**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2005**                                                                                                                                                                                         |
|  ̈     | **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 of registrant asspecified 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**(Addressof registrant’s principal executive offices and registrant’s telephone number,including area code)

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

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

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K.  ̈

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    ̈                Accelerated filer   ý          Non-accelerated filer    ̈

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

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the registrant as of June 30,2005 was $268.1 million, based on the closing price of the stock on that date. Asof March 1, 2006, 34,919,041 shares of common stock, $0.01 par value pershare, were outstanding.

The registrant intends tofile, not later than April 30, 2006, a definitive proxy statement pursuantto Regulation 14A, promulgated under the Securities Exchange Act of 1934, asamended, to be used in connection with the registrant’s annual meeting ofstockholders. The information required in response to Items 10-14 of Part IIIof this Form 10-K is hereby incorporated by reference to such proxystatement.

 

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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                                                               |   | 33 |
| PART II                               |                                                                                                                       | 34     |
|                                       | Item 5. Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |   | 34 |
|                                       | Item  6. Selected Financial Data                                                                                           |   | 34 |
|                                       | Item 7. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                        |   | 36 |
|                                       | Item 7A. Quantitative and Qualitative Disclosure about  Market Risk                                                        |   | 52 |
|                                       | Item 8. Financial Statements and Supplementary Data                                                                        |   | 52 |
|                                       | Item 9. Changes in and Disagreements with Accountants  on Accounting and Financial Disclosure                              |   | 52 |
|                                       | Item 9A. Controls and Procedures                                                                                           |   | 52 |
|                                       | Item  9B. Other Information                                                                                                |   | 54 |
| PART III                              |                                                                                                                       | 56     |
|                                       | Item 10. Directors and Executive Officers of the  Registrant                                                               |   | 56 |
|                                       | Item 11. Executive Compensation                                                                                            |   | 56 |
|                                       | Item 12. Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                   |   | 56 |
|                                       | Item 13. Certain Relationships and Related  Transactions                                                                   |   | 56 |
|                                       | Item 14. Principal Accountant Fees and Services                                                                            |   | 56 |
| PART IV                               |                                                                                                                       | 57     |
|                                       | Item 15. Exhibits, Financial Statements and Schedules                                                                      |   | 57 |
| SIGNATURES                                 |                                                                                                                       | 60     |
| INDEX TO CONSOLIDATED FINANCIAL STATEMENTS |                                                                                                                       | F-1    |
| EXHIBIT INDEX                              |                                                                                                                       |   |

 

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**PART I**

**Disclosure Statement**

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.”

**Available Information**

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,Business Objects, Citibank, Czech Telecom, Israel Aircraft Industries, IsraelDiscount Bank, Orange and Pfizer, which are among the largest clients in eachof our verticals, based on revenues. In 2005, existing clients from prior yearsgenerated more than 80% of our revenues, with no single client accounting formore 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 BEA Systems, EMC Documentum, IBM,Mercury Interactive, Microsoft, SAP and Unisys, as well as various companiesfor whom we distribute software products.

Our revenues have grown from $166.6 million in 2002 to$385.4 million in 2005, representing a compounded annual growth rate ofapproximately 32%. During that time, our results of operations have alsoimproved from net income of $0.9 million for 2002 to $21.7 million for 2005.

For 2001, 2002, 2003, 2004 and 2005, the percentage ofour revenues generated by public and private sector clients in Israel was 93%,80%, 68%, 57% and 52%, respectively. The percentage of our revenues derived, inaggregate, from agencies of the government of Israel for the same time periodswas 16%, 17%, 14%, 12% and 11%, respectively, while our revenues from theseagencies increased steadily during 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 22 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. Ourtelephone number there is (201) 488-7222. Our principal executive officein Israel is located at Ness Tower, Atidim High-Tech Industrial Park, Building4, 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.

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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 share information have been adjusted to reflect the 0.7193for one reverse stock split effected on September 20, 2004.

**Service Offerings**

We offer a broad suite ofservices, including outsourcing, system integration and application development,software and consulting, and quality assurance, or QA, and training.

**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 to managetactical 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 20companies worldwide. After 36 months of operation, we offer our clients theoption of purchasing back the offshore development center assets in theirentirety.

*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 over 30 clients in diversefields, representing over 100,000 end-users, for single-site and multi-siteenterprises 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 and ouroffshore center in Mumbai, India is accredited at CMM Level 5, enabling us toprovide low cost, high quality and 24-hour development cycle capability. ISO9001 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.

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.

*Telecommunications Systems.*   Weprovide industrial, government and defense organizations with turnkeysolutions, including complete systems and specifically tailored projectsdesigned to facilitate the management of telecommunications systems andnetworks. We have developed a wide range of network 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. Recentexamples within the life sciences and healthcare vertical include BI and datawarehousing 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;

·       medicalrecords system, supplying a comprehensive view of medical data;

·       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;

·       digital rights managementsoftware, enabling broadcasters, television and film producers, and mediacompanies and publishers to manage all their author rights, contracts, androyalties; and

***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.

*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 for over 30 companies, including SAP,EMC Documentum, Sybase, Information Builders, Genesys, Sterling Commerce,SyncSort and Telcordia.

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*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.

***Quality Assurance 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 QAmethodology; system integration performance and testing; user interfaceengineering and user experience engineering; validation and full traceabilitycapabilities that allow us to verify that the end product meets the initialproduct specifications; enterprise QA solutions, such as ERP, CRM and datawarehousing; test automation; load testing; and quality consulting. Ourprofessionals have extensive experience in QA and testing using our documentedand 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 onadvanced proprietary training methodologies and evaluation tools satisfying ourclients’ needs in terms of content, target audience, level of knowledge andtraining times. We complement traditional learning methods with learningmanagement systems, e-learning platforms, and computer and web based self studykits, 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 important. Also, due to the recent global economicdownturn and lack of compelling IT initiatives, such as Year 2000 and Euroconversion, companies substantially reduced their IT services spending,resulting in hardship for many IT service vendors. According to industryanalysts, however, the IT services market has now returned to a period ofgrowth. Gartner Inc., an independent industry analyst, forecasted in itsGartner Dataquest Market Databook of December 2005 that the global ITservices market will grow from $617 billion in 2005 to $760 billion in 2009, acompounded annual growth rate of approximately 5.3%.

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Companies are increasingly seeking cost effectivealternatives to acquire high quality IT services. The use of offshore vendorsis becoming increasingly common among larger corporations. Based on our reviewof publicly available information, we believe IT services provided offshoretotaled between $15 billion and $18 billion in 2004, representing less than 3%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 35%, 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.

**Competitive Strengths**

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 5 and CMMI level 3 offshorefacilities in India, enable us to minimize the difficulties other outsourcingvendors now face in using foreign employees in the United States on a temporarybasis due to the tightening 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. These groups provide QA, testingand audit services to our delivery organizations. We also provide theseservices 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. An example of such innovation is the creation of our managedlabs extended development center offering, which supplements and extends theresearch and development facilities of ISVs for core product development andother activities.

*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 andcomprehensive business solutions to meet the needs of our clients in the keyverticals we cover.

*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 2005,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 single client. In2005, no client accounted for more than 5% of 

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our revenues and ourlargest twenty clients together accounted for approximately 32% of our revenues.Agencies of the government of Israel, in aggregate, represented 11% of ourrevenues in 2005.

*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. Forexample, over the past two years we have expanded our Bangalore, India deliveryfacility from approximately 500 to over 1,100 employees in response to ourclients’ rapidly growing offshore development needs, and we have expanded ouremployee base in Europe from approximately 350 to over 700.

*Ourorganizational and business flexibility.*   Ourflexible organizational structure, business culture and technological abilitieshave allowed 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 despite the economic downturn of recent years. Duringthat time we increased our revenues, number of employees, geographic footprintand profitability. Additionally, our strong vertical alignment, the industryand technical experience of our employees, our operational efficiency, ourability to secure and retain key clients and the effective use of our globaldelivery model have helped insulate us from many of the hardships experiencedby our competitors.

*Ourability to integrate acquired companies.*   We havegrown partly through acquisitions since our inception. Due in part to oursignificant focus on the abilities of the senior management of acquired firms,we have been able to retain the senior management of each of these companies. Wehave successfully integrated each acquired company into our corporate structureand culture, working together with existing management, employees and clientsto facilitate 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 reachthrough the 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 services market.In the last five years we expanded outside Israel with acquisitions in NorthAmerica, 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 almost four-fold to $85.9 million, or 22% of ourrevenues, by 2005. During the same period, we grew our European revenue overseven-fold from approximately $11.0 million, or 7% of our revenues, to $74.8million, or 19% of our revenues. We intend to focus considerably on expandingour revenues in North America, both organically and through acquisitions. In2005, the North American market alone represented approximately 44% of totalworldwide IT services spending, according to the Gartner Dataquest MarketDatabook of December 2005, 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 

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target these markets, suchas financial services, as well as emerging markets in which we believe growthand potential profitability are higher, such as Eastern Europe and Asia.

*Be amarket leader in key verticals.*   In NorthAmerica, we presently focus on several verticals:  life sciences, ISVs, defense and financialservices. In Europe, we are focused on the financial services, retail,telecommunications and utilities verticals. In Israel, we have a strong focuson several verticals, including government and defense, financial services andtelecommunications. We intend to further solidify our position in each of theseverticals through internal growth based on complementary offshore offerings andkey partnerships, and external growth through acquisitions. Our goal is toestablish ourselves in North America as a leading provider in outsourcing andoffshore services for life sciences, ISVs and homeland security.

*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 percentage ofrevenue 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 will include media and industry analystevents, sponsorship of and participation in targeted industry conferences,trade shows, recruiting efforts, community outreach, public relations andinvestor relations.

*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 our clientsoperate, and our ability to understand our clients’ needs and tailor solutionsto meet those needs, we have developed a strong reputation for deliveringsystems to businesses that are subject to regulatory supervision, governmentcontrol or other rigorous operational requirements. We are active in all of thefollowing sectors, each influenced by fluctuating market conditions, as well asregulatory 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 services to the public more effectively and efficiently. In Israel,we are a leading provider of integrated solutions for the government anddefense sector.

The defense industry faces a multitude of challenges,including protecting the safety of national borders, improving command andcontrol and intelligence gathering mechanisms, enhancing communicationschannels throughout the military and performing scenario analysis. We possessextensive 

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experience in deliveringhigh-end technical solutions to the defense industry to help surmount thesechallenges.

*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 investment banks; credit card companies; insuranceand reinsurance companies; consumer finance organizations; and pension funds. Serviceswe provide include 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 operatingcosts and increase revenue, while helping telecommunications companies evaluatethe impact of new technologies and make informed planning decisions about theirIT investments. 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 consulting services.

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 inimproving time-to-market of new products through clinical trial optimization,safety and adverse event tracking, knowledge management, BI and datawarehousing, strategic planning and budgeting. We have been delivering businessperformance oriented data and document management solutions to largepharmaceutical and biotechnology firms for over 20 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 development centers that supplementthose of the client. Our expertise lies in the design and development of newsoftware products, re-development, re-engineering, and maintenance of existingproducts, and global implementation and rollout support for existing products. Wefunction as a partner with our clients to manage tactical needs at all phasesof 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 

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supply chain management,enhance their partner and client relations, enhance enterprise resourceplanning and optimize product quality. Intelligent transportation systems use avariety of technologies in order to facilitate the movement of people and goodsvia highways and public transportation systems. We have developed a wide rangeof services specifically tailored for clients within the transportationindustry, including emergency management systems, electronic toll collectionand 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. Ourservices enable retailers to deliver consistent customer service (through storesales, call centers and internet websites) and to develop and extend theirtechnology 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 Delivery Model**

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 recently completed a sophisticatedweb-based document management and workflow solution for a large, internationalbio-pharmaceutical firm based in Switzerland. For this project we used teamsfrom Switzerland, the United States and Israel. Similarly, we are providing SAPsystem integration and project services to a large, global law firm usingresources from the United Kingdom and India. In these and virtually all otherprojects staffed using our global delivery model, the teams work in their homelocations except for periodic travel to the client location for knowledgetransfer, client meetings and implementation work. This model also means thatwe are substantially less affected by changing immigration regulations thanother well-known offshore vendors. In our model, the team that remains at theclient site throughout the engagement comprises our local resources,complementing our local presence with our strong vertical experience to theengagement from inception through completion. Our global delivery model isoptimized by a worldwide proprietary knowledge management system that enablesour employees to communicate and share knowledge. In addition, we continuallyhost internal training courses.

Other benefits gained by clients from our globaldelivery model are 24-hour delivery and support capabilities; built-inredundancy, both in terms of people and facilities; and the availability of aglobal knowledge base of business and technical information that is populated,maintained and leveraged by our employees around the globe.

As of December 31,2005, we employed approximately 5,945 employees worldwide, includingapproximately 3,045 in Israel, 1,415 in India, 325 in North America, 740 inEurope and 420 in the Asia Pacific region.

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**Sales and Marketing**

We market our services to large organizations in NorthAmerica, Europe and Asia. We have a leading market presence in Israel and agrowing presence in North America and Europe. We sell and market our servicesfrom sales offices located in 16 countries. We manage our business and resultsof operations as part of a global sales and marketing strategy. As of December 31,2005, we had approximately 200 direct sales persons and account managers.

Our sales and marketing strategy focuses on increasingawareness of and gaining new business from target clients and promoting clientloyalty and repeat business among existing clients. We constantly seek toexpand the nature and scope of our engagements with existing clients by increasingthe volume of our business and extending the breadth of services offered. Membersof our executive management team are actively involved in business developmentand in managing key client relationships through targeted interaction with ourclients’ senior management.

For each prospective project, we assemble a team ofour senior employees, drawn from various disciplines within our company. Theteam members assume certain roles in a formalized process, using their combinedknowledge and experience to understand the client’s needs, design a solution,identify key decision makers and maximize the strength of our bid. Thisapproach allows for a smooth transition to execution once the sale is completed.We typically bid against other IT services providers in response to requestsfor proposals.

Our sales andmarketing teams work with our technical team as the sales process moves closerto the client’s selection of an IT service provider. The duration of the salesprocess varies depending on the type of service, ranging from approximately twomonths to over one year. Throughout the process, the account manager or salesexecutive works with the technical team to:

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

·       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.

**Clients**

We presently serve over 500 clients in a wide range ofindustries. Our clients vary in size and include a number of Fortune 1000 andGlobal 2000 companies. For 2005, no client represented more than 5% of ourannual revenues, and our largest twenty clients together representedapproximately 32% of our revenues. Agencies of the government of Israel, inaggregate, represented 11% of our revenue in 2005.

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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** | ** ** |
| Israel                 |       |                                       | 93         | % |   |   | 80 | % |   |   | 68 | % |   |   | 57 | % |   |   | 52 | % |   |
| United States          |       |                                       | 3          |   |   |   | 14 |   |   |   | 16 |   |   |   | 25 |   |   |   | 22 |   |   |
| Europe                 |       |                                       | 4          |   |   |   | 7 |   |   |   | 13 |   |   |   | 13 |   |   |   | 19 |   |   |
| Asia and the Far  East |       |                                       | —     |   |   |   | — |   |   |   | 3 |   |   |   | 5 |   |   |   | 5 |   |   |
| Others                 |       |                                       | —     |   |   |   | — |   |   |   | 1 |   |   |   | 1 |   |   |   | 1 |   |   |
| Total                  |       |                                       | 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** | ** ** |
| Outsourcing  (including offshore development)   |       |                                       | 17         | % |   |   | 16 | % |   |   | 31 | % |   |   | 47 | % |   |   | 45 | % |   |
| System  Integration and Application Development |       |                                       | 55         |   |   |   | 46 |   |   |   | 35 |   |   |   | 30 |   |   |   | 31 |   |   |
| Software and  Consulting                        |       |                                       | 19         |   |   |   | 18 |   |   |   | 16 |   |   |   | 14 |   |   |   | 16 |   |   |
| Quality Assurance  and Training                 |       |                                       | 5          |   |   |   | 16 |   |   |   | 11 |   |   |   | 5 |   |   |   | 5 |   |   |
| Other                                           |       |                                       | 4          |   |   |   | 4 |   |   |   | 7 |   |   |   | 4 |   |   |   | 3 |   |   |
| Total                                           |       |                                       | 100        | % |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |

 

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

Government and Defense

·  CzechOfficer for Surveying, Mapping and Cadastre

·  IsraelAircraft Industries

·  IsraelAirport Authority

·  IsraelCourt Authority

·  IsraelMinistry of Defense

·  IsraelMinistry of Finance

·  IsraelMinistry of Justice

·  IsraeliPolice

·  LockheedMartin

·  SingaporePolice

·  Tadiran Systems

*Financial Services*

·  AchmeaZorg

·  BankHapoalim

·  Bank Leumi

·  BanquePrivée Edmond de Rothschild

·  CIBC

·  Citibank

·  CreditSuisse First Boston

·  DBS Bank

·  First InternationalBank of Israel

·  GeneraliGroup

·  HarelInsurance

·  IndustrialDevelopment Bank of Israel Ltd.

·  IsraelDiscount Bank Ltd.

·  KomerčníBanka

·  Menzis

·  Swiss Re

·  Waldviertler Sparkasse

*Telecommunicationsand Utilities*

·  AT&T

·  Bezeq

·  Cellcom

·  ČEZ,a.s.

