80 |   |
| Third Quarter                                      |       | $                    | 13.50      |   | $ | 10.29 |   |
| Fourth Quarter                                     |       | $                    | 16.99      |   | $ | 12.83 |   |
| **2007**                                           |       |                 |       |   |   |
| First Quarter  (through March 2, 2007)        |       | $                    | 15.06      |   | $ | 12.89 |   |

 

We have never paid any cash dividends. We currentlyintend to retain our future earnings to finance the operation and expansion ofour business and we do not anticipate paying cash dividends on our common stockin the foreseeable future. Any future determination as to the payment ofdividends will be at the discretion of our board of directors.

On March 2, 2007, thelast reported sale price per share of our common stock on the Nasdaq GlobalSelect Market was $13.54. As of March 2, 2007, there were approximately 50holders of record of our common stock, although the number of beneficialshareholders was much larger.

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**Stock Performance Graph**

Set forth below are agraph and a table comparing cumulative total return on $100 invested,alternatively, in our common stock, the Nasdaq U.S. Index and the S&P 500Information Technology Sector Index for the period commencing on September 29,2004, the date of our initial public offering, and ending on December 31,2006. Stockholder returns over the indicated period should not be consideredindicative of future stockholder returns.

**Comparison ofCumulative Total Return***

****
| Company/Index                              | ** ** | **9/29/04** | ** ** | **9/30/04** | ** ** | **12/31/04** | ** ** | **3/31/05** | ** ** | **6/30/05** | ** ** | **9/30/05** | ** ** | **12/31/05** | ** ** | **3/31/06** | ** ** | **6/30/06** | ** ** | **9/30/06** | ** ** | **12/31/06** | ** ** |
|--------------------------------------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|-------------|------------|--------------|------------|
| Ness  Technologies, Inc.              |       | $           | 100.00     |        | $          | 106.00       |       |        | $          | 124.00      |       |        | $          | 99.83        |       | $           | 88.50      |        | $          | 83.33       |       |         | $          | 89.75 |   |   | $ | 104.92 |   | $ | 89.58 |   | $ | 111.25 |   |   | $ | 118.83 |   |   |
| Nasdaq U.S. Index                          |       | 100.00      |       | 100.12      |       |         | 114.83     |        |       | 105.48      |       | 109.06      |       | 114.27       |       |        | 117.27     |        |       | 124.39      |       | 115.97       |       | 120.51 |   |   | 128.85 |   |   |
| S&P 500  Information Technology Sector |       | 100.00      |       | 100.32      |       |         | 113.89     |        |       | 105.54      |       | 107.41      |       | 113.81       |       |        | 115.03     |        |       | 119.82      |       | 108.29       |       | 117.52 |   |   | 124.71 |   |   |
|                                            |            |             |            |             |            |              |            |             |            |             |            |             |            |              |            |             |            |             |            |             |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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*                    Assumes $100invested on September 29, 2004 in our common stock, at our initialoffering price, and in each index, at the closing price on the date of ourinitial public offering; and that all dividends have been reinvested. No cashdividends have been declared on our common stock. Prepared by Standard &Poor’s.

***Item 6.****           SelectedFinancial Data*

*You should read thefollowing selected consolidated financial data together with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andour consolidated financial statements and the related notes included elsewherein this report.*

*The selectedconsolidated statement of operations data for the years ended December 31,2004, 2005 and 2006 and the selected consolidated balance sheet data as of December 31,2005 and 2006 are derived from our audited consolidated financial statementsincluded elsewhere in this report. The selected consolidated statement ofoperations data for the years ended December 31, 2002 and 2003 and theselected consolidated balance sheet data as of December 31, 2002, 2003 and2004 are derived from our audited consolidated financial statements notincluded in this report. These financial statements have been prepared inaccordance with U.S. generally accepted accounting principles. Our historicalresults may not be indicative of the operating results to be expected in anyfuture period and our results for interim periods may not be indicative ofresults to be expected for the entire year.*

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|                                                                                                 | ** ** | **Year ended December 31,**                                             | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2002**                                                                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                      | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **Statement  of Operations Data:**                                                              |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Revenues                                                                                        |       | $166,576                                                                               |       | $225,768 |   | $304,525 |   | $385,436 |   | $474,318 |   |
| Cost of revenues                                                                                |       | 104,702                                                                                |       | 159,775 |   | 211,725 |   | 275,233 |   | 342,104 |   |
| Gross profit                                                                                    |       | 61,874                                                                                 |       | 65,993 |   | 92,800 |   | 110,203 |   | 132,214 |   |
| Operating  expenses:                                                                            |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Selling and marketing                                                                           |       | 19,192                                                                                 |       | 21,287 |   | 25,706 |   | 29,033 |   | 35,315 |   |
| General and administrative                                                                      |       | 30,168                                                                                 |       | 36,115 |   | 46,042 |   | 54,730 |   | 63,288 |   |
| Research and development, net                                                                   |       | 1,516                                                                                  |       | 1,559 |   | — |   | — |   | — |   |
| Other                                                                                           |       | 198                                                                                    |       | 665 |   | — |   | — |   | — |   |
| Total operating expenses                                                                        |       | 51,074                                                                                 |       | 59,626 |   | 71,748 |   | 83,763 |   | 98,603 |   |
| Operating income                                                                                |       | 10,800                                                                                 |       | 6,367 |   | 21,052 |   | 26,440 |   | 33,611 |   |
| Financial  expenses, net                                                                        |       | (8,829                                                                                 | )          | (1,451 | ) | (3,461 | ) | (1,521 | ) | (1,280 | ) |
| Other income  (expenses), net                                                                   |       | (347                                                                                   | )          | (422 | ) | (91 | ) | (243 | ) | 5,349 |   |
| Income before  taxes on income                                                                  |       | 1,624                                                                                  |       | 4,494 |   | 17,500 |   | 24,676 |   | 37,680 |   |
| Taxes on income  (tax benefit)                                                                  |       | (48                                                                                    | )          | (54 | ) | 2,320 |   | 3,518 |   | 8,035 |   |
| Equity in earnings  (losses) of affiliates and gain from disposal of an affiliate               |       | (35                                                                                    | )          | 11 |   | (647 | ) | (65 | ) | 168 |   |
| Minority interests  in losses (earnings) of a subsidiary                                        |       | (377                                                                                   | )          | — |   | (156 | ) | 101 |   | — |   |
| Income from  continuing operations                                                              |       | 1,260                                                                                  |       | 4,559 |   | 14,377 |   | 21,194 |   | 29,813 |   |
| Loss from  discontinued operations(1)                                                           |       | (395                                                                                   | )          | (1,105 | ) | — |   | — |   | — |   |
| Extraordinary  income, net of taxes                                                             |       | —                                                                                 |       | — |   | — |   | 495 |   | — |   |
| Net income                                                                                      |       | $                                                                                      | 865        |   | $ | 3,454 |   | $ | 14,377 |   | $ | 21,689 |   | $ | 29,813 |   |
| Basic earnings  (loss) per share from continuing operations(2)                             |       | $                                                                                      | (0.18      | ) | $ | 0.20 |   | $ | 0.58 |   | $ | 0.63 |   | $ | 0.83 |   |
| Basic earnings  (loss) per share(2)                                                             |       | $                                                                                      | (0.23      | ) | $ | 0.13 |   | $ | 0.58 |   | $ | 0.63 |   | $ | 0.83 |   |
| Diluted earnings  (loss) per share from continuing operations(2)                                |       | $                                                                                      | (0.18      | ) | $ | 0.19 |   | $ | 0.53 |   | $ | 0.61 |   | $ | 0.82 |   |
| Diluted earnings  (loss) per share(2)                                                           |       | $                                                                                      | (0.23      | ) | $ | 0.12 |   | $ | 0.53 |   | $ | 0.61 |   | $ | 0.82 |   |
| Basic earnings  (loss) per share from continuing operations excluding extraordinary income(2)   |       | $                                                                                      | (0.18      | ) | $ | 0.20 |   | $ | 0.58 |   | $ | 0.62 |   | $ | 0.83 |   |
| Basic earnings  (loss) per share excluding extraordinary income(2)                              |       | $                                                                                      | (0.23      | ) | $ | 0.13 |   | $ | 0.58 |   | $ | 0.62 |   | $ | 0.83 |   |
| Diluted earnings  (loss) per share from continuing operations excluding extraordinary income(2) |       | $                                                                                      | (0.18      | ) | $ | 0.19 |   | $ | 0.53 |   | $ | 0.59 |   | $ | 0.82 |   |
| Diluted earnings  (loss) per share excluding extraordinary income(2)                            |       | $                                                                                      | (0.23      | ) | $ | 0.12 |   | $ | 0.53 |   | $ | 0.59 |   | $ | 0.82 |   |
| Weighted average  number of shares used in computing basic earnings (loss) per share            |       | 8,474                                                                                  |       | 15,379 |   | 22,292 |   | 34,413 |   | 35,999 |   |
| Weighted average number  of shares used in computing diluted earnings (loss) per share          |       | 8,474                                                                                  |       | 16,611 |   | 24,748 |   | 35,661 |   | 36,549 |   |

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(1)          In January 2003, wedecided to discontinue the operations of one of our subsidiaries. Theoperations of this subsidiary have been eliminated from our operations as aresult.

(2)          Gives effect to issuanceof additional shares of our common stock as payment of accrued dividends on Class Bpreferred stock.

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|                                           | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**                    | ** ** |
| **Balance  Sheet Data:**                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                |       | $                                          | 43,494     |   | $ | 46,004 |   | $ | 104,229 |   | $ | 33,579 |   | $ | 46,675 |   |
| Short-term bank  deposits                 |       | —                                     |       | 3,248 |   | — |   | 39,561 |   | 2,027 |   |
| Working capital                           |       | 18,178                                     |       | 16,770 |   | 92,548 |   | 66,144 |   | 71,276 |   |
| Total assets                              |       | 241,883                                    |       | 339,483 |   | 424,756 |   | 454,368 |   | 541,617 |   |
| Total debt,  including current maturities |       | 84,204                                     |       | 90,453 |   | 51,557 |   | 34,167 |   | 12,600 |   |
| Stockholders’ equity                 |       | 62,365                                     |       | 126,355 |   | 232,480 |   | 254,502 |   | 332,655 |   |
|                                           |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Item 7.****           Management’sDiscussion and Analysis of Financial Condition and Results of Operations*

*You should read the following discussion and analysistogether with our unaudited consolidated financial statements and theaccompanying notes. This discussion contains forward-looking statements, withinthe meaning of Section 27A of Securities Act of 1933, as amended, Section 21Eof the Securities Exchange Act of 1934, as amended, and the Private SecuritiesLitigation Reform Act of 1995, including statements regarding our expectedfinancial position, business and financing plans. These statements involverisks and uncertainties. Our actual results could differ materially from theresults described in or implied by these forward-looking statements as a resultof various factors, including those discussed below and elsewhere in thisreport, particularly under the headings “Disclosure Statement” and “RiskFactors.”*

**Overview**

We are a global provider of information technology, orIT, services and end-to-end business solutions designed to help clients improvetheir competitiveness and effectiveness. End-to-end business solutionsencompass all stages of a client’s business process and incorporate alltechnologies and IT services related to that process. Our portfolio ofsolutions and services includes outsourcing, system integration and applicationdevelopment, software and consulting, and quality assurance and training. Theprimary industries, or verticals, we serve include government and defense,financial services, life sciences and healthcare, telecommunications andutilities, and independent software vendors, or ISVs.

We have operations in 16 countries across NorthAmerica, Europe and Asia. We combine our deep vertical expertise and strongtechnical capabilities to provide a complete range of high quality services ona global scale. By integrating our local and international personnel in focusedbusiness and project teams, this global delivery model leverages our corporateknowledge and experience, intellectual property and global infrastructure todevelop innovative solutions for clients across the geographies and verticalswe serve. We complement this global delivery model with our offshore deliverycapabilities to achieve meaningful cost reductions or other benefits for ourclients.

Our revenues increased to $474.3 million for 2006,from $385.4 million for 2005. Net income increased to $29.8 million for 2006,from $21.7 million for 2005.

Our revenue growth is attributable to a number offactors, including acquisitions we made, increases in the number and size ofprojects for existing clients, and the addition of new clients. Our client baseis diverse, and we are not dependent on any single client. In 2006, no client accountedfor more than 5% of our revenues and our largest twenty clients togetheraccounted for approximately 29% of our revenues. For 2006, the percentage ofour revenues generated by public and private clients in Israel was 48%, and thepercentage of our revenues derived, in aggregate, from agencies of thegovernment of Israel was 10%. Existing clients from prior years generated morethan 80% of our revenues in 2006.

Our backlog as of December 31, 2006 was $606million compared to $450 million as of December 31, 2005. This $156million increase in our backlog was due primarily to new bookings. We achievebacklog through new signings of IT services projects and outsourcing contracts,including for new and repeat customers. We recognize backlog as revenue when weperform the services related to backlog.

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For 2006, the impact of inflation and changing priceson net sales and revenues and on income from continuing operations wasinsignificant.

As of December 31, 2006, trade receivables andother accounts receivable and prepaid expenses included a total balance ofapproximately $5 million from one of our clients, an Israeli insurance company,with whom we are currently in a contract dispute (see “Item 3—LegalProceedings”).

As of December 31,2006, we had approximately 7,515 employees, including approximately 6,600 ITprofessionals. Of the 7,515 employees, approximately 3,430 were in Israel,2,330 were in India, 545 were in North America, 835 were in Europe and 375 werein the Asia Pacific region.

**Application ofCritical Accounting Policies and Estimates**

Our discussion and analysis of our financial conditionand results of operations are based on consolidated financial statements, whichhave been prepared in accordance with U.S. generally accepted accountingprinciples. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amount of assets andliabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities at the date of our financial statements. The actual results maydiffer from these estimates under different assumptions or conditions.

Critical accountingpolicies are defined as those that are reflective of significant judgments anduncertainties, and which could result in materially different results underdifferent assumptions and conditions. Application of these policies isparticularly important to the portrayal of our financial condition and resultsof operations. We believe that the accounting policies described below meetthese characteristics. Our significant accounting policies are more fullydescribed in the notes to the accompanying consolidated financial statements.

***Revenue Recognition***

We generate our revenues from contracts for systemintegration and application development services, outsourcing, consultation,quality assurance and training services as well sales of third party softwarelicenses. We provide services on either a fixed price or time and materialsbasis. For time and materials contracts, we recognize revenues as services areperformed based on the hours actually incurred at the negotiated billing rates.We also charge our clients for certain costs and expenses, such as theinstallation of hardware and cost of subcontractors.

Our fixed price contracts relate primarily tolong-term development projects. Such projects that require significantcustomization, integration and installation are recognized in accordance withSOP No. 81-1 “Accounting for Performance of Construction-Type andCertain Production-Type Contracts.” We recognize revenues related to thesecontracts using the percentage of completion method based on the percentage ofcosts incurred to date in relation to the total estimated costs expected uponcompletion. This requires us to make estimates and assumptions regarding theresources and time required to fulfill the contracts’ obligations includingwork effort, materials and subcontractors. We rely on our experience from otherprojects in making these estimates, and, in addition, use our internal projectmanagement and financial systems to track and manage the projects. Employeesand project managers regularly submit updates to these systems, which are thenused by executive management to monitor the projects and revise the estimates,if necessary. These systems, which are updated on a regular basis by inputsfrom employees’ and project managers’ estimates, produce analyses and are usedby executive management to monitor the projects and revise the estimates, ifnecessary. Historically, our estimates have been indicative of our actualresults; however, there have been a few cases where we had to adjustassumptions, primarily regarding work effort.

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We generally recognize revenues on a gross basis,representing the entire amount, because we bear the risks and rewards ofownership, including the risk of loss for collection, delivery and returns, andhave latitude in establishing product pricing above specific minimums.Management determines whether we bear the risks and rewards of ownership basedon relevant sale contract terms. Whenever the majority of contract termsindicate that we bear the risks and rewards, revenues are recognized on a grossbasis. For most software license sales and hardware sales, we record revenueson a net basis, based on management’s determination that majority of contractterms indicate that we do not bear the risks and rewards related to suchcontracts.

For arrangements that involve multiple revenueactivities, (i.e., the delivery or performance of multiple products and services,management allocates the associated consideration to the separate activitiesbased on their relative fair values. In order to determine the fair values of thedifferent activities covered by each agreement, management applies standardpricing used for products and services in similar arrangements and hourly ratesbased on similar activities we have performed for other clients. For contractsentered into with the same party at or near the same time, management evaluateson a case-by-case basis, based on the specific circumstances, whether toaccount for these contracts as a single arrangement or separate contracts.

Our revenue recognitionapproach for software licensing requires that, in accordance with Statement ofPosition No. 97-2 “Software Revenue Recognition” (as amended), fourbasic criteria must be met before revenue can be recognized: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or servicesrendered; (3) the fee is fixed and determinable; and (4) collectibilityis reasonably assured. Determination of criteria (3) and (4) is basedon management’s judgments regarding the fixed nature of the fee charged forservices rendered and products delivered, and the collectibility of those fees.Should changes in conditions cause management to determine these criteria arenot met for certain future transactions, revenue recognized for any reportingperiod could be adversely affected.

***Allowance for Doubtful Accounts***

We maintain an allowancefor doubtful accounts for estimated losses resulting from the inability of ourclients to make required payments. The allowance for doubtful accounts isdetermined by evaluating the credit worthiness of each client based upon marketcapitalization and other information, including the aging of the receivables.If the financial condition of our clients were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. In each financial period, we estimate the likelihood of collectingevery receivable and record a cumulative allowance.

***Business Combinations***

In accordance with business combination accounting, weallocate the purchase price of acquired companies to the tangible andintangible assets acquired and liabilities assumed, based on their estimatedfair values. We engage third-party appraisal firms to assist management indetermining the fair values of certain assets acquired and liabilities assumed.Such valuations require management to make significant estimates andassumptions, especially with respect to intangible assets.

Management makes estimatesof fair value based upon assumptions believed to be reasonable. These estimatesare based on historical experience and information obtained from the managementof the acquired companies and are inherently uncertain. Critical estimates invaluing certain assets acquired and liabilities assumed include but are notlimited to: future expected cash flows from license and service sales,maintenance agreements, customer contracts and estimated cash flows from theprojects when completed, the acquired company’s brand awareness and discountrate. Unanticipated events and circumstances may occur that may affect theaccuracy or validity of such assumptions, estimates or actual results.

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***Goodwill***

SFAS No. 142 requiresgoodwill to be tested for impairment on adoption and at least annuallythereafter or between annual tests in certain circumstances, and written downwhen impaired, rather than amortized as previous accounting standards required.Goodwill is tested for impairment at the reporting unit level by comparing thefair value of the reporting unit with its carrying value. Fair value isdetermined using discounted cash flows, market multiples and marketcapitalization. Significant estimates used in the methodologies includeestimates of future cash flows, future short-term and long-term growth rates,and weighted average cost of capital for the reportable unit. If theseestimates or their related assumptions change in the future, we may be requiredto record impairment charges for our goodwill. As of December 31, 2006, noimpairment losses were identified.

***Realizability of Long-Lived Assets***

In accordance with SFAS No. 144“Accounting for the Impairment or Disposal of Long-Lived Assets,” ourlong-lived assets are reviewed for impairment annually and whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of the assets to the future undiscounted cashflows expected to be generated by the assets. If such assets are considered tobe impaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the fair value of the assets. Inmeasuring the recoverability of assets, we are required to make estimates andjudgments in assessing our forecast and cash flows and compare that with thecarrying amount of the assets. Additional significant estimates used bymanagement in the methodologies used to assess the recoverability of ourlong-lived assets include estimates of future cash-flows, future short-term andlong-tem growth rates, market acceptance of products and services, and otherjudgmental assumptions, which are also affected by factors detailed in our RiskFactors section in this Annual Report. If these estimates or the relatedassumptions change in the future, we may be required to record impairmentcharges for our long-lived assets. As of December 31, 2006 and 2005, noimpairment losses were identified.

***Tax Accounting***

As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income tax expense ineach of the jurisdictions in which we operate. In the ordinary course of aglobal business, there are many transactions and calculations where theultimate tax outcome is uncertain. Some of these uncertainties arise as aconsequence of revenue sharing and reimbursement arrangements among relatedentities, the process of identifying items of revenue and expenses that qualifyfor preferential tax treatment and segregation of foreign and domestic incomeand expense to avoid double taxation. This process involves us estimating ourcurrent tax exposure, which is accrued as taxes payable, together withassessing temporary differences resulting from differing treatment of items,such as deferred revenue, for tax and accounting differences. These differencesresult in deferred tax assets and liabilities, which are included within ourconsolidated balance sheet. We may record a valuation allowance to reduce ourdeferred tax assets to the amount of future tax benefit that is more likelythan not to be realized.

Although we believe that our estimates are reasonableand that we have considered future taxable income and ongoing prudent andfeasible tax strategies in estimating our tax outcome and in assessing the needfor the valuation allowance, there is no assurance that the final tax outcomeand the valuation allowance will not be different than those that are reflectedin our historical income tax provisions and accruals. Such differences couldhave a material effect on our income tax provision, net income and cashbalances in the period in which such determination is made.

41

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We have filed, or are inthe process of filing, federal, state and foreign tax returns that are subjectto audit by the respective tax authorities. Although the ultimate outcome isunknown, we believe that adequate amounts have been provided for and anyadjustments that may result from tax return audits are not likely to have amaterial adverse effect on our consolidated results of operations, financialcondition or cash flows.

***Stock based Compensation***

On January 1, 2006, we adopted Statement ofFinancial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS123(R)”) utilizing the *modified prospective*transition method. SFAS 123(R) requires employee stock options to bevalued at their fair value on the date of grant and charged to expense over theapplicable service period. Under the modified prospective method, compensationexpense is recognized for all share-based payments issued on or after January 1,2006 and for all share-based payments issued to employees prior to January 1,2006 that remain unvested.

Prior to the adoption of SFAS 123(R), we accounted forshare-based awards to employees and directors using the intrinsic value methodin accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” under which we recognized compensation expensewhen the exercise price of our share options was less than the fair marketprice of the underlying shares on the date of grant. Adoption of SFAS 123(R) didnot change our accounting for share-based payments issued to non-employees.

SFAS 123(R) requiresmanagement to estimate the fair value of share-based awards on the date ofgrant using an option-pricing model, where applicable. Changes in theseestimates could have a material impact on our compensation expense.

***Severance Pay***

The liability of ourIsraeli subsidiaries for severance pay is calculated pursuant to Israel’sSeverance Pay Law based on the most recent salary of Israeli employeesmultiplied by the number of years of employment, as of the balance sheet date.Employees are entitled to one month’s salary for each year of employment or aportion thereof. This liability is fully provided for by monthly deposits into severancepay funds, insurance policies and by an accrual. The value of these policies isrecorded as an asset on our balance sheet. The deposited funds may be withdrawnonly upon the fulfillment of the obligation pursuant to Israel’s Severance PayLaw or labor agreements. The value of the deposited funds is based on the cashsurrender value of these policies, and includes immaterial profits.

**Recent Developments**

None.

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**ConsolidatedResults of Operations**

Thefollowing table sets forth the items in our consolidated statement ofoperations as a percentage of revenues for the periods presented.
|                                                          | ** ** | **Year ended December, 31** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                 |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                         |       | 69.5                                       |       | 71.4 |   | 72.1 |   |
| Gross profit                                             |       | 30.5                                       |       | 28.6 |   | 27.9 |   |
| Operating expenses:                                      |       |                                       |       |   |   |   |   |
| Selling and marketing                                    |       | 8.4                                        |       | 7.5 |   | 7.4 |   |
| General and administrative                               |       | 15.1                                       |       | 14.2 |   | 13.3 |   |
| Total operating expenses                                 |       | 23.6                                       |       | 21.7 |   | 20.8 |   |
| Operating income                                         |       | 6.9                                        |       | 6.9 |   | 7.1 |   |
| Financial  expenses, net                                 |       | (1.1                                       | )          | (0.4 | ) | (0.3 | ) |
| Other income  (expenses), net                            |       | (0.0                                       | )          | (0.1 | ) | 1.1 |   |
| Income before  taxes on income                           |       | 5.7                                        |       | 6.4 |   | 7.9 |   |
| Taxes on income                                          |       | 0.8                                        |       | 0.9 |   | 1.7 |   |
| Equity in losses  and gain from disposal of an affiliate |       | (0.2                                       | )          | 0.0 |   | 0.0 |   |
| Minority  interests in losses (earnings) of a subsidiary |       | (0.1                                       | )          | 0.0 |   | — |   |
| Income before  extraordinary item                        |       | 4.7                                        |       | 5.5 |   | 6.3 |   |
| Extraordinary income, net of taxes                       |       | —                                     |       | 0.1 |   | — |   |
| Net income                                               |       | 4.7                                        |       | 5.6 |   | 6.3 |   |

 

**2006 Compared to 2005**

Thefollowing table summarizes certain line items from our consolidated statementof operations (dollars in thousands):

| ** **       | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **       | ** ** | **2005**                               | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues         |       | $                                      | 385,436    |                     | $          | 474,318 |   | 88,882 |   | 23.1 |   |
| Cost of revenues |       | 275,233                                |       | 342,104                  |       | 66,871 |   | 24.3 |   |
| Gross profit     |       | $                                      | 110,203    |                     | $          | 132,214 |   | 22,011 |   | 20.0 |   |
| Gross margin     |       | 28.6                                   | %          | 27.9                     | %          |   |   |   |   |

 

***Revenues***

Our revenues increasedfrom $385.4 million in 2005 to $474.3 million in 2006, representing an increaseof $88.9 million, or 23.1%. Approximately $54.0 million this increase wasattributable to acquisitions, a significant portion of which was due topost-acquisition growth resulting from synergies with Ness. Of the $88.9million increase in revenues, $31.6 million represents growth in outsourcingand offshore engagements and $57.3 million represents growth in our otherofferings, comprised of system integration and application development,software and consulting, and quality assurance and training. Revenues fromoutsourcing and offshore services increased as a result of volume growth due toour sales initiatives related to these offerings, including the hiring of keypersonnel and aligning of our organizational structure. There was nosignificant change in our billing rates, or prices, from 2005 to 2006. Weexpect our revenues to grow in 2007 due to continued expansion into NorthAmerican and European 

43

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marketsin key verticals, including through acquisitions, and the securing of contractsfrom new and existing clients.

***Cost of revenues***

Our cost of revenues,including salaries, wages and other direct and indirect costs, increased from$275.2 million in 2005 to $342.1 million in 2006, representing an increase of$66.6 million, or 24.2 %. Approximately $38.1 million of this increase wasattributable to acquisitions, a significant portion of which was due to growthin our delivery staff needed to support post-acquisition revenue growthresulting from synergies with Ness, and $28.0 million was due to normal growthin our delivery staff needed to support our increased revenues. In 2007, weexpect our cost of revenues to increase, primarily due to an increase in thenumber of IT professionals needed to support our expected revenue growth. Inaddition, our cost of revenues will likely increase due to increases insalaries, especially in India, where there is strong demand for experienced ITprofessionals.

***Gross Profit***

Our gross profit (revenues less cost of revenues)increased from $110.2 million in 2005 to $132.2 million in 2006, representingan increase of $22.0 million, or 20.0%. The increase was primarily due to our increasein revenues. Approximately $16.4 million of the increase was attributable toacquisitions, a significant portion of which was due to post-acquisitionrevenue growth resulting from synergies with Ness, and $5.6 million was relatedto our other revenue growth. Gross margin for 2006 was 27.9%, compared to 28.6%in 2005. This decrease in gross margin was mainly due to reorganizationexpenses in the fourth quarter of 2006, mostly in our ‘Other’ segment,representing approximately $2.6 million. In 2007, we expect that gross profitwill increase as a result of our anticipated revenue growth, while gross marginwill remain relatively constant.