·  CzechTelecom

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·  Electrica

·  Eurotel

·  IsraelElectric Company

·  Orange

·  SlovakTelecom

·  SlovenskéElektrárne

·  TelusCommunications

·  YES

*Life Sciences andHealthcare*

·  ClalitHealth Services

·  IdenixPharmaceuticals

·  Pfizer

·  ScheringPlough

·  Serono

·  Teva

·  VITAS

·  WockhardtUSA

·  Wyeth

·  Zentiva

*High-Tech andIndependent Software Vendors*

·  BridgeCo

·  BusinessObjects

·  Cartesis

·  CheckPoint

·  Chordiant

·  Cisco

·  CobaltGroup

·  Comverse

·  Documentum

·  DoradoCorporation

·  IndusInternational

·  Micromuse

·  Portal Software

*Manufacturing andTransportation*

·  Coca-Cola

·  EL AL Airlines

·  Israeli Chemicals Ltd. (ICL)

·  Mitsubishi

·  Philips

·  Strauss-Elite

·  Toyota

·  Vítkovice

*Retail, Media,Entertainment, Publishing & Other*

·  Cushman &Wakefield

·  FremantleMedia Services

·  HollywoodMedia Corp.

·  Israel’sYellow Pages

·  KurtSalmon Associates

·  SuperSol

**BusinessPartners and 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 notionsregarding the technology that will ultimately be deployed, and we recommendwhat we believe to be the most effective technology for our clients’ needs.

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Wehave over 100 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**                                                                                                                                                                                                                                                                                                                                        |
|-------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| BEA Systems                         |       | We work with BEA Systems  around the world to deliver powerful, scalable solutions built on BEA’s  application server, portal and EAI platforms.                                                                                                                                                                                                           |
| 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. In addition, we have supplier agreements  with IBM in the United States, Asia Pacific 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.                                                                                   |
| Mercury Interactive                 |       | We partner with  Mercury Interactive 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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Whilewe are not substantially dependent on any one of these partnerships, we believethey collectively 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 thesebenefits, the relationships enhance our ability to:  deliver a broad range of IT servicesoutsourcing; provide us channels to sell additional services to our clients,such as quality assurance and training; and make us a more attractive employer,based on our employees’ use of these advanced platforms and access to ourpartners.

Some of the certificationlevels our partners require are difficult to attain, requiring thedemonstration of significant technical expertise, high levels of training andcertification, the influencing of a certain amount of product sales for thepartner, certain levels of investment in the products and technologies of ourpartners, or other factors. Our relationships with these partners arelong-term, unlike typical vendor relationships.

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 andother arrangements may be terminated by either party at any time withoutpenalty, they also afford greater flexibility to our partners and alliances aswell as to us.

**Competition**

The ITservices market has become increasingly competitive in recent years as a resultof the economic downturn and associated decline in IT service spending. Whilesome vendors have not survived, others have become more aggressive and somelow-cost offshore vendors have entered new markets traditionally dominated bylarge multinational consultancy firms. The IT services vendors with whom wecompete 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 Patni, Sonata Software and Symphony;

·        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 competitorsare more established, enjoy greater market recognition and have significantlygreater financial, technical and marketing resources than we do. Moreover, theIT services industry is experiencing rapid changes, primarily consolidation,that are affecting the competitive landscape. These changes may result in agreater number of competitors with significantly larger resources than ours. Inaddition, some of our competitors have added cost competitive offshorecapabilities to their service offerings, which may adversely affect our abilityto compete successfully against these competitors. We expect competition tointensify in the future as current competitors enhance their service offeringsand new competitors penetrate the market due to low barriers to entry. Existingor future competitors may develop or offer services and products that providesignificant performance, price or other advantages over those we offer.

Ourfuture success will depend in part on our ability to develop and market new orenhanced services that adequately address changes in technology, industrystandards and client requirements and gain commercial acceptance. Any delay orfailure to develop new services or to adapt our services to technologicalchange and market requirements could have a material adverse effect on ourcompetitive position. We believe that the principal competitive factors in ourbusiness include 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 propertyrights are important to our business. We rely on a combination of copyright,trademark and design laws, trade secrets, confidentiality procedures andcontractual provisions to protect our intellectual property. We currently haveno issued patents. We require employees, independent contractors and, wheneverpossible, vendors to enter into confidentiality agreements upon the 

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commencementof their relationships with us. These agreements generally provide that anyconfidential or proprietary information developed by us or on our behalf bekept confidential. These agreements also provide that any confidential orproprietary information disclosed to third parties in the course of ourbusiness be kept confidential by such third parties. However, our clientsusually own the intellectual property in the software we develop for them.

We regard our trade name,trademarks, service marks and domain names as important to our success. We relyon the law to protect our proprietary rights to them and we have taken steps toenhance our rights by filing trademark applications where appropriate. We haveregistered our key brand “Ness” as a trademark in both Israel and in the UnitedStates.

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 31,2005, we employed approximately 5,945 employees, including approximately 5,190IT professionals. None of our employees is represented by a labor union and wehave not experienced any strikes or work stoppages. We believe our relationswith our employees are good.

Our employees in Israelare subject to Israeli labor laws and regulations and other special practicesand employment customs. The laws and regulations principally concern matterssuch as paid annual vacation, paid sick days, the length of the workday,payment for overtime and severance pay. Israeli law generally requiresseverance pay equal to one month’s salary for each year of employment upon theretirement or death of an employee or termination of employment without a validlegal reason. Furthermore, Israeli employees and employers are required to paypredetermined sums to the National Insurance Institute, which is similar to theU.S. Social Security Administration. Since January 1, 1995, these amountsalso include payments for national health insurance. Our payments to theNational Insurance Institute amount to approximately 15% of wages up to aspecified amount, of which the employee contributes two-thirds and the employercontributes one-third.

In addition, by order ofthe Israeli Ministry of Labor and Welfare, the provisions of a collectivebargaining agreement between the Histadrut (the General Federation of Labor inIsrael) and the Industrialists Association in Israel may be applicable to ouremployees in Israel. This collective bargaining agreement principally concernscost of living increases, vacation and holiday pay, length of the workday, wagetariffs, termination and severance payments. We provide our employees withbenefits and working conditions that are at least as favorable as theconditions specified in the collective bargaining agreement.

Our employees are our mostimportant asset. We believe that the quality and level of service that ourprofessionals deliver are among the highest in the global IT services industry.We believe we provide a challenging, entrepreneurial and empowering workenvironment that demands dedication and a strong work ethic.

Our training, continuingeducation and career development programs are primarily designed to ensure ourIT professionals enhance their skill-sets in alignment with their respectiveroles. We continually provide our IT professionals with challenging assignmentsand exposure to new skills, technologies and global opportunities. We haveinstituted an appraisal program that incorporates a feedback system, 

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recognizinghigh performers 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.

**Corporate History**

Ness Technologies, Inc.was incorporated in Delaware in March 1999 in connection with theacquisition of six Israeli IT companies and their consolidation into a singleoperating structure. Compro Software Industries, a privately-held Israelisoftware consulting company founded in 1985, was acquired by our founders in December 1997and by us in April 1999. At the time of its acquisition, Compro had astaff of approximately 170 people.

Wesubsequently acquired 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;

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·        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.

Towardsthe end of 2001, and after becoming a leading IT services company in Israel, weembarked on our global expansion strategy. The following material acquisitionswere made as 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, in2005, as part of our growth strategy in Eastern Europe’s emerging market for ITservices:  Radix Company SA, based inRomania, a provider of ERP, content management, decision support and workflowmanagement solutions; Delta Electronic Services a.s., based in Slovakia, aprovider of ERP and custom enterprise solutions; and Efcon a.s., a provider ofdocument management, ERP and workflow systems. The acquisitions closed duringthe second through fourth quarters of 2005.

The acquired companieswere integrated into our corporate structure, with capabilities and staffassigned to the various divisions 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. RiskFactors**

*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 price of our common stock maydecline due to any of these risks, and you could lose all or part of yourinvestment.*

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***Risks Relating to Our Business***

**If wefail to manage our growth, our business could be disrupted and ourprofitability will likely decline.**

We have experiencedrapid growth in recent periods through both acquisitions and organic growth. Thenumber of our employees increased from approximately 2,240 as of December 31,2001 to approximately 5,945 as of December 31, 2005. 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, strategicinvestments, partnerships, alliances or other ventures that are not successful,or fail to integrate acquired businesses into our operations, which mayadversely affect our competitive position and growth prospects.**

We have in the past engaged in acquisitions, strategicinvestments, partnerships and alliances. Since our last annual report weacquired three additional significant companies. We may acquire or makestrategic investments in complementary businesses, technologies, services orproducts, or enter into strategic partnerships or alliances with third partiesin the future in order to expand our business. We may be unable to identifysuitable acquisition, strategic investment or strategic partnership candidates,or if we do identify suitable candidates, we may not complete thosetransactions on terms commercially favorable to us or at all, which mayadversely affect our competitive 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.

These difficulties could disrupt our ongoing businessand increase our expenses. As of the date of this report, we have no agreementsto enter into any material acquisition, investment, partnership, alliance orother joint venture transaction.

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**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 would negativelyimpact our cash flows.**

We perform work for a widerange of Israeli governmental agencies, including defense, education, justiceand finance, which collectively represented approximately 11% of our revenuesin 2005. 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 has since re-entered aperiod of economic growth, and we do not expect any additional short-termdecrease. However, any future reduction in Israeli government spending forpolitical or economic reasons would reduce, possibly materially, our revenuesand profitability. In addition, the government of Israel has experiencedsignificant delays in the approval of its annual budget in recent years. Suchdelays in the future could materially and negatively affect our cash flows bydelaying receipt of payment from the government of Israel for servicesperformed.

**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 $2.4 million to approximately $6.8 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

·       changesin accounting standards, such as the implementation of Statement of FinancialAccounting Standards No. 123R (revised 2004), “Share-Based Payment” (“SFAS123R”).

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 typically retain our services for setengagements pursuant to contracts that may be terminated by them with little orno notice and without termination fees. The termination, cancellation ordeferral of one or more significant projects could materially and adverselyaffect our operating results in any fiscal quarter. In addition, we base ourcurrent and future expense levels on our internal operating plans and salesforecasts, and our near-term operating costs are, therefore, to a large extent,fixed. As a 

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result, we may not be ableto sufficiently reduce our costs on a timely basis in any quarter to compensatefor an unexpected near-term shortfall in revenues.

##### **Ifwe fail to attract and retain highly skilled IT professionals, we may not havethe necessary resources to properly staff projects.**

Our success depends largely on the contributions ofour employees and our ability to attract and retain qualified personnel,including technology, consulting, engineering, marketing and managementprofessionals. Competition for qualified personnel in the IT services industry,in the markets in which we operate, particularly in India, is intense and,accordingly, we may not be able to retain or hire all of the personnelnecessary to meet our ongoing and future business needs. If we are unable toattract and retain the highly skilled IT professionals we need, we may have toforego projects for lack of resources or be unable to staff projects optimally.In addition, the competition for highly skilled employees may require us toincrease salaries of highly skilled employees, and we may be unable to pass onthese increased costs to our clients, which would reduce our profitability.

**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 multiple stages.In addition, the increased breadth of our service offerings may result inlarger and more complex projects for our clients that require us to devoteresources to more thoroughly understanding 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 potential terminations,cancellations or delays in planned or existing engagements could make itdifficult for us to use our personnel efficiently. In addition, some of ourclient contracts restrict us from engaging in business with certain competitorsof our clients during the term of the agreements and for a limited periodfollowing termination of these agreements. Any of the foregoing factors maynegatively impact our revenues and profitability.

**If we fail to meet our clients’performance expectations, our reputation may be harmed, causing us to loseclients or exposing 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 unprofitableengagement. Moreover, if we fail to meet our clients’ performance expectations,we may lose 

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clients and be subject tolegal liability, particularly if such failure has a consequential adverseimpact on our clients’ businesses.

In addition, many of our projects are critical to theoperations of our clients’ businesses. Our exposure to legal liability may beincreased in the case of outsourcing contracts in which we become more involvedin our clients’ operations. While our contracts typically include provisionsdesigned to limit our exposure to legal claims relating to our services and thesolutions we develop, these provisions may not adequately protect us or may notbe enforceable in all cases. The general liability insurance coverage that wemaintain, including coverage for errors or omissions, is subject to importantexclusions and limitations. We cannot be certain that this coverage willcontinue to be available on reasonable terms or will be available in sufficientamounts to cover one or more large claims, or that the insurer will notdisclaim coverage as to any future claim. A successful assertion of one or morelarge claims against us that exceeds our available insurance coverage orchanges in our insurance policies, including premium increases or theimposition of large deductible or co-insurance requirements, could adverselyaffect 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 of our more complexengagements, we have been required, and may in the future be required, toassume contingent responsibility for the performance of business partners. Ourbeing required to perform the third party obligations of these commitmentscould have a material adverse affect on our margins and profitability becausewe would be required to incur additional costs, possibly without anycorresponding recovery against the third parties. While we will continue tomanage liabilities or risks through rigorous transaction review, we expect thatclients may require us to assume certain additional contractual obligations andpotential liabilities when we are responsible for the performance of businesspartners we do not control.

**If we fail to complete fixed price contracts onbudget and on time, our reputation may be harmed, causing us to lose clientsand negatively affecting our profitability.**

We offer a portion of our services on a fixed pricebasis, rather than on a time-and-materials basis. In 2001, 2002, 2003, 2004 and2005, revenues from fixed price projects accounted for approximately 24%, 24%,26%, 19% and 22% of our total revenues, respectively. Under these contractualarrangements, we bear the risk of cost overruns, completion delays and wageinflation. If we fail to estimate accurately the resources and time required tocomplete a project or fail to complete our contractual obligations within thescheduled timeframe, our profitability may suffer. Historically, we have nothad any cost overruns that have had a material impact on our profitability. However,we cannot be certain that this will continue to be the case.

**Our success depends in part upon the seniormembers of our management team, and our inability to attract and retain themcould have a negative effect on our ability to operate our business.**

We are highly dependent on the senior members of ourmanagement team, particularly Aharon Fogel, our chairman, and Raviv Zoller, ourpresident and chief executive officer. Mr. Fogel has a strong reputationand significant business experience in the public and private sectors in Israel.Mr. Zoller has been with us since our inception, as our chief financialofficer for two years and our president and chief executive officer since 2001,and has been instrumental in securing important client contracts. We do notmaintain key man life insurance for any of the senior members of our managementteam. Competition for senior management in our industry is intense, and we maynot be able to retain our senior management personnel or attract and retain newsenior management personnel in the future. The loss of one or more members ofour senior management team could have a negative effect on our ability toattract and retain clients, execute our business strategy and otherwise operateour business, which could reduce our revenues, increase our expenses and reduceour profitability.

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**Disruptions in our telecommunicationsinfrastructure could harm our ability to operate and to deliver our serviceseffectively, which could result in client dissatisfaction and a reduction ofour revenues and 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.

**Ourinability to protect our intellectual property rights may force us to incurunanticipated costs.**

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.

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

Many of our clients, particularly those in thefinancial services, life sciences, healthcare and defense verticals, aresubject to complex and constantly changing regulatory requirements. Onoccasion, these regulatory requirements change unpredictably. These regulationsmay increase our potential liabilities if our services are found to contributeto a failure by our clients to comply with the requirements applicable to themand may increase compliance costs as regulatory requirements increase or change.These increased costs could negatively impact our profits.

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**We willbe exposed to risks relating to evaluations of internal control over financialreporting required by Section 404 of the Sarbanes-Oxley Act of 2002.**

We arespending a substantial amount of management time and resources to comply withchanging laws, regulations and standards relating to corporate governance andpublic disclosure, including the Sarbanes-Oxley Act of 2002, new SECregulations and the American Stock Exchange rules. In particular, Section 404of the Sarbanes-Oxley Act of 2002 requires management’s annual review andevaluation of our internal control systems, and attestations as to theeffectiveness of these systems by our independent registered public accountingfirm. We have expended and expect to continue to expend significant resourcesand management time documenting and testing our internal control systems andprocedures. This process has been complicated by the decentralized nature ofour operations and information systems. If we fail to maintain the adequacy ofour internal controls, as such standards are modified, supplemented or amendedfrom time to time, we may not be able to ensure that we can conclude on anongoing basis that we have effective internal control over financial reportingin accordance with Section 404 of the Sarbanes-Oxley Act. Failure tomaintain an effective internal control environment could have a materialadverse effect on the 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.

**If wefail to achieve planned growth in our offshore facilities, our ability tofulfill client commitments profitably or to fulfill them at all may becompromised.**

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 of operationsmay be adversely affected. Employee attrition rates in India are significantlyhigher than in other geographies. Wage costs in India have historically beensignificantly lower than wage costs in North America and Western Europe forcomparably skilled professionals; however, wages in India are currentlyincreasing at a faster rate than in North America and 

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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 mayadversely affect business conditions in those regions, which may disrupt ouroperations and negatively affect our revenues and profitability.**

We generated approximately 52% of our revenues inIsrael in 2005. 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. Thefuture of peace efforts between Israel and its Arab neighbors remains uncertain.Any future armed conflicts or political instability in the region would likelynegatively affect business conditions and adversely affect our results of operations.Furthermore, several countries restrict or prohibit business with Israel orcompanies that do business in Israel. These restrictive laws and policies mayseverely limit our ability to provide services in those countries.

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 generate revenuesfrom services we deliver from India. India has from time to time experiencedinstances of civil unrest and hostilities with Pakistan. In recent years, therehave been military confrontations between India and Pakistan that have occurredin the region of Kashmir and along the India-Pakistan border. Although therelations between the two countries are currently improving, military activityor terrorist attacks in the future could adversely affect the Indian economy bydisrupting communications and making travel more difficult, which may have amaterial adverse effect on our ability to deliver services from India.

**Wage inflationin India 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 one to two years. If we are unable to provide adequately for suchwage increases in our contracts with our customers, or if unexpectedly largewage increases occur, we may experience a material adverse effect on ourprofitability.

**Our international operations subject us tocurrency exchange 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. Forfinancial reporting purposes, we translate all non-United States denominatedtransactions into dollars in accordance with United States generally acceptedaccounting principles. Despite our use of certain forward foreign 

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currencyexchange contracts to hedge our exposure against foreign currencies, we may beexposed to the risk that fluctuations in the value of these currencies relativeto the dollar could increase the dollar cost of our operations and thereforehave an adverse effect on our profitability.

**Potentialanti-outsourcing legislation could impair our ability to service our clients.**

Over the past few years,the issue of outsourcing of services abroad by American companies has become atopic of political discussions in the United States. Measures aimed at limitingor restricting outsourcing by United States companies are under discussion inCongress and in as many as one-half of the state legislatures. While nosubstantive anti-outsourcing legislation has been introduced to date, given theintensifying debate over this issue, the introduction of such legislation is possible.If introduced, such measures are likely to fall within two categories:  (1) measures that extend restrictions onoutsourcing by federal government agencies and on government contracts withfirms that outsource services directly or indirectly, and (2) measuresthat affect private industry, such as tax disincentives or intellectualproperty transfer restrictions. If any of these measures become law, ourability to service our clients could be impaired.

**Terroristattacks or a war could negatively affect our financial 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 abilityto compete for and provide services in our clients’ countries, which couldhamper our 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 business visas.A number of European countries are considering changes in immigration policiesas well. The inability of key project personnel to obtain necessary visas coulddelay or prevent our fulfillment of client projects, which could hamper ourgrowth and cause our revenues to decline.

**If the government of India were to reduce orwithdraw tax benefits and other incentives it provides to us, our net incomewill decrease.**

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. When these tax benefits are eliminated on March 31,2009 as scheduled, or if they are eliminated or reduced earlier as the resultof political change in India, our tax expense will increase, reducing ourprofitability.

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***Risks Relating to Our Stock***

**Ourstock price is likely 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; 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 maybe limited because our executive officers, directors and affiliated majorstockholders beneficially own approximately 28.1% 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 28.1% of our outstanding commonstock. As a result of their stock ownership, if these stockholders were tochoose to act together, they would likely be able to control all 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.

**Provisionsin our charter documents and under Delaware law may prevent or delay a changeof control of us and could also limit the market 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 ourstockholders;

·       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 stock 

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that our board ofdirectors has not approved. These provisions and other similar provisions makeit more difficult for stockholders or potential acquirers to acquire us withoutnegotiation. These provisions may apply even if some stockholders may considerthe 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.

***Item 1B. Unresolved Staff Comments***

None.

***Item 2. Properties***

Our principal executive office is located in leasedpremises of approximately 235,000 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 more than 30 additional locations in 16 countries, all ofwhich are leased, totaling approximately 660,000 square feet.

In 2005, we completed construction of two leasedstate-of-the-art offshore centers containing an aggregate of approximately180,000 square feet of space in the Indian cities of Bangalore and Mumbai. Eachof these centers contains up-to-date technology infrastructure andcommunications capabilities. Together with our other leased properties inBangalore and Mumbai, we are able to accommodate approximately 2,500 employees.

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. Legal Proceedings***

We are periodically aparty to routine litigation incidental to our business. We do not believe thatwe are a party to any pending legal proceeding that is likely to have amaterial adverse effect on our business, financial condition or results ofoperations.

***Item 4. Submission of Matters to a Vote of SecurityHolders***

No matters were submitted to a vote of securityholders during the fourth quarter of 2005.

33

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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 National Market under the symbol “NSTC.”The following table shows the high and low per share closing sale prices of ourcommon stock, as reported on The Nasdaq National 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  (through March 1, 2006)        |       | $                    | 11.67      |   | $ | 9.65 |   |

 

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 1, 2006, thelast reported sale price per share of our common stock on the Nasdaq NationalMarket was $11.50. As of March 1, 2006, there were approximately 100holders of record of our common stock, although the number of beneficialshareholders was much larger.

***Item 6. Selected Financial 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 selected consolidated statement of operations datafor the years ended December 31, 2003, 2004 and 2005 and the selectedconsolidated balance sheet data as of December 31, 2004 and 2005 arederived from our audited consolidated financial statements included elsewherein this report. The selected consolidated statement of operations data for theyears ended December 31, 2001 and 2002 and the selected consolidatedbalance sheet data as of December 31, 2001, 2002 and 2003 are derived fromour audited consolidated financial statements not included in this report. Thesefinancial statements have been prepared in accordance with U.S. generallyaccepted accounting principles. Our historical results may not be indicative ofthe operating results to be expected in any future period and our results forinterim periods may not be indicative of results to be expected for the entireyear.*

34

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| ** **                                                                                          | ** ** | **Year ended December 31,**                                             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2001**                                                                               | ** ** | **2002** | ** ** | **2003(4)** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                          | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **Statement of Operations Data:**                                                                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Revenues                                                                                            |       | $                                                                                      | 151,612    |   | $ | 166,576 |   | $ | 225,768 |   | $ | 304,525 |   | $ | 385,436 |   |
| Cost of revenues                                                                                    |       | 105,604                                                                                |       | 104,541 |   | 158,987 |   | 212,034 |   | 275,465 |   |
| Provision for losses  (reverse of losses) on uncompleted contracts, net                             |       | —                                                                                 |       | 161 |   | 788 |   | (309 | ) | (232 | ) |
| Gross profit                                                                                        |       | 46,008                                                                                 |       | 61,874 |   | 65,993 |   | 92,800 |   | 110,203 |   |
| Operating expenses:                                                                                 |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Selling and  marketing                                                                              |       | 18,302                                                                                 |       | 19,192 |   | 21,287 |   | 25,706 |   | 29,033 |   |
| General and  administrative                                                                         |       | 29,679                                                                                 |       | 30,168 |   | 36,115 |   | 46,042 |   | 54,730 |   |
| Research and  development, net                                                                      |       | 2,250                                                                                  |       | 1,516 |   | 1,559 |   | — |   | — |   |
| Goodwill  amortization(1)                                                                           |       | 5,390                                                                                  |       | — |   | — |   | — |   | — |   |
| Other                                                                                               |       | —                                                                                 |       | 198 |   | 665 |   | — |   | — |   |
| Total operating  expenses                                                                           |       | 55,621                                                                                 |       | 51,074 |   | 59,626 |   | 71,748 |   | 83,763 |   |
| Operating income (loss)                                                                             |       | (9,613                                                                                 | )          | 10,800 |   | 6,367 |   | 21,052 |   | 26,440 |   |
| Financial expenses, net                                                                             |       | (5,887                                                                                 | )          | (8,829 | ) | (1,451 | ) | (3,461 | ) | (1,521 | ) |
| Other expenses, net                                                                                 |       | (856                                                                                   | )          | (347 | ) | (422 | ) | (91 | ) | (243 | ) |
| Income (loss) before  taxes on income                                                               |       | (16,356                                                                                | )          | 1,624 |   | 4,494 |   | 17,500 |   | 24,676 |   |
| Taxes on income (tax  benefit)                                                                      |       | 807                                                                                    |       | (48 | ) | (54 | ) | 2,320 |   | 3,518 |   |
| Equity in net earnings  (losses) of affiliates                                                      |       | 12                                                                                     |       | (35 | ) | 11 |   | (647 | ) | (65 | ) |
| Minority interests in  losses (earnings) of subsidiary                                              |       | (96                                                                                    | )          | (377 | ) | — |   | (156 | ) | 101 |   |
| Income (loss) from  continuing operations                                                           |       | (17,247                                                                                | )          | 1,260 |   | 4,559 |   | 14,377 |   | 21,194 |   |
| Loss from discontinued  operations(2)                                                               |       | (1,234                                                                                 | )          | (395 | ) | (1,105 | ) | — |   | — |   |
| Extraordinary income, net  of taxes                                                                 |       | —                                                                                 |       | — |   | — |   | — |   | 495 |   |
| Net income (loss)                                                                                   |       | $                                                                                      | (18,481    | ) | $ | 865 |   | $ | 3,454 |   | $ | 14,377 |   | $ | 21,689 |   |
| Basic net earnings (loss)  per share from continuing operations(3)                                  |       | $                                                                                      | (2.43      | ) | $ | (0.18 | ) | $ | 0.20 |   | $ | 0.58 |   | $ | 0.63 |   |
| Basic net earnings (loss)  per share(3)                                                             |       | $                                                                                      | (2.58      | ) | $ | (0.23 | ) | $ | 0.13 |   | $ | 0.58 |   | $ | 0.63 |   |
| Diluted net earnings  (loss) per share from continuing operations(3)                                |       | $                                                                                      | (2.43      | ) | $ | (0.18 | ) | $ | 0.19 |   | $ | 0.53 |   | $ | 0.61 |   |
| Diluted net earnings  (loss) per share(3)                                                           |       | $                                                                                      | (2.58      | ) | $ | (0.23 | ) | $ | 0.12 |   | $ | 0.53 |   | $ | 0.61 |   |
| Basic net earnings (loss)  per share from continuing operations excluding extraordinary income(3)   |       | $                                                                                      | (2.43      | ) | $ | (0.18 | ) | $ | 0.20 |   | $ | 0.58 |   | $ | 0.62 |   |
| Basic net earnings (loss)  per share excluding extraordinary income(3)                              |       | $                                                                                      | (2.58      | ) | $ | (0.23 | ) | $ | 0.13 |   | $ | 0.58 |   | $ | 0.62 |   |
| Diluted net earnings  (loss) per share from continuing operations excluding extraordinary income(3) |       | $                                                                                      | (2.43      | ) | $ | (0.18 | ) | $ | 0.19 |   | $ | 0.53 |   | $ | 0.59 |   |
| Diluted net earnings  (loss) per share excluding extraordinary income(3)                            |       | $                                                                                      | (2.58      | ) | $ | (0.23 | ) | $ | 0.12 |   | $ | 0.53 |   | $ | 0.59 |   |
| Weighted average number  of shares used in computing basic net earnings (loss) per share            |       | 8,247                                                                                  |       | 8,474 |   | 15,379 |   | 22,292 |   | 34,413 |   |
| Weighted average number of shares used in computing  diluted net earnings (loss) per share          |       | 8,247                                                                                  |       | 8,474 |   | 16,611 |   | 24,748 |   | 35,661 |   |

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(1)          Under SFAS No. 142,goodwill acquired in a business combination on or after July 1, 2001 isnot amortized. Goodwill arising from acquisitions prior to July 1, 2001was amortized until December 31, 2001, on a straight line basis over 20years.

(2)          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.

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

(4)          In June 2003, weacquired Apar Holding Corp. See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Consolidated Results ofOperations—2004 Compared to 2003.”

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| ** **                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(in thousands)**                    | ** ** |
| **Balance  Sheet Data:**                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                |       | $                                          | 41,356     |   | $ | 43,494 |   | $ | 46,004 |   | $ | 104,229 |   | $ | 33,579 |   |
| Short-term bank  deposits                 |       | 204                                        |       | — |   | 3,248 |   | — |   | 39,561 |   |
| Working capital                           |       | 22,857                                     |       | 18,178 |   | 16,770 |   | 92,548 |   | 66,144 |   |
| Total assets                              |       | 230,854                                    |       | 241,883 |   | 339,483 |   | 424,756 |   | 454,234 |   |
| Total debt,  including current maturities |       | 92,183                                     |       | 84,204 |   | 90,453 |   | 51,557 |   | 34,167 |   |
| Stockholders’ equity                 |       | 52,887                                     |       | 62,365 |   | 126,355 |   | 232,480 |   | 254,502 |   |
|                                           |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***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 $385.4 million for 2005,from $304.5 million for 2004. Net income increased to $21.7 million for 2005,from $14.4 million for 2004.

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 2005, no clientaccounted for more than 5% of our revenues and our largest twenty clientstogether accounted for approximately 32% of our revenues. For 2005, thepercentage of our revenues generated by public and private clients in Israelwas 52%, and the percentage of our revenues derived, in aggregate, fromagencies of the government of Israel was 11%. Existing clients from prior yearsgenerated more than 80% of our revenues in 2005.

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Our backlog as of December 31, 2005 was $450million compared to $401 million as of December 31, 2004. This $49 millionincrease in our backlog was due primarily to new bookings. We achieve backlogthrough 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.

For 2005, the impact of inflation and changing priceson net sales and revenues and on income from continuing operations wasinsignificant.

As of December 31,2005, we had approximately 5,945 employees, including approximately 5,190 ITprofessionals. Of the 5,945 employees, approximately 3,045 were in Israel,1,415 were in India, 325 were in North America, 740 were in Europe and 420 werein the Asia Pacific region.

**Applicationof Critical 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. 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 are updated on a regular basis by inputs fromemployees’ and project managers’ estimates, which produce analysis, and areused by executive management to monitor the projects and revise the estimates,if necessary. 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.

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 

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latitude in establishingproduct pricing above specific minimums. Management determines whether we bearthe risks and rewards of ownership based on relevant sale contract terms. Wheneverthe majority of contract terms indicate that we bear the risks and rewards,revenues are recognized on a gross basis. For software license sales andhardware sales, we record revenues on a net basis, based on management’sdetermination that majority of contract terms indicate that we do not bear therisks and rewards related to such contracts.

For arrangements that involve multiple revenueactivities, (i.e., the delivery or performance of multiple products, services,and/or rights to use assets), management assumes that separate contracts withthe same party entered into at or near the same time are a package, andallocate the associated consideration to the separate activities based on theirrelative fair values. In order to determine the fair values of the differentactivities covered by each agreement, management applies standard pricing usedfor products and services in similar arrangements and hourly rates based onsimilar activities we have performed for other clients.

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.

***Foreign Currency Translation***

The financial statementsof our subsidiaries whose functional currency is not the dollar have beentranslated into U.S. dollars. All balance sheet accounts have been translatedusing the exchange rates in effect at the balance sheet date. Statement ofoperations amounts have been translated using the average exchange rate for theperiod. The resulting translation adjustments are reported as a component ofstockholders’ equity in accumulated other comprehensive income (loss). For subsidiarieswith transactions in currencies other than their functional currency, monetaryaccounts maintained in other currencies are re-measured into their functionalcurrency in accordance with Statement No. 52 of the Financial AccountingStandards Board (“FASB”) “Foreign Currency Translation.” All transaction gainsand losses from the re-measurement of monetary balance sheet items arereflected in the statement of operations as financial income or expenses asappropriate.

***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. Ifthe 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.

***Goodwill and Other Intangible Assets***

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. Fair value is determined 

38

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using discounted cashflows, market multiples and market capitalization. Significant estimates usedin the methodologies include estimates of future cash flows, future short-termand long-term growth rates, and weighted average cost of capital for thereportable unit. If these estimates or their related assumptions change in thefuture, we may be required to record impairment charges for our goodwill. As ofDecember 31, 2005, no impairment losses were identified.

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.

***Capitalized software development costs***

Our policy on capitalizedsoftware costs determines the timing of our recognition of certain developmentcosts. In addition, this policy determines whether the cost is classified as adevelopment expense or cost-of-license fee. Software development costs incurredfrom the point of reaching technological feasibility until the time of generalproduct release should be capitalized. We define technological feasibility asthe completion of a detailed program design. The determination of technologicalfeasibility requires the exercise of judgment by our management. Since we sellour products in a market that is subject to rapid technological changes, newproduct development and changing customer needs, changes in circumstances andestimations may significantly affect the timing and the amounts of softwaredevelopment costs capitalized and thus our financial condition and results ofoperations.

***Deferred Taxes***

Management judgment isrequired in determining our future taxable income for purposes of assessing ourability to realize any future benefits from our deferred tax assets. We recorda valuation allowance to reduce our deferred tax assets to the amount that ismore likely than not to be realized. If actual results differ from theseestimates or we adjust these estimates in future periods, our operating resultsand financial position could be materially affected. If we determine that wewill be able to realize the deferred tax assets in the future in excess oftheir net recorded amount, an adjustment to the deferred tax asset wouldincrease income in the period in which such determination is made. On the otherhand, should we determine that we will not be able to realize all or part ofthe net deferred tax assets in the future, an adjustment to the deferred taxassets will be charged to income in the period in which such determination ismade.

***Income Taxes***

Through our operatingsubsidiaries, we operate within multiple tax jurisdictions and may be subjectto tax audit in these jurisdictions. These tax audits can involve complexissues, which may require an extended 

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periodof time to resolve. In management’s opinion, adequate provisions for incometaxes have been made for all years.

***Stock based Compensation***

We have elected to followAccounting Principles Board Opinion No. 25 “Accounting for Stock Issued toEmployees” (“APB 25”) and Interpretation No. 44 “Accounting for CertainTransactions Involving Stock Compensation” (“FIN 44”) in accounting for ouremployee stock option plans. Under APB 25, we recognize compensation expensewhen the exercise price of our share options is less than the fair market priceof the underlying shares on the date of grant. The calculation of the intrinsicvalue of a stock award is based on management’s estimate of the fair value ofour common stock. Changes in this estimate could have a material impact on ourcompensation 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. Employeesare entitled to one month’s salary for each year of employment or a portionthereof. This liability is fully provided for by monthly deposits intoseverance pay funds, insurance policies and by an accrual. The value of thesepolicies is recorded as an asset on our balance sheet. The deposited funds maybe withdrawn only upon the fulfillment of the obligation pursuant to Israel’sSeverance Pay Law or labor agreements. The value of the deposited funds isbased on the cash surrender value of these policies, and includes immaterialprofits.

**Recent Developments**

On February 28, 2006, we closed the acquisitionof Innova Solutions (OLAS Software Solutions, Inc.), a privately heldprovider of IT services and solutions based in the United States and India. Thepurchase price in the all cash transaction is $25.0 million, of which $10.0million will be paid over the next two years based on the achievement ofcertain performance goals. For the full year 2005, Innova generated revenues ofover $30 million and was profitable. The acquisition is expected to beaccretive to 2006 earnings per share. Innova has over 700 employees, mainly inHyderabad, India. Innova is an IT services provider and system integratoroffering a portfolio of offshore and on-site IT services and solutions, with afocus on financial services. The acquisition is expected to provide synergieswith Ness’ current operations in the United States and India, adding directlyto Ness’ financial services practice as well as expanding the capacity of andfurther strengthening Ness’ other core verticals, such as ISVs and lifesciences. Following the acquisition, the Hyderabad delivery center became Ness’third major delivery center in India, complementing Ness’ existing delivery centersin Bangalore and Mumbai. Upon completion of the acquisition, Innova changed itsname to Ness Innovative Business Services, Inc.