Thefollowing table summarizes certain line items from our consolidated statementof operations (dollars in thousands):

| ** **                  | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **2005**                               | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                      | 29,033     |                     | $          | 35,315 |   | 6,282 |   | 21.6 |   |
| General and  administrative |       | 54,730                                 |       | 63,288                   |       | 8,558 |   | 15.6 |   |
| Total operating  expenses   |       | 83,763                                 |       | 98,603                   |       | 14,840 |   | 17.7 |   |
| Operating income            |       | $                                      | 26,440     |                     | $          | 33,611 |   | 7,171 |   | 27.1 |   |

 

44

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***Selling and marketing***

Selling and marketingexpenses increased from $29.0 million in 2005 to $35.3 million in 2006,representing an increase of $6.3 million, or 21.6%. This increase was dueprimarily to the inclusion of marketing and sales expenses from ouracquisitions, representing $4.9 million, and amortization of backlog andcustomer relations related to acquisitions, representing $2.3 million. In 2007,we expect selling and marketing expenses to increase to support growth in newvertical markets and regions as well as to enhance our brand recognition.Selling and marketing expenses are expected to decrease as a percentage ofrevenues in 2007.

***General and administrative***

General and administrativeexpenses increased from $54.7 million in 2005 to $63.3 million in 2006,representing an increase of $8.6 million, or 15.6%. This increase was due primarilyto our acquisitions, representing $3.5 million, the rollout of long-termretention programs and bonuses, representing $2.4 million, and general andadministrative expenses associated with the reorganization of our Ness Israelsegment, representing $1.0 million, offset by lower stock-based compensationexpenses, representing $1.4 million. In 2007, we expect our general andadministrative expenses to increase to support our anticipated revenue growth.In addition, we expect a higher level of general and administrative costs inthe first half of 2007, attributable to the transitions of our Chief ExecutiveOfficer and Chief Financial Officer. General and administrative expenses areexpected to decrease as a percentage of revenues in 2007, assuming no provisionis required in 2007 in relation to the disputed contract described in “Item 3—LegalProceedings.”

***Operating Income***

Operating income increased from $26.4 million in 2005to $33.6 million in 2006, representing an increase of $7.2 million, or 27.1%.The major factors contributing to this increase were the growth in operatingincome of our Managed Strategic Services, Technologies & ServicesGroup, Ness Israel, Ness Europe and Other segments, representing $1.7 million,$1.3 million, $1.0 million, $0.4 million and $2.0 million, respectively, and adecrease in unallocated expenses, representing $0.7 million. See also “—Results by Business Segment.”

Thefollowing table summarizes certain line items from our consolidated statementof operations (dollars in thousands):

| ** **                                               | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **2005**                               | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                                         |       | $                                      | 26,440     |                     | $          | 33,611 |   | 7,171 |   | 27.1 |   |
| Financial  expenses, net                                 |       | (1,521                                 | )          | (1,280                   | )          | 241 |   | (15.8 | ) |
| Other income  (expenses), net                            |       | (243                                   | )          | 5,349                    |       | 5,592 |   | N/A |   |
| Income before  taxes on income                           |       | 24,676                                 |       | 37,680                   |       | 13,004 |   | 52.7 |   |
| Taxes on income                                          |       | 3,518                                  |       | 8,035                    |       | 4,517 |   | 128.4 |   |
| Equity in losses  and gain from disposal of an affiliate |       | (65                                    | )          | 168                      |       | 233 |   | N/A |   |
| Minority  interests in losses of a subsidiary            |       | 101                                    |       | —                   |       | (101 | ) | (100.0 | ) |
| Income before  extraordinary item                        |       | 21,194                                 |       | 29,813                   |       | 8,619 |   | 40.7 |   |
| Extraordinary  income, net of taxes                      |       | 495                                    |       | —                   |       | (495 | ) | (100.0 | ) |
| Net income                                               |       | $                                      | 21,689     |                     | $          | 29,813 |   | 8,124 |   | 37.5 |   |

 

45

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***Financial expenses, net***

Financial expenses, net,decreased from $1.5 million in 2005 to $1.3 million in 2006, representing adecrease of $0.2 million, or 15.8%. The decrease occurred despite thesignificant decrease in average net cash from $43.3 million to $14.9 million,as a result of improved cash management, repayment of relatively expensiveloans and effective hedging of foreign currencies. For 2007, we expectfinancial expenses to remain relatively low.

***Other income (expenses), net***

Other income (expenses),net, changed from expenses of $0.2 million in 2005 to income of $5.3 in 2006.This increase was primarily due to a one-time gain from the sale of ournon-controlling interest in the company dbMotion, net of related expenses,representing $5.0 million, and consideration received for a third partytransaction, representing $0.4 million, net of expenses.

***Taxes on income***

Our taxes on incomeincreased from $3.5 million in 2005 to $8.0 million in 2006, representing anincrease of $4.5 million, or 128%. This increase was primarily attributable tothe increase in our income before taxes, representing $1.9 million, of which taxeson the gain we realized in the sale of our interest in dbMotion represented$1.2 million, and an increase in income before taxes from geographies withhigher tax rates, including tax expenses related to prior years, togetherrepresenting $2.6 million. We do not expect our effective tax rate in 2007 tochange significantly from our 2006 effective tax rate.

***Equity in losses and gain from disposal of anaffiliate***

Equity in losses and gainfrom disposal of an affiliate increased from a loss of $0.1 million in 2005 toa gain of $0.2 million in 2006. The change was primarily attributable to a gainrealized in the disposal in the fourth quarter of 2006 of our affiliate, NessMatach, representing $0.3 million.

***Minority interests in losses of a subsidiary***

Minority interests inlosses of a subsidiary changed from losses of $0.1 million in 2005 to zero in2006. This change was not significant.

***Extraordinary income, net of taxes***

Extraordinary income, netof taxes, changed from $0.5 million in 2005 to zero in 2006. In 2001, when weacquired certain assets and assumed certain liabilities of Blueflame, Inc.,we recorded a long-term liability of $0.8 million in respect of a contingentpromissory note associated with the acquisition, which we later classified intocurrent liabilities on December 31, 2004. On December 31, 2005, thecontingent liability ended, at which time we reversed the liability andrecorded it as extraordinary item in the statement of income, net of taxes,representing $0.5 million. There was no corresponding extraordinary income in2006.

***Net Income***

Net income increased from$21.7 million in 2005 to $29.8 million in 2006, representing an increase of$8.1 million, or 37.5%. The increase in net income was due primarily to ourincrease in operating income of $7.2 million, our increase in other income(expenses), net, of $5.6 million, partially offset by our increase in taxes onincome of $4.5 million and our decrease in extraordinary income, net of taxes,of $0.5 million.

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**2005 Compared to2004**

Thefollowing table summarizes certain line items from our consolidated statementof operations (dollars in thousands):

| ** **       | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **       | ** ** | **2004**                               | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues         |       | $                                      | 304,525    |                     | $          | 385,436 |   | 80,911 |   | 26.6 |   |
| Cost of revenues |       | 211,725                                |       | 275,233                  |       | 63,508 |   | 30.0 |   |
| Gross profit     |       | $                                      | 92,800     |                     | $          | 110,203 |   | 17,403 |   | 18.8 |   |
| Gross margin     |       | 30.5                                   | %          | 28.6                     | %          |   |   |   |   |

 

***Revenues***

Our revenues increasedfrom $304.5 million in 2004 to $385.4 million in 2005, representing an increaseof $80.9 million, or 26.6%. The increase was primarily due to growth inoutsourcing and offshore engagements, representing $27.9 million, and growth inour other offerings, comprised of system integration and applicationdevelopment, software and consulting, and quality assurance and training,representing $53.1 million. Revenues from outsourcing and offshore servicesincreased as a result of volume growth due to our sales initiatives related tothese offerings, including the hiring of key personnel and aligning of ourorganizational structure, and expansion into geographical areas in which wecurrently do business but previously had not offered outsourcing and offshoreservices. There was no significant change in our billing rates, or prices, from2004 to 2005.

***Cost of revenues***

Our cost of revenues,including salaries, wages and other direct and indirect costs, increased from$211.7 million in 2004 to $275.2 million in 2005, representing an increase of$63.5 million, or 30.0 %. The increase was attributable to growth in ourdelivery staff needed to support our increased revenues.

***Gross Profit***

Our gross profit (revenues less cost of revenues)increased from $92.8 million in 2004 to $110.2 million in 2005, representing anincrease of $17.4 million, or 18.8%. The increase was primarily related to ourincrease in revenues, representing $24.7 million, offset by a decrease in ourgross margin, representing approximately ($7.3) million. Gross margin for 2005was 28.6%, compared to 30.5% in 2004. The decrease in gross margin resultedprimarily from an increase in our use of subcontractors and vendors in thefirst quarter in order to meet certain delivery commitments and from asignificant component of lower gross margin hardware resale business in our2005 Eastern Europe acquisitions.

Thefollowing table summarizes certain line items from our consolidated statementof operations (dollars in thousands):

| ** **                  | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **2004**                               | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                      | 25,706     |                     | $          | 29,033 |   | 3,327 |   | 12.9 |   |
| General and  administrative |       | 46,042                                 |       | 54,730                   |       | 8,688 |   | 18.9 |   |
| Total operating  expenses   |       | 71,748                                 |       | 83,763                   |       | 12,015 |   | 16.7 |   |
| Operating income            |       | $                                      | 21,052     |                     | $          | 26,440 |   | 5,388 |   | 25.6 |   |

 

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***Selling and marketing***

Selling and marketingexpenses increased from $25.7 million in 2004 to $29.0 million in 2005,representing an increase of $3.3 million, or 12.9%. This increase was dueprimarily to the inclusion of marketing and sales expenses from ouracquisitions in Eastern Europe in 2005, representing $1.2 million, an increasein marketing expenses needed to enhance our brand recognition and to supportour revenue growth, representing $1.0 million, and increases in our salescommissions and other sales expenses of $1.1 million.

***General and administrative***

General and administrative expenses increased from$46.0 million in 2004 to $54.7 million in 2005, representing an increase of$8.7 million, or 18.9%. This increase was due primarily to increased generaland administrative expenses necessary to support our revenue growth, includingthe general and administrative expenses of our second quarter acquisitions,together representing $4.7 million, certain additional expenses associated withbeing a public company including implementation of compliance measures requiredby the Sarbanes-Oxley Act, representing $2.4 million, and stock-based compensationexpenses of $1.9 million in respect of redeemable options, as described in Note14(b)9 to our Consolidated Financial Statements.

Thefollowing table summarizes certain line items from our consolidated statementof operations (dollars in thousands):

| ** **                                               | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **2004**                               | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                                         |       | $                                      | 21,052     |                     | $          | 26,440 |   | 5,388 |   | 25.6 |   |
| Financial  expenses, net                                 |       | (3,461                                 | )          | (1,521                   | )          | 1,940 |   | (56.1 | ) |
| Other expenses,  net                                     |       | (91                                    | )          | (243                     | )          | (152 | ) | 167.0 |   |
| Income before  taxes on income                           |       | 17,500                                 |       | 24,676                   |       | 7,176 |   | 41.0 |   |
| Taxes on income                                          |       | 2,320                                  |       | 3,518                    |       | 1,198 |   | 51.7 |   |
| Equity in net  losses of affiliates                      |       | (647                                   | )          | (65                      | )          | 582 |   | (89.9 | ) |
| Minority  interests in losses (earnings) of a subsidiary |       | (156                                   | )          | 101                      |       | 257 |   | N/A |   |
| Income before  extraordinary item                        |       | 14,377                                 |       | 21,194                   |       | 6,817 |   | 47.4 |   |
| Extraordinary  income, net of taxes                      |       | —                                 |       | 495                      |       | 495 |   | N/A |   |
| Net income                                               |       | $                                      | 14,377     |                     | $          | 21,689 |   | 7,312 |   | 50.9 |   |

 

***Financial expenses, net***

Financial expenses, net,decreased from $3.5 million in 2004 to $1.5 million in 2005, representing adecrease of $1.9 million, or 56.1%. The decrease was due primarily toinvestment income from the proceeds of our initial public offering and reduceddebt service expenses following our reduction of net long-term debt in thefourth quarter of 2004 and subsequently. In 2005, we replaced high rate loans,increased the return on our deposits and entered into certain forward foreigncurrency exchange contracts to hedge our exposure against foreign currencieswhich differ from the local functional currencies.

***Other expenses, net***

Other expenses, net,changed from $0.1 million in 2004 to $0.2 in 2005. This change was notsignificant.

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***Taxes on income***

Our taxes on incomeincreased from $2.3 million in 2004 to $3.5 million in 2005, representing anincrease of $1.2 million, or 51.7%. This increase was attributable to theincrease in our income before taxes, representing $1.9 million, offset by a taxbenefit attributable to our stock-based compensation expense, representing($0.7) million.

***Equity in net losses of affiliates***

Equity in net losses ofaffiliates decreased from $0.6 million for 2004 to $0.1 million in 2005. Thisdecrease was due to a capital loss recorded in 2004 which related to ourreduced ownership of our affiliate, Ness ISI (now known as dbMotion Ltd.), withno equivalent amount in 2005. Following the January 1, 2004 issuance ofpreferred shares by Ness ISI that reduced our share ownership to anon-controlling interest, we no longer consolidate Ness ISI’s results in ourfinancial statements.

***Minority interests in losses (earnings) of asubsidiary***

Minority interests inlosses (earnings) of a subsidiary changed from earnings of $0.2 million in 2004to losses of $0.1 million in 2005. This change was not significant.

***Extraordinary income, net of taxes***

In 2001, when we acquired certain assets and assumedcertain liabilities of Blueflame, Inc., we recorded a long-term liabilityof $0.8 million in respect of a contingent promissory note associated with theacquisition, which we later classified into current liabilities on December 31,2004. On December 31, 2005, the contingent liability ended, at which timewe reversed the liability and recorded it as extraordinary item in thestatement of income, net of taxes, representing $0.5 million.

***NetIncome***

Net income increased from$14.4 million in 2004 to $21.7 million in 2005, representing an increase of$7.3 million, or 50.9%. The increase in net income was due primarily to ourincrease in operating income of $5.4 million, our decrease in financial expensesof $1.9 million, our decrease in equity in net losses of affiliates of $0.6million and our extraordinary income, net of taxes, of $0.5 million, partiallyoffset by the increase in our taxes on income of $1.2 million. The increase inour operating income was itself offset by an increase in stock-basedcompensation of $1.9 million.

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**Quarterly Resultsof Operations**

Thefollowing table presents our unaudited quarterly results of operations for theeight quarters in the period ended December 31, 2006. You should read thefollowing table together with the consolidated financial statements and relatednotes contained elsewhere in this report. We have prepared the unauditedinformation on the same basis as our audited consolidated financial statements.This table includes normal recurring adjustments that we consider necessary forfair presentation of our financial position and operating results for thequarters presented. Operating results for any quarter are not necessarilyindicative of results for any future quarters or for a full year.
|                                                         | ** ** | **Three months ended**                      | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                              | ** ** | **Mar 31,  2005**                                | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** | **Mar 31,  2006** | ** ** | **Jun 30,  2006** | ** ** | **Sep 30,  2006** | ** ** | **Dec 31,  2006** | ** ** |
| ** **                                              | ** ** | **(unaudited) (dollars in thousands)** | ** ** |
| Revenues                                                |       |                                                  | $          | 88,405 |   |   | $ | 94,218 |   | $ | 97,719 |   | $ | 105,094 |   | $ | 107,042 |   | $ | 116,614 |   | $ | 119,135 |   | $ | 131,527 |   |
| Cost of revenues                                        |       |                                                  | 62,577     |   |   | 68,046 |   | 69,628 |   | 74,980 |   | 75,716 |   | 83,981 |   | 85,095 |   | 97,312 |   |
| Gross profit                                            |       |                                                  | 25,828     |   |   | 26,172 |   | 28,091 |   | 30,114 |   | 31,326 |   | 32,633 |   | 34,040 |   | 34,215 |   |
| Operating  expenses:                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling and marketing                                   |       |                                                  | 7,031      |   |   | 7,002 |   | 7,081 |   | 7,919 |   | 8,491 |   | 8,733 |   | 8,391 |   | 9,700 |   |
| General and administrative                              |       |                                                  | 12,942     |   |   | 14,252 |   | 13,344 |   | 14,192 |   | 14,930 |   | 16,426 |   | 15,489 |   | 16,443 |   |
| Total operating expenses                                |       |                                                  | 19,973     |   |   | 21,254 |   | 20,425 |   | 22,111 |   | 23,421 |   | 25,159 |   | 23,880 |   | 26,143 |   |
| Operating income                                        |       |                                                  | 5,855      |   |   | 4,917 |   | 7,666 |   | 8,003 |   | 7,905 |   | 7,474 |   | 10,160 |   | 8,072 |   |
| Financial expenses, net                                 |       |                                                  | (420       | ) |   | (494 | ) | (383 | ) | (224 | ) | (61 | ) | (577 | ) | (492 | ) | (150 | ) |
| Other income (expenses), net                            |       |                                                  | (6         | ) |   | 10 |   | (14 | ) | (232 | ) | (39 | ) | 483 |   | (8 | ) | 4,913 |   |
| Income before taxes on income                           |       |                                                  | 5,429      |   |   | 4,433 |   | 7,269 |   | 7,547 |   | 7,805 |   | 7,380 |   | 9,660 |   | 12,835 |   |
| Taxes on income                                         |       |                                                  | 602        |   |   | 423 |   | 1,252 |   | 1,241 |   | 1,468 |   | 1,340 |   | 1,709 |   | 3,518 |   |
| Equity in losses and gain from disposal of an affiliate |       |                                                  | (2         | ) |   | (27 | ) | — |   | (37 | ) | — |   | (90 | ) | (13 | ) | 271 |   |
| Minority interests in losses of a subsidiary            |       |                                                  | 101        |   |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Income before extraordinary item                        |       |                                                  | 4,926      |   |   | 3,983 |   | 6,017 |   | 6,269 |   | 6,337 |   | 5,950 |   | 7,938 |   | 9,588 |   |
| Extraordinary income, net of taxes                      |       |                                                  | —     |   |   | — |   | — |   | 495 |   | — |   | — |   | — |   | — |   |
| Net income                                              |       |                                                  | $          | 4,926 |   |   | $ | 3,983 |   | $ | 6,017 |   | $ | 6,764 |   | $ | 6,337 |   | $ | 5,950 |   | $ | 7,938 |   | $ | 9,588 |   |

 

**Results by BusinessSegment**

Our segment information has been prepared inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information.” Operating segments are defined as components of anenterprise engaging in business activities about which separate financialinformation is available that is evaluated regularly by our chief operatingdecision-maker in deciding how to allocate resources and assess performance.

On January 1, 2006, we completed thereorganization of our operations into operating segments. Our chief operatingdecision-maker is our chief executive officer, who evaluates our performanceand allocates resources based on segment revenues and operating profit.

Our operatingsegments are:

1.                **Managed Strategic Services**, which includesIndia-based offshore services as well as system integration and applicationdevelopment and consulting services. Verticals served by this segment are:independent software vendors, life sciences and healthcare and others.

2.                **Technologies & Systems Group**,which includes system integration and application development, real-timesystems development, consulting and outsourcing services for the defense,government and homeland security vertical, as well as systems for thetelecommunications vertical.

3.                **Ness Europe**, which includes systemintegration and application development, outsourcing and software andconsulting for Eastern European and Western European customers, including near-

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shore services fromEastern Europe for Western European customers. Verticals served by this segmentare: telecommunications and utilities, financial services and others.

4.                **Ness Israel**, which includes systemintegration and application development, outsourcing, software and consultingand quality assurance and training for customers in Israel within the followingverticals: financial services, government, life sciences and healthcare,manufacturing, retail, transportation and others.

5.                **Other**, which comprises operationsrepresenting, individually, less than 10% of our consolidated revenues andoperating profit. These include our operations in the United Kingdom and AsiaPacific as well as the recently acquired Ness Innovative Business Services(formerly Innova) and NessPRO Spain (formerly Selesta España).

Segment operating profit is defined as income fromoperations excluding unallocated headquarters costs. Expenses included insegment operating profit consist principally of direct selling, general,administrative and delivery costs. Certain general and administrative expensesand a portion of depreciation and amortization are not specifically allocatedto specific segments as management believes they are not directly attributableto any specific segment. Accordingly, these expenses are categorized as “UnallocatedExpenses” and adjusted against our total income from operations. Additionally,our management has determined that it is not practical to allocate certainidentifiable assets by segment, when such assets are used interchangeably amongthe segments.

Thetable below presents financial information for our five reportable segments(dollars in thousands). Prior period data is presented on a pro forma basis, aswe were not organized into SFAS No. 131 operating segments at that time.
|                                             | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|
| ** **                                  | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Segment Data:**                           | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues:**                               |       |                                  |       |   |   |   |   |
| Managed Strategic Services (MSS)            |       | $                                     | 73,229     |   | $ | 80,544 |   | $ | 80,597 |   |
| Technologies & Systems Group (TSG) |       | 37,047                                |       | 44,200 |   | 56,391 |   |
| Ness Europe                                 |       | 25,294                                |       | 63,554 |   | 88,223 |   |
| Ness Israel                                 |       | 143,453                               |       | 168,234 |   | 190,009 |   |
| Other                                       |       | 25,502                                |       | 28,904 |   | 59,098 |   |
|                                        |       | $                                     | 304,525    |   | $ | 385,436 |   | $ | 474,318 |   |
| **Operating Income (Loss):**                |       |                                  |       |   |   |   |   |
| Managed Strategic Services (MSS)            |       | $                                     | 6,825      |   | $ | 7,927 |   | $ | 9,645 |   |
| Technologies & Systems Group (TSG) |       | 3,980                                 |       | 5,617 |   | 6,929 |   |
| Ness Europe                                 |       | 2,472                                 |       | 8,051 |   | 8,472 |   |
| Ness Israel                                 |       | 12,019                                |       | 13,148 |   | 14,154 |   |
| Other                                       |       | (130                                  | )          | (403 | ) | 1,627 |   |
| Unallocated Expenses                        |       | (4,114                                | )          | (7,900 | ) | (7,216 | ) |
|                                        |       | $                                     | 21,052     |   | $ | 26,440 |   | $ | 33,611 |   |

 

**Liquidity andCapital Resources**

***Overview***

As of December 31,2006, we had cash, cash equivalents and short-term bank deposits of $48.7million compared to $73.1 million as of December 31, 2005. The funds heldat locations outside of the United States are for future operating expenses andcapital expenditures, and we have no intention of repatriating 

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thosefunds. We are not, however, restricted in repatriating those funds back to theUnited States, if necessary. While we expect that cash generated by ournon-U.S. subsidiaries will be reinvested in their respective geographies tosupport expansion of our business, to the extent that funds were remitted tothe United States in the form of dividend payments, those payments may besubject to withholding taxes in their respective countries, and would besubject to tax in the United States.

***CashFlows***

Thefollowing table summarizes our cash flows for the periods presented (dollars inthousands):
|                                                               | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                   | ** ** | **2006** | ** ** |
| Net cash provided  by operating activities                    |       | $                                          | 6,801      |   | $ | 4,245 |   |
| Net cash provided  by (used in) investing activities          |       | (60,594                                    | )          | 2,140 |   |
| Net cash provided  by (used in) financing activities          |       | (9,860                                     | )          | 5,083 |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | (6,997                                     | )          | 1,628 |   |
| Increase (decrease)  in cash and cash equivalents             |       | (70,650                                    | )          | 13,096 |   |
| Cash and cash  equivalents at the beginning of the period     |       | 104,229                                    |       | 33,579 |   |
| Cash and cash  equivalents at the end of the period           |       | $                                          | 33,579     |   | $ | 46,675 |   |

 

*2006 compared to2005*

Net cash provided by operating activities was $4.2million in 2006, compared to $6.8 million in 2005. The major contributingfactors were tax payments in 2006 to the Israeli Tax Authority related to priorperiods of $10.5 million, offset by an increase in our net income of $8.1million, which is net of the gain on the sale of an investment that wasincluded in investing activities, representing $5.0 million, excess tax benefitrelated to exercise of options that was classified in financing activitiesrather than operating activities, in accordance with SFAS 123(R), representing$2.3 million, and an increase in depreciation and amortization of $4.4 million.

Net cash provided by investing activities was $2.1million in 2006, compared with net cash used of $60.6 million in 2005. Themajor factors contributing to the change were the sale of short-term bankdeposits, sale of investment at cost and sale of marketable securities,together representing $84.9 million, offset by payments in respect of theacquisitions we made during 2006, net of cash acquired, of $28.6 million versus$10.2 million in 2005.

Net cash provided by financing activities was $5.1million in 2006, compared with net cash used of $9.9 million in 2005. Thechange was primarily due to an increase in the exercise of options,representing $20.6 million, offset by repayment of short-term and long-termloans, representing $8.0 million.

The effect of exchangerate changes on cash and cash equivalents was $1.6 million in 2006, compared to($7.0) million in 2005. The change was primarily due to long-term inter-companybalances, representing $4.9 million.

***Long-termand Short-term Debt***

At December 31, 2006,we had aggregate short-term and long-term bank borrowings of $10.5 million,consisting of various notes denominated in dollars and NIS (linked to index)with interest rates ranging from approximately 6.5% to 7.5% and a weightedaverage interest rate of approximately 7.12%, with maturities of one to twoyears. These aggregate bank borrowings included $5.0 million from IsraelDiscount Bank, with interest rates of approximately 6.5% to 7.5% and maturitiesof one to two years; and $0.8 million from two other lenders, in amountsranging from $0.3 million to $0.5 million, with interest rates of approximately6.5% to 6.7% and maturities of up to one year.

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***Anticipated Capital Expenditures***

Ouronly material indebtedness is amounts owed by Ness A.T. Ltd., one of oursubsidiaries, to Israel Discount Bank. The relevant debt instruments containcustomary restrictive covenants relating to the borrower, including thefollowing:

·       anegative pledge;

·       stockholders’equity must not be less than 30% of its total assets; and

·       limitationson merging or transferring assets.

As of December 31,2006, we are in compliance and expect to remain in compliance with all of ourcovenants. Our failure to comply with these covenants could lead to an event ofdefault under the agreements governing some or all of the indebtedness,permitting the applicable lender to accelerate all borrowings under theapplicable agreement, and to foreclose on any collateral.

***Anticipated Needs***

We intend to fund futuregrowth through future cash flow from operations, available bank borrowings andthe remaining net proceeds of our initial public offering. We believe theremaining balance of the proceeds of our initial public offering, together withborrowings and future cash flow from operations, will be sufficient to fundcontinuing operations for the foreseeable future. In order to achieve ourstrategic business objectives, we may be required to seek additional financing.For example, future acquisitions may require additional equity and/or debtfinancing. In addition, we may require further capital to continue to enhanceour infrastructure and for working capital purposes. These financings may notbe available on acceptable terms, or at all.

**Off-Balance Sheet Arrangements**

We do not have anysignificant off-balance sheet arrangements, investments in special purposeentities or undisclosed borrowings or debt. In addition, we have not enteredinto any derivative contracts or any synthetic leases.