In February 2006, wepaid the Israeli Tax Authority, or ITA, a sum of $3.4 million in full paymentof an assessment agreement with ITA regarding a tax assessment of our Israelisubsidiaries for the years 1999 through 2003. Since the agreed tax payment wasfully provided for in our consolidated balance sheet as of December 31,2005 and 2004, the agreement did not result in any additional tax expense inthe year ended December 31, 2005.

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**Consolidated Results 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** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues                                                                |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                                        |       | 70.4                                       |       | 69.6 |   | 71.5 |   |
| Provision for  losses (reverse of losses) on uncompleted contracts, net |       | 0.3                                        |       | (0.1 | ) | (0.1 | ) |
| Gross profit                                                            |       | 29.2                                       |       | 30.5 |   | 28.6 |   |
| Operating expenses:                                                     |       |                                       |       |   |   |   |   |
| Selling and marketing                                                   |       | 9.4                                        |       | 8.4 |   | 7.5 |   |
| General and administrative                                              |       | 16.0                                       |       | 15.1 |   | 14.2 |   |
| Research and development, net                                           |       | 0.7                                        |       | — |   | — |   |
| Other                                                                   |       | 0.3                                        |       | — |   | — |   |
| Total operating expenses                                                |       | 26.4                                       |       | 23.6 |   | 21.7 |   |
| Operating income                                                        |       | 2.8                                        |       | 6.9 | ) | 6.9 |   |
| Financial  expenses, net                                                |       | (0.6                                       | )          | (1.1 | ) | (0.4 | ) |
| Other expenses,  net                                                    |       | (0.2                                       | )          | (0.0 |   | (0.1 | ) |
| Income before  taxes on income                                          |       | 2.0                                        |       | 5.7 |   | 6.4 |   |
| Taxes on income (tax benefit)                                           |       | 0.0                                        |       | 0.8 | ) | 0.9 |   |
| Equity in net  earnings (losses) of affiliate                           |       | 0.0                                        |       | (0.2 | ) | 0.0 |   |
| Minority  interests in losses (earnings) of subsidiary                  |       | 0.0                                        |       | (0.1 |   | 0.0 |   |
| Income from  continuing operations                                      |       | 2.0                                        |       | 4.7 |   | 5.5 |   |
| Loss from discontinued operations                                       |       | (0.5                                       | )          | — |   | — |   |
| Extraordinary  income, net of taxes                                     |       | —                                     |       | — |   | 0.1 |   |
| Net income                                                              |       | 1.5                                        |       | 4.7 |   | 5.6 |   |

 

**2005 Compared to 2004**

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                                                   |       | 212,034                                |       | 275,465                  |       | 63,431 |   | 29.9 |   |
| Provision for  losses (reverse of losses) on uncompleted contracts |       | (309                                   | )          | (232                     | )          | 77 |   | (24.9 | ) |
| Gross profit                                                       |       | $                                      | 92,800     |                     | $          | 110,203 |   | 17,403 |   | 18.8 |   |
| Gross margin                                                       |       | 30.5                                   | %          | 28.6                     | %          |   |   |   |   |

 

41

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***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. We expect our revenues to grow in 2006 due to continued expansioninto North American and European markets in key verticals, including throughacquisitions, and the securing of contracts from new and existing clients.

***Cost of revenues and provision for losses (reverse oflosses) on uncompleted contracts***

Our cost of revenues,including salaries, wages and other direct and indirect costs, increased from$212.0 million in 2004 to $275.5 million in 2005, representing an increase of$63.4 million, or 29.9 %. The increase was attributable to growth in ourdelivery staff needed to support our increased revenues. In 2006, we expect ourcost of revenues to increase, primarily due to an increase in the number of ITprofessionals needed to support our expected revenue growth. In addition, ourcost of revenues will likely increase due to increases in salaries, especiallyin India, where there is strong demand for experienced IT professionals. Thechange in our provision for losses (reverse of losses) on uncompleted contractschanged from ($0.3) million in 2004 to ($0.2) million in 2005, as a result ofnet updates to our estimated costs of completion of our fixed price projects.

***Gross Profit***

Our gross profit (revenues less cost of revenues andprovision for losses (reverse of losses) on uncompleted contracts) increasedfrom $92.8 million in 2004 to $110.2 million in 2005, representing an increaseof $17.4 million, or 18.8%. The increase was primarily related to our increasein revenues, representing $24.7 million, offset by a decrease in our grossmargin, representing approximately ($7.3) million. Gross margin for 2005 was28.6%, 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. In 2006, we expect that gross profit willincrease as a result of our anticipated revenue growth.

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 |   |

 

***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 

42

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marketingand sales expenses from our acquisitions in Eastern Europe in 2005,representing $1.2 million, an increase in marketing expenses needed to enhanceour brand recognition and to support our revenue growth, representing $1.0million, and increases in our sales commissions and other sales expenses of$1.1 million. In 2006, we expect selling and marketing expenses to increase tosupport growth in new vertical markets and regions as well as to enhance ourbrand recognition.

***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-basedcompensation expenses of $1.9 million in respect of redeemable options, asdescribed in Note 14(b)12 to our Consolidated Financial Statements. We expectno further significant compensation expense related to these redeemable options.In 2006, we expect our general and administrative expenses to increase tosupport our anticipated revenue growth. We also expect to incur ongoingexpenses associated with being a public company and maintaining ourSarbanes-Oxley compliance.

The following table summarizes certain line items fromour consolidated statement of 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 | ) | 166.7 |   |
| 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 from  continuing operations                       |       | 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. For 2006, we expectfinancial expenses to increase due to an anticipated significant decrease innet cash (cash, cash equivalents and short-term bank deposits less total debt)resulting from payments made, or to be made, in respect of acquisitions closedin 2005 or the first quarter of 2006.

***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. We expect that our effective tax rate in 2006 will remain atapproximately the same level as our 2005 effective tax rate. In 2009, the taxholiday in India will terminate, at which time we expect our effective tax rateto increase significantly.

***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 acquiredcertain assets and assumed certain liabilities of Blueflame, Inc., werecorded 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.

***Net Income***

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 financialexpenses of $1.9 million, our decrease in equity in net losses of affiliates of$0.6 million and our extraordinary income, net of taxes, of $0.5 million,partially offset by the increase in our taxes on income of $1.2 million. Theincrease in our operating income was itself offset by an increase instock-based compensation of $1.9 million.

***2004 Compared to 2003***

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

| ** **                                                              | ** ** | **Year ended December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|
| ** **                                                              | ** ** | **2003**                                   | ** ** | **2004**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                                                |       | $                                          | 225,768    |                     | $          | 304,525 |   | 78,757 |   | 34.9 |   |
| Cost of revenues                                                        |       | 158,987                                    |       | 212,034                  |       | 53,047 |   | 33.4 |   |
| Provision for  losses (reverse of losses) on uncompleted contracts, net |       | 788                                        |       | (309                     | )          | (1,097 | ) | (139.2 | ) |
| Gross profit                                                            |       | $                                          | 65,993     |                     | $          | 92,800 |   | 26,807 |   | 40.6 |   |
| Gross margin                                                            |       | 29.2                                       | %          | 30.5                     | %          |   |   |   |   |

 

44

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***Revenues***

Our revenues increasedfrom $225.8 millionin 2003 to $304.5 million in2004, representing an increase of $78.8million, or 34.9%. The increasewas due primarily to the inclusion of $40.0 million of revenues attributable tothe acquisition of Apar, effective June 30, 2003, with the remaining $38.8 million attributable to anincrease in sales. The $38.8million sales increase was primarily due to growth in outsourcing and offshoreengagements, representing $23.3million, while $15.5 million wasattributable to growth in our other offerings, comprised of system integrationand application development, software and consulting, and quality assurance andtraining. Revenues from outsourcing and offshore services increased as a resultof volume growth due to our sales initiatives related to these offerings,including the hiring of key personnel and aligning of our organizationalstructure, and expansion into geographical areas in which we currently dobusiness but previously had not offered outsourcing and offshore services. Therewas no significant change in our billing rates, or prices, from 2003 to 2004.

***Cost of revenues and provision for losses (reverse oflosses) on uncompleted contracts, net***

Our cost of revenues,including salaries, wages and other direct costs, increased from $159.0 millionin 2003 to $212.0 million in 2004, representing an increase of $53.0 million, or 33.4%. The increasewas due primarily to the acquisition of Apar, representing $28.4 million, andother costs of revenues, representing $24.6 million. The other costs ofrevenues are attributable primarily to growth in delivery staff needed tosupport our increased revenues. The change in our provision for losses (reverseof losses) on uncompleted contracts, net, changed from $1.0 million in 2003 to($0.3) million in 2004, as a result of net changes in our fixed price projectloss provisions.

***Gross Profit***

Our gross profit (revenuesless cost of revenues and provision for losses (reverse of losses) onuncompleted contracts, net) increased from $66.0 million in 2003 to $92.8million in 2004, representing an increase of $26.8 million, or 40.6%. The increasewas primarily due to the inclusion of $11.6 million of gross profit from theApar acquisition, and the increase in our revenues along with an increase inour gross margin, together representing $15.2 million. Gross margin for 2004was 30.5%, compared to 29.2% in 2003. The increase in gross margin resultedprimarily from an increase in billable utilization. We define billableutilization as the total billable hours in a period divided by the totalavailable hours of our professionals in that period.

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

| ** **                     | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **2003**                               | ** ** | **2004**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing         |       | $                                      | 21,287     |                     | $          | 25,706 |   | 4,419 |   | 20.8 |   |
| General and  administrative    |       | 36,115                                 |       | 46,042                   |       | 9,927 |   | 27.5 |   |
| Research and  development, net |       | 1,559                                  |       | —                   |       | (1,559 | ) | (100.0 | ) |
| Other                          |       | 665                                    |       | —                   |       | (665 | ) | (100.0 | ) |
| Total operating  expenses      |       | 59,626                                 |       | 71,748                   |       | 12,122 |   | 20.3 |   |
| Operating income               |       | $                                      | 6,367      |                     | $          | 21,052 |   | 14,685 |   | 230.6 |   |

 

45

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***Selling and marketing***

Selling and marketingexpenses increased from $21.3 million in 2003 to $25.7 million in 2004,representing an increase of $4.4 million, or 20.8%. This increase was due primarily to theinclusion of $1.4 million of expenses attributable to the Apar acquisition, a$1.9 million increase in marketing expenses, increases in our sales commissionsand other sales expenses of $0.7 million, and a $0.4 million increase inclient-based asset amortization. The increase in marketing expenses relatedprimarily to our efforts to enhance our brand recognition. The increase inclient-based asset amortization was due primarily to an increased cumulativecost of amortization of client-based assets that we acquired in connection withthe Apar acquisition.

***General and administrative***

General and administrativeexpenses increased from $36.1 million in 2003 to $46.0 million in 2004,representing an increase of $9.9 million, or 27.5%. This increase was due primarily toinclusion of $8.3 million of expenses attributable to the Apar acquisition andother general and administrative expenses of $1.6 million. These other generaland administrative expenses were necessary to support our revenue growth.

***Research and development, net***

Research and developmentexpenses decreased from $1.6 million in 2003 to no material expenses in 2004.These expenses were comprised solely of the development of Ness ISI’s dbMotionsystem. Following the January 1, 2004 issuance of preferred shares by NessISI that reduced our share ownership to a non-controlling interest, we nolonger consolidate Ness ISI’s results in our financial statements.

***Other***

Other expenses decreased from $0.7 million in 2003 tono expenses in 2004. The expense in 2003 resulted from the consolidation ofcertain corporate and branch administrative services in the United States.

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

| ** **                                             | ** ** | **Year ended  December 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                                             | ** ** | **2003**                               | ** ** | **2004**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                                       |       | $                                      | 6,367      |                     | $          | 21,052 |   | 14,685 |   | 230.6 |   |
| Financial  expenses, net                               |       | (1,451                                 | )          | (3,461                   | )          | (2,010 | ) | 138.5 |   |
| Other expenses,  net                                   |       | (422                                   | )          | (91                      | )          | 331 |   | (78.4 | ) |
| Income before  taxes on income                         |       | 4,494                                  |       | 17,500                   |       | 13,006 |   | 289.4 |   |
| Taxes on income  (tax benefit)                         |       | (54                                    | )          | 2,320                    |       | 2,374 |   | N/A |   |
| Equity in net  earnings (losses) of affiliates         |       | 11                                     |       | (647                     | )          | (658 | ) | N/A |   |
| Minority  interests in losses (earnings) of subsidiary |       | —                                 |       | (156                     | )          | (156 | ) | N/A |   |
| Income from  continuing operations                     |       | 4,559                                  |       | 14,377                   |       | 9,818 |   | 215.4 |   |
| Loss from discontinued  operations                     |       | (1,105                                 | )          | —                   |       | 1,105 |   | (100.0 | ) |
| Net income                                             |       | $                                      | 3,454      |                     | $          | 14,377 |   | 10,923 |   | 316.2 |   |

 

***Financial expenses, net***

Financial expenses, net,increased from $1.5 million in 2003 to $3.5 million in 2004, representing anincrease of $2.0million, or 138.5%. The increase was due primarily to the changes in theexchange rate for the dollar against the NIS.

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***Other expenses, net***

Other expenses, net,decreased from $0.4 million in 2003 to $0.1 million in 2004. Termination ofproperty in 2003, which resulted in a capital loss, representing an estimated$0.4 million, was the primary expense in 2003.

***Taxes on income (tax benefit)***

Our taxes on income (taxbenefit) changed from a benefit of $54,000 in 2003 to taxes of $2.3 million in2004. This change was due to the increase in our income before taxes and thedepletion of our net operating loss carry forwards in Israel and the UnitedStates.

***Equity in net earnings (losses) of affiliates***

Equity in net earnings(losses) of affiliates changed from earnings of $11,000 for 2003 to losses of$0.6 million in 2004. This change was due to a one-time capital loss related toour reduced ownership of our affiliate, Ness ISI (now known as dbMotion Ltd.),in 2004. Following the January 1, 2004 issuance of preferred shares byNess ISI that reduced our share ownership to a non-controlling interest, we nolonger consolidate Ness ISI’s results in our financial statements.

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

Minority interests inlosses (earnings) of subsidiary changed from no earnings in 2003 to losses of$0.2 million in 2004. This change was insignificant.

***Income from continuing operations***

Income from continuingoperations increased from $4.6 million in 2003 to $14.4 million in 2004,representing an increase of $9.8 million, or 215.4%. The increase in net income was dueprimarily to our increase in operating income of $14.7 million, partiallyoffset by our increased financial expenses of $2.0 million, the increase in ourincome taxes of $2.4 million and our decrease in equity in net earnings(losses) of affiliates of $0.7 million.

***Loss from discontinued operations***

In 2003, we recognized anet loss after taxes of $1.1 million, compared to no loss for 2004. The losswas attributable to the closing of an insignificant line of business.

***Net income***

Net income increased from$3.5 million in 2003 to $14.4 million in 2004, representing an increase of $10.9 million, or 316.2%. The increasein net income was due primarily to our increase in operating income of $14.4million and the retirement on December 31, 2003 of losses fromdiscontinued operations of $1.1 million, partially offset by our increasedfinancial expenses of $2.0 million, the increase in our income taxes of $2.4million and our decrease in equity in net earnings (losses) of affiliates of$0.7 million.

**Quarterly Results of Operations**

Thefollowing table presents our unaudited quarterly results of operations for theeight quarters in the period ended December 31, 2005. 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 

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operating results for the quarters presented. Operatingresults for any quarter are not necessarily indicative of results for anyfuture quarters or for a full year.

| ** **                                                              | ** ** | **Three months ended**                      | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Mar 31,  2004**                                | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** |
| ** **                                                              | ** ** | **(unaudited) (dollars in thousands)** | ** ** |
| Revenues                                                                |       |                                                  | $          | 71,146 |   |   | $ | 73,879 |   | $ | 77,152 |   | $ | 82,348 |   |   | $ | 88,405 |   |   | $ | 94,218 |   | $ | 97,719 |   | $ | 105,094 |   |
| Cost of revenues                                                        |       |                                                  | 48,848     |   |   | 51,785 |   | 53,969 |   | 57,432 |   |   | 62,492 |   |   | 68,033 |   | 69,882 |   | 75,056 |   |
| Provision for  losses (reverse of losses) on uncompleted contracts, net |       |                                                  | (442       | ) |   | (43 | ) | 26 |   | 150 |   |   | 85 |   |   | 13 |   | (254 | ) | (76 | ) |
| Gross profit                                                            |       |                                                  | 22,740     |   |   | 22,137 |   | 23,157 |   | 24,766 |   |   | 25,828 |   |   | 26,172 |   | 28,091 |   | 30,114 |   |
| Operating expenses:                                                     |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling and marketing                                                   |       |                                                  | 6,086      |   |   | 6,044 |   | 6,822 |   | 6,754 |   |   | 7,031 |   |   | 7,002 |   | 7,081 |   | 7,919 |   |
| General and administrative                                              |       |                                                  | 11,448     |   |   | 11,749 |   | 10,945 |   | 11,900 |   |   | 12,942 |   |   | 14,252 |   | 13,344 |   | 14,192 |   |
| Total operating expenses                                                |       |                                                  | 17,534     |   |   | 17,793 |   | 17,767 |   | 18,654 |   |   | 19,973 |   |   | 21,254 |   | 20,425 |   | 22,111 |   |
| Operating income                                                        |       |                                                  | 5,206      |   |   | 4,344 |   | 5,390 |   | 6,112 |   |   | 5,855 |   |   | 4,917 |   | 7,666 |   | 8,003 |   |
| Financial income  (expenses), net                                       |       |                                                  | (2,369     | ) |   | (781 | ) | (1,177 | ) | 866 |   |   | (420 | ) |   | (494 | ) | (383 | ) | (224 | ) |
| Other income  (expenses), net                                           |       |                                                  | 84         |   |   | 11 |   | (16 | ) | (170 | ) |   | (6 | ) |   | 10 |   | (14 | ) | (232 | ) |
| Income before  taxes on income                                          |       |                                                  | 2,921      |   |   | 3,574 |   | 4,197 |   | 6,808 |   |   | 5,429 |   |   | 4,433 |   | 7,269 |   | 7,547 |   |
| Taxes on income  (tax benefit)                                          |       |                                                  | (111       | ) |   | 596 |   | 473 |   | 1,362 |   |   | 602 |   |   | 423 |   | 1,252 |   | 1,241 |   |
| Equity in net  earnings (losses) of affiliates                          |       |                                                  | (615       | ) |   | (33 | ) | (3 | ) | 4 |   |   | (2 | ) |   | (27 | ) | — |   | (37 | ) |
| Minority interests  in losses (earnings) of a subsidiary           |       |                                                  | —     |   |   | (35 | ) | (30 | ) | (91 | ) |   | 101 |   |   | — |   | — |   | — |   |
| Income from  continuing operations                                      |       |                                                  | 2,417      |   |   | 2,910 |   | 3,691 |   | 5,359 |   |   | 4,926 |   |   | 3,983 |   | 6,017 |   | 6,269 |   |
| Extraordinary  income, net of taxes                                     |       |                                                  | —     |   |   | — |   | — |   | — |   |   | — |   |   | — |   | — |   | 495 |   |
| Net income                                                              |       |                                                  | $          | 2,417 |   |   | $ | 2,910 |   | $ | 3,691 |   | $ | 5,359 |   |   | $ | 4,926 |   |   | $ | 3,983 |   | $ | 6,017 |   | $ | 6,764 |   |

 

**Liquidity and Capital Resources**

***Overview***

As of December 31,2005, we had cash, cash equivalents and short-term bank deposits of $73.1million compared to $104.2 million as of December 31, 2004. The funds heldat locations outside of the United States are for future operating expenses,and we have no intention of repatriating those funds. We are not, however,restricted in repatriating those funds back to the United States, if necessary.While we expect that cash generated by our non-U.S. subsidiaries will bereinvested in their respective countries to support expansion of our business,to the extent that funds were remitted to the United States in the form ofdividend payments, those payments would be subject to a withholding tax.

***Cash Flows***

Thefollowing table summarizes our cash flows for the periods presented (dollars inthousands):

| ** **                                                    | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** |
| Net cash provided  by operating activities                    |       | $                                          | 15,568     |   | $ | 6,801 |   |
| Net cash used in  investing activities                        |       | (9,041                                     | )          | (60,594 | ) |
| Net cash provided  by (used in) financing activities          |       | 51,583                                     |       | (9,860 | ) |
| Effect of  exchange rate changes on cash and cash equivalents |       | 115                                        |       | (6,997 | ) |
| Increase (decrease)  in cash and cash equivalents             |       | 58,225                                     |       | (70,650 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 46,004                                     |       | 104,229 |   |
| Cash and cash  equivalents at the end of the period           |       | $                                          | 104,229    |   | $ | 33,579 |   |

 

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*2005 compared to2004*

Net cash provided by operating activities was $6.8million in 2005, compared to $15.6 million in 2004. The major factorscontributing to the change were payments made to several of our suppliers inconnection with a reduction of indebtedness and the revising of commercialterms following our initial public offering, including a large payment to oneof our suppliers of $8.2 million, offset by our increase in net income,representing $7.3 million.

Net cash used in investing activities was $60.6million in 2005, compared with $9.0 million in 2004. The major factorscontributing to the increase were investments we made in short-term deposits inorder to realize higher yields, representing $39.1 million, payments in respectof the acquisitions we made during the second, third and fourth quarters,representing $10.2 million, net of cash acquired, and investment inavailable-for-sale marketable securities, representing $2.3 million.

Net cash used in financing activities was $9.9 millionin 2005, compared to net cash provided of $51.6 million in 2004. The net cashprovided by financing activities in 2004 resulted primarily from net proceedsfrom our initial public offering, representing $89.3 million, partially offsetby payment of long term and short term loans, net, representing $30.7 million. Thedecrease in net cash provided by financing activities in 2005 was primarily dueto the absence of an equivalent amount in 2005 plus a reduction in ourlong-term net debt of $17.8 million, offset by an increase of $19.5 million inshort-term bank loans and credit and by the proceeds from employee exercises ofstock options, representing $9.6 million.

The effect of exchangerate changes on cash and cash equivalents was ($7.0) million in 2005, comparedto $0.1 million in 2004. The change was primarily due to long-terminter-company balances, representing ($4.0) million.

***Long-term and Short-term Debt***

At December 31, 2005,we had aggregate short-term and long-term bank and other borrowings of $34.2million, consisting of various notes denominated in dollars and NIS (linked toindex) with interest rates ranging from approximately 4.5% to 7.5% and aweighted average interest rate of approximately 6.75%, with maturities of oneto four years. These aggregate bank borrowings included $21.0 million from BankHapoalim, with an interest rate of approximately 4.5% and maturity of one year;$7.2 million from Israel Discount Bank, with interest rates of approximately6.5% to 7.5% and maturities of two to three years; and $6.0 million from fiveother lenders, in amounts ranging from $1.0 million to $1.7 million, withinterest rates of approximately 5% to 6% and maturities of up to four years.The maximum interest rate for our dollar-linked borrowings was approximately4.5%, and for NIS index linked borrowings was approximately 7.5%.

***Anticipated CapitalExpenditures***

In 2005, we used$17.8 million of the proceeds of our initial public offering in the fourthquarter of 2004 to further reduce net debt beyond the net debt reduction of$35.6 million accomplished in the fourth quarter of 2004, exceeding ourpreviously announced $40 million debt reduction plan. Following the use ofproceeds, our only material indebtedness is amounts owed by Ness TechnologiesHoldings Ltd., one of our subsidiaries, to Bank Hapoalim and Israel DiscountBank. The shares of two of our Israeli subsidiaries are pledged to these banksas security for borrowings under the agreements. We are currently the processof canceling the pledges on these shares. The relevant debt instruments containcustomary restrictive covenants relating to the borrower and our wholly-ownedsubsidiary Ness A.T. Ltd., including the following:

·       limitationson incurring debt;

·       prohibitionon pledging assets;

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·       prohibitionon distributing dividends;

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

·       EBITDAmust not be less than 9.5% of revenues and not less than NIS 34 million; and

·       limitationson merging or transferring assets.

In addition, the IsraelDiscount Bank agreement requires that the net cash and liquid assets of theborrower must not be lower than $18.0 million. As of December 31, 2005, weare in compliance and expect to remain in compliance with all of our covenants.Our failure to comply with these covenants could lead to an event of defaultunder the agreements governing some or all of the indebtedness, permitting theapplicable lender to accelerate all borrowings under the applicable agreement,and to foreclose on any collateral.

***Anticipated Needs***

We intend to fund futuregrowth through cash flow from operations, available bank borrowings and theremaining net proceeds of our initial public offering. We believe the remainingbalance of the proceeds of our initial public offering, together withborrowings and cash flow from operations, will be sufficient to fund continuingoperations for the foreseeable future. In order to achieve our strategicbusiness objectives, we may be required to seek additional financing. Forexample, 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.

**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.

**ContractualObligations**

Ourmajor outstanding contractual obligations relate to our long-term debt,operating leases and accrued severance pay. We have no long-term obligationsfor a period longer than three years. We have summarized in the table below ourfixed contractual cash obligations for long-term debt and operating leases asof December 31, 2005 (dollars in thousands).

| ** **        | ** ** | **Total** | ** ** | **Less than    year** | ** ** | **1-3 years** | ** ** | **4 years** | ** ** |
|-------------------|------------|-----------|------------|--------------------------------------|------------|--------------------|------------|------------------|------------|
| Long-term debt    |       | $         | 11,610     |                                 |       | $                  | 5,726      |             |       |   | $ | 5,883 |   |   |   | $ | — |   |   |
| Interest payments |       | 1,483     |       |                                 | 706        |               |       |             | 777        |   |   |   | — |   |   |
| Operating leases  |       | 1,546     |       |                                 | 1,136      |               |       |             | 410        |   |   |   | — |   |   |
| Total             |       | $         | 14,639     |                                 |       | $                  | 7,568      |             |       |   | $ | 7,070 |   |   |   | $ | — |   |   |

 

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Our obligation for accruedseverance pay under Israel’s Severance Pay Law as of December 31, 2005 was$39.7 million, of which $35.8 million was funded through deposits intoseverance pay funds, leaving a net obligation of $3.9 million.

**RecentlyIssued Accounting Pronouncements**

On December 16, 2004, the FASB issued SFASNo. 123R (revised 2004), “Share-Based Payment,” which is a revision ofSFAS No. 123, “Accounting for Stock-Based Compensation,” which requirescompanies to recognize in the statements of income, all share-based payments toemployees, including grants of employee stock options, based on their fairvalues. Accounting for share-based compensation transactions using theintrinsic method supplemented by pro forma disclosures will no longer be permissible.The new statement is effective for public entities as of the beginning of thefirst interim or annual reporting period of the first fiscal year beginningafter June 15, 2005. We plan to adopt the new statement effectiveJanuary 1, 2006, using the “modified prospective” method. We believe thatthe adoption of this new statement will have an impact on our results ofoperations and net earnings per share as we will be required to expense thefair value of all share-based payments. However, our assessment of theestimated compensation charges is affected by our stock price as well asassumptions regarding a number of complex and subjective variables and therelated tax impact. These variables include, but are not limited to, thevolatility of our stock price and employee stock option exercise behaviors.

In March 2005, the SEC released Staff AccountingBulletin No. 107, “Share-Based Payment” (“SAB 107”). SAB 107 provides theSEC staff position regarding the application of SFAS No. 123R. SAB 107contains interpretive guidance related to the interaction between SFASNo. 123R and certain SEC rules and regulations, as well as providesthe Staff’s views regarding the valuation of share-based payment arrangementsfor public companies. SAB 107 also highlights the importance of disclosuresmade related to the accounting for share-based payment transactions. We expectthat the adoption of SAB 107 will have an impact on our results of operationsand net earnings per share as we will be required to expense the fair value ofall share-based payments.

In May 2005, the FASB issued FASB StatementNo. 154, “Accounting Changes and Error Corrections” (“SFAS 154”) whichreplaces APB Opinion No. 20, “Accounting Changes”, and FASB StatementNo. 3, “Reporting Accounting Changes in Interim FinancialStatements.”  Among other changes, SFAS154 requires that a voluntary change in accounting principles or a changerequired by a new accounting pronouncement that does not include specifictransition provisions be applied retrospectively with all prior periodfinancial statements presented on the new accounting principle, unless it isimpracticable to do so. SFAS 154 also provides that (1) a change in methodof depreciating or amortizing a long-lived non-financial asset be accounted foras a change in estimate (prospectively) that was affected by a change inaccounting principle, and (2) correction of errors in previously issuedfinancial statements should be termed a “restatement”. SFAS 154 is effectivefor accounting changes and correction of errors made in fiscal years beginningafter June 15, 2005. Accordingly, we are required to adopt the provisionsof SFAS 154 in the first quarter of fiscal 2006, beginning on January 1,2006. We are currently evaluating the effect that the adoption of SFAS 154 willhave on our consolidated results of operations and financial condition but wedo not expect SFAS 154 to have a material impact.

In November 2005, theFASB issued FASB Staff Position (“FSP”) Financial Accounting Standard (“FAS”)115-1 and FAS 124-1, “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments” (“FSP 115-1”),which provides guidance on determining when investments in certain debt andequity securities are considered impaired, whether that impairment isother-than-temporary, and on measuring such impairment loss. FSP 115-1also includes accounting considerations subsequent to the recognition of another-than temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments. FSP 115-1 is required to be applied to reporting periodsbeginning after December 15, 2005 and is required to be 

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adoptedby us in the second quarter of fiscal 2006. We do not expect the adoption ofFSP 115-1 to have a significant effect on our consolidated financialstatements.

***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 relationships in many other parts of the world. Our foreign operationscontract with clients in their applicable local currencies or dollars. As aresult, we are subject to adverse movements in foreign currency exchange ratesin those countries where we conduct business. Beginning in the second quarterand continuing into the third quarter of 2005, we entered into certain forwardforeign currency exchange contracts to hedge our exposure against foreigncurrencies which differ from the local functional currencies. No such contractsare outstanding as of December 31, 2005. In the future, we may enter intoadditional forward foreign currency exchange or other derivatives contracts tofurther hedge our exposure to foreign currency exchange rates.

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

***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*

**Evaluationof Disclosure 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 onlyreasonable, and not absolute, assurance that the objectives of the system aremet. In addition, the design of any control system is based in part uponcertain assumptions about the likelihood of future events. Given these andother inherent limitations of control systems, there is only reasonableassurance that our controls will succeed in achieving their stated goals underall potential future conditions.

**Management’sReport On 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). Underthe supervision and with the participation of our management, including ourprincipal executive officer and 

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principal financialofficer, we conducted an evaluation of the effectiveness of our internalcontrol over financial reporting as of December 31, 2005 based on theframework in Internal Control-Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission. As permitted, we haveexcluded from our evaluation the 2005 acquisitions of Radix Company SA, DeltaElectronic Services a.s., Efcon a.s. and N.T.R. Holding Ltd., which areincluded in our 2005 Consolidated Financial Statements, and which in theaggregate represented 5.6% of consolidated total assets and 3.3% ofconsolidated shareholders’ equity as of December 31, 2005, and 7.8% ofconsolidated net revenues and 21.3% of consolidated net income for the yearended December 31, 2005. Based on that evaluation, our managementconcluded that our internal control over financial reporting was effective asof December 31, 2005.

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31,2005 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.

**ReportOf Independent 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 internalcontrol over financial reporting as of December 31, 2005, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the COSO criteria). NessTechnologies, Inc.’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon 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 

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that controls may becomeinadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

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 Radix Company SA, Delta ElectronicServices a.s., Efcon a.s. and N.T.R. Holding Ltd., which are included in the2005 consolidated financial statements of Ness Technologies, Inc. andwhich constituted, in aggregate, 5.6% of total assets and 3.3% of shareholders’equity as of December 31, 2005, and 7.8% of revenues and 21.3% 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 Radix Company SA, DeltaElectronic Services a.s., Efcon a.s. and N.T.R. Holding Ltd.

In our opinion, management’s assessment that NessTechnologies, Inc. maintained effective internal control over financialreporting as of December 31, 2005, 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, 2005, based on the COSO criteria.

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 2004, and therelated consolidated statements of income, shareholders’ equity and cash flowsfor each of the three years in the period ended December 31, 2005 of NessTechnologies, Inc. and our report dated March 14, 2006 expressed anunqualified opinion thereon.

| Tel Aviv, Israel    | Kost Forer Gabbay &  Kasierer    |
|---------------------|-------------------------------------------|
| March 14, 2006 | A MEMBER OF ERNST & YOUNG GLOBAL |

 

**Changes in Internal Control**

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***

On March 13, 2006, we amended our employment agreementwith Raviv Zoller, our president and chief executive officer.  Effective January 1, 2006, Mr. Zoller’smonthly salary was adjusted to the NIS equivalent of $25,000, as provided inhis employment agreement, based on the Israeli Consumer Price Index publishedon January 15, 2006; and in the event of a voluntary termination by Mr. Zoller,he will receive (1) his salary and benefits for six months following his dateof termination and (2) a pro rata portion of any bonus to which he is entitledunder the agreement.

On March 13, 2006, we amended our employment agreementwith Ytzhak Edelman, our chief financial officer and deputy to the chiefexecutive officer.  Effective January 1,2006, Mr. Edelman’s monthly salary was adjusted to 80,000 NIS, as provided inhis employment agreement, based on the Israeli Consumer Price Index publishedon February 15, 2006.

On March 13, 2006, we amended our employment agreementwith Tuvia Feldman, our chief operating officer.  Effective March 1, 2006, Mr. Feldman isentitled to receive twelve months’ prior notice if we terminate his employmentagreement, and he must provide twelve months’ prior notice if he terminates theagreement.

On March 13, 2006, we amended our employment agreementwith Shashank Samant, one of our executive officers, effective as of January 1,2006.  Mr. Samant may be deemed to be anemployee-at-will because his agreement does not specify a term of employment.  Mr. Samant’s annual base salary is 

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$240,000 and he is eligibleto receive an annual bonus of up to $250,000 based on achievement of certaingoals relating to the performance of his business unit and the company.  He is also eligible to receive an additionalbonus of up to $50,000 at the discretion of our chief executive officer.  Either party may terminate the agreement atany time by providing the other party with fifteen days’ prior written notice,and we may terminate Mr. Samant without notice in the event of misconduct ornon-performance.  Upon termination by theCompany, Mr. Samant will be entitled to his base salary through the date oftermination, and, except in the case of termination for cause, to nine monthsof severance pay.  In the event ofresignation “for good reason,” Mr. Samant will be entitled to 75% of the annualbonus otherwise due; and in the event of an otherwise voluntary resignation,50% of the annual bonus otherwise due. The agreement also contains customaryconfidentiality and non-solicitation provisions.  The non-solicitation of employees provision appliesduring Mr. Samant’s employment and for one year thereafter.

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**PART III**

***Item 10.   Directors and Executive Officers of theRegistrant***

The information requiredby this item is incorporated by reference to our definitive proxy statement tobe filed with the Securities and Exchange Commission not later than April 30,2006 in connection with our annual meeting of stockholders (the “ProxyStatement”) under the headings “Executive Officers,” “Election of Directors,” “CorporateGovernance Principles and Board Matters,” “Director Compensation” and “Compliancewith Section 16(a) of the Exchange Act.”