**Contractual Obligations**

Ourmajor outstanding contractual obligations related to our long-term debt,operating leases and accrued severance pay. We have summarized in the tablebelow our fixed contractual cash obligations for long-term debt and operatingleases as of December 31, 2006 (dollars in thousands):

| ** **             | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **More than  3 years** | ** ** |
|------------------------|------------|-----------|------------|---------------------------------|------------|--------------------|------------|----------------------------------|------------|
| Long-term debt         |       | $         | 6,981      |                            |       | $                  | 4,420      |                             |       | $ | 2,561 |   |   | $ | — |   |   |
| Interest payments  (1) |       | 580       |       |                            | 370        |               |       | 210                              |       |   | — |   |   |
| Operating leases       |       | 72,978    |       |                            | 21,740     |               |       | 30,416                           |       |   | 17,822 |   |   |
| Total                  |       | $         | 80,539     |                            |       | $                  | 26,530     |                             |       | $ | 33,187 |   |   | $ | 17,822 |   |   |

 

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(1)          Amount representsinterest on fixed rate debt.

Our obligation for accrued severance pay under Israel’sSeverance Pay Law as of December 31, 2006 was $46.6 million, of which$42.1 million was funded through deposits into severance pay funds, leaving anet obligation of $4.5 million.

**Recently IssuedAccounting Pronouncements**

In February 2007, the FASB issued Statement No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS159”). SFAS 159 permits companies to choose to measure certain 

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financial instruments andcertain other items at fair value. The standard requires that unrealized gainsand losses on items for which the fair value option has been elected bereported in earnings. SFAS 159 is effective for companies beginning in thefirst quarter of fiscal year 2008, although earlier adoption is permitted. Weare currently evaluating the effect that the application of SFAS 159 will haveon our consolidated results of operations and financial condition.

In September 2006, the FASB issued Statement No. 157,“Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS No. 157 applies under other accounting pronouncements that require orpermit fair value measurements. SFAS 157 will be effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. We are currently evaluating the effect that the application of SFAS 157 willhave on our consolidated results of operations and financial condition.

In September 2006, the SEC issued StaffAccounting Bulletin No. 108, “Financial Statements—Considering the Effectsof Prior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements” (“SAB 108”). SAB 108 requires companies to quantify theimpact of all correcting misstatements, including both the carryover andreversing effects of prior year misstatements, on the current year financialstatements. SAB 108 is effective for fiscal years ending after November 15,2006. The adoption of SAB 108 did not have a material effect on our financialstatements.

In June 2006, theFASB issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes,” (“FIN 48”). FIN 48 addresses the determination of whether tax benefitsclaimed or expected to be claimed on a tax return should be recorded in thefinancial statements. Under FIN 48, a company may recognize the tax benefitfrom an uncertain tax position only if it is more likely than not that the taxposition will be sustained on examination by the taxing authorities, based onthe technical merits of the position. The tax benefits recognized in thefinancial statements from such a position should be measured based on thelargest benefit that has a greater than fifty percent likelihood of beingrealized upon ultimate settlement. FIN 48 also provides guidance onderecognizing, classification, interest and penalties on income taxes,accounting in interim periods, and requires increased disclosures. Theprovisions of FIN 48 are effective beginning January 1, 2007. We arecurrently in the process of assessing the impact the adoption of FIN 48 willhave on our financial statements.

***Item 7A.   Quantitativeand Qualitative Disclosure about Market Risk***

We do not engage in trading market-risk instruments orpurchase hedging or “other than trading” instruments that are likely to exposeus to market risk, whether interest rate, commodity price or equity price risk.We have not purchased options or entered into swaps or forward or futurescontracts and do not use derivative financial instruments for speculativetrading purposes.

We have direct operations in 16 different countriesand commercial relationships in many other parts of the world. Our foreignoperations contract with clients in their applicable local currencies ordollars. As a result, we are subject to adverse movements in foreign currencyexchange rates in those countries where we conduct business. In order tominimize the effect of such movements, we entered into certain forward foreigncurrency exchange contracts to hedge our exposure against foreign currencieswhich differ from the local functional currencies, beginning in the secondquarter of 2006. In the future, we may enter into additional forward foreigncurrency exchange or other derivatives contracts to further hedge our exposureto foreign currency exchange rates.

In the future, we may besubject to interest rate risk on our investments, which would affect their carryingvalue.

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***Item 8.   FinancialStatements and Supplementary Data***

See the index included onpage F-1, Index to Consolidated Financial Statements.

***Item 9.   Changesin and Disagreements with Accountants on Accounting and Financial Disclosure***

None.

***Item 9A.****                  Controlsand Procedures*

**Evaluation ofDisclosure Controls and Procedures**

As of the end of the period covered by this report,our chief executive officer and chief financial officer evaluated theeffectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended).Based on their evaluation of our disclosure controls and procedures, our chiefexecutive officer and chief financial officer, with the participation of ourmanagement, have concluded that our disclosure controls and procedures areeffectively designed to ensure that information required to be disclosed by usin the reports that we file or submit under the Securities Exchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and are operating in an effective manner.

It should be noted thatany system of controls, however well designed and operated, can provide only reasonable,and not absolute, assurance that the objectives of the system are met. Inaddition, the design of any control system is based in part upon certainassumptions about the likelihood of future events. Given these and otherinherent limitations of control systems, there is only reasonable assurancethat our controls will succeed in achieving their stated goals under allpotential future conditions.

**Management’s ReportOn Internal Control Over Financial Reporting**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f) and 15d-15(f).Under the supervision and with the participation of our management, includingour principal executive officer and principal financial officer, we conductedan evaluation of the effectiveness of our internal control over financialreporting as of December 31, 2006 based on the framework in InternalControl-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. As permitted, we have excluded fromour evaluation the 2006 acquisitions of Olas Software Solutions, Inc.,d/b/a Innova Solutions, and Selesta España, which are included in our 2006Consolidated Financial Statements, and which in the aggregate represented 3.5%of consolidated total assets and 1.6% of consolidated shareholders’ equity asof December 31, 2006, and 6.9% of consolidated net revenues and 13.4% ofconsolidated net income for the year ended December 31, 2006. Based onthat evaluation, our management concluded that our internal control overfinancial reporting was effective as of December 31, 2006.

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31,2006 has been audited by Kost Forer Gabbay & Kasierer, a member ofErnst & Young Global, an independent registered public accountingfirm, as stated in their report immediately following.

**Report OfIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersNess Technologies, Inc.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting, that Ness Technologies, Inc. maintained effective internal 

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control over financialreporting as of December 31, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). Ness Technologies, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

As indicated in the accompanying Management’s ReportOn Internal Control Over Financial Reporting, management’s assessment of andconclusion on the effectiveness of internal control over financial reportingdid not include the internal controls of Olas Software Solutions, Inc.,d/b/a Innova Solutions, and Selesta España, which are included in the 2006consolidated financial statements of Ness Technologies, Inc. and whichconstituted, in aggregate, 3.5% of total assets and 1.6% of shareholders’equity as of December 31, 2006, and 6.9% of revenues and 13.4% of netincome for the year then ended. Our audit of internal control over financialreporting of Ness Technologies, Inc. also did not include an evaluation ofthe internal control over financial reporting of Olas Software Solutions, Inc.,d/b/a Innova Solutions, and Selesta España.

In our opinion, management’s assessment that NessTechnologies, Inc. maintained effective internal control over financialreporting as of December 31, 2006, is fairly stated, in all materialrespects, based on the COSO criteria. Also, in our opinion, Ness Technologies, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2006, based on the COSO criteria.

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Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofNess Technologies, Inc. as of December 31, 2005 and 2006, and therelated consolidated statements of income, shareholders’ equity and cash flowsfor each of the three years in the period ended December 31, 2006 of NessTechnologies, Inc. and our report dated March 14, 2007 expressed anunqualified opinion thereon.
| Tel Aviv, Israel     |   | Kost Forer  Gabay & Kasierer     |
|----------------------|--------|-------------------------------------------|
| March 14,  2007 |   | A MEMBER OF ERNST & YOUNG GLOBAL |

 

**Changes in InternalControl**

As of the end of theperiod covered by this report, there were no significant changes in ourinternal controls over financial reporting or in other factors that couldsignificantly affect these controls.

***Item 9B.****                  OtherInformation*

Raviv Zoller has waivedhis minimum bonus for the year 2006. On March 12, 2007, we entered into aSeparation and Release agreement with Mr. Zoller, who had previouslyannounced his intention to resign from the position of president and chiefexecutive officer. Under the terms of the agreement, Mr. Zoller willprovide consulting services as requested by us through September 15, 2007and will continue to serve as a member of the board of directors until at leastthe 2007 meeting of shareholders, unless otherwise agreed in writing. Mr. Zollerwill vacate his office as president and chief executive officer on March 16,2007. According to the terms of Mr. Zoller’s employment agreement and thisagreement, he will continue to receive his salary, benefits and minimum bonusuntil March 15, 2008; and he will receive a one-time payment equal to$750,000 upon the earlier of September 15, 2007 and the date on which hisboard membership terminates. In consideration of these benefits, Mr. Zoller’snon-competition term is extended by an additional 12 months and he releases usfrom any claims other than those that would result from our breach of thisagreement. In addition, Mr. Zoller is entitled to a special bonus of $125,000for his role in a recent knowledge transfer transaction in our TSG segment.

On March 12, 2007, we entered into an employmentagreement with Issachar (Sachi) Gerlitz. Mr. Gerlitz began his employmenton January 8, 2007 and, beginning on March 16, 2007, he will serve asour president and chief executive officer, or CEO. The current term of theagreement expires on December 31, 2009 but is automatically extended forsuccessive one-year periods, unless terminated by either party giving writtennotice no later than six months prior to the expiration of the then existingterm. Mr. Gerlitz’s annual base salary, which is denominated in NewIsraeli Shekels, or NIS, is approximately $327,000, based on the dollar to NISexchange rate of March 1, 2007. Mr. Gerlitz will receive a sign-onbonus equivalent to $175,000 upon completion of seven months as CEO and he iseligible to receive an annual bonus, as of January 1, 2008, of up to$250,000 with a minimum annual bonus, as of January 1, 2008, of $125,000.We may terminate the agreement by providing Mr. Gerlitz with six months ofprior written notice during his first year of employment, nine months in hissecond year or twelve months in his third year and thereafter. Mr. Gerlitzmay terminate the agreement by providing us with six months of prior writtennotice. However, we may terminate Mr. Gerlitz for cause immediately if heis convicted of committing a felony. Except for termination by us for seriousmisconduct, Mr. Gerlitz will be entitled to all amounts deposited in hisfavor in pension funds, including payments made for severance pay. Theagreement also contains customary assignment of rights, confidentiality,non-competition and non-solicitation provisions. The non-competition andnon-solicitation provisions apply during Mr. Gerlitz’s employment and forone year thereafter. Mr. Gerlitz will be granted 250,000 stock options assoon as practicable with an exercise price equal to the closing price on theNasdaq Stock Market on March 15, 2007. The options will vest in threeequal parts over the next three years, and will expire on December 31,2011. In the event of a change in control, the vesting dates of Mr. Gerlitz’sunvested options will be 

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accelerated. In case of achange in control prior to December 31, 2008, Mr. Gerlitz willreceive an additional cash payment equal to his gain on any options vested atthe time of the event.

On March 12, 2007, we entered into an employmentagreement with Ofer Segev. Mr. Segev began his employment on March 1,2007 and, beginning on April 1, 2007, he will serve as our chief financialofficer and executive vice president. The current term of the agreement expireson December 31, 2009 but is automatically extended for successive one-yearperiods, unless terminated by either party giving written notice no later thansix months prior to the expiration of the then existing term. Mr. Segev’sannual base salary is $200,000, and he is also entitled to an annual bonus ofup to $100,000 as determined by our chief executive officer, subject to thediscretion of the Stock Option and Compensation Committee; which maximum may beincreased to $200,000 in the second year of his employment. We may terminatethe agreement by providing Mr. Segev with six months of prior writtennotice during his first year of employment or nine months in his second yearand thereafter. Mr. Segev may terminate the agreement by providing us withsix months of prior written notice. However, we may terminate Mr. Segevfor cause immediately if he is convicted of committing a felony. Except fortermination by us for serious misconduct, Mr. Segev will be entitled toall amounts deposited in his favor in pension funds, including payments madefor severance pay. The agreement also contains customary assignment of rights,confidentiality, non-competition and non-solicitation provisions. Thenon-competition and non-solicitation provisions apply during Mr. Segev’semployment and for one year thereafter. Mr. Segev will be granted 100,000stock options as soon as practicable with an exercise price equal to theclosing price on the Nasdaq Stock Market on March 15, 2007. The optionswill vest in three equal parts over the next three years, and will expire on December 31,2011. In the event of a change in control, the vesting dates of Mr. Segev’sunvested options will be accelerated.

On December 29, 2006, we entered into a revisedand restated employment contract, effective January 1, 2007, with IvanHruška, the president of our Ness Europe segment. Mr. Hruška may be deemedto be an employee-at-will because his agreement does not specify a term ofemployment. Mr. Hruška’s annual base salary, which is denominated inSlovak Koruna, or SKK, is approximately $314,000, based on the dollar to SKKexchange rate of January 1, 2007. In addition, based on achievement ofcertain goals relating to the performance of his business unit and the company,he is eligible to receive an annual bonus of up to approximately $209,000,based on the dollar to SKK exchange rate of January 1, 2007. Either partymay terminate the agreement by giving six months prior written notice to theother party. The agreement also contains customary assignment of rights,confidentiality, non-competition and non-solicitation provisions. The non-competitionand non-solicitation provisions apply during Mr. Hruška’s employment andfor six months and one year thereafter, respectively.

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**PART III**

***Item 10.   Directors,Executive Officers and Corporate Governance***

Theinformation required by this item is incorporated by reference to ourdefinitive proxy statement to be filed with the Securities and ExchangeCommission not later than April 30, 2007 in connection with our annualmeeting of stockholders (the “Proxy Statement”) under the headings “Directorsand Executive Officers,” “Voting Securities and Principal Holders Thereof” and “Compensationof Directors and Executive Officers.”

***Item 11.   ExecutiveCompensation***

The information requiredby this item is incorporated by reference to the Proxy Statement under theheading “Compensation of Directors and Executive Officers.”

***Item 12.   SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters***

The information requiredby this Item is incorporated by reference to the Proxy Statement under theheading “Voting Securities and Principal Holders Thereof.”

***Item 13.   CertainRelationships and Related Transactions, and Director Independence***

The information requiredby this item is incorporated by reference to the Proxy Statement under theheading “Interest of Certain Persons in Matters to Be Acted Upon.”

***Item 14.    PrincipalAccountant Fees and Services***

The information required by this item is incorporatedby reference to the Proxy Statement under the heading “Independent PublicAccountants.”

59

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**PART IV**

***Item 15.   Exhibitsand Financial Statement Schedules***

**(a) List of documents filed aspart of this report:**

***1. FinancialStatements as of December 31, 2005 and December 31, 2006 and for eachof the three years in the period ended December 31, 2006 included in Part IIof this Form 10-K:***

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Changes in Stockholders’Equity

Consolidated Statements of Cash Flows

Notes to ConsolidatedFinancial Statements

***2. Financial Statement Schedules:***

None.

***3. Exhibit Index***

Thefollowing is a list of exhibits filed as part of this Form 10-K:

| Exhibit   Number | ** ** | **Description**                                                                                                                                                                      |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *3.1             |       | Amended and Restated Certificate of Incorporation of  the Registrant.                                                                                                                |
| *3.2             |       | Amended and Restated  Bylaws of the Registrant.                                                                                                                                      |
| **4.1            |       | Specimen Certificate for  the Registrant’s common stock.                                                                                                                        |
| **10.1           |       | Registration Rights  Agreement, dated as of March 26, 1999, among the Registrant and the  other signatories listed therein.                                                     |
| **10.2           |       | Registration Rights  Agreement, dated as of May 13, 1999, between the Registrant and Velston  Pte. Ltd.                                                                         |
| **10.3           |       | Second Amended and  Restated Registration Rights Agreement, dated as of June 30, 2003, among  the Registrant and the other signatories listed therein.                          |
| **10.4           |       | Amendment to Second  Amended and Restated Registration Rights Agreement, dated as of  September 2, 2004, by and among the Registrant and the other signatories  listed therein. |
| **10.5           |       | Loan Agreement, dated as  of July 29, 1999, between Israel Discount Bank Ltd. and Nesstech  Advanced Technologies (1999) Ltd.                                                   |
| **10.6           |       | Loan Agreement, dated as  of July 29, 1999, between Bank Hapoalim B.M. and Nesstech Advanced  Technologies (1999) Ltd.                                                          |
| +**10.7          |       | Apar Holding Corp.  Employees’ Equity Plan.                                                                                                                                     |
| +**10.8          |       | Ness  Technologies, Inc. 1999 Share Option Plan.                                                                                                                                |
| +**10.9          |       | Ness  Technologies, Inc. 2001 Stock Option Plan.                                                                                                                                |
| +**10.10         |       | Ness  Technologies, Inc. 2003 Israeli Share Option Plan.                                                                                                                        |
| +**10.11         |       | Ness  Technologies, Inc. 2003 Stock Option Plan.                                                                                                                                |
| +**10.12         |       | Agreement, dated as of  August 1, 1999, between the Registrant and Aharon Fogel.                                                                                                |

60

----

 

| +**10.13           |   | Amendment to Agreement,  dated as of May 31, 2001, between the Registrant and Aharon Fogel.                                                                       |
|--------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| +§§10.14 |   | Amendment to Employment  Agreement, effective as of May 8, 2006, between the Registrant and  Aharon Fogel.                                                        |
| +**10.15           |   | Amended and Restated  Employment Agreement, effective as of June 1, 2001, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd.                 |
| +**10.16           |   | Amendment to Amended and  Restated Employment Agreement, effective as of January 1, 2004, between  the Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |
| +§10.17       |   | Amendment to Employment  Agreement, effective as of January 1, 2006, between the Registrant,  Raviv Zoller and Ness Technologies Israel Ltd.                      |
| +10.18             |   | Separation and Release  Agreement, dated as of March 12, 2007, between the Registrant and Raviv  Zoller.                                                          |
| +10.19             |   | Employment Agreement,  dated as of March 12, 2007, between the Registrant and Sachi Gerlitz.                                                                      |
| +¶10.20       |   | Employment Agreement,  dated as of April 21, 2005, between the Registrant and Ytzhak Edelman.                                                                     |
| +§10.21       |   | Amendment to Employment  Agreement, effective as of January 1, 2006, between the Registrant and  Ytzhak Edelman.                                                  |
| +10.22             |   | Employment Agreement,  dated as of March 12, 2007, between the Registrant and Ofer Segev.                                                                         |
| +**10.23           |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Tuvia Feldman (English translation).                 |
| +**10.24           |   | Addendum to Personal  Employment Agreement, dated as of August 1, 1999, between Advanced  Technology Ltd. and Tuvia Feldman (English translation).                |
| +**10.25           |   | Addendum to Personal  Employment Agreement, dated as of August 23, 1999, between Advanced  Technology Ltd. and Tuvia Feldman (English translation).               |
| +**10.26           |   | Employment Agreement  Addendum, dated as of August 27, 2000, between the Registrant and Tuvia  Feldman.                                                           |
| +**10.27           |   | Summary of Meeting,  dated May 3, 2001, between Raviv Zoller and Tuvia Feldman (English  translation).                                                            |
| +§10.28       |   | Amendment to Employment  Agreement, effective as of March 1, 2006, between the Registrant and  Tuvia Feldman.                                                     |
| +**10.29           |   | Offer Letter, dated  January 29, 2004, between the Registrant and Ivan Hruška.                                                                               |
| +**10.30           |   | Contract of Employment,  effective as of March 1, 2004, between the Registrant and Ivan Hruška.                                                              |
| +10.31             |   | Employment Contract,  dated as of December 29, 2006, between NESS Slovensko, a.s. and Ivan  Hruška.                                                          |
| +**10.32           |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).               |
| +**10.33           |   | Addendum to Personal  Employment Agreement, dated as of August 1, 1999, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).              |

61

----

 

| +**10.34           |   | Addendum to Personal  Employment Agreement, dated as of August 23, 1999, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).                     |
|--------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| +¶¶10.35 |   | Personal Employment  Agreement, dated as of August 10, 2005, between Ness Technologies  Holdings Ltd. and Shachar Efal (English translation)                              |
| +§10.36       |   | Offer letter, dated as  of December 1, 1999, from Apar Infotech Corporation to Shashank Samant.                                                                           |
| +§10.37       |   | Addendum to Employment  Agreement, effective as of January 1, 2006, between Ness USA, Inc.  and Shashank Samant.                                                     |
| **10.38            |   | Form of  Indemnification Agreement by and between the Registrant and its officers and  directors.                                                                         |
| **10.39            |   | Stock Purchase  Agreement, dated as of August 30, 2002, among the shareholders of APP  Group CEE B.V. listed therein and the Registrant.                                  |
| **10.40            |   | Merger Agreement, dated  as of May 12, 2003, among the Registrant, Ness Acquisition Corp., Apar  Holding Corp. and the shareholders of Apar Holding Corp. listed therein. |
| 14                 |   | Code of Business Conduct  and Ethics.                                                                                                                                          |
| 21                 |   | Subsidiaries of the  Registrant.                                                                                                                                               |
| 23.1               |   | Consent of Kost Forer  Gabbay & Kasierer, a member of Ernst & Young Global.                                                                                  |
| **24               |   | Powers of Attorney.                                                                                                                                                            |
| 31.1               |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                     |
| 31.2               |   | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                     |
| 32.1               |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                 |
| 32.2               |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                 |

----

*                    Incorporatedby reference to the Registrant’s Registration Statement on Form S-4(Commission File No. 333-120389), as amended, initially filed withthe Commission on November 12, 2004.

**             Incorporatedby reference to the Registrant’s Registration Statement on Form S-1(Commission File No. 333-115260), as amended, initially filed withthe Commission on May 7, 2004.

¶                    Incorporatedby reference to the Registrant’s Quarterly Report on Form 10-Q forthe quarterly period ended March 31, 2005, filed with the commission on May 16,2005.

¶¶             Incorporatedby reference to the Registrant’s Quarterly Report on Form 10-Q forthe quarterly period ended June 30, 2005, filed with the Commission on August 12,2005.

§                    Incorporatedby reference to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2005, filed with the Commission on March 15,2006.

§§             Incorporatedby reference to the Registrant’s Quarterly Report on Form 10-Q forthe quarterly period ended March 31, 2006, filed with the Commission on August 10,2006.

+                Indicatesthose contracts that are management contracts or compensation plans orarrangements.

62

----

**SIGNATURES**

Pursuantto the requirements of section 13 or 15(d) of the Securities Exchange Actof 1934, as amended, the registrant has duly caused this report to be signed onits behalf by the undersigned thereunto duly authorized, in the City of TelAviv, State of Israel on the 14th day of March, 2007.

|     | NESS TECHNOLOGIES, INC. |
|----------|-------------------------|
|     | (Registrant)            |
|     | By:                     | /s/ RAVIV ZOLLER |
|     |                    | Raviv Zoller |
| * * | * *                | *President  and Chief Executive Officer* |

 

**POWEROF ATTORNEY**

KNOW ALL MEN BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Raviv Zoller and Ytzhak Edelman as his true and lawfulattorney-in-fact, each acting alone, with full power of substitution andresubstitution for him and in his name, place and stead, in any and allcapacities, to sign any and all amendments, including post-effective amendmentsto this report, with exhibits thereto, and other documents in connectiontherewith, with the Securities and Exchange Commission, hereby ratifying andconfirming all that said attorneys-in-fact or their substitutes, each actingalong, may lawfully do or cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Act of 1933, this Registration Statementhas been signed below by the following persons in the capacities and on thedates indicated.
|                               | **Signature** | ** **                                      | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------------|---------------|-------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/ AHARON  FOGEL             |          | Chairman of the Board                           |       | March 14, 2007 |
| Aharon  Fogel                 |          |                                            |       |                |
| /s/ RAVIV  ZOLLER             |          | President, Chief Executive Officer and Director |       | March 14, 2007 |
| Raviv  Zoller                 |          | (principal  executive officer)                  |       |                |
| /s/ YTZHAK  EDELMAN           |          | Chief Financial Officer and deputy to the CEO   |       | March 14, 2007 |
| Ytzhak  Edelman               |          | (principal  financial and accounting officer)   |       |                |
| /s/ ISSACHAR  GERLITZ         |          | President and CEO Elect, Director               |       | March 14, 2007 |
| Issachar  Gerlitz             |          |                                            |       |                |
| /s/ HENRY  KRESSEL            |          | Director                                        |       | March 14, 2007 |
| Dr. Henry  Kressel       |          |                                            |       |                |
| /s/ MORRIS  WOLFSON           |          | Director                                        |       | March 14, 2007 |
| Morris  Wolfson               |          |                                            |       |                |
| /s/ SATYAM C.  CHERUKURI      |          | Director                                        |       | March 14, 2007 |
| Dr. Satyam  C. Cherukuri |          |                                            |       |                |
| /s/ DAN S.  SUESSKIND         |          | Director                                        |       | March 14, 2007 |
| Dan  S. Suesskind             |          |                                            |       |                |
| /s/ KENNETH A.  PICKAR        |          | Director                                        |       | March 14, 2007 |
| Dr. Kenneth  A. Pickar   |          |                                            |       |                |

 

63

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**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

|                                                                  | ** ** | ** ** | **Page** | ** ** |
|------------------------------------------------------------------|------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm         |       | F-2        |
| Consolidated  Balance Sheets                                     |       | F-3        |
| Consolidated Statements of Income                                |       | F-5        |
| Consolidated Statements of Changes in Stockholders’  Equity |       | F-6        |
| Consolidated Statements of Cash Flows                            |       | F-9        |
| Notes to Consolidated Financial Statements                       |       | F-12       |

 

F-1

----

****

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To the Stockholdersof**

**NESS TECHNOLOGIES,INC.**

We have audited the accompanying consolidated balance sheetsof Ness Technologies, Inc. (the “Company”) and its subsidiaries as of December 31,2005 and 2006, and the related consolidated statements of income, stockholders’equity and cash flows for each of the three years in the period ended December 31,2006. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of the Company and its subsidiaries as of December 31,2005 and 2006, and the consolidated results of their operations and their cashflows for each of the three years in the period ended December 31, 2006,in conformity with U.S. generally accepted accounting principles.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting at December 31, 2006, based oncriteria established in Internal Control—Integrated framework issued by theCommittee of Sponsoring Organization of the Treadway Commission and our reportdated March 14, 2007 expresses an unqualified opinion thereon.
| Tel-Aviv, Israel    |   | KOST FORER GABBAY & KASIERER     |
|---------------------|--------|-------------------------------------------|
| March 14, 2007 |   | A Member of Ernst & Young Global |

 

F-2

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED BALANCE SHEETSU.S. dollars in thousands**
|                                                                                                                                    | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                         | ** ** | **2005**              | ** ** | **2006** | ** ** |
| ASSETS                                                                                                                             |       |                  |       |   |   |
| CURRENT ASSETS:                                                                                                                    |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                          |       | $                     | 33,579     |   | $ | 46,675 |   |
| Short-term bank deposits                                                                                                           |       | 39,561                |       | 2,027 |   |
| Marketable securities                                                                                                              |       | 2,651                 |       | — |   |
| Trade receivables (net of allowance for doubtful  accounts of $2,320 and $2,812 at December 31, 2005 and 2006,  respectively) |       | 99,097                |       | 134,999 |   |
| Unbilled receivables                                                                                                               |       | 21,500                |       | 32,865 |   |
| Other accounts receivable and prepaid expenses                                                                                     |       | 13,417                |       | 14,033 |   |
| Inventories and work in progress                                                                                                   |       | 2,506                 |       | 177 |   |
| Total current  assets                                                                                                              |       | 212,311               |       | 230,776 |   |
| LONG-TERM ASSETS:                                                                                                                  |       |                  |       |   |   |
| Long-term prepaid expenses and other assets                                                                                        |       | 4,848                 |       | 6,480 |   |
| Investments at cost                                                                                                                |       | 381                   |       | 1,193 |   |
| Unbilled receivables                                                                                                               |       | 7,045                 |       | 14,985 |   |
| Deferred income taxes, net                                                                                                         |       | 5,271                 |       | 7,529 |   |
| Severance pay fund                                                                                                                 |       | 35,845                |       | 42,321 |   |
| Total long-term  assets                                                                                                            |       | 53,390                |       | 72,508 |   |
| PROPERTY AND EQUIPMENT, NET                                                                                                        |       | 21,308                |       | 28,279 |   |
| INTANGIBLE ASSETS, NET                                                                                                             |       | 7,938                 |       | 8,336 |   |
| GOODWILL                                                                                                                           |       | 159,421               |       | 201,718 |   |
| Total assets                                                                                                                       |       | $                     | 454,368    |   | $ | 541,617 |   |