***Item 11.   Executive Compensation***

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

***Item 12.   Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters***

The information requiredby this Item is incorporated by reference to the Proxy Statement under theheading “Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters.”

***Item 13.   Certain Relationships and Related Transactions***

The information requiredby this item is incorporated by reference to the Proxy Statement under theheading “Certain Relationships and Related Transactions.”

***Item 14.   Principal Accountant Fees and Services***

The information requiredby this item is incorporated by reference to the Proxy Statement under theheading “Principal Accountant Fees and Services.”

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**PART IV**

***Item 15.   Exhibits, Financial Statements andSchedules***

(a) List of documents filed as part of thisreport:

***1. Financial Statements as ofDecember 31, 2005 and December 31, 2004 and for each of the threeyears in the period ended December 31, 2005 included in Part II ofthis 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 StatementSchedules:***

Schedule II—Valuation andQualifying Accounts of Ness Technologies, Inc.

***3. Exhibit Index***

The following is a list ofexhibits 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.                                                                                                                                |

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| +**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           |   | Amended and  Restated Employment Agreement, effective as of June 1, 2001, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd.                 |
| +**10.15           |   | Amendment to  Amended and Restated Employment Agreement, effective as of January 1,  2004, between the Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |
| +10.16             |   | Amendment to  Employment Agreement, effective as of January 1, 2006, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd.                      |
| +¶10.17       |   | Employment  Agreement, dated as of April 21, 2005, between the Registrant and Ytzhak  Edelman.                                                                    |
| +10.18             |   | Amendment to  Employment Agreement, effective as of January 1, 2006, between the  Registrant and Ytzhak Edelman.                                                  |
| +**10.19           |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Tuvia Feldman (English translation).                 |
| +**10.20           |   | Addendum to  Personal Employment Agreement, dated as of August 1, 1999, between  Advanced Technology Ltd. and Tuvia Feldman (English translation).                |
| +**10.21           |   | Addendum to Personal Employment  Agreement, dated as of August 23, 1999, between Advanced Technology Ltd.  and Tuvia Feldman (English translation).               |
| +**10.22           |   | Employment Agreement  Addendum, dated as of August 27, 2000, between the Registrant and Tuvia  Feldman.                                                           |
| +**10.23           |   | Summary of Meeting,  dated May 3, 2001, between Raviv Zoller and Tuvia Feldman (English  translation).                                                            |
| +10.24             |   | Amendment to Employment  Agreement, effective as of March 1, 2006, between the Registrant and  Tuvia Feldman.                                                     |
| +**10.25           |   | Offer Letter, dated  January 29, 2004, between the Registrant and Ivan Hruška.                                                                               |
| +**10.26           |   | Contract of Employment,  effective as of March 1, 2004, between the Registrant and Ivan Hruška.                                                              |
| +**10.27           |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).               |
| +**10.28           |   | Addendum to Personal  Employment Agreement, dated as of August 1, 1999, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).              |
| +**10.29           |   | Addendum to Personal  Employment Agreement, dated as of August 23, 1999, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).             |
| +¶¶10.30 |   | Personal Employment  Agreement, dated as of August 10, 2005, between Ness Technologies  Holdings Ltd. and Shachar Efal (English translation)                      |
| +10.31             |   | Offer letter, dated as  of December 1, 1999, from Apar Infotech Corporation to Shashank Samant.                                                                   |

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| +10.32  |   | Addendum to Employment  Agreement, effective as of January 1, 2006, between Ness USA, Inc.  and Shashank Samant.                                                     |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.33 |   | Form of Indemnification  Agreement by and between the Registrant and its officers and directors.                                                                          |
| **10.34 |   | Stock Purchase Agreement, dated as of  August 30, 2002, among the shareholders of APP Group CEE B.V. listed  therein and the Registrant.                                  |
| **10.35 |   | 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.                 |
| 99.1    |   | Consent of  Gartner, Inc.                                                                                                                                                 |

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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.

+                Indicates thosecontracts that are management contracts or compensation plans or arrangements.

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**SIGNATURES**

Pursuant to therequirements of section 13 or 15(d) of the Securities Exchange Act of1934, 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, 2006.

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

 

**POWER OF ATTORNEY**

KNOW ALL MEN BY THESE PRESENTS, that each person whosesignature appears below constitutes and appoints Raviv Zoller and YtzhakEdelman as his true and lawful attorney-in-fact, each acting alone, with fullpower of substitution and resubstitution for him and in his name, place andstead, in any and all capacities, to sign any and all amendments, includingpost-effective amendments to this report, with exhibits thereto, and otherdocuments in connection therewith, with the Securities and Exchange Commission,hereby ratifying and confirming all that said attorneys-in-fact or theirsubstitutes, each acting along, may lawfully do or cause to be done by virtuehereof.

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,  2006 |
| Aharon  Fogel            |          |                                            |       |                 |
| /s/ RAVIV  ZOLLER        |          | President, Chief Executive Officer and Director |       | March 14,  2006 |
| Raviv  Zoller            |          | (principal  executive officer)                  |       |                 |
| /s/ YTZHAK  EDELMAN      |          | Chief  Financial Officer and deputy to the CEO  |       | March 14,  2006 |
| Ytzhak  Edelman          |          | (principal  financial and accounting officer)   |       |                 |
| /s/ HENRY  KRESSEL       |          | Director                                        |       | March 14,  2006 |
| Dr. Henry  Kressel       |          |                                            |       |                 |
| /s/ MORRIS  WOLFSON      |          | Director                                        |       | March 14,  2006 |
| Morris  Wolfson          |          |                                            |       |                 |
| /s/ SATYAM C.  CHERUKURI |          | Director                                        |       | March 14,  2006 |
| Dr. Satyam  C. Cherukuri |          |                                            |       |                 |
| /s/ DAN S.  SUESSKIND    |          | Director                                        |       | March 14,  2006 |
| Dan  S. Suesskind        |          |                                            |       |                 |
| /s/ KENNETH A.  PICKAR   |          | Director                                        |       | March 14,  2006 |
| Dr. Kenneth A.  Pickar   |          |                                            |       |                 |

 

60

----

**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      |            |   | Amended and  Restated Employment Agreement, effective as of June 1, 2001, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |
|             | +**10.15      |            |   | Amendment to  Amended and Restated Employment Agreement, effective as of January 1,  2004, between the Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |
|             | +10.16        |            |   | Amendment to  Employment Agreement, effective as of January 1, 2006, between the  Registrant, Raviv Zoller and Ness Technologies Israel Ltd. |
|             | +¶10.17  |            |   | Employment  Agreement, dated as of April 21, 2005, between the Registrant and Ytzhak  Edelman. |
|             | +10.18        |            |   | Amendment to  Employment Agreement, effective as of January 1, 2006, between the  Registrant and Ytzhak Edelman. |
|             | +**10.19      |            |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Tuvia Feldman (English translation). |
|             | +**10.20      |            |   | Addendum to Personal Employment Agreement, dated as  of August 1, 1999, between Advanced Technology Ltd. and Tuvia Feldman  (English translation). |

----

 

|        | +**10.21           |   |   | Addendum to Personal Employment Agreement, dated as  of August 23, 1999, between Advanced Technology Ltd. and Tuvia Feldman  (English translation).                       |
|--------|--------------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | +**10.22           |   |   | Employment Agreement Addendum, dated as of  August 27, 2000, between the Registrant and Tuvia Feldman.                                                                    |
|   | +**10.23           |   |   | Summary of Meeting, dated May 3, 2001, between  Raviv Zoller and Tuvia Feldman (English translation).                                                                     |
|   | +10.24             |   |   | Amendment to Employment Agreement, effective as of  March 1, 2006, between the Registrant and Tuvia Feldman.                                                              |
|   | +**10.25           |   |   | Offer Letter, dated January 29, 2004, between  the Registrant and Ivan Hruška.                                                                                       |
|   | +**10.26           |   |   | Contract of  Employment, effective as of March 1, 2004, between the Registrant and  Ivan Hruška.                                                                     |
|   | +**10.27           |   |   | Special Personal  Employment Agreement, dated as of December 12, 1995, between Advanced  Technology Ltd. and Yoram Michaelis (English translation).                       |
|   | +**10.28           |   |   | Addendum to  Personal Employment Agreement, dated as of August 1, 1999, between  Advanced Technology Ltd. and Yoram Michaelis (English translation).                      |
|   | +**10.29           |   |   | Addendum to  Personal Employment Agreement, dated as of August 23, 1999, between  Advanced Technology Ltd. and Yoram Michaelis (English translation).                     |
|   | +¶¶10.30 |   |   | Personal  Employment Agreement, dated as of August 10, 2005, between Ness  Technologies Holdings Ltd. and Shachar Efal (English translation)                              |
|   | +10.31             |   |   | Offer letter,  dated as of December 1, 1999, from Apar Infotech Corporation to Shashank  Samant.                                                                          |
|   | +10.32             |   |   | Addendum to  Employment Agreement, effective as of January 1, 2006, between Ness  USA, Inc. and Shashank Samant.                                                     |
|   | **10.33            |   |   | Form of  Indemnification Agreement by and between the Registrant and its officers and  directors.                                                                         |
|   | **10.34            |   |   | Stock Purchase  Agreement, dated as of August 30, 2002, among the shareholders of APP  Group CEE B.V. listed therein and the Registrant.                                  |
|   | **10.35            |   |   | 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. |
|--------|------------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 99.1  |   |   | Consent of  Gartner, Inc.                                                                                                                                 |

----

*                    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 for thequarterly 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.

+                Indicates thosecontracts that are management contracts or compensation plans or arrangements.

----

**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-11     | ** ** |

 

F-1

----

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To the Stockholders of**

**NESS TECHNOLOGIES, INC.**

We have audited the accompanying consolidated balancesheets of Ness Technologies, Inc. (the “Company”) and its subsidiaries asof December 31, 2004 and 2005, and the related consolidated statements ofincome, stockholders’ equity and cash flows for each of the three years in theperiod ended December 31, 2005. Our audits included the financialstatement schedule listed in the Index at Item 15. These financial statementsand schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andschedule 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 31,2004 and 2005, and the consolidated results of their operations and their cashflows for each of the three years in the period ended December 31, 2005,in conformity with U.S. generally accepted accounting principles.

Also, in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements takenas a whole, presents fairly in all material respects the information set forththerein.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2005, basedon criteria established in Internal Control—Integrated framework issued by theCommittee of Sponsoring Organization of the Treadway Commission and our reportdated March 14, 2006 expresses an unqualified opinion thereon.

| Tel-Aviv, Israel    |   | KOST FORER GABBAY & KASIERER     |
|---------------------|--------|-------------------------------------------|
| March 14, 2006 |   | A Member of Ernst & Young Global |

 

F-2

----

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED BALANCE SHEETSU.S. dollars in thousands**

| ** **                                                                                                                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                         | ** ** | **2004**              | ** ** | **2005** | ** ** |
| ASSETS                                                                                                                             |       |                  |       |   |   |
| CURRENT ASSETS:                                                                                                                    |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                          |       | $                     | 104,229    |   | $ | 33,579 |   |
| Short-term bank deposits                                                                                                           |       | —                |       | 39,561 |   |
| Marketable securities                                                                                                              |       | 383                   |       | 2,651 |   |
| Trade receivables (net of allowance for doubtful  accounts of $2,154 and $2,320 at December 31, 2004 and 2005,  respectively) |       | 75,188                |       | 99,097 |   |
| Unbilled receivables                                                                                                               |       | 20,327                |       | 28,545 |   |
| Other accounts receivable and prepaid expenses                                                                                     |       | 9,122                 |       | 13,664 |   |
| Inventories and work in progress                                                                                                   |       | 1,168                 |       | 2,506 |   |
| Total current  assets                                                                                                              |       | 210,417               |       | 219,603 |   |
| LONG-TERM ASSETS:                                                                                                                  |       |                  |       |   |   |
| Long-term prepaid expenses                                                                                                         |       | 3,655                 |       | 4,816 |   |
| Marketable securities                                                                                                              |       | 69                    |       | 32 |   |
| Deferred income taxes                                                                                                              |       | 4,823                 |       | 5,271 |   |
| Severance pay fund                                                                                                                 |       | 33,558                |       | 35,845 |   |
| Total long-term  assets                                                                                                            |       | 42,105                |       | 45,964 |   |
| PROPERTY AND EQUIPMENT, NET                                                                                                        |       | 18,879                |       | 21,308 |   |
| INTANGIBLE ASSETS, NET                                                                                                             |       | 4,197                 |       | 7,938 |   |
| GOODWILL                                                                                                                           |       | 149,158               |       | 159,421 |   |
| Total assets                                                                                                                       |       | $                     | 424,756    |   | $ | 454,234 |   |

 

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

F-3

----

**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED BALANCE SHEETSU.S. dollars in thousands (except share and par value data)**

| ** **                                                                                                                                                                 | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2004**              | ** ** | **2005** | ** ** |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                 |       |                  |       |   |   |
| CURRENT LIABILITIES:                                                                                                                                                       |       |                  |       |   |   |
| Short-term bank credit                                                                                                                                                     |       | $                     | 1,275      |   | $ | 21,011 |   |
| Current maturities of long-term debt                                                                                                                                       |       | 13,364                |       | 6,862 |   |
| Trade payables                                                                                                                                                             |       | 31,280                |       | 35,259 |   |
| Advances from customers                                                                                                                                                    |       | 7,679                 |       | 7,670 |   |
| Other accounts payable and accrued expenses                                                                                                                                |       | 64,271                |       | 82,657 |   |
| Total current  liabilities                                                                                                                                                 |       | 117,869               |       | 153,459 |   |
| LONG-TERM  LIABILITIES:                                                                                                                                                    |       |                  |       |   |   |
| Long-term debt, net of current maturities                                                                                                                                  |       | 36,918                |       | 6,294 |   |
| Excess of losses over investment in affiliates                                                                                                                             |       | 306                   |       | 257 |   |
| Accrued severance pay                                                                                                                                                      |       | 36,888                |       | 39,722 |   |
| Minority interests                                                                                                                                                         |       | 295                   |       | — |   |
| Total long-term  liabilities                                                                                                                                               |       | 74,407                |       | 46,273 |   |
| COMMITMENTS AND  CONTINGENT LIABILITIES                                                                                                                                    |       |                  |       |   |   |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                |       |                  |       |   |   |
| Common stock of $0.01  par value—                                                                                                                                     |       |                  |       |   |   |
| Authorized: 76,500,000  shares at December 31, 2004 and 2005; Issued and  outstanding: 32,772,578 at December 31, 2004 and 34,771,837 at  December 31, 2005 |       | 328                   |       | 348 |   |
| Additional paid-in capital                                                                                                                                                 |       | 270,967               |       | 282,669 |   |
| Deferred stock compensation                                                                                                                                                |       | (152                  | )          | (27 | ) |
| Accumulated other comprehensive loss                                                                                                                                       |       | (2,045                | )          | (13,559 | ) |
| Accumulated deficit                                                                                                                                                        |       | (36,618               | )          | (14,929 | ) |
| Total  stockholders’ equity                                                                                                                                           |       | 232,480               |       | 254,502 |   |
| Total liabilities and  stockholders’ equity                                                                                                                           |       | $                     | 424,756    |   | $ | 454,234 |   |

 

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,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues                                                                           |       | $                                          | 225,768    |   | $ | 304,525 |   | $ | 385,436 |   |
| Cost of revenues                                                                   |       | 158,987                                    |       | 212,034 |   | 275,465 |   |
| Provision for  losses (reverse of losses) on uncompleted   contracts, net          |       | 788                                        |       | (309 | ) | (232 | ) |
| Gross profit                                                                       |       | 65,993                                     |       | 92,800 |   | 110,203 |   |
| Operating expenses:                                                                |       |                                       |       |   |   |   |   |
| Selling and marketing                                                              |       | 21,287                                     |       | 25,706 |   | 29,033 |   |
| General and administrative                                                         |       | 36,115                                     |       | 46,042 |   | 54,730 |   |
| Research and development, net                                                      |       | 1,559                                      |       | — |   | — |   |
| Other                                                                              |       | 665                                        |       | — |   | — |   |
| Total operating  expenses                                                          |       | 59,626                                     |       | 71,748 |   | 83,763 |   |
| Operating income                                                                   |       | 6,367                                      |       | 21,052 |   | 26,440 |   |
| Financial  expenses, net                                                           |       | (1,451                                     | )          | (3,461 | ) | (1,521 | ) |
| Other expenses, net                                                                |       | (422                                       | )          | (91 | ) | (243 | ) |
| Income before  taxes on income                                                     |       | 4,494                                      |       | 17,500 |   | 24,676 |   |
| Taxes on income  (tax benefit)                                                     |       | (54                                        | )          | 2,320 |   | 3,518 |   |
| Equity in net  earnings (losses) of affiliates                                     |       | 11                                         |       | (647 | ) | (65 | ) |
| Minority  interests in losses (earnings) of a subsidiary                           |       | —                                     |       | (156 | ) | 101 |   |
| Income from  continuing operations                                                 |       | 4,559                                      |       | 14,377 |   | 21,194 |   |
| Loss from  discontinued operations                                                 |       | (1,105                                     | )          | — |   | — |   |
| Extraordinary  income, net of taxes                                                |       | —                                     |       | — |   | 495 |   |
| Net income                                                                         |       | $                                          | 3,454      |   | $ | 14,377 |   | $ | 21,689 |   |
| Allocation of  undistributed earnings on Class B Convertible  Preferred stock |       | $                                          | (1,445     | ) | $ | (1,356 | ) | $ | — |   |
| Net income after  allocation of undistributed earnings                             |       | $                                          | 2,009      |   | $ | 13,021 |   | $ | 21,689 |   |
| Net earnings (loss) per  share:                                                    |       |                                       |       |   |   |   |   |
| Basic net  earnings per share from continuing operations                           |       | $                                          | 0.20       |   | $ | 0.58 |   | $ | 0.63 |   |
| Basic and diluted  net loss per share from discontinued operations                 |       | $                                          | (0.07      | ) | $ | — |   | $ | — |   |
| Basic net  earnings per share                                                      |       | $                                          | 0.13       |   | $ | 0.58 |   | $ | 0.63 |   |
| Basic net  earnings per share from extraordinary income                            |       | $                                          | —     |   | $ | — |   | $ | 0.01 |   |
| Basic net earnings  per share excluding extraordinary income                       |       | $                                          | 0.13       |   | $ | 0.58 |   | $ | 0.62 |   |
| Diluted net  earnings per share from continuing operations                         |       | $                                          | 0.19       |   | $ | 0.53 |   | $ | 0.61 |   |
| Diluted net  earnings per share                                                    |       | $                                          | 0.12       |   | $ | 0.53 |   | $ | 0.61 |   |
| Diluted net  earnings per share from extraordinary income                          |       | $                                          | —     |   | $ | — |   | $ | 0.02 |   |
| Diluted net earnings per  share excluding extraordinary income                     |       | $                                          | 0.12       |   | $ | 0.53 |   | $ | 0.59 |   |

 

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

F-5

----

**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYU.S. dollars in thousands (except share data)**

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

| Balance as of December 31, 2002                                                                    |   | 9,823,633  |   |   | $      | 98     |   |   | 4,676,986 |   |   | $      | 47     |   |   | 3,352,654 |   |   | $      | 34     |   |   |   | $      | 114,298 |   |   |   | $      | — |   |   |   | $      | (7,458 | )      |   |   | $      | (44,654 | )      |   |   |   |   |   |   | $ | 62,365  |   |   |
|----------------------------------------------------------------------------------------------------|--------|------------|--------|--------|--------|--------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|---|---------|--------|--------|
| Issuance of Common stock and options related to Ness  GSG and Ness CEE acquisition                 |   | 6,226,458  |   |   | 62     |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | 55,594 |   |   |   | —  |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | 55,656 |   |   |
| Exercise of warrants granted to banks                                                              |   | 113,192    |   |   | 1      |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | 210    |   |   |   | —  |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | 211    |   |   |
| Exercise of options granted to employees                                                           |   | 176,228    |   |   | 2      |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | 1,168  |   |   |   | —  |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | 1,170  |   |   |
| Exercise of options granted to investors                                                           |   | 120,627    |   |   | 1      |   |   | — |      |   |   |   |   | — |   |      |   |   |   |   | 1      |   |   |   | —  |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | 2      |   |   |
| Deferred stock compensation related to Ness GSG  acquisition                                       |   | —     |   |   | — |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | 548    |   |   |   | (548    | )      |   |   | — |   |   |   | — |   |   |   |   |   |   |    | — |   |   |
| Reversal of deferred stock compensation in respect of  forfeitures related to Ness GSG acquisition |   | —     |   |   | — |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | (78    | )      |   |   | 78      |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | — |   |   |
| Amortization of deferred stock compensation related  to Ness GSG acquisition                       |   | —     |   |   | — |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | — |   |   |   | 105     |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | 105    |   |   |
| Stock based compensation related to warrants  granted to banks                                     |   | —     |   |   | — |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | 45     |   |   |   |    |   |   |   | — |   |   |   | — |   |   |   |   |   |   |    | 45     |   |   |
| Comprehensive income:                                                                              |   |       |   |   |   |   |   |   |      |   |   |   |   |   |   |      |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |
| Foreign currency translation adjustments                                                           |   | —     |   |   | — |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | — |   |   |   | —  |   |   |   | 3,350  |   |   |   | — |   |   |   | $      | 3,350  |   |    |   | 3,350  |   |   |
| Unrealized losses on available-for-sale marketable  securities, net of taxes                       |   | —     |   |   | — |   |   | — |      |   | — |   |   | — |   |      | — |   |   |   | — |   |   |   | —  |   |   |   | (3     | )      |   |   | — |   |   |   | (3     | )      |   |    | (3     | )      |   |
| Net income                                                                                         |   | —     |   |   | — |   |   | — |      |   | — |   |   |   |   |      | — |   |   |   | — |   |   |   | —  |   |   |   | — |   |   |   | 3,454  |   |   |   | 3,454  |   |   |    | 3,454  |   |   |
| Total comprehensive income                                                                         |   |       |   |   |   |   |   |   |      |   |   |   |   |   |   |      |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   | $      | 6,801  |   |    |   |   |   |   |
| 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 |   |   |

----

*)                    Represents an amount lower than $ 1.

The accompanying notes are an integral part of thefinancial statements.

F-6

 

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**NESS TECHNOLOGIES,INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**U.S. dollars in thousands (except share data)

| ** ** | ** ** | ** **            | ** ** | ** **               | ** ** | **Class B**         | ** ** | **Class C** | ** ** | ** **           | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **        | ** ** | ** **             | ** ** | ** **  | ** ** |
|------------|------------|-----------------------|------------|--------------------------|------------|--------------------------|------------|------------------|------------|----------------------|------------|-------------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|-------------|------------|
| ** ** | ** ** | ** **            | ** ** | ** **               | ** ** | **Convertible**          | ** ** | **Convertible**  | ** ** | **Additional ** | ** ** | **Deferred**      | ** ** | **other**       | ** ** | ** **        | ** ** | **Total**              | ** ** | **Total**   | ** ** |
| ** ** | ** ** | **Common stock** | ** ** | **Preferred stock** | ** ** | **Preferred stock** | ** ** | **paid-in**      | ** ** | **stock**            | ** ** | **comprehensive** | ** ** | **Accumulated** | ** ** | **comprehensive** | ** ** | **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 |   |   |
| Unrealized losses  on available-for-sale marketable securities, net of tax        |   |       |   |   |   |   |   |       |      |   |   |   |   |       |   |      |   |   |   |   |   |   |   |   |    |   |   |   | $      | (94    | )      |   |   |   |   |   |   |   |   |    |   |   |   |   |
| Accumulated  foreign currency translation adjustment as of December 31, 2004 |   |       |   |   |   |   |   |       |      |   |   |   |   |       |   |      |   |   |   |   |   |   |   |   |    |   |   |   | (1,951 | )      |   |   |   |   |   |   |   |   |   |    |   |   |   |
| Accumulated other  comprehensive loss as of December 31, 2004                |   |       |   |   |   |   |   |       |      |   |   |   |   |       |   |      |   |   |   |   |   |   |   |   |    |   |   |   | $      | (2,045 | )      |   |   |   |   |   |   |   |   |    |   |   |   |   |

----

*)                   Represents an amount lower than $1.

**)              Issuance of Common stock, conversion of Class Band Class C Convertible Preferred stock, conversion of undistributedearnings resulting from the cumulative accumulated dividend on Class BPreferred stock and issuance of additional Common stock as a result of ananti-dilution provision on Class C Preferred stock, net of issuanceexpenses in the amount of $ 10,296, in respect of the Company’s initialpublic offering.

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

F-7

 

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**U.S. dollars in thousands (except share data)

| ** **                                                                                             | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** **  | ** **       | ** ** | **Accumulated**   | ** ** | ** **        | ** ** | ** **       | ** **  | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|-------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|-------------|------------|------------|
| ** **                                                                                             | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred** | ** **  | **other**        | ** ** | ** **        | ** ** | **Total**         | ** ** | **Total’**  | ** **  |
| ** **                                                                                             | ** ** | **Common stock** | ** ** | **paid-in**    | ** ** | **stock**    | ** **  | **compensation** | ** ** | **Accumulated**   | ** ** | **comprehensive** | ** ** | **Stockholders** | ** **  |
|                                                                                                   |       | **Stock**             |       | **Amount**     |       |         | **capital** |             |       | **comprehensive** |       | **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 anamount lower than $1.

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

F-8

 

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSU.S. dollars in thousands**

| ** **                                                                                    | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Cash flows from operating  activities:                                                        |       |                                       |       |   |   |   |   |
| Net income                                                                                    |       | $                                          | 3,454      |   | $ | 14,377 |   | $ | 21,689 |   |
| Adjustments  required to reconcile net income to net cash provided by operating  activities:  |       |                                       |       |   |   |   |   |
| Amortization of deferred stock compensation related  to Ness GSG acquisition                  |       | 105                                        |       | 213 |   | 125 |   |
| Stock based compensation related to warrants granted  to banks and consultants                |       | 45                                         |       | 45 |   | 11 |   |
| Stock-based compensation related to options extended  to terminated employees                 |       | —                                     |       | 34 |   | — |   |
| Stock based compensation related to redeemable  options                                       |       | —                                     |       | — |   | 1,975 |   |
| Depreciation and amortization                                                                 |       | 3,449                                      |       | 5,117 |   | 7,611 |   |
| Deferral of costs                                                                             |       | —                                     |       | (167 | ) | (433 | ) |
| Equity in net (earnings) losses of affiliates                                                 |       | (11                                        | )          | 647 |   | 65 |   |
| Minority interests in earnings (losses) of subsidiary                                         |       | —                                     |       | 156 |   | (101 | ) |
| Currency fluctuation of long-term debt                                                        |       | (3,276                                     | )          | 131 |   | 2,772 |   |
| Accrued interest on long-term debt                                                            |       | (1,056                                     | )          | (850 | ) | (452 | ) |
| Deferred income taxes, net                                                                    |       | (2,148                                     | )          | (610 | ) | (3,016 | ) |
| Loss on sale of property and equipment                                                        |       | 36                                         |       | 108 |   | 556 |   |
| Loss on sale of an investment                                                                 |       | —                                     |       | — |   | 156 |   |
| Trading marketable securities, net                                                            |       | (37                                        | )          | (9 | ) | (30 | ) |
| Other than temporary decrease in fair value of  available-for-sale marketable securities      |       | —                                     |       | — |   | 186 |   |
| Accrued interest on short-term bank deposits                                                  |       | —                                     |       | — |   | (532 | ) |
| Decrease (increase) in trade receivables                                                      |       | 1,519                                      |       | (12,298 | ) | (26,236 | ) |
| Increase in unbilled receivables                                                              |       | (6,498                                     | )          | (5,115 | ) | (9,738 | ) |
| Decrease (increase) in other accounts receivable and  prepaid expenses                        |       | (454                                       | )          | 1,103 |   | (544 | ) |
| Decrease (increase) in inventories                                                            |       | 308                                        |       | 219 |   | (1,145 | ) |
| Decrease (increase) in long-term prepaid expenses                                             |       | 948                                        |       | (1,498 | ) | (1,423 | ) |
| Increase in trade payables                                                                    |       | 4,461                                      |       | 848 |   | 2,986 |   |
| Increase (decrease) in advances from customers                                                |       | (2,226                                     | )          | 3,534 |   | (761 | ) |
| Increase in other accounts payable and accrued  expenses                                      |       | 5,500                                      |       | 8,527 |   | 12,109 |   |
| Increase in accrued severance pay, net                                                        |       | 775                                        |       | 889 |   | 971 |   |
| Net cash provided by operating activities                                                     |       | 4,894                                      |       | 15,401 |   | 6,801 |   |
| Cash flows from investing  activities:                                                        |       |                                       |       |   |   |   |   |
| Net cash paid for acquisitions of consolidated  subsidiaries(a)(b)                            |       | (9,165                                     | )          | — |   | (10,320 | ) |
| Cash in a subsidiary at the time it ceased being  consolidated                                |       | —                                     |       | (168 | ) | — |   |
| Proceeds from sale of short-term bank deposits                                                |       | 6,577                                      |       | 3,176 |   | — |   |
| Investment in short-term bank deposits                                                        |       | —                                     |       | — |   | (39,107 | ) |
| Proceeds from sale of available-for-sale marketable  securities                               |       | —                                     |       | — |   | 5,543 |   |
| Investment in available-for-sale of marketable  securities                                    |       | —                                     |       | — |   | (7,864 | ) |
| Proceeds from sale of property and equipment                                                  |       | 516                                        |       | 544 |   | 601 |   |
| Purchase of property and equipment and capitalization  of software developed for internal use |       | (6,600                                     | )          | (9,881 | ) | (7,921 | ) |
| Capitalization of software development costs                                                  |       | (514                                       | )          | (2,545 | ) | (1,526 | ) |
| Net cash used in  investing activities                                                        |       | (9,186                                     | )          | (8,874 | ) | (60,594 | ) |
|                                                                                               |            |                                            |            |  |  |  |  |  |  |  |

 

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

F-9

----

**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSU.S. dollars in thousands**

| ** **                                                                                                                                                                                                                                   | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                   | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| 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                                                                                                                                                                                                            |       | 1,383                                      |       | 43 |   | 9,634 |   |
| Short-term bank  credit, net                                                                                                                                                                                                                 |       | 2,346                                      |       | (7,121 | ) | 19,312 |   |
| Proceeds from  long-term debt                                                                                                                                                                                                                |       | 20,445                                     |       | 33,856 |   | — |   |
| Principal payments  of long-term debt                                                                                                                                                                                                        |       | (20,349                                    | )          | (18,688 | ) | (38,806 | ) |
| 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                                                                                                                                                                                         |       | 3,825                                      |       | 51,583 |   | (9,860 | ) |
| Effect of exchange rate  changes on cash and cash equivalents                                                                                                                                                                                |       | 2,977                                      |       | 115 |   | (6,997 | ) |
| Increase (decrease) in  cash and cash equivalents                                                                                                                                                                                            |       | 2,510                                      |       | 58,225 |   | (70,650 | ) |
| Cash and cash equivalents  at the beginning of the year                                                                                                                                                                                      |       | 43,494                                     |       | 46,004 |   | 104,229 |   |
| Cash and cash equivalents  at the end of the year                                                                                                                                                                                            |       | $                                          | 46,004     |   | $ | 104,229 |   | $ | 33,579 |   |
|                                                                                                                                                                                                                                              |       |                                       |       |   |   |   |   |
| *(a)  I**n conjunction with the  acquisitions, the fair values of the assets     acquired and liabilities assumed at the dates of related  acquisitions     were as follows:*                        |       |                                       |       |   |   |   |   |
| Working capital  (capital deficiency), net (excluding cash and cash equivalents)                                                                                                                                                             |       | $                                          | 16,598     |   | — |   | $ | (2,360 | ) |
| Property and  equipment                                                                                                                                                                                                                      |       | 2,401                                      |       | — |   | 2,928 |   |
| Long-term loans                                                                                                                                                                                                                              |       | —                                     |       | — |   | (1,726 | ) |
| Accrued severance  pay                                                                                                                                                                                                                       |       | —                                     |       | — |   | (70 | ) |
| Other assets                                                                                                                                                                                                                                 |       | —                                     |       | — |   | 669 |   |
| Goodwill                                                                                                                                                                                                                                     |       | 44,308                                     |       | — |   | 13,860 |   |
| Customer related  intangible assets                                                                                                                                                                                                          |       | 1,514                                      |       | — |   | 2,067 |   |
|                                                                                                                                                                                                                                         |       | 64,821                                     |       | — |   | 15,368 |   |
| Accrual for  additional consideration paid or to be paid subsequent to the balance sheet  date                                                                                                                                               |       | —                                     |       | — |   | (5,162 | ) |
| Issuance of shares                                                                                                                                                                                                                           |       | (55,656                                    | )          | — |   | — |   |
| Net cash used in  acquisitions of consolidated subsidiaries                                                                                                                                                                                  |       | $                                          | 9,165      |   | $ | — |   | $ | 10,206 |   |
| Supplemental disclosures  of cash flows information:                                                                                                                                                                                         |       |                                       |       |   |   |   |   |
| Cash paid during the year  for:                                                                                                                                                                                                              |       |                                       |       |   |   |   |   |
| Interest                                                                                                                                                                                                                                     |       | $                                          | 4,449      |   | $ | 3,905 |   | $ | 895 |   |
| Taxes                                                                                                                                                                                                                                        |       | $                                          | 2,520      |   | $ | 862 |   | $ | 1,361 |   |
|                                                                                                                                                                                                                                              |       |                                       |       |   |   |   |   |
| *(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 |   |

 

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

F-10

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

**NOTE 1—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.      Ness GSGInc. (“Ness GSG”):

Effective June 2003, the Company acquired throughmerger all of the outstanding stock of Ness GSG (formerly, Apar Holding Corp.)for the purpose of expanding the Group’s IT services capabilities. Ness GSG isa corporation incorporated under the laws of the Commonwealth of Pennsylvania,with operations in Asia, the United States and Europe. Ness GSG specializes inhardware and software consulting. Some of the principal stockholders of theCompany, who owned approximately 53% of the outstanding Common stock of NessGSG prior to the acquisition, received 3,955,169 shares of the Company’s Commonstock upon the closing of the merger.

The total consideration of $ 67,650 (including$ 1,542 of transaction costs) for the merger consisted of (i) theissuance of 6,221,712 shares of the Company’s Common stock valued at the fairvalue of $ 52,677, (ii) the assumption of options to purchase 540,121shares of the Company’s Common stock at a weighted average exercise price of$ 3.64 per share valued at the fair value of $ 2,979 of which $ 548was allocated to deferred stock compensation (see Notes 14b5 and 14b8) and (iii) $ 11,000in cash. The value of the options issued was determined based on theBlack-Scholes options pricing model. Pursuant to the merger agreement, theCompany agreed to issue additional shares of Common stock to the stockholdersof Ness GSG if and when the Company issues shares of Common stock in exchangefor the remaining shares of Ness U.S.A. (see also Note 1b2). The Company agreedto issue the number of shares necessary to preserve the ownership percentage ofthe former stockholders of Ness GSG to the same percentage ownership they heldprior to the issuance of such shares to the Ness U.S.A. remaining stockholdersin exchange for their Ness U.S.A. shares. The Company issued on March 2,2005, 89,305 shares of Common stock to the former stockholders of Ness GSG.These shares were recorded at their par value and reduced from additionalpaid-in capital when issued. The June 2003 transaction was accounted forby the purchase method of accounting according to Statement of FinancialAccounting Standards (“SFAS”) No. 141, “Business Combinations.” Theresults of Ness GSG operations have been included in the Group’s consolidatedfinancial statements since July 1, 2003.