 

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

F-3

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED BALANCE SHEETSU.S. dollars in thousands (except share and par value data)**
|                                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2005**              | ** ** | **2006** | ** ** |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                 |       |                  |       |   |   |
| CURRENT LIABILITIES:                                                                                                                                                       |       |                  |       |   |   |
| Short-term bank credit                                                                                                                                                     |       | $                     | 21,011     |   | $ | 4,869 |   |
| Current maturities of long-term debt                                                                                                                                       |       | 6,862                 |       | 4,420 |   |
| Trade payables                                                                                                                                                             |       | 35,259                |       | 42,839 |   |
| Advances from customers and deferred revenues                                                                                                                              |       | 14,651                |       | 30,364 |   |
| Other accounts payable and accrued expenses                                                                                                                                |       | 75,810                |       | 76,128 |   |
| Total current  liabilities                                                                                                                                                 |       | 153,593               |       | 158,620 |   |
| LONG-TERM  LIABILITIES:                                                                                                                                                    |       |                  |       |   |   |
| Long-term debt and other liabilities, net of current  maturities                                                                                                           |       | 6,294                 |       | 3,311 |   |
| Excess of losses over investment in affiliate                                                                                                                              |       | 257                   |       | — |   |
| Accrued severance pay                                                                                                                                                      |       | 39,722                |       | 47,031 |   |
| Total long-term  liabilities                                                                                                                                               |       | 46,273                |       | 50,342 |   |
| COMMITMENTS AND  CONTINGENT LIABILITIES                                                                                                                                    |       |                  |       |   |   |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                |       |                  |       |   |   |
| Common stock of $0.01 par value—                                                                                                                                      |       |                  |       |   |   |
| Authorized: 76,500,000  shares at December 31, 2005 and 2006;  Issued and outstanding: 34,771,837 at December 31, 2005 and 38,638,682  at December 31, 2006 |       | 348                   |       | 387 |   |
| Additional paid-in capital                                                                                                                                                 |       | 282,642               |       | 317,799 |   |
| Accumulated other comprehensive loss                                                                                                                                       |       | (13,559               | )          | (415 | ) |
| Retained earnings (accumulated deficit)                                                                                                                                    |       | (14,929               | )          | 14,884 |   |
| Total stockholders’  equity                                                                                                                                           |       | 254,502               |       | 332,655 |   |
| Total liabilities and  stockholders’ equity                                                                                                                           |       | $                     | 454,368    |   | $ | 541,617 |   |

 

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

F-4

----

** **

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEU.S. dollars in thousands (except per share data)**
|                                                                                                           | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                                                  |       | $                                          | 304,525    |   | $ | 385,436 |   | $ | 474,318 |   |
| Cost of revenues                                                                                          |       | 211,725                                    |       | 275,233 |   | 342,104 |   |
| Gross profit                                                                                              |       | 92,800                                     |       | 110,203 |   | 132,214 |   |
| Operating  expenses:                                                                                      |       |                                       |       |   |   |   |   |
| Selling and marketing                                                                                     |       | 25,706                                     |       | 29,033 |   | 35,315 |   |
| General and administrative                                                                                |       | 46,042                                     |       | 54,730 |   | 63,288 |   |
| Total operating expenses                                                                                  |       | 71,748                                     |       | 83,763 |   | 98,603 |   |
| Operating income                                                                                          |       | 21,052                                     |       | 26,440 |   | 33,611 |   |
| Financial expenses, net                                                                                   |       | (3,461                                     | )          | (1,521 | ) | (1,280 | ) |
| Gain on sale of cost investment                                                                           |       | —                                     |       | — |   | 5,001 |   |
| Other income (expenses), net                                                                              |       | (91                                        | )          | (243 | ) | 348 |   |
| Income before taxes on income                                                                             |       | 17,500                                     |       | 24,676 |   | 37,680 |   |
| Taxes on income                                                                                           |       | 2,320                                      |       | 3,518 |   | 8,035 |   |
| Equity in losses and gain from disposal of an  affiliate                                                  |       | (647                                       | )          | (65 | ) | 168 |   |
| Minority interests in losses (earnings) of a  subsidiary                                                  |       | (156                                       | )          | 101 |   | — |   |
| Income before extraordinary item                                                                          |       | 14,377                                     |       | 21,194 |   | 29,813 |   |
| Extraordinary income, net of taxes                                                                        |       | —                                     |       | 495 |   | — |   |
| Net income                                                                                                |       | $                                          | 14,377     |   | $ | 21,689 |   | $ | 29,813 |   |
| Allocation of undistributed earnings on Class B  Convertible Preferred stock     |       | $                                          | (1,356     | ) | $ | — |   | $ | — |   |
| Net income after allocation of undistributed  earnings                                                    |       | $                                          | 13,021     |   | $ | 21,689 |   | $ | 29,813 |   |
| Earnings per share:                                                                                       |       |                                       |       |   |   |   |   |
| Basic earnings  per share                                                                                 |       | $                                          | 0.58       |   | $ | 0.63 |   | $ | 0.83 |   |
| Basic earnings  per share from extraordinary income                                                       |       | $                                          | —     |   | $ | 0.01 |   | $ | — |   |
| Basic earnings  per share excluding extraordinary income                                                  |       | $                                          | 0.58       |   | $ | 0.62 |   | $ | 0.83 |   |
| Diluted earnings  per share                                                                               |       | $                                          | 0.53       |   | $ | 0.61 |   | $ | 0.82 |   |
| Diluted earnings  per share from extraordinary income                                                     |       | $                                          | —     |   | $ | 0.02 |   | $ | — |   |
| Diluted earnings per  share excluding extraordinary income                                                |       | $                                          | 0.53       |   | $ | 0.59 |   | $ | 0.82 |   |

 

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

F-5

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYU.S. dollars in thousands (except sharedata)**

| ** ** | ** ** | **Common stock** | ** ** | **Class B  Convertible  Preferred stock** | ** **             | **Class C  Convertible  Preferred stock** | ** **             | **Additional  paid-in** | ** **             | **Deferred  stock** | ** **             | **Accumulated  other  comprehensive** | ** **             | **Accumulated** | ** **             | **Total  comprehensive** | ** **             | **Total  Stockholders’** | ** **             |
|------------|------------|------------------|------------|------------------------------------------------|------------------------|------------------------------------------------|------------------------|-------------------------|------------------------|---------------------|------------------------|---------------------------------------|------------------------|-----------------|------------------------|--------------------------|------------------------|-------------------------------|------------------------|
| ** ** | ** ** | **Stock**        | ** ** | **Amount**                                     | **   ** | **Stock**                                      | **   ** | **Amount**              | **   ** | **Stock**           | **   ** | **Amount**                            | **   ** | **capital**     | **   ** | **compensation**         | **   ** | **Income (loss)**        | **   ** | **deficit** | ** ** | **Income (loss)** | ** ** | **Equity** | ** ** |
|            |            |                  |            |                                                |                        |                                                |                        |                         |                        |                     |                        |                                       |                        |                 |                        |                          |                        |                               |                        |  |  |  |  |  |  |

| Balance as of December 31, 2003                                          |     | 16,460,138 |     |   | $      | 164                |     |     | 4,676,986          |     |   | $                  | 47                 |     |     | 3,352,654 |     |               | $                  | 34     |     |     |   | $      | 171,786 |   |     |     | $      | (365   | )      |     |   | $      | (4,111 | )      |     |   | $      | (41,200 | )      |     |   |   |   |     |   | $ | 126,355 |   |     |
|-------------------------------------------------------------------------------|--------------------|------------|--------------------|--------|--------|--------------------|--------------------|--------------------|--------------------|--------------------|--------|--------------------|--------------------|--------------------|--------------------|-----------|--------------------|--------------------|--------------------|--------|--------------------|--------------------|--------|--------|---------|--------|--------------------|--------------------|--------|--------|--------|--------------------|--------|--------|--------|--------|--------------------|--------|--------|---------|--------|--------------------|--------|--------|--------|--------------------|--------|---|---------|--------|--------------------|
| Initial Public Offering **)                                              |               | 16,114,115 |     |   | 162    |     |     | (4,676,986         | )                  |               | (47    | )                  |     | (3,352,654         | )                  |      | (34                | )                  |     |   | 99,061             |               |   |   | —  |   |               |               | — |   |   |               | (9,795 | )      |   |   |               |   |   |    | 89,347 |               |   |
| Exercise of warrants granted to investors                                     |               | 175,078    |     |   | 2      |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | —             |               |   |   | —  |   |               |               | — |   |   |               | — |   |   |   |               |   |   |    | 2      |               |   |
| Exercise of options granted to employees                                      |               | 23,247     |     |   | — | *)                 |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | 41                 |               |   |   | —  |   |               |               | — |   |   |               | — |   |   |   |               |   |   |    | 41     |               |   |
| Amortization of deferred stock compensation related  to Ness GSG acquisition  |               | —     |     |   | — |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | —             |               |   |   | 213     |   |               |               | — |   |   |               | — |   |   |   |               |   |   |    | 213    |               |   |
| Stock based compensation related to warrants granted  to banks                |               | —     |     |   | — |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | 45                 |               |   |   | —  |   |               |               | — |   |   |               | — |   |   |   |               |   |   |    | 45     |               |   |
| Stock based compensation related to options extended  to terminated employees |               | —     |     |   | — |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | 34                 |               |   |   | —  |   |               |               | — |   |   |               | — |   |   |   |               |   |   |    | 34     |               |   |
| Comprehensive  income:                                                        |               |       |     |   |   |     |     |               |     |               |   |     |     |               |     |      |               |     |     |   |               |               |   |   |    |   |               |               |   |   |   |               |   |   |   |   |               |   |   |    | — |               |   |
| Foreign currency translation adjustments                                      |               | —     |     |   | — |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | —             |               |   |   | —  |   |               |               | 2,117  |   |   |               | — |   |   |   | $                  | 2,117  |   |    |   | 2,117              |   |   |
| Unrealized losses on available-for-sale marketable  securities, net of taxes  |               | —     |     |   | — |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | —             |               |   |   | —  |   |               |               | (51    | )      |   |               | — |   |   |   | (51                | )      |   |    | (51    | )                  |   |
| Net income                                                                    |               | —     |     |   | — |     |     | —             |     |               | — |     |     | —             |     |      | —             |     |     |   | —             |               |   |   | —  |   |               |               | — |   |   |               | 14,377 |   |   |   | 14,377             |   |   |    | 14,377 |               |   |
| Total comprehensive income                                                    |               |       |     |   |   |     |     |               |     |               |   |     |     |               |     |      |               |     |     |   |               |               |   |   |    |   |               |               |   |   |   |               |   |   |   |   | $                  | 16,443 |   |    |   |               |   |   |
| Balance as of  December 31, 2004                                         |               | 32,772,578 |     |   | $      | 328                |     |     | —             |     |   | $                  | —             |     |     | —    |     |               | $                  | — |     |     |   | $      | 270,967 |   |               |               | $      | (152   | )      |               |   | $      | (2,045 | )      |               |   | $      | (36,618 | )      |               |   |   |   |               |   | $ | 232,480 |   |               |

----

*)                    Represents an amount lower than $1.

**)                Issuance of Common stock, conversion of Class Band Class C Convertible Preferred stock, conversion of undistributed earningsresulting from the cumulative accumulated dividend on Class B Preferredstock and issuance of additional Common stock as a result of an anti-dilutionprovision on Class C Preferred stock, net of issuance expenses in theamount of $10,296, in respect of the Company’s initial public offering.

The accompanyingnotes are an integral part of the consolidated financial statements.

F-6

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYU.S. dollars in thousands (except sharedata)**
|                                                                                                        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional ** | ** ** | **Deferred**      | ** ** | **Accumulated  other** | ** ** | ** **        | ** ** | **Total**              | ** ** | **Total**                | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------------|------------|-------------------|------------|------------------------|------------|-------------------|------------|------------------------|------------|--------------------------|------------|
| ** **                                                                                             | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **stock**            | ** ** | **comprehensive** | ** ** | **Accumulated**        | ** ** | **comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                             | ** ** | **Stock**             | ** ** | **Amount**  | ** ** | **capital**          | ** ** | **compensation**  | ** ** | **Income (loss)** | ** ** | **deficit**       | ** ** | **Income (loss)** | ** ** | **Equity**               | ** ** |
| Balance as of December 31, 2004                                                                   |       | 32,772,578            |       |        | $          | 328                  |       |              |       | $                      | 270,967    |              |       |                   | $          | (152                     | )          |   |   | $ | (2,045 | ) |   |   | $ | (36,618 | ) |   |   |   |   |   |   | $ | 232,480 |   |   |
| Exercise of warrants granted to banks                                                                  |       | 8,561                 |       |        | —     | *)                   |       |              | —     |                   |       |              | —     |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | — | *) |   |
| Exercise of warrants granted to  investors                                                             |       | 326,871               |       |        | 3          |                 |       |              | 95         |                   |       |              | —     |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | 98 |   |   |
| Exercise of options granted to employees                                                               |       | 1,314,206             |       |        | 13         |                 |       |              | 9,704      |                   |       |              | —     |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | 9,717 |   |   |
| Issuance of Common stock related to the  acquisition of 14% of Ness USA                                |       | 349,621               |       |        | 4          |                 |       |              | 3,414      |                   |       |              | —     |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | 3,418 |   |   |
| Amortization of deferred stock compensation related  to Ness GSG acquisition                           |       | —                |       |        | —     |                 |       |              | —     |                   |       |              | 125        |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | 125 |   |   |
| Stock based compensation related to  warrants granted to banks                                         |       | —                |       |        | —     |                 |       |              | 11         |                   |       |              | —     |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | 11 |   |   |
| Stock based compensation related to options granted  to employees                                      |       | —                |       |        | —     |                 |       |              | (1,522     | )                      |       |              | —     |                   |       |                     | —     |   |   |   | — |   |   |   |   |   |   |   | (1,522 | ) |   |
| Comprehensive income:                                                                                  |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation adjustments                                                               |       | —                |       |        | —     |                 |       |              | —     |                   |       |              | —     |                   |       |                     | (11,602    | ) |   |   | — |   |   |   | $ | (11,602 | ) |   |   | (11,602 | ) |   |
| Unrealized losses on available-for-sale  marketable securities, net of tax                             |       | —                |       |        | —     |                 |       |              | —     |                   |       |              | —     |                   |       |                     | (42        | ) |   |   | — |   |   |   | (42 | ) |   |   | (42 | ) |   |
| Other-than-temporary decrease in fair value of  available-for-sale marketable securities, net of taxes |       | —                |       |        | —     |                 |       |              | —     |                   |       |              | —     |                   |       |                     | 130        |   |   |   | — |   |   |   | 130 |   |   |   | 130 |   |   |
| Net income                                                                                             |       | —                |       |        | —     |                 |       |              | —     |                   |       |              | —     |                   |       |                     | —     |   |   |   | 21,689 |   |   |   | 21,689 |   |   |   | 21,689 |   |   |
| Total comprehensive income                                                                             |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     |       |   |   |   |   |   |   |   | $ | 10,175 |   |   |   |   |   |   |
|                                                                                                   |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance as of December 31, 2005                                                                   |       | 34,771,837            |       |        | $          | 348                  |       |              |       | $                      | 282,669    |              |       |                   | $          | (27                      | )          |   |   | $ | (13,559 | ) |   |   | $ | (14,929 | ) |   |   |   |   |   |   | $ | 254,502 |   |   |
|                                                                                                        |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized losses on available-for-sale marketable  securities, net of tax                             |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     | $          | (42 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accumulated foreign currency translation  adjustment as of December 31, 2005                      |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     | (13,517    | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accumulated other  comprehensive loss as of December 31, 2005                                     |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |                     | $          | (13,559 | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                   |       |                  |       |        |       |                 |       |              |       |                   |       |              |       |                   |       |      |       |      |   |   |   |   |   |   |   |   |   |   |   |   |   |

----

*)                   Represents an amount lower than $1.

F-7

----

**NESS TECHNOLOGIES,INC. AND ITS SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**U.S.dollars in thousands (except share data)**

|                                                                                   | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** **  | **Accumulated**  | ** ** | **Retained**      | ** ** | ** **             | ** **        | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|-------------------|-------------|------------------|------------|-------------------|------------|------------------------|-------------------|------------|------------|
| ** **                                                                        | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred** | ** ** | **other**         | ** **  | **Earnings**     | ** ** | **Total**         | ** ** | **Total**              | ** **        |
| ** **                                                                        | ** ** | **Common stock** | ** ** | **paid-in**    | ** ** | **stock**    | ** ** | **comprehensive** | ** **  | **(Accumulated** | ** ** | **comprehensive** | ** ** | **Stockholders’** | ** **        |
|                                                                              |       | **Stock**             |       |           | **Amount** |         |       |              | **capital** |             |       | **compensation**  |       |                   | **Income (loss)** |       |       |   | **deficit)** |   |   |   | **Income (loss)** |   |   |   | **Equity** |   |   |
| Balance as of December 31, 2005                                              |       | 34,771,837            |       |           | $          | 348          |       |              |        | $                | 282,669    |              |       | $                      | (27               | )          |       | $ | (13,559 | ) |   |   | $ | (14,929 | ) |   |   |   |   |   |   | $ | 254,502 |   |   |
| Reclassification of deferred stock compensation to  additional-paid-in capital    |       | —                |       |           | —     |         |       |              | (27         | )                |       | 27                |       |                   | —            |       |       |   | — |   |   |   |   |   |   |   | — |   |   |
| Exercise of options granted to employees                                          |       | 3,866,845             |       |           | 39         |         |       |              | 30,363      |             |       | —            |       |                   | —            |       |       |   | — |   |   |   |   |   |   |   | 30,402 |   |   |
| Tax benefits related to exercise of stock options                                 |       | —                |       |           | —     |         |       |              | 2,343       |             |       | —            |       |                   | —            |       |       |   | — |   |   |   |   |   |   |   | 2,343 |   |   |
| Stock based compensation related to  options granted to employees                 |       | —                |       |           | —     |         |       |              | 583         |             |       | —            |       |                   | —            |       |       |   | — |   |   |   |   |   |   |   | 583 |   |   |
| Redeemable options                                                                |       | —                |       |           | —     |         |       |              | 1,868       |             |       | —            |       |                   | —            |       |       |   | — |   |   |   |   |   |   |   | 1,868 |   |   |
| Comprehensive income:                                                             |       |                  |       |           |       |         |       |              |        |             |       |              |       |                   |              |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation adjustments                                          |       | —                |       |           | —     |         |       |              | —      |             |       | —            |       |                   | 13,103            |       |       |   | — |   |   |   | $ | 13,103 |   |   |   | 13,103 |   |   |
| Realized losses on available-for-sale  marketable securities, net of taxes        |       | —                |       |           | —     |         |       |              | —      |             |       | —            |       |                   | 41                |       |       |   | — |   |   |   | 41 |   |   |   | 41 |   |   |
| Net income                                                                        |       | —                |       |           | —     |         |       |              | —      |             |       | —            |       |                   | —            |       |       |   | 29,813 |   |   |   | 29,813 |   |   |   | 29,813 |   |   |
| Total comprehensive income                                                        |       |                  |       |           |       |         |       |              |        |             |       |              |       |                   |              |       |       |   |   |   |   |   | $ | 42,957 |   |   |   |   |   |   |
| Balance as of December 31, 2006                                              |       | 38,638,682            |       |           | $          | 387          |       |              |        | $                | 317,799    |              |       | $                      | —            |       |       | $ | (415 | ) |   |   | $ | 14,884 |   |   |   |   |   |   |   | $ | 332,655 |   |   |
| Unrealized losses on available-for-sale  marketable securities, net of tax        |       |                  |       |           |       |         |       |              |        |             |       |              |       |                   | $                 | (1         | )          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accumulated foreign currency  translation adjustment as of December 31, 2006 |       |                  |       |           |       |         |       |              |        |             |       |              |       |                   | (414              | )          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Accumulated other comprehensive loss as  of December 31, 2006                |       |                  |       |           |       |         |       |              |        |             |       |              |       |                   | $                 | (415       | )          |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

F-8

----

**NESS TECHNOLOGIES,INC. AND ITS SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**U.S.dollars in thousands**
|                                                                                               | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Cash flows from operating activities:                                                         |       |                                       |       |   |   |   |   |
| Net income                                                                                    |       | $                                          | 14,377     |   | $ | 21,689 |   | $ | 29,813 |   |
| Adjustments required to reconcile net income to net  cash provided by operating activities:   |       |                                       |       |   |   |   |   |
| Stock-based  compensation-related expenses                                                    |       | 292                                        |       | 2,111 |   | 583 |   |
| Deferral of costs                                                                             |       | (167                                       | )          | (433 | ) | — |   |
| Equity in losses and gain  from disposal of an affiliate                                      |       | 647                                        |       | 65 |   | (168 | ) |
| Minority interests in  earnings (losses) of a subsidiary                                      |       | 156                                        |       | (101 | ) | — |   |
| Currency fluctuation of  long-term debt                                                       |       | 131                                        |       | 2,772 |   | 116 |   |
| Depreciation and  amortization                                                                |       | 5,117                                      |       | 7,767 |   | 12,161 |   |
| Deferred income taxes,  net                                                                   |       | (610                                       | )          | (3,016 | ) | (730 | ) |
| Loss on sale of property  and equipment                                                       |       | 108                                        |       | 556 |   | 198 |   |
| Excess tax benefits  related to exercise of options                                           |       | —                                     |       | — |   | (2,343 | ) |
| Gain on sale of cost  investment(c)                                                           |       | —                                     |       | — |   | (5,001 | ) |
| Realized gain on sale of  marketable securities                                               |       | (9                                         | )          | (30 | ) | (128 | ) |
| Other than temporary  decrease in fair value of available-for-sale marketable securities      |       | —                                     |       | 186 |   | — |   |
| Accrued interest on  short-term bank deposits                                                 |       | —                                     |       | (532 | ) | — |   |
| Increase in trade  receivables, net                                                           |       | (12,298                                    | )          | (26,236 | ) | (20,960 | ) |
| Increase in unbilled  receivables                                                             |       | (5,115                                     | )          | (9,738 | ) | (14,709 | ) |
| Decrease (increase) in  other accounts receivable and prepaid expenses                        |       | 1,103                                      |       | (544 | ) | 1,853 |   |
| Decrease (increase) in  inventories and work in progress                                      |       | 219                                        |       | (1,145 | ) | 2,597 |   |
| Increase in long-term  prepaid expenses                                                       |       | (1,498                                     | )          | (1,423 | ) | (419 | ) |
| Increase (decrease) in  trade payables                                                        |       | 848                                        |       | 2,986 |   | (679 | ) |
| Increase in advances from  customers and deferred revenues                                    |       | 3,534                                      |       | 6,220 |   | 21,417 |   |
| Increase in other  long-term liability                                                        |       | —                                     |       | — |   | 749 |   |
| Increase(decrease) in  other accounts payable and accrued expenses                            |       | 7,677                                      |       | 4,676 |   | (20,560 | ) |
| Increase in accrued  severance pay, net                                                       |       | 889                                        |       | 971 |   | 455 |   |
| Net cash provided by  operating activities                                                    |       | 15,401                                     |       | 6,801 |   | 4,245 |   |
| Cash flows from investing activities:                                                         |       |                                       |       |   |   |   |   |
| Net cash paid for acquisitions  of consolidated subsidiaries(a)                               |       | —                                     |       | (10,206 | ) | (23,401 | ) |
| Cash in a subsidiary at  the time it ceased being consolidated                                |       | (168                                       | )          | — |   | — |   |
| Proceeds from sale of  cost investment(c)                                                     |       | —                                     |       | — |   | 3,135 |   |
| Additional payments in  connection with acquisitions in prior periods                         |       | —                                     |       | — |   | (5,162 | ) |
| Acquisition of minority  interest in a subsidiary(b)                                          |       | —                                     |       | (114 | ) | — |   |
| Proceeds from maturity of  short-term bank deposits                                           |       | 3,176                                      |       | — |   | 38,368 |   |
| Investment in short-term  bank deposits                                                       |       | —                                     |       | (39,107 | ) | — |   |
| Proceeds from sale of marketable  securities                                                  |       | —                                     |       | 5,543 |   | 2,779 |   |
| Investment in affiliate  at cost                                                              |       | —                                     |       | — |   | (727 | ) |
| Investment in  available-for-sale marketable securities                                       |       | —                                     |       | (7,864 | ) | — |   |
| Proceeds from sale of  property and equipment                                                 |       | 544                                        |       | 601 |   | 605 |   |
| Purchase of property and  equipment and capitalization of software developed for internal use |       | (9,881                                     | )          | (7,921 | ) | (13,224 | ) |
| Capitalization of  software development costs                                                 |       | (2,545                                     | )          | (1,526 | ) | (233 | ) |
| Net cash provided by (used in) investing activities                                           |       | (8,874                                     | )          | (60,594 | ) | 2,140 |   |
|                                                                                               |            |                                            |            |  |  |  |  |  |  |  |

 

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

F-9

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands**
|                                                                                                                                                                                         | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Cash flows from financing activities:                                                                                                                                                   |       |                                       |       |   |   |   |   |
| Issuance of Common stock in respect of the Company’s  Initial Public Offering                                                                                                      |       | $                                          | 99,643     |   | $ | — |   | $ | — |   |
| Issuance costs in respect of the Company’s Initial  Public Offering                                                                                                                |       | (10,296                                    | )          | — |   | — |   |
| Exercise of options and warrants                                                                                                                                                        |       | 43                                         |       | 9,634 |   | 30,234 |   |
| Excess tax benefits related to exercise of options                                                                                                                                      |       | —                                     |       | — |   | 2,343 |   |
| Short-term bank credit, net                                                                                                                                                             |       | (7,121                                     | )          | 19,312 |   | (19,372 | ) |
| Proceeds from long-term debt                                                                                                                                                            |       | 33,856                                     |       | — |   | — |   |
| Principal payments of long-term debt                                                                                                                                                    |       | (18,688                                    | )          | (38,806 | ) | (8,122 | ) |
| Pre-payment of long-term debt in respect of the  Company’s Initial Public Offering                                                                                                 |       | (45,854                                    | )          | — |   | — |   |
| Net cash provided by (used in) financing activities                                                                                                                                     |       | 51,583                                     |       | (9,860 | ) | 5,083 |   |
| Effect of exchange rate changes on cash and cash  equivalents                                                                                                                           |       | 115                                        |       | (6,997 | ) | 1,628 |   |
| Increase (decrease) in cash and cash equivalents                                                                                                                                        |       | 58,225                                     |       | (70,650 | ) | 13,096 |   |
| Cash and cash equivalents at the beginning of the  year                                                                                                                                 |       | 46,004                                     |       | 104,229 |   | 33,579 |   |
| Cash and cash equivalents at the end of the year                                                                                                                                        |       | $                                          | 104,229    |   | $ | 33,579 |   | $ | 46,675 |   |
| *Supplemental disclosures of  cash flows information:*                                                                                                                                  |       |                                       |       |   |   |   |   |
| Cash paid during the year for:                                                                                                                                                          |       |                                       |       |   |   |   |   |
| Interest                                                                                                                                                                                |       | $                                          | 3,905      |   | $ | 895 |   | $ | 2,222 |   |
| Taxes                                                                                                                                                                                   |       | $                                          | 862        |   | $ | 1,361 |   | $ | 14,965 |   |
| *(a)   **In conjunction with the  acquisitions, the fair values of   the assets acquired and liabilities assumed at the  dates of related acquisitions were as follows:* |       |                                       |       |   |   |   |   |
| Capital deficiency, net (excluding cash and cash  equivalents)                                                                                                                          |       | $                                          | —     |   | $ | (2,360 | ) | $ | (2,841 | ) |
| Property and equipment                                                                                                                                                                  |       | —                                     |       | 2,928 |   | 1,373 |   |
| Other assets                                                                                                                                                                            |       | —                                     |       | 669 |   | 519 |   |
| Long-term loans                                                                                                                                                                         |       | —                                     |       | (1,726 | ) | (214 | ) |
| Customer relations and backlog                                                                                                                                                          |       | —                                     |       | 2,067 |   | 3,525 |   |
| Goodwill and workforce                                                                                                                                                                  |       | —                                     |       | 13,860 |   | 30,655 |   |
| Accrual for additional consideration paid or to be  paid subsequent to the balance sheet date                                                                            |       | —                                     |       | (5,162 | ) | (9,295 | ) |
| Deferred tax liability                                                                                                                                                                  |       | —                                     |       | — |   | (321 | ) |
| Accrued severance pay, net                                                                                                                                                              |       | —                                     |       | (70 | ) | — |   |
| Net cash used in  acquisitions of consolidated subsidiaries                                                                                                                             |       | $                                          | —     |   | $ | 10,206 |   | $ | 23,401 |   |

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

F-10

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands**

 
| *(b)    In conjunction with the acquisition of the minority interest in  a subsidiary in 2005, the fair values of the assets acquired and liabilities  assumed at the date of acquisition were as follows:* |   |   |   |   |   |   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Minority Interest                                                                                                                                                                                                          |   | $      | — |   | $      | 197    |   | $ | — |   |
| Goodwill                                                                                                                                                                                                                   |   | — |   | 3,196  |   | — |   |
| Customer-related  intangible assets                                                                                                                                                                                        |   | — |   | 139    |   | — |   |
|                                                                                                                                                                                                                       |   | — |   | 3,532  |   | — |   |
| Issuance of shares                                                                                                                                                                                                         |   | — |   | (3,418 | )      | — |   |
| Net cash used in  acquisition of minority interest                                                                                                                                                                         |   | — |   | $      | 114    |   | $      | — |   |
| *(c)    Non-cash activity:*                                                                                                                                                                                 |   |   |   |   |   |   |   |
| Reclassification to  equity of redeemable options accrual upon partial exercise of options                                                                                                                                 |   | $      | — |   | $      | — |   | $ | 1,868 |   |
| Accrual for additional  consideration of acquisitions                                                                                                                                                                      |   | $      | — |   | $      | 5,162  |   | $ | 11,271 |   |
| Receivables from sale of  investment, net of related expenses                                                                                                                                                              |   | $      | — |   | $      | — |   | $ | 1,866 |   |

 

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

F-11

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL**

a.      NessTechnologies, Inc. (“the Company”) was incorporated under the laws of theState of Delaware in March 1999, and operates through its subsidiaries(together “the Group”) in Israel, the United States, Europe and Asia.

The Group is a global provider of informationtechnology (“IT”) services and solutions designed to help clients improve theircompetitiveness and effectiveness. The Group’s portfolio of solutions andservices includes system integration and application development, outsourcing,software and consulting, and quality assurance and training. Offshore servicesand development are a significant component of each of these categories. TheGroup primarily serves the following vertical markets: defense and government,financial services, life sciences and healthcare, telecommunications andutilities, and independent software vendors.

On September 29,2004, the Securities and Exchange Commission declared effective the Company’sRegistration Statement in respect of its Initial Public Offering (“IPO”). Theclosing of the Company’s IPO occurred on October 4, 2004 (see also Note14a).

b.     Acquisitionsof subsidiaries:

1.      NessU.S.A. Inc. (“Ness U.S.A.”):

On November 12, 2004, the Company filed a Form S-4Registration Statement in respect of an exchange offer for the remaining sharesof Ness U.S.A which it did not already own. The offer commenced on January 31,2005 and ended on February 28, 2005. 96 of 98 offerees accepted the offerbringing the Company’s holdings in Ness U.S.A. following the offer to 99.9%. OnMarch 1, 2005, the Company issued 260,316 shares of Common stock to theofferees, for the consideration of $3,532. The acquisition was accounted forunder the purchase method of accounting according to SFAS No. 141.

In September 2005, Ness U.S.A. purchased theoutstanding shares of Ness U.S.A.’s common stock from the remainingtwo offerees in a private transaction, and it immediately thereafter retiredthe shares, since which time the Company has held 100% of the shares of commonstock of Ness U.S.A.

On January 3, 2006, Ness U.S.A was merged intoNess Global Services, Inc. Subsequently the surviving company changed itsname to Ness USA, Inc.

F-12

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

Based upon a valuation oftangible and intangible assets acquired and liabilities assumed, the Companyhas allocated the total cost of the acquisition to Ness U.S.A.’s assets andliabilities as follows:

| Cash and cash equivalents                                   |   | $     | 426    |   |
|-------------------------------------------------------------|--------|-------|--------|--------|
| Trade receivables                                           |   | 277   |   |
| Unbilled receivable                                         |   | 185   |   |
| Other accounts receivable                                   |   | 64    |   |
| Other long-term tangible assets                             |   | 20    |   |
| Property and equipment                                      |   | 18    |   |
| Total tangible assets acquired                              |   | 990   |   |
| Customer related intangible asset (five years useful  life) |   | 139   |   |
| Goodwill                                                    |   | 3,236 |   |
| Total intangible assets acquired                            |   | 3,375 |   |
| Total tangible and intangible assets acquired               |   | 4,365 |   |
| Accounts payable                                            |   | 148   |   |
| Other accounts payable                                      |   | 280   |   |
| Deferred tax liability                                      |   | 40    |   |
| Related parties, net                                        |   | 365   |   |
| Total liabilities assumed                                   |   | 833   |   |
| Net assets  acquired                                        |   | $     | 3,532  |   |

 

2.     Ness Romania

On April 1, 2005, the Company acquired all of theoutstanding shares of Radix Company SA (“Radix”), a provider of IT services andsolutions based in Romania. The purchase price was €4million, or $5,385, consisting of €2 million paid in cash atthe closing and €2million placed in escrow for six months contingent on the verification of theaccuracy of certain representations made by the sellers. Additional payment of €1.5million, or $1,775, was made in April 2006 based on achievement of certainrevenue and operating income milestones in 2005. The additional payment wasaccrued for and recorded as goodwill in the December 31, 2005 consolidatedbalance sheet. An additional payment of €1.5 million or $1,976 willbe made in April 2007 based on an achievement of certain revenue and operatingincome milestones for 2006. The additional payment was accrued for and recordedas goodwill in the December 31, 2006 consolidated balance sheet. Radixbecame a wholly-owned subsidiary of the Company’s Dutch subsidiary, NessTechnologies, B.V., and, accordingly, its results of operations have beenincluded in the Company’s consolidated financial statements since theacquisition date. Upon completion of the acquisition, Radix Company SA changedits name to Ness Romania.

F-13

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

This acquisition wasaccounted for under the purchase method of accounting and, accordingly, thepurchase price was allocated to the assets acquired and liabilities assumedbased on their related fair values (as of the acquisition date, except forgoodwill, which was updated to include the additional payments), as follows: 

| Cash and cash equivalents                                                             |   | $      | 2,511  |   |
|---------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Trade receivables                                                                     |   | 933    |   |
| Inventories                                                                           |   | 137    |   |
| Property and equipment                                                                |   | 2,094  |   |
| Other accounts receivable                                                             |   | 97     |   |
| Intangible  assets:                                                                   |   |   |   |
| Customer relationships                                                                |   | 420    |   |
| Backlog                                                                               |   | 260    |   |
| Work force                                                                            |   | 730    |   |
| Goodwill                                                                              |   | 6,635  |   |
| Total assets  acquired                                                                |   | 13,817 |   |
| Liabilities  assumed:                                                                 |   |   |   |
| Accounts payable and other accrued expenses                                           |   | 1,420  |   |
| Accrual for  additional consideration to be paid subsequent to the balance sheet date |   | 1,976  |   |
| Other current liabilities                                                             |   | 1,506  |   |
| Deferred tax liability                                                                |   | 204    |   |
| Long-term liabilities                                                                 |   | 1,551  |   |
| Total liabilities  assumed                                                            |   | 6,657  |   |
| Net assets acquired                                                                   |   | $      | 7,160  |   |

 

The value assignedto the tangible assets, intangible assets and liabilities has been determinedas follows:

a.                 Radix’s currentassets and liabilities were recorded at their carrying amounts. The carryingamounts of the current assets and liabilities were reasonable proxies for theirmarket values due to their short-term maturity. Property and equipment werepresented at current replacement cost. Long-term liabilities are presented atpresent value of amounts to be paid determined at appropriate current interestrates.

b.                The value assignedto the customer-related intangibles amounted to $680. The fair value of Radix’scustomer-related intangibles was determined using the Income Approach.

c.                 The Companyrecorded a deferred tax liability of $204 for the difference between theassigned values and the tax bases of the customer-related intangibles acquired.

Pro forma information inaccordance with SFAS No. 141 is provided in Note 1b(8).

F-14

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 1—GENERAL (Continued)**

3.     Ness DMa.s.

On June 1, 2005, the Company acquired all of theoutstanding shares of Efcon a.s. (“Efcon”), a provider of IT services andsolutions based in the Czech Republic. The purchase price was €0.6million, or $738, consisting of €350,000 paid at closingand €250,000paid in July 2005. An additional payment of €0.2 million, or $237, wasmade in February 2006 based on achievement of certain 2005 performancegoals. The additional payment was accrued for and recorded as goodwill in theDecember 31, 2005 balance sheet. Efcon became a wholly-owned subsidiary ofNess Czech s.r.o., a part of the Company’s Ness Europe group, and, accordingly,its results of operations have been included in the Company’s consolidatedfinancial statements since the acquisition date. Following the acquisition,Efcon changed its name to Ness DM a.s.

Thisacquisition was accounted for under the purchase method of accounting and,accordingly, the purchase price was allocated to the assets acquired and liabilitiesassumed based on their related fair values (as of the acquisition date, exceptfor goodwill, which was updated to include the additional payments), asfollows: 

| Cash and cash equivalents                   |   | $      | 426    |   |
|---------------------------------------------|--------|--------|--------|--------|
| Trade receivables                           |   | 314    |   |
| Inventories                                 |   | 33     |   |
| Property and equipment                      |   | 212    |   |
| Other accounts receivable                   |   | 494    |   |
| Intangible assets:                          |   |   |   |
| Work force                                  |   | 278    |   |
| Customer relations                          |   | 64     |   |
| Goodwill                                    |   | 253    |   |
| Total assets  acquired                      |   | 2,074  |   |
| Liabilities assumed:                        |   |   |   |
| Accounts payable and other accrued expenses |   | 442    |   |
| Other current liabilities                   |   | 588    |   |
| Deferred tax liabilities                    |   | 19     |   |
| Long term liabilities                       |   | 50     |   |
| Total liabilities  assumed                  |   | 1,099  |   |
| Net assets acquired                         |   | $      | 975    |   |

 

The value assignedto the tangible assets, intangible assets and liabilities has been determinedas follows:

a.      Ness DM’scurrent assets and liabilities were recorded at their carrying amounts. Thecarrying amounts of the current assets and liabilities were reasonable proxiesfor their market values due to their short-term maturity. Property andequipment were presented at current replacement cost. Long-term liabilities arepresented at present value of amounts to be paid determined at appropriatecurrent interest rates.

F-15

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

b.     The valueassigned to the customer-related intangibles amounted to $64. The fair value ofNess DM’s customer-related intangibles was determined using the IncomeApproach.

c.      TheCompany recorded a deferred tax liability of $19 for the difference between theassigned values and the tax bases of the customer-related intangibles acquired.

Pro forma information inaccordance with SFAS No. 141 is provided in Note 1b(8).

4.   NTR

On September 12, 2005, the Company acquired allof the outstanding shares of N.T.R. Holding Ltd. (“NTR”), a provider of ITservices and solutions based in Israel. The purchase price was $1,350.Additional payments of $150 were made in June 2006 based on achievement ofcertain 2005 performance goals. The additional required payment was accrued forand recorded as goodwill in the December 31, 2005 consolidated balancesheet. NTR became a wholly-owned subsidiary of Ness A.T., a part of the Company’sNess Israel group, and, accordingly, its results of operations have beenincluded in the consolidated financial statements since September 12,2005.

Thisacquisition was accounted for under the purchase method of accounting and,accordingly, the purchase price was allocated to the assets acquired andliabilities assumed based on their related fair values (as of the acquisitiondate, except for goodwill, which was updated to include the additionalpayments), as follows: 

| Cash and cash equivalents                   |   | $      | 173    |   |
|---------------------------------------------|--------|--------|--------|--------|
| Trade receivables                           |   | 408    |   |
| Property and equipment                      |   | 47     |   |
| Other accounts receivable                   |   | 391    |   |
| Intangible assets:                          |   |   |   |
| Backlog                                     |   | 119    |   |
| Customer relations                          |   | 345    |   |
| Goodwill                                    |   | 889    |   |
| Total assets  acquired                      |   | 2,372  |   |
| Liabilities assumed:                        |   |   |   |
| Accounts payable and other accrued expenses |   | 25     |   |
| Other current liabilities                   |   | 443    |   |
| Deferred tax liability                      |   | 139    |   |
| Long-term liabilities                       |   | 265    |   |
| Total liabilities  assumed                  |   | 872    |   |
| Net assets acquired                         |   | $      | 1,500  |   |

 

The value assignedto the tangible assets, intangible assets and liabilities has been determinedas follows:

a.                 NTR’s currentassets and liabilities were recorded at their carrying amounts. The carryingamounts of the current assets and liabilities were reasonable proxies for theirmarket values due 

F-16

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

to their short-termmaturity. Property and equipment were presented at current replacement cost.Long-term liabilities are presented at present value of amounts to be paiddetermined at appropriate current interest rates.

b.     The valueassigned to the customer-related intangibles amounted to $464. The fair valueof NTR’s customer-related intangibles was determined using the Income Approach.

c.      TheCompany recorded a deferred tax liability of $139 for the difference betweenthe assigned values and the tax bases of the customer-related intangiblesacquired.

Pro forma information inaccordance with SFAS No. 141 is provided in Note 1b(8).

**5.**   Ness Slovakia

On October 3, 2005, the Company acquired all theoutstanding shares of Delta Electronic Services a.s. (“Delta”), a provider ofIT services and solutions in Slovakia. The Company acquired the outstandingshares for cash consideration of $8,000 and related purchase costs ofapproximately $115. In addition, as Delta achieved certain business goals bythe end of 2005, the Company paid an additional amount of $3,000 during 2006.Upon completion of the acquisition, Delta changed its name to Ness Slovakia,and it operates as a part of Ness Europe. Delta became a wholly-ownedsubsidiary of Ness B.V., a part of Ness European group, and, accordingly, itsresults of operations have been included in the consolidated financialstatements since October 3, 2005.

Thisacquisition was accounted for under the purchase method of accounting and,accordingly, the purchase price was allocated to the assets acquired andliabilities assumed based on their related fair values (as of the acquisitiondate, except for goodwill, which was updated to include the additionalpayments), as follows:

| Cash and cash equivalents                   |   | $      | 2,158  |   |
|---------------------------------------------|--------|--------|--------|--------|
| Trade receivables                           |   | 1,476  |   |
| Property and equipment                      |   | 575    |   |
| Other accounts receivable                   |   | 1,176  |   |
| Intangible assets:                          |   |   |   |
| Customer relations                          |   | 1,616  |   |
| Backlog                                     |   | 265    |   |
| Workforce                                   |   | 1,290  |   |
| Goodwill                                    |   | 6,408  |   |
| Total assets  acquired                      |   | 14,964 |   |
| Liabilities assumed:                        |   |   |   |
| Accounts payable and other accrued expenses |   | 1,235  |   |
| Other current liabilities                   |   | 1,925  |   |
| Deferred tax liabilities                    |   | 564    |   |
| Long-term liabilities                       |   | 125    |   |
| Total liabilities  assumed                  |   | 3,849  |   |
| Net assets acquired                         |   | $      | 11,115 |   |

 

F-17

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

The value assigned to the tangible assets, intangibleassets and liabilities has been determined as follows:

a.                 Delta’s currentassets and liabilities were recorded at their carrying amounts. The carryingamounts of the current assets and liabilities were reasonable proxies for theirmarket values due to their short-term maturity. Property and equipment werepresented at current replacement cost. Long-term liabilities are presented atpresent value of amounts to be paid determined at appropriate current interestrates.

b.                The value assignedto the customer-related intangibles amounted to $1,881. The fair value of Delta’scustomer-related intangibles was determined using the Income Approach.

c.                 TheCompany recorded a deferred tax liability of $564 for the difference betweenthe assigned values and the tax bases of the customer-related intangiblesacquired.

Pro forma information inaccordance with SFAS No. 141 is provided in Note 1b(8).

**6.**   Ness IBS

On February 28, 2006, the Company acquired all ofthe outstanding shares of Olas Software Solutions, Inc., d/b/a InnovaSolutions (“Innova”), a provider of IT services and solutions based in the 

United States and India.The Company acquired the outstanding shares for cash consideration of $15,000and related purchase costs of $249. Additional payments of up to $10,000 arerequired to be made in April 2007 and April 2008 based on achievementof certain revenue and operating income milestones for the years 2006 and 2007,respectively. The Company has provided for a payment of $8,225 related to themilestones of 2006.

Innova became a wholly-owned subsidiary of NessTechnologies, Inc. and, accordingly, its results of operations areincluded in the Company’s consolidated financial statements since theacquisition date. Upon completion of the acquisition, Innova changed its nameto Ness Innovative Business Services.

F-18

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

This acquisition wasaccounted for under the purchase method of accounting and, accordingly, thepurchase price was allocated to the assets acquired and liabilities assumedbased on their relative fair values (as of the acquisition date, except forgoodwill, which was updated to include the additional payments), as follows:

| Cash and cash equivalents                                                             |   | $      | 1,566  |   |
|---------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Trade receivables                                                                     |   | 3,527  |   |
| Other accounts receivable                                                             |   | 1,310  |   |
| Property and equipment                                                                |   | 1,233  |   |
| Other long-term assets                                                                |   | 519    |   |
| Intangible assets:                                                                    |   |   |   |
| Customer relations                                                                    |   | 1,848  |   |
| Backlog                                                                               |   | 640    |   |
| Workforce                                                                             |   | 4,773  |   |
| Goodwill                                                                              |   | 14,886 |   |
| Total assets  acquired                                                                |   | 30,302 |   |
| Liabilities assumed:                                                                  |   |   |   |
| Accounts payable and other accrued expenses                                           |   | 4,606  |   |
| Other current liabilities                                                             |   | 2,008  |   |
| Accrual for additional consideration to be paid  subsequent to the balance sheet date |   | 8,225  |   |
| Long-term liabilities                                                                 |   | 214    |   |
| Total liabilities  assumed                                                            |   | 15,053 |   |
| Net assets acquired                                                                   |   | $      | 15,249 |   |

 

The value assigned to the tangible assets, intangibleassets and liabilities has been determined as follows:

a.                 Innova’s currentassets and liabilities were recorded at their carrying amounts. The carryingamounts of the current assets and liabilities were reasonable proxies for theirmarket values due to their short-term maturity. Property and equipment werepresented at current replacement cost. Long-term liabilities are presented atpresent value of amounts to be paid determined at appropriate current interestrates.

b.     The valueassigned to the customer-related intangibles amounted to $2,488. The fair valueof Innova’s customer-related intangibles was determined using the IncomeApproach. Customer relations are amortized over its useful life, estimated as4.83 years. Backlog is amortized according to its expected revenue recognitionschedule.

c.      Thisacquisition was treated as an asset purchase for tax purposes and as such thegoodwill related to this acquisition is deductible for tax purposes.

Pro forma information inaccordance with SFAS No. 141 is provided in Note 1b(8).

F-19

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

**7.**   NessPro Spain

On December 14, 2006, the Company acquired all ofthe outstanding shares of Selesta España (“Selesta”), IT software distributionand systems integration company based in Spain. The purchase price was €8million, or $10,579 and relative purchase costs of $125, consisting of €6.25million paid in cash at the closing and €1.75 million placed inescrow for six months contingent on the verification of the accuracy of certainrepresentations made by the sellers. Additional payment of €0.8million, or $1,070, will be made during 2007 based on achievement of certainrevenue and operating income milestones in 2006. The additional payment wasaccrued for and recorded as goodwill in the December 31, 2006 consolidatedbalance sheet as the milestones were met. An additional payment of €1million or $1,317 may be made during 2008 based on achievement of certainrevenue and operating income milestones for 2007. Selesta became a wholly-ownedsubsidiary of the Company’s Dutch subsidiary, Ness Technologies, B.V., and,accordingly, its results of operations have been included in the Company’sconsolidated financial statements since the acquisition date. Upon completionof the acquisition, Selesta Company SA changed its name to NessPro Spain.

Thisacquisition was accounted for under the purchase method of accounting and,accordingly, the purchase price was allocated to the assets acquired andliabilities assumed based on their related fair values (as of the acquisitiondate, except for goodwill, which was updated to include the additional payments),as follows:

| Cash and cash equivalents                                                             |   | $      | 986    |   |
|---------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Trade receivables                                                                     |   | 3,168  |   |
| Property and equipment                                                                |   | 140    |   |
| Other accounts receivable                                                             |   | 984    |   |
| Intangible assets:                                                                    |   |   |   |
| Customer relationships                                                                |   | 758    |   |
| Distribution agreements                                                               |   | 279    |   |
| Work force                                                                            |   | 435    |   |
| Goodwill                                                                              |   | 10,561 |   |
| Total assets  acquired                                                                |   | 17,311 |   |
| Liabilities assumed:                                                                  |   |   |   |
| Accounts payable and other accrued expenses                                           |   | 3,125  |   |
| Accrual for additional consideration to be paid  subsequent to the balance sheet date |   | 1,070  |   |
| Deferred tax liability                                                                |   | 321    |   |
| Other current liabilities                                                             |   | 2,091  |   |
| Total liabilities  assumed                                                            |   | 6,607  |   |
| Net assets acquired                                                                   |   | $      | 10,704 |   |

 

F-20

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 1—GENERAL (Continued)**

The value assignedto the tangible assets, intangible assets and liabilities has been determinedas follows:

a.      Selesta’scurrent assets and liabilities were recorded at their carrying amounts. Thecarrying amounts of the current assets and liabilities were reasonable proxiesfor their market values due to their short-term maturity. Property andequipment were presented at current replacement cost. Long-term liabilities arepresented at present value of amounts to be paid determined at appropriatecurrent interest rates.

b.     The valueassigned to the customer-related intangibles amounted to $1,037. The fair valueof Selesta’s customer-related intangibles was determined using the IncomeApproach.

c.      TheCompany recorded a deferred tax liability of $321 for the difference betweenthe assigned values and the tax bases of the customer-related intangiblesacquired.

Pro forma information in accordance with SFAS No. 141is provided in Note 1b(8).

8.     The following table for the years ended December 31, 2004and 2005, presents certain combined unaudited statements of income data as ifthe acquisitions of 14% of Ness U.S.A., occurred in January 1, 2003 andNess Romania, Ness DM a.s., NTR, Ness Slovakia, occurred on January 1,2004, after giving effect to purchase accounting adjustments, includingamortization of identifiable intangible assets:

| ** **           | ** ** | **December 31,** | ** ** |
|----------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2004**              | ** ** | **2005** | ** ** |
| ** **           | ** ** | **(unaudited)**       | ** ** |
| Revenues             |       | $                     | 342,075    |   | $ | 399,729 |   |
| Net income           |       | $                     | 16,381     |   | $ | 22,022 |   |
| Earnings per  Share: |       |                  |       |   |   |
| Basic                |       | $                     | 0.72       |   | $ | 0.64 |   |
| Diluted              |       | $                     | 0.65       |   | $ | 0.62 |   |

 

Thefollowing table for the years ended December 31, 2005 and 2006 presentscertain combined unaudited statements of income data as if the acquisitions ofNess IBS and NessPro Spain occurred on January 1, 2005, after givingeffect to purchase accounting adjustments, including amortization ofidentifiable intangible assets:

| ** **           | ** ** | **December 31,** | ** ** |
|----------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2005**              | ** ** | **2006** | ** ** |
| ** **           | ** ** | **(unaudited)**       | ** ** |
| Revenues             |       | $                     | 428,876    |   | $ | 485,379 |   |
| Net income           |       | $                     | 24,947     |   | $ | 29,128 |   |
| Earnings per  Share: |       |                  |       |   |   |
| Basic                |       | $                     | 0.73       |   | $ | 0.81 |   |
| Diluted              |       | $                     | 0.70       |   | $ | 0.80 |   |

 

F-21

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE1—GENERAL (Continued)**

The pro forma financial information is not necessarilyindicative of the combined results that would have been attained had theacquisitions taken place at the beginning of 2004, 2005 and 2006, nor is itnecessarily indicative of future results.

9.     Revenuesfrom agencies of the government of Israel:

For the years ended December 31,2004, 2005 and 2006, the percentage of the Group’s revenues derived, inaggregate, from agencies of the government of Israel was 12%, 11% and 10%,respectively.

**NOTE 2—SIGNIFICANTACCOUNTING POLICIES**

The consolidated financial statements have beenprepared in accordance with United States generally accepted accountingprinciples (“U.S. GAAP”).

a.      Use of estimates:

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates.

b.     Financial statementsin U.S. dollars:

The Company’s subsidiaries’ transactions are recordedin local currencies. The Company has designated the U.S. dollar as the primaryfunctional currency of its operations in the United States, the NIS as theprimary functional currency of its subsidiaries’ operations in Israel, andlocal currencies as the primary functional currencies of its operationselsewhere.

Monetary amounts denominated in a currency other thanthe functional currency are re-measured into the functional currency, inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 52“Foreign Currency Translation.” All transaction gains and losses of there-measured monetary balance sheet items are reflected in the statements ofincome as financial income or expenses, as appropriate.

For those foreignsubsidiaries whose functional currency has been determined to be their localcurrency, assets and liabilities are translated at year-end exchange rates andstatements of income items are translated at average exchange rates prevailingduring the year. Such translation adjustments are recorded as a separatecomponent of accumulated other comprehensive income (loss) in stockholders’equity.

c.      Principlesof consolidation:

The Company’sconsolidated financial statements include the accounts of the Company and it’swholly and majority owned subsidiaries. Inter-company transactions andbalances, including profit from inter-company sales not yet realized outsidethe Group, have been eliminated in consolidation.

d.     Cashequivalents and short-term bank deposits:

Cash equivalents are short-term, highly liquidinvestments that are readily convertible into cash, with maturities of threemonths or less at the date acquired.

F-22

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

Short-term bank deposits are deposits with maturitiesof more than three months but less than one year. The short-term bank depositsare presented at their costs including accrued interest.

e.      Marketablesecurities:

The Group accounts for investments in equitysecurities (other than those under the equity method) in accordance with SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”).Management determines the appropriate classification of its investments inequity securities at the time of purchase and reevaluates such determinationsat each balance sheet date. As of December 31, 2006 and 2005, allmarketable securities are classified as available-for-sale and are carried atfair value, with the unrealized gains and losses, net of income taxes, reportedas a separate component of stockholders’ equity, in accumulated othercomprehensive income (loss). Realized gains and losses on sales of investments,as determined on a specific identification basis, are included in theconsolidated statements of income.

According to Staff Accounting Bulletin No. 59 (“SABNo. 59”) and EITF 03-1, “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments,” for any marketablesecurities whose value declined during the period, management is required toevaluate whether the decline is other than temporary. Under SAB No. 59,fair value below cost for two consecutive quarters is considered to be otherthan a temporary impairment. In 2005, a decline in value that was consideredother than temporary of one of the Company’s available-for-sale securitiesresulted in reversing the accumulated unrealized loss of $130 relating to thisinvestment, and in an additional charge of $56, both classified as financeexpenses in the consolidated statements of income.

f.      Inventories:

Inventories are stated at the lower of cost or marketvalue. Inventories represent supplies using the “first-in, first-out” method.

Work in progressincludes costs incurred related to long-term IT services contracts asdetermined by the completed work method of accounting.

g.      Investmentin affiliates:

Excess of loss over investment in an affiliatereflects a 50% investment in the Ordinary shares of a privately held company,in which the Company can exercise significant influence over operating andfinancial policies, but does not assume control. The investment in thisaffiliate is accounted for by the equity method. As the Company guaranteed theobligations of this entity and provides further financial support, reflectingits share of ownership, it recorded an excess of losses over this investment.

Differences between the balance of excess of lossesover investment in affiliates as of December 31, 2005 derive fromaccumulated net losses and foreign currency translation adjustments. During2006, 2005 and 2004,  the companyrecorded $103, $65, and $647 respectively, equity in loss from this investment.The investment was sold in December 2006. The gain of $271 is presented inequity in losses and gain from disposal of affiliate in the consolidated incomestatements.

As of December 31, 2005, the Company holds votinginterest of 19% in a former wholly-owned subsidiary. Theinvestment is accounted for under the cost method in accordancewith Accounting 

F-23

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

Principles Board OpinionNo 18. “The Equity Method of Accounting for Investments inCommon Stock”. The investment wasrecorded at zero as of December 31, 2005.

On December 28, 2006 the Company executed sharepurchase agreement with the other shareholders in order to sell them its sharesand warrant for a total consideration of $6,000 before $999 of related costs.The gain of $5,001 is presented in gain on sale of cost investment in theconsolidated income statements.

h.     Propertyand equipment:

Property and equipment arestated at cost, net of accumulated depreciation. Depreciation is calculated bythe straight-line method over the estimated useful lives of the assets, at thefollowing annual rates:

| ** **                          | ** ** | **%**                                                              | ** ** |
|-------------------------------------|------------|--------------------------------------------------------------------|------------|
| Computers and  peripheral equipment |       | 20 -33                                                             |       |
| Motor vehicles                      |       | 15                                                                 |       |
| Office furniture  and equipment     |       | 6 - 15                                                             |       |
| Leasehold  improvements             |       | By the shorter of the term of the  lease and the life of the asset |       |

 

The Group accountsfor costs of computer software developed or obtained for internal use inaccordance with Statement of Position (“SOP”) No. 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use.” SOPNo. 98-1 requires the capitalization of certain costs incurred inconnection with developing or obtaining internal use software.

i.      Intangibleassets:

Intangible assetsare amortized over their useful lives using a method of amortization thatreflects the pattern in which the economic benefits of the intangible assetsare consumed or otherwise used up, in accordance with SFAS No. 142.Backlog is amortized according to its expected revenue recognition schedule.Other intangible assets are amortized over a period of approximately 2-5years using straight-line method.

j.       Impairmentof long-lived assets:

The Group’s long-lived assets and certain identifiableintangibles are reviewed for impairment in accordance with SFAS No. 144,whenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held andused is measured by a comparison of the carrying amount of an asset to thefuture undiscounted cash flows expected to be generated by the assets. If suchassets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets. As of December 31, 2006 and 2005, no impairmentlosses have been identified.

F-24

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 2—SIGNIFICANTACCOUNTING POLICIES (Continued)**

k.     Goodwill:

SFAS No. 142 requires goodwill to be tested forimpairment on adoption and at least annually thereafter or between annual testsin certain circumstances, and written down when impaired, rather than amortizedas previous accounting standards required. Goodwill is tested for impairment atthe reporting unit level by comparing the fair value of the reporting unit withits carrying value. The test was based on the Group’s operating segments, as furtherdescribed in note 16. Fair value is determined using discounted cash flows andmarket capitalization. Significant estimates used in the methodologies includeestimates of future cash flows, future short-term and long-term growth rates,and weighted average cost of capital for the reportable unit.

On January 1, 2006, the Company began segmentreporting, and therefore the Company allocated its goodwill balance as of January 1,2006 to its reportable segments based on their relative fair value as of that date.

In the year ended December 31, 2006, the Companyrecorded additional goodwill resulting mainly from the acquisition of Ness IBS,NessPro Spain and additional consideration to be paid subsequent to the balancesheet date, together representing $33,669.

The Company haselected to perform its analysis of goodwill during the fourth quarter of theyear. As of December 31, 2006 and 2005, no impairment losses wereidentified.

l.      Derivativeinstruments:

Financial Accounting Standards Board Statement No. 133,“Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”),requirescompanies to recognize allof its derivative instruments as either assets or liabilities in the statementof financial position at fair value. For those derivative instruments that aredesignated and qualify as hedging instruments, a company must designate thehedging instrument, based upon theexposure being hedged, as afair value hedge, cash flow hedge or a hedge of a net investment in a foreignoperation. For derivative instruments that are designated and qualify as a fairvalue hedge (i.e., hedging the exposure to changes in the fair value of anasset or a liability or an identified portion thereof that is attributable to aparticular risk), the gain or losson the derivative instrumentas well as the offsetting loss or gain on the hedged item attributable to thehedged risk are recognized in current earnings during the period of the changein fair values.

Fair Value HedgingStrategy:

The Company enters into forward exchange contracts tohedge a portion of its trade payables and receivables for a period of one tothree months. The purpose of the Company’s foreign currency hedging activitiesis to protect the fair value of its trade payables and receivables due to foreignexchange rates.

In addition, the Company enters into forward IsraeliConsumer Price Index (“CPI”) to hedge a portion of its long-term bank loans fora period of one year. The purpose of the Company’s CPI hedging activities is toprotect the fair value of its CPI linked long-term bank loans due to CPI’sfluctuation.

As of December 31, 2006 unrealized gain on theopen hedging transactions included in other accounts receivables and prepaidexpenses are $53 and unrealized loss on the open hedging transaction includedin 

F-25

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

other account payables andaccrued expenses are $61. As of December 31, 2005 there were no openhedging transactions.

The Companyrecognized gain (losses) of $(195) and $286 during the years ended December 31,2005 and 2006, respectively. All amounts have been included in finance expensesin the statement of income.

m.    Revenuerecognition:

The Group’s portfolio of solutions and servicesincludes: 1) system integration and application development services for whichrevenues are generated from either long term fixed-price basis ortime-and-materials basis contracts; 2) outsourcing, consultation, qualityassurance and training services for which revenues are generated from eitherfixed-price basis or time-and-materials basis contracts; and; 3) sales of thirdparty software licenses.

1)   Under fixed-pricecontracts, the Group agrees to perform certain work for a fixed price.Fixed-price basis engagements generally involve a period between the signing ofthe contract and the final customer acceptance exceeding one year. Fees arepayable upon completion of agreed upon milestones. Such projects that requiresignificant customization, integration and installation are recognized inaccordance with SOP No. 81-1 “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts,” using contractaccounting on a percentage of completion method, in accordance with the “InputMethod.” The amounts of revenues recognized are based on the total fees underthe agreement and the percentage to completion achieved. The percentage tocompletion is measured by monitoring progress using records of actual time,materials and subcontractor costs incurred to date in the project compared tothe total estimated project requirement, which corresponds to the costs relatedto earned revenues. Estimates of total project requirements are based on priorexperience of customization, delivery and acceptance of similar services, andare reviewed and updated regularly by management. Provisions for estimatedlosses on uncompleted contracts are made in the period in which such losses arefirst determined, in the amount of the estimated loss on the entire contract.

Estimated gross profit or loss from long-termcontracts may change due to changes in estimates resulting from differencesbetween actual performance and original forecasts. Such changes in estimatedgross profit are recorded in results of operations when they are reasonablydeterminable by management, on a cumulative catch-up basis.

The Group believes that the use of the percentage ofcompletion method is appropriate as the Group has the ability to makereasonably dependable estimates of the extent of progress towards completion,contract revenues and contract costs. In addition, contracts executed includeprovisions that clearly specify the enforceable rights regarding services to beprovided and received by the parties to the contracts, the consideration to beexchanged and the manner and the terms of settlement, including in cases ofterminations for convenience. In all cases the Group expects to perform itscontractual obligations and its customers are expected to satisfy theirobligations under the contract. In cases where enforceable rights could not bedemonstrated, revenues are recognized in accordance with thecompleted-contract-cost method.

F-26

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

According to SOP No. 81-1, costs that areincurred for a specific anticipated contract are deferred, subject to evaluationof their probable recoverability, and only if the costs can be directlyassociated with a specific anticipated contract. Such deferred costs arerecorded as deferred contract costs.

Amounts recognized as revenue in advance ofcontractual billing are recorded as unbilled receivables.

Advances from customers include unearned amounts undersystem integration and application development services.

Amounts received in advance of meeting revenuerecognition criteria are deferred.

2)   Other engagementsare performed under time-and-materials basis contracts. Undertime-and-materials contracts, the Group is reimbursed for labor hours atnegotiated hourly billing rates. Such service contracts are not in the scope ofSOP No. 81-1, and accordingly, related revenues are recognized inaccordance with SEC Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition.” If a contract involves the provision of a single element,revenues are recognized as those services are performed or over the term of therelated agreements, provided that, an evidence of an arrangement has beenobtained, fees are fixed and determinable and collectibility is reasonablyassured.

If a contact involves the provision of multipleservice elements, total estimated contract revenue is allocated to each elementbased on the relative fair value of each element. The fair value of thoseelements is determined based on the price charged for those elements when soldseparately. The Group’s accounting policy complies with the revenuedetermination requirements set forth in EITF No. 00-21, “RevenueArrangement with Multiple Deliverables,” relating to the separation of multipledeliverables into individual accounting units with determinable fair values.

Deferred revenue includes unearned amounts undertime-and-materials basis contracts.

3)   Sales ofthird-party software licenses are recognized in accordance with SOP No. 97-2,“Software Revenue Recognition,” as amended. SOP No. 97-2 generallyrequires revenue earned on software arrangements involving multiple elements tobe allocated to each element based on the relative fair value of the element.In addition, the Group has adopted SOP No. 98-9, “Modification ofSOP 97-2, Software Revenue Recognition with Respect to Certain Transactions.”SOP No. 98-9 requires that revenue be recognized under the “residualmethod” when Vendor Specific Objective Evidence (“VSOE”) of fair value existsfor all undelivered elements, VSOE does not exist for all of the deliveredelements and all other SOP No. 97-2 criteria are met. Under theresidual method, any discount in the arrangement is allocated to the deliveredelements.

Revenues are recognized when persuasive evidence of anagreement exists, delivery of the product has occurred, no significant obligationswith regard to implementation remain, the fee is fixed or determinable andcollectibility is probable.

Maintenance and support revenue included in multipleelement arrangements is deferred and recognized on a straight-line basis overthe term of the maintenance and support agreement. The VSOE of fair value ofthe undelivered elements (maintenance, support and services) is determinedbased on the price charged for the undelivered element when sold separately.

F-27

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

In respect of such arrangements the Group follows theguidance of EITF No. 99-19, “Reporting Revenue Gross as a Principalversus Net as an Agent.” The Group records revenue on a gross basisrepresenting the amount that has been billed to a customer when the Group bearsthe risks and rewards of ownership including the risk of loss for collection,latitude in establishing product pricing above a specific minimum price and thecredit risk in the event collection is not made from a customer. When the Groupperforms as an agent without assuming the risk and rewards of ownership,revenues are recorded on a net basis.

n.     Accountingfor stock-based compensation:

On January 1, 2006, the Company adopted Statementof Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS123(R)”) utilizing the modified prospective transition method. SFAS 123(R) requiresemployee stock options to be valued at fair value on the date of grant andcharged to expense over the applicable service period. Under the modifiedprospective method, compensation expense is recognized for all share-basedpayments issued on or after January 1, 2006 and for all share-basedpayments issued to employees prior to January 1, 2006 that remainunvested.

The Company’s results of operations for 2006 includeexpenses of $583 in operating expenses related to the adoption of SFAS 123(R).In accordance with the modified prospective method, the Company’s consolidatedfinancial statements for prior periods have not been restated to reflect, anddo not include, the impact of SFAS 123(R).

Prior to the adoption of SFAS 123(R), the Companyaccounted for share-based awards to employees and directors using the intrinsicvalue method in accordance with Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees.” Under APB Opinion No. 25, theexercise price of stock options granted to employees and directors equaled thefair market value of the underlying stock at the grant date, therefore, noshare-based compensation expense was recognized in the Company’s condensedconsolidated statement of income.

The Company applies SFAS No. 123 and EITF No. 96-18,“Accounting for Equity Instruments That Are Issued to Other Than Employees forAcquiring, or in Conjunction with Selling, Goods or Services,” with respect tooptions and warrants issued to non-employees. SFAS No. 123 requires theuse of option valuation models to measure the fair value of the options andwarrants at the measurement date as defined in EITF No. 96-18.

SFAS 123(R) requires companies to estimate thefair value of share-based awards on the date of grant using an option-pricingmodel, where applicable. Share-based compensation expense recognized in theCompany’s condensed consolidated statement of income for fiscal year 2006includes compensation expense for share-based awards granted (i) prior to,but not yet vested as of, January 1, 2006, based on the grant date fairvalue estimated in accordance with the original provisions of SFAS 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”), and (ii) subsequent to January 1,2006, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R).

The Company recognizes these compensation costs net ofa forfeiture rate and recognizes the compensation costs for only those sharesexpected to vest on a straight-line basis over the requisite service period ofthe award, which is generally the option vesting term of three to four years. 

F-28

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

SFAS 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. In itspro forma information required under SFAS 123 for periods prior to fiscal2006, the Company accounted for forfeitures as they occurred.

As a result of adopting SFAS No. 123(R) on January 1,2006, the Company’s income before taxes on income for year ended December 31,2006, was $583 lower, than if the Company had continued to account for stock-basedcompensation under APB No. 25. Basic and diluted net earnings per sharefor the year ended December 31, 2006 were $ 0.01 lower, than if theCompany had continued to account for stock-based compensation under APB No. 25.

As of December 31, 2006, approximately $157 oftotal unrecognized compensation cost related to stock based compensation isexpected to be recognized over a period of 2 years. The total unrecognizedstock-based compensation cost to be recognized in future periods does notconsider the effect of stock options that may be issued in subsequent periods.

During 2006, the Company extended the term of certainoptions previously granted to the Company’s Chairman of the Board, and itsPresident and CEO, representing 366,262 and 154,323 options, respectively, to February 28,2007, and it granted 26,974 options to a former employee. There were no othergrants during 2006.The Company’s results of operations include expenses of $195related to these modifications.

The Company estimates the fair value of stock optionsgranted using the Black-Scholes-Merton option pricing model. The option-pricingmodel requires a number of assumptions, of which the most significant are theexpected stock price volatility and the expected option term. Expected volatilitywas calculated based upon actual historical stock price movements. The expectedterm of options granted is based upon historical experience and represents theperiod of time that options granted are expected to be outstanding. Therisk-free interest rate is based on the yield from U.S. treasury bonds with anequivalent term. The Company has historically not paid dividends and has noforeseeable plans to pay dividends

Thefair value for options granted in 2004 and 2005 and the options extended andgranted in 2006 is estimated at the date of grant using the Black-Scholesoption pricing model with the following weighted average assumptions:

| ** **               | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield           |       | 0        | %          | 0        | %          | 0        | %          |
| Expected  volatility     |       | 0.50     |       | 0.33     |       | 0.33     |       |
| Risk-free  interest      |       | 2.5      | %          | 4.3      | %          | 5.1      | %          |
| Expected life (in years) |       | 4        |       | 2.64     |       | 0.28     |       |

 

F-29

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

The pro forma informationregarding net income and earnings per share required by SFAS No. 123 hasbeen determined as if the Company accounted for its stock-based compensationplans under the fair value method. Had compensation cost for its stock-basedcompensation plans been determined in accordance with SFAS No. 123, itsnet income and earnings per share would have been reduced to the pro forma amountsindicated below:

|                                                                                                              | ** ** | **Year ended December 31,**                           | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **     2004     ** | ** ** | **     2005     ** | ** ** |
| Net income available to  Common stock—as reported                                                       |       |                                                                 | $          | 13,021 |   |   |   | $ | 21,689 |   |   |
| Add—allocation of  undistributed earnings on Class B Convertible Preferred stock—as  reported |       |                                                                 | 1,356      |   |   |   | — |   |   |
| Deduct—pro forma allocation  of undistributed earnings on Class B Convertible Preferred stock      |       |                                                                 | (1,022     | ) |   |   | — |   |   |
| Add—stock-based  employee compensation—intrinsic value                                             |       |                                                                 | 247        |   |   |   | 1,992 |   |   |
| Deduct—stock-based employee  compensation—fair value                                               |       |                                                                 | (3,299     | ) |   |   | (8,254 | ) |   |
| Pro forma net  income                                                                                        |       |                                                                 | $          | 10,303 |   |   |   | $ | 15,427 |   |   |
| Basic earnings per share as  reported                                                                        |       |                                                                 | $          | 0.58 |   |   |   | $ | 0.63 |   |   |
| Diluted earnings  per share as reported                                                                      |       |                                                                 | $          | 0.53 |   |   |   | $ | 0.61 |   |   |
| Pro forma basic earnings per  share                                                                          |       |                                                                 | $          | 0.46 |   |   |   | $ | 0.43 |   |   |
| Pro forma diluted  earnings per share                                                                        |       |                                                                 | $          | 0.41 |   |   |   | $ | 0.42 |   |   |

 

See Note 14b(5) foracceleration of vesting and a grant of fully vested options during 2005.

o.                Earnings pershare:

Basic net earnings per share are computed based on theweighted average number of shares of Common stock outstanding during each year,plus dilutive convertible Preferred stock considered outstanding during 2004,in accordance with the guidance of EITF No. D-95, “Effect ofParticipating Convertible Securities on the Computation of Basic Earnings PerShare. “Diluted net earnings per share are computed based on the weightedaverage number of shares of Common stock outstanding during each year, plusdilutive potential shares of Common stock considered outstanding during theyear, in accordance with SFAS No. 128, “Earnings Per Share.”

p.                Income taxes:

The Group accounts for income taxes in accordance withSFAS No. 109, “Accounting for Income Taxes.” This statement prescribes theuse of the liability method whereby deferred tax assets and liability accountbalances are determined based on differences between financial reporting andtax bases of assets and liabilities and are measured using the enacted taxrates and laws that will be in effect when the differences are expected toreverse. Deferred tax assets are reduced by a valuation allowance if it is morelikely than not that some portion or all of the deferred tax asset will not berealized.

Deferred tax liabilities and assets are classified ascurrent or non current based on the classification of the related asset orliability for financial reporting, or according to the expected reversal datesof the specific temporary differences if not related to an asset or liabilityfor financial reporting.

F-30

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE2—SIGNIFICANT ACCOUNTING POLICIES (Continued)**

q.                Concentrationsof credit risk:

Financial instruments thatpotentially subject the Group to concentrations of credit risk consistprincipally of cash and cash equivalents, short-term bank deposits, tradereceivables and unbilled receivables.

Cash and cash equivalentsand short-term bank deposits are mainly invested with major banks in Israel,the United States and Europe. Cash and cash equivalents in the United Statesmay be in excess of insured limits and are not insured in other jurisdictions.Management believes that the financial institutions that hold the Group’s fundsare financially sound, and accordingly minimal credit risk exists with respectto these funds.

Trade receivables andunbilled receivables of the Group are derived from sales to customers locatedthroughout the world. The Group performs ongoing credit evaluations of itsclients and, to date, has not experienced any material losses. In certain casesthe Company requires letters of credit, other collateral or additionalguarantees. An allowance for doubtful accounts is determined with respect tothose amounts that the Group has determined to be doubtful of collection, andin accordance with an aging key.

Trade receivables andother accounts receivables and prepaid expenses include a total balance ofapproximately $5 million from one of our clients, an Israeli insurancecompany, which we are currently in dispute with. (refer to litigationdisclosure in Note 11 (b))

The Group has nosignificant off-balance-sheet concentration of credit risk such as foreignexchange contracts or foreign hedging arrangements.

r.                  Severancepay:

Certain of the Company’sIsraeli subsidiaries’ liability for severance pay is calculated pursuant toIsraeli severance pay law based on the most recent salary of the employeesmultiplied by the number of years of employment, as of the balance sheet date.Employees are entitled to one month’s salary for each year of employment or aportion thereof. These companies’ liability for all of their employees is fullyprovided for by monthly deposits with severance pay funds, insurance policiesand by accrual. The value of these policies is recorded as an asset in theGroup’s balance sheet.

The deposited fundsinclude profits accumulated up to the balance sheet date. The deposited fundsmay be withdrawn only upon the fulfillment of the obligation pursuant toIsraeli severance pay law or labor agreements. The value of the deposited fundsis based on the cash surrendered value of these policies and includesimmaterial profits.

Severance expenses for theyears ended December 31, 2004, 2005 and 2006 were $2,516, $2,750 and $3,328,respectively.

s.                  Fairvalue of financial instruments:

Thefollowing methods and assumptions were used by the Group in estimating fairvalue and disclosures for financial instruments:

(i)            Thecarrying amounts of cash and cash equivalents, short-term bank deposits, tradereceivables, unbilled receivables, short-term bank credit and trade payablesapproximate their fair values due to the short-term maturity of suchinstruments.

(ii)        Thefair market value of marketable securities is based on quoted market prices(see Note 3).

F-31

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 2—SIGNIFICANT ACCOUNTINGPOLICIES (Continued)**

(iii)    Thecarrying amounts of the Group’s long-term debt and long-term lease depositsapproximate their fair value, estimated by discounting the future cash flows,using incremental borrowing rates for similar type of arrangements.

t.                   Advertisingcosts:

Advertising costs arecharged as expenses to the statement of income, as incurred. Advertisingexpenses for the years ended December 31, 2004, 2005 and 2006 were $821,$1,527 and $1,598 respectively.

u.                Comprehensiveincome (loss)

The Company accounts forcomprehensive income (loss) under the provisions of SFAS No. 130, “ReportingComprehensive Income,” which established standards for the reporting anddisplay of comprehensive income (loss) and its components. Comprehensive income(loss) represents the change in shareholders’ equity during a period fromtransactions and other events and circumstances from non owner sources. Itincludes all changes in equity except those resulting from investments byowners and distributions to owners.

v.                 CapitalizedSoftware:

SFAS No. 86, “Accountingfor the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,”requires capitalization of certain software development costs, subsequent tothe establishment of technological feasibility. Based on the Group’s productdevelopment process, technological feasibility is established upon thecompletion of a working model or a detailed program design. Research anddevelopment costs incurred in the process of developing product improvements ornew products, are generally charged to expenses as incurred. Significant costsincurred by the Group between completion of the working model or a detailedprogram design and the point at which the product is ready for general release,have been capitalized. Capitalized software costs will be amortized by thegreater of the amount computed using the: (i) ratio that current grossrevenues from sales of the software bears to the total of current andanticipated future gross revenues from sales of that software, or (ii) thestraight-line method over the estimated useful life of the product (up to threeyears). The Group assesses the recoverability of this intangible asset on aregular basis by determining whether the amortization of the asset over itsremaining life can be recovered through undiscounted future operating cashflows from the specific software product sold. No impairment of capitalizedsoftware development costs exists as of December 31, 2006 and 2005.

w.              Impactof recently issued accounting pronouncements:

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, “Financial Statements—Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”). SAB 108 requirescompanies to quantify the impact of all correcting misstatements, includingboth the carryover and reversing effects of prior year misstatements, on the currentyear financial statements. SAB 108 is effective for fiscal years endingafter November 15, 2006. The adoption of SAB 108 did not have amaterial effect on the consolidated financial statements.

F-32

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)**

**NOTE 2—SIGNIFICANTACCOUNTING POLICIES (Continued)**

In June 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty inIncome Taxes” (“FIN 48”)—an interpretation of FASB Statement No. 109,“Accounting for Income Taxes.” The Interpretation addresses the determinationof whether tax benefits claimed or expected to be claimed on a tax returnshould be recorded in the financial statements. Under FIN 48, the Companymay recognize the tax benefit from an uncertain tax position only if it is morelikely than not that the tax position will be sustained on examination by thetaxing authorities, based on the technical merits of the position. The taxbenefits recognized in the financial statements from such a position should bemeasured based on the largest benefit that has a greater than fifty percentlikelihood of being realized upon ultimate settlement. FIN 48 alsoprovides guidance on derecognizing, classification, interest and penalties onincome taxes, accounting in interim periods and requires increased disclosures.The provisions of FIN 48 are effective beginning January 1, 2007. TheCompany is currently in the process of assessing the impact the adoption ofFIN 48 will have on its financial statements.

In September 2006, the FASB issued Statement No. 157,“Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS No. 157 applies under other accounting pronouncements that require orpermit fair value measurements. SFAS 157 will be effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. The Company is currently evaluating the effect that the application ofSFAS 157 will have on its consolidated results of operations and financialcondition.

In February 2007,the FASB issued Statement No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities” (“SFAS 159”). SFAS 159 permitscompanies to choose to measure certain financial instruments and certain otheritems at fair value. The standard requires that unrealized gains and losses onitems for which the fair value option has been elected be reported in earnings.SFAS 159 is effective for the company beginning in the first quarter offiscal year 2008, although earlier adoption is permitted. The Company iscurrently evaluating the effect that the application of SFAS 159 will have onits consolidated results of operations and financial condition.

x.      Reclassification:

Certain prior periodamounts have been reclassified to conform to the current period presentation.

**NOTE 3—MARKETABLESECURITIES**

Thefollowing is summary of available-for-sale marketable securities:
|                              | ** ** | **December 31, 2005** | ** ** |
|------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | ** **                      | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                      | ** ** | **unrealized** | ** ** | **Estimated** | ** ** |
| ** **                   | ** ** | **Cost**                        | ** ** | **losses and  impairment** | ** ** | **fair  value** | ** ** |
| Short-term  government notes |       | $2,693                          |       |   | $(42 | ) |   |   | $2,651 |   |   |
|                              |            |                                 |            |  |  |  |  |  |  |  |  |

 

F-33

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)**

**NOTE4—OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES**

| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Government  authorities                    |       | $                     | 833        |   | $ | 698 |   |
| Deferred income  taxes (see also Note 12c) |       | 6,363                 |       | 3,525 |   |
| Prepaid expenses                           |       | 4,005                 |       | 5,131 |   |
| Receivables from  sale of investment       |       | —                |       | 2,865 |   |
| Others                                     |       | 2,216                 |       | 1,814 |   |
|                                       |       | $                     | 13,417     |   | $ | 14,033 |   |

 

**NOTE 5—PROPERTY ANDEQUIPMENT, NET**

a.      Compositionof assets grouped by major classification is as follows:

| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Cost:                                        |       |                  |       |   |   |
| Computers, software and peripheral equipment |       | $41,306               |       | $52,700 |   |
| Motor vehicles                               |       | 1,479                 |       | 1,645 |   |
| Office furniture and equipment               |       | 5,332                 |       | 6,847 |   |
| Leasehold improvements                       |       | 4,345                 |       | 5,762 |   |
|                                         |       | 52,462                |       | 66,954 |   |
| Accumulated depreciation                     |       | 31,154                |       | 38,675 |   |
| Property and equipment,  net                 |       | $21,308               |       | $28,279 |   |

 

Depreciationexpenses for the years ended December 31, 2004, 2005 and 2006 were $4,734,$6,699 and $7,948, respectively.

b.     Cost ofcomputers, software and peripheral equipment at December 31, 2005 and 2006include costs of computer software development for internal use in the amountsof $1,945 and $3,714, respectively.

c.      As forproperty under operating lease, see Note 11a.

d.     As for liens and charges, see Note 11d.

F-34

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)**

**NOTE 6—INTANGIBLE ASSETS,NET**

a.      Intangible assets:

| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Cost:                                  |       |                  |       |   |   |
| Capitalized software development costs |       | $                     | 4,512      |   | $ | 4,393 |   |
| Deferral of costs                      |       | 600                   |       | 653 |   |
| Customer related intangible assets     |       | 4,478                 |       | 9,224 |   |
|                                   |       | 9,590                 |       | 14,270 |   |
| Accumulated  amortization:             |       |                  |       |   |   |
| Capitalized software development costs |       | 183                   |       | 1,924 |   |
| Deferral of costs                      |       | —                |       | 166 |   |
| Customer related intangible assets     |       | 1,469                 |       | 3,844 |   |
|                                   |       | 1,652                 |       | 5,934 |   |
| Intangible  assets, net                |       | $                     | 7,938      |   | $ | 8,336 |   |

 

b.     Amortizationexpenses of customer related intangible assets for the years ended December 31,2004, 2005 and 2006 amounted to $383, $729 and $2,344, respectively, and wereincluded in selling and marketing expenses. Amortization of capitalizedsoftware development costs for the years ended December 31, 2004, 2005 and2006 amounted to $0, $183 and $1,712, respectively, and were included in costof revenues.

Amortization expenses of deferral of costs for theyears ended December 31, 2004, 2005 and 2006 amounted to $0, $0 and $157,respectively, and were included in the cost of revenues.

c.      Thefollowing are estimated amortization expenses of intangible assets for theyears ending:

| **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|------------|------------|
| 2007                  |       | $          | 3,686      |       |
| 2008                  |       | 1,743      |       |
| 2009                  |       | 1,133      |       |
| 2010                  |       | 942        |       |
| 2011 and  thereafter  |       | 832        |       |
|                  |       | $          | 8,336      |       |

 

F-35

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)**

**NOTE 7—GOODWILL**

a.      The changes in the carrying amount ofgoodwill for the years ended December 31, 2005 and 2006 are as follows:

| ** **                                | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------|------------|
| Balance as of  January 1, 2005       |       | $         | 149,158    |   |
| Goodwill acquired  during the year        |       | 16,828    |       |
| Sale of an  investment                    |       | (156      | )          |
| Foreign currency  translation adjustments |       | (6,409    | )          |
| Balance as of  December 31, 2005     |       | $         | 159,421    |   |
| Goodwill acquired  during the year        |       | 33,669    |       |
| Foreign currency  translation adjustments |       | 8,628     |       |
| Balance as of  December 31, 2006     |       | $         | 201,718    |   |

 

b.     As for liens and charges, see Note 11d.

**NOTE 8—SHORT-TERM BANKCREDIT**

Classifiedby currency, linkage terms and interest rates, the credit arrangements are asfollows:

| ** **                                                | ** ** | **Interest rate** | ** ** | **Amount**            | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **December 31,**  | ** ** | **December 31,** | ** ** |
| ** **                                                | ** ** | **2005**               | ** ** | **2006**              | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                | ** ** | **%**                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| In, or linked to, dollar                                  |       | 4.5                    |       | 9.75                  |       | $ | 21,011 |   | $ | 2,477 |   |
| In Euro                                                   |       | —                 |       | 6                     |       | — |   | 2,392 |   |
|                                                      |       |                   |       |                  |       | $ | 21,011 |   | $ | 4,869 |   |
| (1) Total authorized  credit lines (including guarantees) |       |                   |       |                  |       | $ | 139,800 |   | $ | 110,660 |   |

 

The Company has unusedlines of credit in the aggregate amount of approximately $72,560 as of December 31,2006.

**NOTE9—OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES**
|                                                           | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Employees and  payroll accruals                           |       | $                     | 16,764     |   | $ | 21,739 |   |
| Accrued vacation  pay and employee benefits               |       | 9,100                 |       | 11,588 |   |
| Government  authorities                                   |       | 19,002                |       | 7,808 |   |
| Accrued expenses                                          |       | 23,930                |       | 22,073 |   |
| Payables in  connection with acquisitions of subsidiaries |       | 5,162                 |       | 11,271 |   |
| Accrued costs  related to sale of investment              |       | —                |       | 999 |   |
| Others                                                    |       | 1,852                 |       | 650 |   |
|                                                      |       | $                     | 75,810     |   | $ | 76,128 |   |

 

F-36

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 10—LONG-TERM DEBT ANDOTHER LIABILITIES**

a.                 Composedas follows:

| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Long-term bank  loans (1) |       | $                     | 11,610     |   | $ | 5,636 |   |
| Other  liabilities (2)    |       | 1,546                 |       | 2,095 |   |
|                           |       | 13,156                |       | 7,731 |   |
| Less—current  maturities  |       | 6,862                 |       | 4,420 |   |
|                           |       | $                     | 6,294      |   | $ | 3,311 |   |

----

(1)          Thelong-term bank loans default upon the failure of any of the Company’ssubsidiaries named as borrowers under the loans to satisfy certain conditionsand comply with covenants. As of December 31, 2006 and 2005, managementbelieves that the subsidiaries are in compliance with foregoing conditions. Theweighted average interest rate on the bank loans as of December 31, 2005and 2006 is 6.75% and 6.85%, respectively. As of December 31 2006, theinterest rates were fixed (as of December 31, 2005, the interest rateswere both fixed and variable).

(2)          Otherliabilities as of December 31, 2006 include a sum of $750 which reflectsparticipation in leasehold improvements.

b.     Classified by currency, linkage terms andinterest rates, the total amount of the liabilities (before deduction ofcurrent maturities) is as follows:

| ** **                         | ** ** | **Interest rate**  | ** ** | **Amount**            | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **December 31,**   | ** ** | **December 31,** | ** ** |
| ** **                         | ** ** | **2005**                | ** ** | **2006**              | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **%   ** | ** ** | ** **            | ** ** | ** ** | ** ** |
| In, or linked to  dollar           |       |                    | 5-6        |                  |       |   |   | $ | 2,169 |   | $ | 143 |   |
| In NIS—linked to  CPI         |       |                    | 6-8        |                  |       | 6.5-7.5 |   | 10,987 |   | 5,636 |   |
| In, or linked to  other currencies |       |                    | —     |                  |       | 4.6-6 |   | — |   | 1,202 |   |
|                               |       |                    |       |                  |       |   |   | $ | 13,156 |   | $ | 6,981 |   |

 

c.      The loans mature as follows:

| **December 31,**    | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|------------|------------|
| 2007 (current  maturity) |       | $          | 4,420      |       |
| 2008                     |       | 1,500      |       |
| 2009                     |       | 1,061      |       |
|                     |       | $          | 6,981      |       |

 

F-37

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 11—COMMITMENTS ANDCONTINGENT LIABILITIES**

a.      Lease commitments:

TheGroup has various operating lease agreements, which expire on various dates,such as rent facilities and vehicles. Aggregate minimum commitments, undernon-cancelable leases as of December 31, for the years presented, are asfollows:

| **Year**             | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2007                 |       | $          | 21,740     |       |
| 2008                 |       | 15,922     |       |
| 2009                 |       | 9,423      |       |
| 2010                 |       | 5,071      |       |
| 2011                 |       | 3,846      |       |
| 2012 and  thereafter |       | 16,976     |       |
|                 |       | $          | 72,978     |       |

 

Total rent expenses for the years ended December 31,2004, 2005 and 2006 amounted to $7,654, $8,534 and $11,818, respectively.

b.     Litigation:

There are several outstanding claims filed againstsubsidiaries of the Company by ex-employees and others. The Company’smanagement believes that the provision in its consolidated financial statementsand its insurance coverage are adequate to cover probable costs arising fromthese matters.

One of our Israeli subsidiaries is currently in adispute with one of its clients, an Israeli insurance company, regarding theterms and conditions of a software development contract (the “Contract”). Theinsurance company claims that we have materially breached the Contract by nottimely delivering the required software. The insurance company has issued acontract termination notice, has collected autonomous guarantees provided byour subsidiary in the amount of about $2 million, and is demanding paymentof the amounts paid so far, as well as damages. Furthermore, this terminationcould affect our reputation and impair our relations with another client aswell as with additional prospects for the software. We believe that we have notmaterially breached the Contract and that the delays were caused by theinsurance company’s actions. However, we do not contest the insurance company’sright to terminate the contract for convenience, subject to certain provisionsincluding proper settlement of payments, as per the Contract. The Contractprovides for mandatory arbitration, which commenced in January 2007, inwhich we intend to vigorously defend our position. The insurance company andour subsidiary have both issued their respective claims to the arbitrator, aswell as responses to the other party’s claims. The total scope of the projectis approximately $9 million. With respect to this contract approximately$3 million is included in our accounts receivable, and $2 million isincluded in other accounts receivable and prepaid expenses. We can give noassurance at the present time of the exposure, if any, for these claims. Webelieve that our liability insurance policy, which has a cap of $5 millionper claim, should cover such exposure. At this stage we can not estimate theresult of the arbitration and we expect that the arbitration process may beprotracted. If the outcome of the dispute is not in our favor and not in linewith our position described above, it may adversely affect our financialposition, results of operations and cash flows.

F-38

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE11—COMMITMENTS AND CONTINGENT LIABILITIES (Continued)**

c.      Guarantees:

Guarantees are contingent commitments issued by theCompany generally to guarantee the performance of the Group in differentprojects to its customers, such as tenders. The term of a guarantee generallyis equal to the term of the related projects, which can be as short as30 days or as long as 8 years. The maximum potential amount of futurepayments the Group could be required to make under its guarantees at December 31,2005 and December 31, 2006, is $36,168 and $37,336, respectively. TheGroup does not hold collateral to support guarantees when deemed necessary.

d.     Liens and charges:

To secure its liabilities, the Group recorded fixedand floating charges on the Company’s holdings in subsidiaries, and on theproperty and equipment and goodwill of the Group.

e.      Forcontingencies related to acquisitions of subsidiaries see Note 1b.

f.      For the bank covenants for one of the subsidiaries, seeNote 10a(1).

**NOTE 12—INCOME TAXES**

a.      Income (loss) before taxes consists of thefollowing:

| ** ** | ** ** | **Year ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Domestic   |       | $                                          | 2,178      |   | $ | 1,239 |   | $ | 7,476 |   |
| Foreign    |       | 15,322                                     |       | 23,437 |   | 30,204 |   |
|       |       | $                                          | 17,500     |   | $ | 24,676 |   | $ | 37,680 |   |

 

b.     Taxes on income are comprised as follows:

| ** **                       | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Current taxes                    |       | $                                          | 2,930      |   | $ | 6,631 |   | $ | 6,435 |   |
| Taxes in respect  of prior years |       | —                                     |       | 158 |   | 2,375 |   |
| Deferred income  tax benefit     |       | (610                                       | )          | (3,271 | ) | (775 | ) |
|                             |       | $                                          | 2,320      |   | $ | 3,518 |   | $ | 8,035 |   |
| Domestic                         |       | $                                          | 276        |   | $ | 566 |   | $ | 2,780 |   |
| Foreign                          |       | 2,044                                      |       | 2,952 |   | 5,255 |   |
|                             |       | $                                          | 2,320      |   | $ | 3,518 |   | $ | 8,035 |   |

 

F-39

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE12—INCOME TAXES (Continued)**

c.      Deferredtaxes on income:

Deferredincome taxes reflect the net tax effect of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of the Group’sdeferred tax liabilities and assets are as follows:

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Deferred tax assets:                                 |       |                  |       |   |   |
| Reserves and  allowances                             |       | $                     | 4,906      |   | $ | 4,224 |   |
| Different  depreciation rates                        |       | 166                   |       | 206 |   |
| Net operating  loss carry forwards of subsidiaries   |       | 8,599                 |       | 12,755 |   |
| Deferred tax  asset before valuation allowance       |       | 13,671                |       | 17,185 |   |
| Valuation  allowance                                 |       | (2,171                | )          | (5,020 | ) |
| Deferred tax  asset                                  |       | 11,500                |       | 12,165 |   |
| Deferred tax  liability related to intangible assets |       | —                |       | (1,409 | ) |
| Net deferred tax  asset                              |       | $                     | 11,500     |   | $ | 10,756 |   |
| Domestic:                                            |       |                  |       |   |   |
| Current deferred  tax liability, net                 |       | (134                  | )          | (298 | ) |
| Non current  deferred tax asset                      |       | 758                   |       | 569 |   |
|                                                 |       | 624                   |       | 271 |   |
| Foreign:                                             |       |                  |       |   |   |
| Current deferred  tax asset                          |       | 6,363                 |       | 3,525 |   |
| Non current  deferred tax asset                      |       | 4,513                 |       | 6,960 |   |
|                                                 |       | 10,876                |       | 10,485 |   |
|                                                 |       | $                     | 11,500     |   | $ | 10,756 |   |

 

Current deferredtax liability, net is included within other accounts payables and accruedexpenses, current deferred tax asset, net is included within other accountsreceivables and prepaid expenses, in our balance sheet.

d.     As of December 31,2006, the Company’s subsidiaries in Israel, the United Kingdom, theNetherlands, Spain and Singapore have estimated total available carry forwardtax losses of $9,904, $7,927, $7,903, 13,835 and $2,163, respectively, tooffset against future taxable profits.

Management currently believes that since certain ofthe Company’s subsidiaries have a history of losses it is more likely than notthat some of the deferred tax assets regarding the loss carry forwards will notbe utilized in the foreseeable future. Thus, a valuation allowance was providedto reduce deferred tax assets to their realizable value. During the year 2006,the net change in valuation allowance was in the amount of $2,280.

F-40

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE12—INCOME TAXES (Continued)**

The cumulative amount of undistributed earnings offoreign subsidiaries, which is intended to be permanently reinvested and forwhich U.S. income taxes have not been provided, totaled approximately $26,870and $42,157 at December 31, 2005 and 2006, respectively. Determination ofthe deferred tax liability is not practicable.

e.      TheCompany has tax benefits that India provides to the export of IT services.These benefits provide a complete exemption from corporate income tax forexported IT services, compared to an ordinary corporate tax rate of approximately34%. These tax benefits are expected to be valid until March 31, 2009.

f.      In February 2006,the Company paid the Israeli Tax Authority (“ITA”) a sum of $3,400 in fullpayment of an assessment agreement with ITA regarding a tax assessment of theIsraeli subsidiaries of the Company for the years 1999 through 2003. Taxes inrespect of prior years mainly represent the implications of the tax assessmentagreement on      years.

g.      A reconciliation between the theoreticaltax expenses, assuming all income is taxed at the statutory tax rate applicableto income of the Company and the actual tax expense as reported in theconsolidated statements of income, is as follows:

| ** **                                                                      | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Income before  taxes, as reported in the consolidated statements of income      |       | $                                          | 17,500     |   | $ | 24,676 |   | $ | 37,680 |   |
| Statutory tax  rate                                                             |       | 35                                         | %          | 35 | % | 35 | % |
| Theoretical tax  expenses on the above amount at the federal statutory tax rate |       | $                                          | 6,125      |   | $ | 8,637 |   | $ | 13,188 |   |
| Effect of tax  holiday                                                          |       | (1,604                                     | )          | (2,195 | ) | (4,177 | ) |
| Effect of foreign  subsidiaries with different tax rates                        |       | (26                                        | )          | (1,659 | ) | (1,390 | ) |
| Deferred taxes on  losses for which valuation   allowance was provided          |       | (2,674                                     | )          | (1,629 | ) | (2,280 | ) |
| Non-deductible  expenses                                                        |       | 440                                        |       | 791 |   | 874 |   |
| Taxes in respect  of prior years                                                |       | —                                     |       | 158 |   | 2,375 |   |
| Effect of gain on  sale of investment at cost                                   |       | —                                     |       | — |   | (510 | ) |
| Others                                                                          |       | 59                                         |       | (585 | ) | (45 | ) |
| Actual tax  expense (benefit)                                                   |       | $                                          | 2,320      |   | $ | 3,518 |   | $ | 8,035 |   |
| Basic net earnings per share related to tax holiday                             |       | $                                          | 0.07       |   | $ | 0.06 |   | $ | 0.12 |   |
| Diluted net earnings per  share related to tax holiday                          |       | $                                          | 0.06       |   | $ | 0.06 |   | $ | 0.11 |   |

 

**NOTE13—RELATED PARTIES BALANCES**

| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Balances with related  parties:             |       |                  |       |   |   |   |   |
| Non-consolidated  affiliate current balance |       | $                     | 582        |   |   | $ | — |   |   |
|                                             |            |                       |            |  |  |  |  |  |  |

 

F-41

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 14—STOCKHOLDERS’EQUITY**

a.      General:

On September 29, 2004, the Securities andExchange Commission declared effective the Company’s Registration Statement inrespect of its IPO. The closing of the Company’s IPO occurred on October 4,2004. Upon the closing, the Company received from the underwriters of the IPO anet amount of $73,129 and issued 6,552,774 new shares of Common stock. Certainstockholders sold 5,119,226 shares of Common stock for a net sum of $57,131.Upon the closing, all the shares of Preferred stock were converted to shares ofCommon stock. The Company issued to the holders of the Class B Preferredstock 541,946 shares of Common stock as cumulative accumulated dividend at theprice of $18.07 per share. The Company also issued to the holders of the Class CPreferred stock 1,492,880 shares of Common stock pursuant to the ratchetdescribed below. On October 5, 2004, the underwriters exercised in fullthe over-allotment option granted to them and purchased, on October 12,2004, from the Company an additional 1,750,800 shares of Common stock, forwhich the Company received the additional net sum of $19,521.

The Company’s stockholders approved on September 2,2004, to adopt a 0.7193-for-1 reverse split of the Company’s sharesof Common stock, to be effectedon the effective date of filing an amendment to the Company’s certificate ofincorporation in respect of the reverse split. Such filing became effective on September 20,2004. All Common stock, options, warrants and per share data included in thesefinancial statements for all periods presented as well as the exchange ratiosfor the Preferred stock and convertible loan from stockholders have beenretroactively adjusted to reflect this 0.7193-for-1 reverse split.

Common stock confers upon its holders the right toreceive notice to participate and vote in the stockholders meetings of theCompany, the right to receive dividends, if and when declared, and the right toreceive assets of theCompany upon liquidation.

b.     Stockoption plans:

1.      Under theCompany’s 1999 Israeli and 2003 Stock Option Plans (the “Israeli Plans”) andthe Company’s U.S. 2001 and 2003 stock option plans (including the assumptionof the Apar Employee Equity Plan) (the “U.S. Plans”), options may be granted toofficers, directors, employees and consultants of the Company or itssubsidiaries.

2.      Pursuantto the Israeli Plans, 7,640,149 options to purchase Common stock were approved.The number of shares issuable upon exercise of outstanding options as ofDecember 31, 2006, under these Israeli Plans is 2,068,296, and options topurchase 382,933 shares are available for future grant.

Pursuant to the U.S. Plans, options to purchase up to2,557,900 shares were approved. The number of shares issuable upon exercise ofoutstanding options as of December 31, 2006, under these U.S. Plans is842,806 and options to purchase 354,668 shares are available for future grant.

3.      Optionsgranted under the Israeli Plans and the U.S. Plans are exercisable between fiveto ten years from the date of grant. The exercise price of the options grantedunder the Israeli Plans may not be less than the par value of the shares forwhich the options are exercisable. The minimum exercise price of the optionsgranted under the U.S. Plans may not be less than a price ranging from 80% to110% of the fair market value, depending on the applicable circumstances, ofthe shares for which the options are exercisable. Any options that are canceledor forfeited before expiration become available for future grants.

F-42

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 14—STOCKHOLDERS’EQUITY (Continued)**

4.      OnSeptember 2, 2004, the Board of Directors of the Company and itsstockholders approved an increase of 400,000 options to the U.S. Stock OptionPlan and 600,000 options to the 2003 Israeli Stock Option Plan.

5.      A summaryof the Company’s employees’ stock option activity and related information is asfollows:
|                                              | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | ** **                                 | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                   | ** ** | ** **                                 | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                                   | ** ** | **Number of**                         | ** ** | **exercise** | ** ** | **Number of** | ** ** | **exercise** | ** ** | **Number of** | ** ** | **exercise** | ** ** |
| ** **                                   | ** ** | **Options**                                | ** ** | **price** | ** ** | **Options** | ** ** | **price** | ** ** | **Options** | ** ** | **price** | ** ** |
| Outstanding at  the beginning of  the year   |       | 5,217,834                                  |       |   | $ | 7.55 |   |   | 6,268,136 |   |   | $ | 8.32 |   |   | 6,313,306 |   |   | $ | 9.29 |   |   |
| Granted                                      |       | 1,143,166                                  |       |   | $ | 11.82 |   |   | 1,571,800 |   |   | $ | 11.69 |   |   | 26,974 |   |   | $ | 8.47 |   |   |
| Exercised                                    |       | (23,247                                    | )          |   | $ | 1.78 |   |   | (1,314,206 | ) |   | $ | 7.39 |   |   | (3,630,678 | ) |   | $ | 7.89 |   |   |
| Forfeited                                    |       | (69,617                                    | )          |   | $ | 10.23 |   |   | (212,424 | ) |   | $ | 10.19 |   |   | (218,695 | ) |   | $ | 9.2 |   |   |
| Outstanding at  the end of  the year         |       | 6,268,136                                  |       |   | $ | 8.32 |   |   | 6,313,306 |   |   | $ | 9.29 |   |   | 2,490,907 |   |   | $ | 10.65 |   |   |
| Exercisable options at  the end of  the year |       | 4,067,023                                  |       |   | $ | 8.20 |   |   | 5,878,250 |   |   | $ | 9.28 |   |   | 2,302,816 |   |   | $ | 10.72 |   |   |

 

The options outstanding asof December 31, 2006 have been classified by exercise price as follows:
|                    | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** **      | ** **            | ** ** | **Weighted**      | ** ** |
|--------------------|------------|-----------------------|------------|-----------------|------------|--------------|-----------------|-----------------------|------------|-------------------|------------|
| ** **         | ** ** | **Options**           | ** ** | **Weighted**    | ** ** | ** **   | ** **      | **Options**           | ** ** | **average**       | ** ** |
| ** **         | ** ** | **outstanding**       | ** ** | **average**     | ** ** | **Weighted** | ** **      | **Exercisable**       | ** ** | **exercise**      | ** ** |
| ** **         | ** ** | **as of**        | ** ** | **remaining**   | ** ** | **average**  | ** **      | **as of**        | ** ** | **price of** | ** ** |
| ** **         | ** ** | **December 31,** | ** ** | **contractual** | ** ** | **exercise** | ** **      | **December 31,** | ** ** | **options**       | ** ** |
| **Exercise price** | ** ** | ** **            | ** ** | **2006**        | ** ** | **life**     | ** **      | **price**             | ** ** | **2006**          | ** ** | **exercisable** | ** ** |
| ** **         | ** ** | **Years**             | ** ** |
| $0.01              |       |                  | 2,158      |            |       |         | 0.2   |                  |       |              | $          | 0.01 |   |   |   | 2,158 |   |   |   | $ | 0.01 |   |   |
|   1.78   |       |                  | 37,127     |            |       |         | 3.73            |                  |       |              | 1.78       |   |   |   | 37,127 |   |   |   | 1.78 |   |   |
|   5.57   |       |                  | 35,170     |            |       |         | 5.44            |                  |       |              | 5.57       |   |   |   | 35,170 |   |   |   | 5.57 |   |   |
|   8.47   |       |                  | 656,079    |            |       |         | 1.21            |                  |       |              | 8.47       |   |   |   | 580,628 |   |   |   | 8.47 |   |   |
| 10.12              |       |                  | 83,334     |            |       |         | 4.00            |                  |       |              | 10.12      |   |   |   | — |   |   |   | 10.12 |   |   |
| 11.82              |       |                  | 1,632,039  |            |       |         | 3.92            |                  |       |              | 11.82      |   |   |   | 1,622,733 |   |   |   | 11.82 |   |   |
| 12.75              |       |                  | 45,000     |            |       |         | 5.06            |                  |       |              | 12.75      |   |   |   | 25,000 |   |   |   | 12.75 |   |   |
|               |       |                  | 2,490,907  |            |       |         | 3.25            |                  |       |              | $          | 10.65 |   |   |   | 2,302,816 |   |   |   | $ | 10.72 |   |   |
|                    |            |                       |            |                 |            |              |                 |                       |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The intrinsic value of the exercised options during2006 was $22,378 and the intrinsic value of the outstanding options andexercisable options as of December 31, 2006 is $8,994 and $8,159,respectively.

F-43

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE14—STOCKHOLDERS’ EQUITY (Continued)**

Substantially all of theoptions were granted with exercise prices equal to or higher than the value onthe grant date. For the excluded options, the weighted average fair values ofoptions granted during the years ended December 31, 2004, 2005 and 2006were:
|                                             | ** ** | **Exceeds market price**         | ** ** | **Less than market price**  | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **Year ended December 31,** | ** ** | **Year ended December 31,** | ** ** |
| ** **                                  | ** ** | **2004**                                   | ** ** | **2005**                                   | ** ** | **2006** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| Weighted average  exercise prices           |       |                                       | $          | —                                     |       |   | $ | 11.69 |   | $ | — |   | $ | 11.82 |   | $ | 11.82 |   | $ | 8.47 |   |
| Weighted average fair  values on grant date |       |                                       | $          | —                                     |       |   | $ | 2.08 |   | $ | — |   | $ | 5.73 |   | $ | 3.87 |   | $ | 2.74 |   |

 

In November and December 2005, the Companygranted 1,404,600 fully vested options to employees and managers of the Companywith an exercise price of $11.82 per share exercisable through December 31,2010.

As of December 21, 2005, 589,213 unvestedout-of-the-money options with an exercise price of $11.82 per share withrelated vesting period from January 1, 2006 through January 1, 2007had been accelerated.

The Company’sdecision to accelerate the vesting of those options and to grant fully vestedoptions was based primarily upon the issuance of SFAS No. 123R, whichrequires the Company to treat all unvested stock options as compensationexpense effective January 1, 2006. The Company believes that theacceleration of vesting of those options enabled the Company to avoidrecognizing stock-based compensation expense associated with these options infuture periods. Additional purposes of the fully vested grant and for theacceleration were to make the options more attractive to the recipients, and toavoid discrimination between groups of option holders.

6.      Warrantsissued to consultants:

The Company’s outstanding warrants to consultants asof December 31, 2006 are as follows:

| **Issuance date** | ** ** | ** ** | ** ** | **Options for  Common stock** | ** ** | **Exercise price  per share** | ** ** | **Options  exercisable** | ** ** | **Exercisable  through** | ** ** |
|------------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| May 2000          |       |       | 19,591     |                                    |       |                                    | $          | 8.47                     |       |                     |       | 19,591 |   |   | May 31, 2007 |   |
|                        |            |            |            |                                         |            |                                         |            |                          |            |                          |            |  |  |  |  |  |  |  |

 

7.      Warrantsissued for financing transactions:

In connection with loans received in March 2000,the Company issued to two banks in Israel warrants to purchase an aggregate of101,270 shares of Common stock of the Company with an exercise price of $10.33per share exercisable through March 2005. In November 2003, warrantsto purchase 60,989 shares were exercised resulting in the issuance of 26,132shares of Common stock. In January 2005, the remaining warrants topurchase 40,281 shares were exercised resulting in the issuance of 8,561 sharesof Common stock.

The Companyaccounted for these warrants under APB No. 14, “Accounting for ConvertibleDebt and Debt Issued with Stock Purchase Warrants.” The total amount of thedeemed discount on the loans as a result of the warrant issuance is amortizedover the period of the loans as interest expenses. The fair value of the warrantsis immaterial.

8.      TheCompany does not intend to pay cash dividends in the foreseeable future.

F-44

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE14—STOCKHOLDERS’ EQUITY (Continued)**

9.      TheExecutive Committee of the Company approved and resolved on August 31,2004 to provide to certain optionees (specifically, those who exchanged theiroptions in two previously public entities acquired by the Company for optionsin the Company) the right to redeem the Company’s options for a cash payment.The grant date occurred during the fourth quarter of 2004.

The redemption right was exercisable from October 1,2004 until May 31, 2006. Each option subject to the redemption right wastransferable by the employee to the Company for a cash payment linked, at theemployee’s sole discretion, either to the Israeli CPI with NIS interest at therate of 5% per year, or to the U.S. dollar with U.S. dollar interest at therate of 6% per year, calculated from the original option grant date of September 23,1999 or October 3, 1999 up to the redemption date. Each of 272,976 optionswere exercisable to acquire one share of the Company’s Common stock at a priceof $3.49 and were redeemable at the NIS equivalent amount of $10.12 per optionas of May 31, 2006. Each of 77,382 options were exercisable to acquire oneshare of The Company’s Common stock at a price of $7.45 and were redeemable atthe NIS equivalent amount of $7.63 per option as of May 31, 2006.

The Company accounted for the rights following theguidance of FIN No. 28, “Accounting for Stock Appreciation Rights and OtherVariable Stock Option or Award Plans,” relating to tandem awards and EITF No. 00-23,“Issues Related to the Accounting for Stock Compensation under APB No. 25and FIN No. 44.” Accordingly, once the Company believed it was likely thatthe rights would be exercised in the future, a liability was recorded at thethen value of the redemption rights with a corresponding charge to compensationexpense.

On May 31, 2006, the redemption value of theredeemable options was higher than the difference between the market price ofthe Company’s shares and the strike price of the options. The Company hadpreviously recorded all the expected redemption value. The holders of 289,836options preferred to exercise their options and sell their shares and receivefrom the Company in cash only the difference between the redemption values andthe proceeds they received from the sale. The holders of the remaining 60,522options elected to fully redeem the options.

The net cash payment was therefore only $1,485 and theremaining balance of the previously recorded liability, or $1,868, wasclassified as equity.

F-45

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 15—BASIC AND DILUTEDNET EARNINGS PER SHARE**

The following tablesets forth the computation of the basic and diluted net earnings per share:

1.                Numerator

|                                                                                                                           | ** ** | **Year ended December 31,** | ** ** |       |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------|
| ** **                                                                                                                     | ** ** | **2004**                                   | ** ** | **2005**   | ** ** | **2006** | ** ** |   |
| ** **                                                                                                                     | ** ** | **Net earnings In thousands**    | ** ** | ** ** | ** ** |
| Net income from continuing  operations as reported                                                                             |       | $                                          | 14,377     |       | $ | 21,194 |   | $ | 29,813 |   |   |
| Allocation of  undistributed earnings on Class B Convertible Preferred stock                                              |       | (1,356                                     | )          | —     |   | — |   |   |
| Numerator for basic and  diluted per share data:                                                                               |       |                                       |       |       |   |   |   |   |
| Net income from  continuing operations after allocation of undistributed earnings on  Class B Convertible Preferred stock |       | 13,021                                     |       | 21,194     |   | 29,813 |   |   |
| Gain from  extraordinary item, net of taxes                                                                                    |       | —                                     |       | 495        |   | — |   |   |
| Net income after  allocation of undistributed earnings on Class B Convertible Preferred  stock                            |       | $                                          | 13,021     |       | $ | 21,689 |   | $ | 29,813 |   |   |

 

2.                Denominator

| ** **                                                                                                                                       | ** ** | **Year ended December 31,**            | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                                                                       | ** ** | **2004**                                              | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                                                                       | ** ** | **Number of shares in thousands** | ** ** |
| Weighted average  number of shares of Common stock                                                                                               |       | 20,483                                                |       | 34,413 |   | 35,999 |   |
| Weighted average  number of shares of Preferred stock                                                                                            |       | 1,809                                                 |       | — |   | — |   |
| Denominator for  basic net earnings per share                                                                                                    |       | 22,292                                                |       | 34,413 |   | 35,999 |   |
| Effect of dilutive  securities:                                                                                                                  |       |                                                  |       |   |   |   |   |
| Stock options and warrants                                                                                                                       |       | 2,456                                                 |       | 1,248 |   | 550 |   |
| Dilutive  potential common shares                                                                                                                |       | 2,456                                                 |       | 1,248 |   | 550 |   |
| Denominator for diluted  net earnings per share—adjusted weighted average shares, assumed conversions  and exercise of options and warrants |       | 24,748                                                |       | 35,661 |   | 36,549 |   |

 

3.                The total weighted average number ofshares related to the outstanding options and warrants, Preferred stock andconvertible loan from stockholders excluded from the calculations of dilutednet earnings per share, as they would have been anti-dilutive for all periodspresented, was 186,401, 1,230,265 and 1,784,338 for the years ended December 31,2004, 2005 and 2006, respectively.

**NOTE 16—SEGMENT REPORTING**

The Company’s segment information has been prepared inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information.” Operating segments are defined as components of an enterpriseengaging in business activities about which separate financial information isavailable that is evaluated regularly by the Company’s chief operatingdecision-maker in deciding how to allocate resources and assess performance.

F-46

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE16—SEGMENT REPORTING (Continued)**

On January 1, 2006, the Company completed thereorganization of its operations into operating segments. The Company’s chiefoperating decision-maker is its chief executive officer, who evaluates theCompany’s performance and allocates resources based on segment revenues andoperating profit.

The Company’soperating segments are:

1.                 **Managed Strategic Services (MSS)**, whichincludes India-based offshore services as well as system integration andapplication development and consulting services. Verticals served by thissegment are: independent software vendors, life sciences and healthcare andothers.

2.                 **Technologies & Systems Group (TSG)**,which includes system integration and application development, real-timesystems development, consulting and outsourcing services for the defense,government and homeland security vertical, as well as systems for thetelecommunications vertical.

3.                 **Ness Europe**, which includes systemintegration and application development, outsourcing and software and consultingfor Eastern European and Western European customers, including near-shoreservices from Eastern Europe for Western European customers. Verticals servedby this segment are: telecommunications and utilities, financial services andothers.

4.                 **Ness Israel**, which includes systemintegration and application development, outsourcing, software and consultingand quality assurance and training for customers in Israel within the followingverticals: financial services, government, life sciences and healthcare, manufacturing,retail, transportation and others.

5.                 **Other**, which comprises operationsrepresenting, individually, less than 10% of the Company’s consolidatedrevenues and operating profit. These include its operations in the UnitedKingdom and Asia Pacific as well as the recently acquired Ness InnovativeBusiness Services division (formerly Innova).

Segment operating profit is defined as income fromoperations excluding unallocated headquarters costs. Expenses included insegment operating profit consist principally of direct selling, general,administrative and delivery costs. Certain general and administrative expensesand a portion of depreciation and amortization are not specifically allocatedto specific segments as management believes they are not directly attributableto any specific segment. Accordingly, these expenses are categorized as “UnallocatedExpenses” and adjusted against the Company’s total income from operations.Additionally, the Company’s management has determined that it is not practicalto allocate certain identifiable assets by segment, when such assets are usedinterchangeably among the segments.

F-47

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE 16—SEGMENT REPORTING(Continued)**

The table belowpresents financial information for the Company’s five reportable segments.Prior period data is presented on a pro forma basis, as the Company was notorganized into SFAS No. 131 operating segments at that time.

| ** **                          | ** ** | **Year ended December 31, 2006** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|
| ** **                          | ** ** | **MSS**                                              | ** ** | **TSG** | ** ** | **Ness  Europe** | ** ** | **Ness  Israel** | ** ** | **Other** | ** ** | **Unallocated** | ** ** | **Total** | ** ** |
| Revenues from  external customers   |       | $                                                    | 80,597     |   | $ | 56,391 |   | $ | 88,223 |   | $ | 190,009 |   | $ | 59,098 |   |   | — |   |   | $ | 474,318 |   |
| Operating income                    |       | $                                                    | 9,645      |   | $ | 6,929 |   | $ | 8,472 |   | $ | 14,154 |   | $ | 1,627 |   |   | $ | (7,216 | ) |   | $ | 33,611 |   |
| Financial  expenses, net            |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 1,280 |   |
| Other income, net                   |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 348 |   |
| Gain on sale of  investment at cost |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 5,001 |   |
| Income before  taxes on income      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | $ | 37,680 |   |
| Depreciation and  amortization      |       | $                                                    | 2,527      |   | $ | 186 |   | $ | 2,282 |   | $ | 4,752 |   | $ | 2,034 |   |   | $ | 380 |   |   | $ | 12,161 |   |
| Expenditure for  segments assets    |       | $                                                    | 3,070      |   | $ | 822 |   | $ | 1,133 |   | $ | 5,325 |   | $ | 2,726 |   |   | $ | 148 |   |   | $ | 13,224 |   |
| Segment assets                      |       | $                                                    | 91,732     |   | $ | 60,441 |   | $ | 95,939 |   | $ | 205,288 |   | $ | 71,723 |   |   | $ | 16,494 |   |   | $ | 541,617 |   |

 

| ** **                        | ** ** | **Year ended December 31, 2005** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **MSS**                                              | ** ** | **TSG** | ** ** | **Ness  Europe** | ** ** | **Ness  Israel** | ** ** | **Other** | ** ** | **Unallocated** | ** ** | **Total** | ** ** |
| Revenues from  external customers |       | $                                                    | 80,544     |   | $ | 44,200 |   | $ | 63,554 |   | $ | 168,234 |   | $ | 28,904 |   |   | — |   |   | $ | 385,436 |   |
| Operating income                  |       | $                                                    | 7,927      |   | $ | 5,617 |   | $ | 8,051 |   | $ | 13,148 |   | $ | (403 | ) |   | $ | (7,900 | ) |   | $ | 26,440 |   |
| Financial  expenses, net          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 1,521 |   |
| Other expenses,  net              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 243 |   |
| Income before  taxes on income    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | $ | 24,676 |   |
| Depreciation and  amortization    |       | $                                                    | 2,693      |   | $ | 107 |   | $ | 1,141 |   | $ | 3,074 |   | $ | 290 |   |   | $ | 462 |   |   | $ | 7,767 |   |
| Expenditure for  segments assets  |       | $                                                    | 2,861      |   | $ | 119 |   | $ | 534 |   | $ | 4,012 |   | $ | 297 |   |   | $ | 98 |   |   | $ | 7,921 |   |
| Segment assets                    |       | $                                                    | 84,050     |   | $ | 58,767 |   | $ | 86,812 |   | $ | 187,985 |   | $ | 17,963 |   |   | $ | 18,791 |   |   | $ | 454,368 |   |

 

| ** **                        | ** ** | **Year ended December 31, 2004** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **MSS**                                              | ** ** | **TSG** | ** ** | **Ness  Europe** | ** ** | **Ness  Israel** | ** ** | **Other** | ** ** | **Unallocated** | ** ** | **Total** | ** ** |
| Revenues from  external customers |       | $                                                    | 73,229     |   | $ | 37,047 |   | $ | 25,294 |   | $ | 143,453 |   | $ | 25,502 |   |   | — |   |   | $ | 304,525 |   |
| Operating income                  |       | $                                                    | 6,825      |   | $ | 3,980 |   | $ | 2,472 |   | $ | 12,019 |   | $ | (130 | ) |   | $ | (4,114 | ) |   | $ | 21,052 |   |
| Financial  expenses, net          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 3,461 |   |
| Other expenses,  net              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | 91 |   |
| Income before  taxes on income    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   | $ | 17,500 |   |
| Depreciation and  amortization    |       | $                                                    | 1,428      |   | $ | 94 |   | $ | 893 |   | $ | 1,915 |   | $ | 259 |   |   | $ | 528 |   |   | $ | 5,117 |   |
| Expenditure for  segments assets  |       | $                                                    | 5,577      |   | $ | 185 |   | $ | 783 |   | $ | 2,482 |   | $ | 643 |   |   | $ | 211 |   |   | $ | 9,881 |   |
| Segment assets                    |       | $                                                    | 75,101     |   | $ | 44,197 |   | $ | 44,922 |   | $ | 171,613 |   | $ | 16,447 |   |   | $ | 72,476 |   |   | $ | 424,756 |   |

 

F-48

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

**NOTE16—SEGMENT REPORTING (Continued)**

The Company’s total revenues are attributed togeographic areas based on the location of the end customer.

The following presents total revenues for the yearsended December 31, 2004, 2005 and 2006 and long-lived assets as of December 31,2005 and 2006:

| ** **                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues from sales to  unaffiliated customers: |       |                                       |       |   |   |   |   |
| Israel                                          |       | $                                          | 172,259    |   | $ | 200,120 |   | $ | 227,992 |   |
| United States                                   |       | 75,890                                     |       | 85,917 |   | 120,768 |   |
| Europe                                          |       | 39,513                                     |       | 74,845 |   | 104,376 |   |
| Asia and the Far East                           |       | 13,844                                     |       | 19,426 |   | 16,673 |   |
| Others                                          |       | 3,019                                      |       | 5,128 |   | 4,509 |   |
|                                            |       | $                                          | 304,525    |   | $ | 385,436 |   | $ | 474,318 |   |

 

| ** **            | ** ** | **December 31,** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Long-lived assets:    |       |                  |       |   |   |
| Israel                |       | $                     | 101,463    |   | $ | 111,634 |   |
| United States         |       | 60,057                |       | 81,740 |   |
| Europe                |       | 19,114                |       | 34,567 |   |
| Asia and the Far East |       | 8,018                 |       | 10,377 |   |
| Others                |       | 15                    |       | 15 |   |
|                  |       | $                     | 188,667    |   | $ | 238,333 |   |

 

**NOTE 17—SELECTED DATA**

**a.     Selected statements ofoperations data:**

| ** ** | ** **                                    | **Year ended December 31,** | ** ** |
|------------|-----------------------------------------------|--------------------------------------------|------------|
| ** ** | ** **                                    | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| 1.         | Software  development costs:                  |                                       |       |   |   |   |   |   |
|       | Total  expenses                               |                                       | $          | 2,559 |   | $ | 1,049 |   | $ | 233 |   |
|       | Less  - capitalized software development cost |                                       | 2,559      |   | 1,049 |   | 233 |   |
|       |                                          |                                       | $          | — |   | $ | — |   | $ | — |   |

 

 

F-49

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) U.S. dollars in thousands (except share and per share data)

 

| ** ** | ** **                                    | **Year ended December 31,**               | ** ** |
|------------|-----------------------------------------------|----------------------------------------------------------|------------|
| ** ** | ** **                                    | **    2004    ** | ** ** | **    2005    ** | ** ** | **   2006   ** | ** ** |
| 2.         | Financial expenses, net:                      |                                                     |       |   |   |   |   |   |   |   |   |   |
|       | Financial Expenses:                           |                                                     |       |   |   |   |   |   |   |   |   |   |
|       | Interest on short-term  loans and bank credit |                                                     |       | $ | (451 | ) |   |   | $ | (1,263 | ) |   | $ | (1,588 | ) |
|       | Interest on long-term  bank loans             |                                                     |       | (3,863 | ) |   |   | (1,942 | ) |   | (1,343 | ) |
|       | Losses from trading  marketable securities    |                                                     |       | (32 | ) |   |   | — |   |   | — |   |
|       | Foreign currency  exchange losses             |                                                     |       | — |   |   |   | (221 | ) |   | (421 | ) |
|       |                                          |                                                     |       | (4,346 | ) |   |   | (3,426 | ) |   | (3,352 | ) |
|       | Financial income:                             |                                                     |       |   |   |   |   |   |   |   |   |   |
|       | Foreign currency  exchange gain               |                                                     |       | 492 |   |   |   | — |   |   | — |   |
|       | Gain from sale of  marketable securities      |                                                     |       | 9 |   |   |   | 30 |   |   | 128 |   |
|       | Interest on short-term  bank deposits         |                                                     |       | 384 |   |   |   | 1,875 |   |   | 1,944 |   |
|       |                                          |                                                     |       | 885 |   |   |   | 1,905 |   |   | 2,072 |   |
|       |                                          |                                                     |       | $ | (3,461 | ) |   |   | $ | (1,521 | ) |   | (1,280 | ) |
|            |                                               |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**b.     Selected other data:**

| ** **                                                     | ** ** | **Balance at  beginning  of period** | ** ** | **Provision  for doubtful  accounts** | ** ** | **Write-off of  previously  provided  accounts** | ** ** | **Translation  adjustments** | ** ** | **Balance  at end of  period** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------|------------|------------------------------------------|------------|
| Year ended  December 31, 2006  Allowance for doubtful accounts |       |                                           | $          | 2,320                                      |       |                                                  |       | $                            | 1,025      |                                     |       |   | $ | (476 | ) |   |   | $ | (57 | ) |   |   | $ | 2,812 |   |   |
| Year ended  December 31, 2005  Allowance for doubtful accounts |       |                                           | $          | 2,154                                      |       |                                                  |       | $                            | 955        |                                     |       |   | $ | (720 | ) |   |   | $ | (69 | ) |   |   | $ | 2,320 |   |   |
| Year ended  December 31, 2004  Allowance for doubtful accounts |       |                                           | $          | 1,785                                      |       |                                                  |       | $                            | 526        |                                     |       |   | $ | (112 | ) |   |   | $ | (45 | ) |   |   | $ | 2,154 |   |   |

 

**NOTE 18—CONSOLIDATEDQUARTERLY FINANCIAL DATA (UNAUDITED)**

| ** **       | ** ** | **Three months ended** | ** ** |
|------------------|------------|----------------------------------|------------|
| ** **       | ** ** | **Mar 31,  2005**           | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** | **Mar 31,  2006** | ** ** | **Jun 30,  2006** | ** ** | **Sep 30,  2006** | ** ** | **Dec 31,  2006** | ** ** |
| ** **       | ** ** | **(unaudited)**                  | ** ** |
| Revenues         |       | $                                | 88,405     |   | $ | 94,218 |   | $ | 97,719 |   | $ | 105,094 |   | $ | 107,042 |   | $ | 116,614 |   | $ | 119,135 |   | $ | 131,527 |   |
| Gross profit     |       | 25,828                           |       | 26,172 |   | 28,091 |   | 30,114 |   | 31,326 |   | 32,633 |   | 34,040 |   | 34,215 |   |
| Operating income |       | 5,855                            |       | 4,917 |   | 7,666 |   | 8,003 |   | 7,905 |   | 7,474 |   | 10,160 |   | 8,072 |   |
| Net income       |       | $                                | 4,926      |   | $ | 3,983 |   | $ | 6,017 |   | $ | 6,764 |   | $ | 6,337 |   | $ | 5,950 |   | $ | 7,938 |   | $ | 9,588 |   |

 

F-50

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**EXHIBIT INDEX**

| Exhibit  Number | ** **         | **Description** | ** ** |
|-----------------|--------------------|-----------------|------------|
|            | *3.1               |            |       | Amended and  Restated Certificate of Incorporation of the Registrant. |   |
|            | *3.2               |            |       | Amended and  Restated Bylaws of the Registrant. |   |
|            | **4.1              |            |       | Specimen  Certificate for the Registrant’s common stock. |   |
|            | **10.1             |            |       | Registration  Rights Agreement, dated as of March 26, 1999, among the Registrant and  the other signatories listed therein. |   |
|            | **10.2             |            |       | Registration  Rights Agreement, dated as of May 13, 1999, between the Registrant and  Velston Pte. Ltd. |   |
|            | **10.3             |            |       | Second Amended  and Restated Registration Rights Agreement, dated as of June 30, 2003,  among the Registrant and the other signatories listed therein. |   |
|            | **10.4             |            |       | Amendment to  Second Amended and Restated Registration Rights Agreement, dated as of  September 2, 2004, by and among the Registrant and the other signatories  listed therein. |   |
|            | **10.5             |            |       | Loan Agreement,  dated as of July 29, 1999, between Israel Discount Bank Ltd. and  Nesstech Advanced Technologies (1999) Ltd. |   |
|            | **10.6             |            |       | Loan Agreement,  dated as of July 29, 1999, between Bank Hapoalim B.M. and Nesstech  Advanced Technologies (1999) Ltd. |   |
|            | +**10.7            |            |       | Apar Holding  Corp. Employees’ Equity Plan. |   |
|            | +**10.8            |            |       | Ness  Technologies, Inc. 1999 Share Option Plan. |   |
|            | +**10.9            |            |       | Ness  Technologies, Inc. 2001 Stock Option Plan. |   |
|            | +**10.10           |            |       | Ness  Technologies, Inc. 2003 Israeli Share Option Plan. |   |
|            | +**10.11           |            |       | Ness  Technologies, Inc. 2003 Stock Option Plan. |   |
|            | +**10.12           |            |       | Agreement, dated  as of August 1, 1999, between the Registrant and Aharon Fogel. |   |
|            | +**10.13           |            |       | Amendment to  Agreement, dated as of May 31, 2001, between the Registrant and Aharon  Fogel. |   |
|            | +§§10.14 |            |       | Amendment to  Employment Agreement, effective as of May 8, 2006, between the  Registrant and Aharon Fogel. |   |
|            | +**10.15           |            |       | Amended and  Restated Employment Agreement, effective as of June 1, 2001, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |   |
|            | +**10.16           |            |       | Amendment to  Amended and Restated Employment Agreement, effective as of January 1,  2004, between the Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |   |
|            | +§10.17       |            |       | Amendment to  Employment Agreement, effective as of January 1, 2006, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |   |
|            | +10.18             |            |       | Separation and  Release Agreement, dated as of March 12, 2007, between the Registrant  and Raviv Zoller. |   |
|            | +10.19             |            |       | Employment  Agreement, dated as of March 12, 2007, between the Registrant and Sachi  Gerlitz. |   |
|            | +¶10.20       |            |       | Employment  Agreement, dated as of April 21, 2005, between the Registrant and Ytzhak  Edelman. |   |

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|        | +§10.21       |   |   | Amendment to  Employment Agreement, effective as of January 1, 2006, between the  Registrant and Ytzhak Edelman.                                                          |   |
|--------|--------------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | +10.22             |   |   | Employment  Agreement, dated as of March 12, 2007, between the Registrant and Ofer  Segev.                                                                                |   |
|   | +**10.23           |   |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Tuvia Feldman (English translation).                         |   |
|   | +**10.24           |   |   | Addendum to  Personal Employment Agreement, dated as of August 1, 1999, between  Advanced Technology Ltd. and Tuvia Feldman (English translation).                        |   |
|   | +**10.25           |   |   | Addendum to  Personal Employment Agreement, dated as of August 23, 1999, between  Advanced Technology Ltd. and Tuvia Feldman (English translation).                       |   |
|   | +**10.26           |   |   | Employment  Agreement Addendum, dated as of August 27, 2000, between the Registrant  and Tuvia Feldman.                                                                   |   |
|   | +**10.27           |   |   | Summary of  Meeting, dated May 3, 2001, between Raviv Zoller and Tuvia Feldman  (English translation).                                                                    |   |
|   | +§10.28       |   |   | Amendment to  Employment Agreement, effective as of March 1, 2006, between the  Registrant and Tuvia Feldman.                                                             |   |
|   | +**10.29           |   |   | Offer Letter,  dated January 29, 2004, between the Registrant and Ivan Hruška.                                                                                       |   |
|   | +**10.30           |   |   | Contract of  Employment, effective as of March 1, 2004, between the Registrant and  Ivan Hruška.                                                                     |   |
|   | +10.31             |   |   | Employment  Contract, dated as of December 29, 2006, between NESS Slovensko, a.s.  and Ivan Hruška.                                                                  |   |
|   | +**10.32           |   |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).                       |   |
|   | +**10.33           |   |   | Addendum to  Personal Employment Agreement, dated as of August 1, 1999, between  Advanced Technology Ltd. and Yoram Michaelis (English translation).                      |   |
|   | +**10.34           |   |   | Addendum to  Personal Employment Agreement, dated as of August 23, 1999, between  Advanced Technology Ltd. and Yoram Michaelis (English translation).                     |   |
|   | +¶¶10.35 |   |   | Personal  Employment Agreement, dated as of August 10, 2005, between Ness  Technologies Holdings Ltd. and Shachar Efal (English translation)                              |   |
|   | +§10.36       |   |   | Offer letter,  dated as of December 1, 1999, from Apar Infotech Corporation to Shashank  Samant.                                                                          |   |
|   | +§10.37       |   |   | Addendum to  Employment Agreement, effective as of January 1, 2006, between Ness  USA, Inc. and Shashank Samant.                                                     |   |
|   | **10.38            |   |   | Form of  Indemnification Agreement by and between the Registrant and its officers and  directors.                                                                         |   |
|   | **10.39            |   |   | Stock Purchase  Agreement, dated as of August 30, 2002, among the shareholders of APP  Group CEE B.V. listed therein and the Registrant.                                  |   |
|   | **10.40            |   |   | Merger Agreement,  dated as of May 12, 2003, among the Registrant, Ness Acquisition Corp.,  Apar Holding Corp. and the shareholders of Apar Holding Corp. listed therein. |   |
|   | 14                 |   |   | Code of Business  Conduct and Ethics.                                                                                                                                          |   |
|   | 21                 |   |   | Subsidiaries of  the Registrant.                                                                                                                                               |   |

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|        | 23.1 |   |   | Consent of Kost  Forer Gabbay & Kasierer, a member of Ernst & Young Global.                                                                  |   |
|--------|------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | **24 |   |   | Powers of  Attorney.                                                                                                                                           |   |
|   | 31.1 |   |   | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                     |   |
|   | 31.2 |   |   | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                     |   |
|   | 32.1 |   |   | Certification of  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |   |
|   | 32.2 |   |   | Certification of  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |   |

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*                    Incorporatedby reference to the Registrant’s Registration Statement on Form S-4(Commission File No. 333-120389), as amended, initially filed withthe Commission on November 12, 2004.

**             Incorporated byreference to the Registrant’s Registration Statement on Form S-1(Commission File No. 333-115260), as amended, initially filed withthe Commission on May 7, 2004.

¶                    Incorporatedby reference to the Registrant’s Quarterly Report on Form 10-Q forthe quarterly period ended March 31, 2005, filed with the commission on May 16,2005.

¶¶             Incorporated byreference to the Registrant’s Quarterly Report on Form 10-Q for thequarterly period ended June 30, 2005, filed with the Commission on August 12,2005.

§                    Incorporatedby reference to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2005, filed with the Commission on March 15,2006.

§§             Incorporatedby reference to the Registrant’s Quarterly Report on Form 10-Q forthe quarterly period ended March 31, 2006, filed with the Commission on August 10,2006.

+                Indicates thosecontracts that are management contracts or compensation plans or arrangements.

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