F-11

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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)**

Based upon a valuation of tangible and intangibleassets acquired and liabilities assumed, the Group has allocated the total costof the acquisition to Ness GSG’s assets and liabilities as follows:

| ** **                                                  | ** ** | **At June 30,  2003** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|
| Cash and cash  equivalents                                  |       |                            | $          | 3,423 |   |   |
| Short-term investments                                      |       |                            | 9,707      |   |   |
| Trade receivables                                           |       |                            | 11,807     |   |   |
| Unbilled  receivables                                       |       |                            | 1,327      |   |   |
| Employee advances  and other current assets                 |       |                            | 1,668      |   |   |
| Other long-term  tangible assets                            |       |                            | 1,193      |   |   |
| Property and  equipment                                     |       |                            | 2,373      |   |   |
| Total tangible  assets acquired                             |       |                            | 31,498     |   |   |
| Customer related intangible asset (five years useful  life) |       |                            | 1,514      |   |   |
| Goodwill                                                    |       |                            | 43,524     |   |   |
| Total intangible  assets acquired                           |       |                            | 45,038     |   |   |
| Total tangible and intangible assets acquired               |       |                            | 76,536     |   |   |
| Accounts payable                                            |       |                            | (3,426     | ) |   |
| Other account  payable                                      |       |                            | (3,936     | ) |   |
| Long-term debt                                              |       |                            | (1,524     | ) |   |
| Total liabilities  assumed                                  |       |                            | (8,886     | ) |   |
| Net assets acquired                                         |       |                            | $          | 67,650 |   |   |

 

Goodwill includes but is not limited to thesynergistic value and potential competitive benefits that could be realized bythe Group from the acquisition, as well as Ness GSG’s skilled and specializedworkforce. The goodwill is not deductible for tax purposes. In accordance withSFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill arisingfrom acquisitions will not be amortized (see also Note 2k).

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

a.      Ness GSG’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 debt ispresented at present value of amounts to be paid determined at appropriatecurrent interest rates.

b.     The valueassigned to the customer-related intangibles amounted to $ 1,514. The fairvalue of Ness GSG’s customer base was determined using the Income Approach.

Pro forma results:

The following unaudited pro forma information does notpurport to represent what the Group’s results of operations would have been hadthe merger been consummated on January 1, 2003, nor does it purport torepresent the results of operations of the Group for any future period.

F-12

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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)**

Pro forma results ofoperations for the period:

| ** **                                                                                                                             | ** ** | **Year ended   December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2003**                                     | ** ** |
| ** **                                                                                                                             | ** ** | **(unaudited)**                              | ** ** |
| Revenues                                                                                                                               |       |                                         | $          | 256,453 |   |   |
| Net income                                                                                                                             |       |                                         | $          | 1,979 |   |   |
| Allocation of  undistributed earnings on Class B Convertible Preferred stock                                                      |       |                                         | (1,180     | ) |   |
| Net income after  allocation of undistributed earnings                                                                                 |       |                                         | $          | 799 |   |   |
| Basic and diluted  net earnings per share                                                                                              |       |                                         | $          | 0.04 |   |   |
| Weighted average number of shares of Common and  Preferred stock used in computation of basic net earnings per share (in  thousands)   |       |                                         | 18,490     |   |   |
| Weighted average  number of shares of Common and Preferred stock used in computation of diluted  net earnings per share (in thousands) |       |                                         | 19,722     |   |   |

 

Effective August 1,2004, Ness GSG was merged into the Company, and, as a result, the Ness GSGoperating subsidiaries are direct, rather than indirect, subsidiaries.

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

On October 25, 2001, the Company and other investorsincorporated Ness U.S.A., a corporation incorporated under the laws of theState of Delaware, for the purpose of acquiring certain assets and assumingcertain liabilities of Blueflame Inc. (“Blueflame”) out of Blueflame’s chapter11 bankruptcy proceeding. On the date of incorporation, the Company held 68% ofthe outstanding common stock of Ness U.S.A. and other investors held theremaining 32% of the outstanding common stock of Ness U.S.A. OnNovember 1, 2001, Ness U.S.A. acquired these assets with a fair marketvalue of approximately $ 6,656 for cash consideration and related purchasecosts totaling approximately $ 5,140. The transaction was accounted for by thepurchase method of accounting according to SFAS No. 141, “BusinessCombinations.”

Ness U.S.A. is a full-service business and advancedtechnology solutions provider to the life sciences, financial services,telecommunications and other industries. Ness U.S.A. offers technical andmanagement consulting services intended to create business improvements bybuilding integrated business process and technology solutions to strategicproblems.

F-13

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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)**

In addition to the consideration paid at closing, theCompany agreed to the following contingent payments:

a)     An amountequal to 50% of the pre-closing accounts receivable actually collected by theCompany in excess of $ 6,000 net of prepayments within six months after theclosing. The Company paid this contingent payment in 2002.

b)     Payment ofa contingent promissory note in the amount of $ 750, following the occurrenceof the earlier of the following two events:

(1)   The sum of $750, if Ness U.S.A.’s annual EBITDA, as defined in the asset purchase agreementrelating to the acquisition, in each of any two calendar years during theperiod commencing on January 1, 2002 and ending December 31, 2005exceeds $ 5,000; or

(2)   Upon the saleor liquidation of Ness U.S.A., or its merger with an unrelated party, whereby:

(i)    if thequalifying transaction occurred prior to December 31, 2003, the contingentpayment would have been equal to the aggregate consideration in excess of$ 4,500, but not more than $ 750.

(ii)   if thequalifying transaction occurred after December 31, 2003 but prior to January 1,2005, the contingent payment would have been equal to $ 650, unless theconsideration for such qualifying transaction was in excess of $ 6,600, inwhich case the contingent payment would have been equal to $ 750.

(iii)  if thequalifying transaction occurs after December 31, 2004 but prior to January 1,2006, the contingent payment will be equal to $ 550, unless the considerationfor such qualifying transaction is equal to or in excess of $ 7,500, in whichcase the contingent payment will be equal to $ 750.

As the purchase price was lower than the fair marketvalue of the net assets acquired, but is subject to contingent payment, theCompany recorded at the date of acquisition, the lesser of the maximum amountof contingent consideration or the excess over cost as if it were a liability,until the consideration contingency is resolved.

In respect of the contingent promissory note, aliability in the amount of $ 750 was recorded among long-term liabilities andas of December 31, 2004, the liability was classified in currentliabilities. Since none of the conditions detailed in (2) above occurred, on December 31,2005, the liability was reversed and recorded as extraordinary item in thestatement of income, net of taxes, in the amount of $ 255. On December 27,2002, under a securities exchange agreement, the Company acquired additionalstock of Ness U.S.A. from certain of the employees and other private investorsso that, as of December 31, 2003, and 2004, the Company held 86% of NessU.S.A.’s common stock. The acquisition was accounted for under the purchasemethod of accounting according to SFAS No. 141. The total consideration of$ 5,001 (including $ 323 in transaction costs) for the shares purchasedconsisted of the issuance of 647,170 shares of the Company’s common stock,valued at a fair value of $ 4,678.

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)**

Under the securitiesexchange agreement, the Company agreed to offer the remaining stockholders ofNess U.S.A. shares of common stock in exchange for their shares of Ness U.S.A.at the same exchange ratio used in the December 2002 exchange on theearliest date practicable after receiving a no-action letter from theSecurities and Exchange Commission or completing an initial public offering ofthe Company’s common stock.

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. The offer commenced on January 31, 2005 and ended on February 28,2005. 96 of 98 offerees accepted the offer bringing the Company’s holdings inNess U.S.A. following the offer to 99.9%. On March 1, 2005, the Companyissued 260,316 shares of Common stock to the offerees, valued at $ 3,532, basedon the Company’s share price and including $ 114 in transaction costs. Theacquisition was accounted for under the purchase method of accounting accordingto 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, subsequent to the balancesheet date, Ness U.S.A was merged into Ness Global Services, Inc.Subsequently the surviving company changed its name to Ness USA, Inc.

Based upon a valuation of tangible and intangibleassets acquired and liabilities assumed, the Company has allocated the totalcost of the acquisition to Ness U.S.A.’s assets and liabilities as follows:

| ** **                                                  | ** ** | **March 1, 2005** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|
| 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                                                    |       |                        | 3,196      |   |   |
| Total intangible  assets acquired                           |       |                        | 3,335      |   |   |
| Total tangible  and intangible assets acquired              |       |                        | 4,325      |   |   |
| Accounts payable                                            |       |                        | 148        |   |   |
| Other accounts  payable                                     |       |                        | 280        |   |   |
| Related parties,  net                                       |       |                        | 365        |   |   |
| Total liabilities  assumed                                  |       |                        | 793        |   |   |
| Net assets acquired                                         |       |                        | $3,532     |   |   |

 

The allocation of the purchase price reflected in theconsolidated balance sheet is according to a valuation of Ness U.S.A.’s currentassets, current liabilities, long-term tangible assets, property and equipmentand intangible assets.

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)**

**NOTE 1—GENERAL (Continued)**

3.     In 2003,the Group acquired three small Israeli IT services companies for aggregateconsideration of $ 1,009.

The excess of the cost over the fair market value ofthe assets acquired as of December 31, 2003 amounted to $ 784, andwas recorded as goodwill.

4.     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 payments of$ 1,775, or €1.5million, will be made in April 2006 because of an achievement of certainrevenue and operating income milestones in 2005. The additional payments were accruedfor and recorded as goodwill in the December 31, 2005 balance sheet. Anadditional payment of up to €1.5 million will berequired to be made in April 2007 based on achievement of certain revenue andoperating income milestones for 2006. Radix became a wholly-owned subsidiary ofthe Company’s Dutch subsidiary, Ness Technologies, B.V., and, accordingly, itsresults of operations have been included in the Company’s consolidatedfinancial statements since the acquisition date. Upon completion of the acquisition,Radix Company SA changed its name to Ness Romania.

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. The Company has allocated the total cost ofthe acquisition to Ness Romania’s assets and liabilities as follows:

| ** **                                  | ** ** | **April 1, 2005** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|
| 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                                    |       |                        | 4,455      |   |   |
| Total assets  acquired                      |       |                        | 11,637     |   |   |
| Liabilities  assumed:                       |       |                        |       |   |   |
| Accounts payable and other accrued expenses |       |                        | 1,420      |   |   |
| Other current liabilities                   |       |                        | 1,506      |   |   |
| Long-term liabilities                       |       |                        | 1,551      |   |   |
| Total liabilities  assumed                  |       |                        | 4,477      |   |   |
| Net assets acquired                         |       |                        | $          | 7,160 |   |   |

 

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)**

**NOTE 1—GENERAL(Continued)**

The allocation of the purchase price reflected in theconsolidated balance sheet is according to a valuation of Radix’s currentassets, current liabilities, long-term liabilities, property and equipment andintangible assets.

The value assigned to the tangible assets, intangibleassets and liabilities has been determined as 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 debt is presented at presentvalue of amounts to be paid determined at appropriate current interest rates.

b.                 The value assignedto the customer-related intangibles amounted to $ 420. The fair value ofRadix’s customer base was determined using the Income Approach.

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

5.     Ness DM a.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 €250,000payable within 55 days contingent on the verification of the accuracy ofcertain representations made by the sellers. An additional payment of $ 237,or €0.2million was made in February 2006 based on achievement of certain 2005performance goals. The additional payment was accrued for and recorded asgoodwill in the December 31, 2005 balance sheet. Efcon became awholly-owned subsidiary of Ness Czech s.r.o., a part of the Company’s NessEurope group, and, accordingly, its results of operations have been included inthe Company’s consolidated financial statements since the acquisition date. Followingthe acquisition, Efcon changed its name to Ness DM a.s.

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)**

**NOTE 1—GENERAL (Continued)**

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. The Company has made apreliminary allocation of the total cost of the acquisition to Ness DM’s assetsand liabilities as follows: 

| ** **                                  | ** ** | **June 1, 2005** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| Cash and cash equivalents                   |       |                       | $          | 426 |   |   |
| Trade receivables                           |       |                       | 314        |   |   |
| Inventories                                 |       |                       | 33         |   |   |
| Property and equipment                      |       |                       | 212        |   |   |
| Other accounts receivable                   |       |                       | 446        |   |   |
| Intangible  assets:                         |       |                       |       |   |   |
| Work force                                  |       |                       | 278        |   |   |
| Backlog                                     |       |                       | 61         |   |   |
| Goodwill                                    |       |                       | 237        |   |   |
| Other                                       |       |                       | 48         |   |   |
| Total assets  acquired                      |       |                       | 2,055      |   |   |
| Liabilities  assumed:                       |       |                       |       |   |   |
| Accounts payable and other accrued expenses |       |                       | 442        |   |   |
| Other current liabilities                   |       |                       | 588        |   |   |
| Long term liabilities                       |       |                       | 50         |   |   |
| Total liabilities  assumed                  |       |                       | 1,080      |   |   |
| Net assets acquired                         |       |                       | $          | 975 |   |   |

 

The allocation of the purchase price reflected in theconsolidated balance sheet is preliminary. The Company has arranged to obtain avaluation of Ness DM a.s.’ current assets, current liabilities, long-termtangible assets, property and equipment and intangible assets. Managementexpects to obtain such completed report during 2006.

Pro forma information in accordance with SFASNo. 141 is provided in Note 1b(8).

6.     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. Anadditional payment of $ 150 will be made based on achievement of certain2005 performance goals, which were achieved. The additional required paymentwas accrued for and recorded as goodwill in the December 31, 2005 balancesheet. NTR became a wholly-owned subsidiary of Ness A.T., a part of theCompany’s Ness Israel group, and, accordingly, its results of operations havebeen included in the consolidated financial statements since September 12,2005.

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)**

**NOTE 1—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. The Company has made a preliminaryallocation of the total cost of the acquisition to NTR’s assets and liabilitiesas follows: 

| ** **                                  | ** ** | **September 12, 2005** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| Cash and cash equivalents                   |       |                             | $          | 173 |   |   |
| Trade receivables                           |       |                             | 408        |   |   |
| Property and equipment                      |       |                             | 47         |   |   |
| Other accounts receivable                   |       |                             | 391        |   |   |
| Intangible assets:                          |       |                             |       |   |   |
| Backlog.                                    |       |                             | 482        |   |   |
| Goodwill                                    |       |                             | 732        |   |   |
| Total assets acquired                       |       |                             | 2,233      |   |   |
| Liabilities assumed:                        |       |                             |       |   |   |
| Accounts payable and other accrued expenses |       |                             | 25         |   |   |
| Other current liabilities                   |       |                             | 443        |   |   |
| Long-term liabilities                       |       |                             | 265        |   |   |
| Total liabilities assumed                   |       |                             | 733        |   |   |
| Net assets  acquired                        |       |                             | $          | 1,500 |   |   |

 

The allocation of the purchase price reflected in theconsolidated balance sheet is preliminary. The Company has arranged to obtain avaluation of NTR’s current assets, current liabilities, long-term tangibleassets, property and equipment and intangible assets. Management expects toobtain such completed report during 2006.

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

7.     Delta

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 purchase price was $ 8,000. Inaddition, as Delta achieved certain business goals by the end of 2005, Nesswill pay an additional amount of $ 3,000 during 2006. The additionalrequired payment was accrued for and recorded as goodwill in the December 31,2005 balance sheet. Upon completion of the acquisition, Delta changed its nameto Ness Slovakia, and it operates as a part of Ness Europe. Delta became awholly-owned subsidiary of Ness B.V., a part of Ness European group, and,accordingly, its results of operations have been included in the consolidatedfinancial statements since October 3, 2005.

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)**

**NOTE 1—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. Based upon a preliminary valuation oftangible and intangible assets acquired and liabilities assumed, the Companyhas allocated the total cost of the acquisition to Delta’s assets andliabilities as follows:

| ** **                                  | ** ** | **October 3, 2005** | ** ** |
|---------------------------------------------|------------|-------------------------------|------------|
| Cash and cash equivalents                   |       |                          | $          | 2,158 |   |   |
| Trade receivables                           |       |                          | 1,476      |   |   |
| Property and equipment                      |       |                          | 575        |   |   |
| Other accounts receivable                   |       |                          | 1,176      |   |   |
| Intangible  assets:                         |       |                          |       |   |   |
| Backlog                                     |       |                          | 844        |   |   |
| Capitalized software development costs      |       |                          | 621        |   |   |
| Goodwill                                    |       |                          | 7,428      |   |   |
| Total assets  acquired                      |       |                          | 14,278     |   |   |
| Liabilities assumed:                        |       |                          |       |   |   |
| Accounts payable and other accrued expenses |       |                          | 1,228      |   |   |
| Other current liabilities                   |       |                          | 1,925      |   |   |
| Long-term liabilities                       |       |                          | 125        |   |   |
| Total liabilities  assumed                  |       |                          | 3,278      |   |   |
| Net assets acquired                         |       |                          | $          | 11,000 |   |   |

 

The allocation of the purchase price reflected in theconsolidated balance sheet is preliminary. The Company has arranged to obtain avaluation of Delta’s current assets, current liabilities, long-term tangibleassets, property and equipment and intangible assets. Management expects toobtain such completed report during 2006.

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

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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)**

8.     Presentedbelow are certain combined unaudited statements of income data for the yearsended December 31, 2005 and 2004, as if the acquisitions of 14% of NessU.S.A., Ness Romania, Ness DM a.s., NTR and Delta occurred on January 1,2004 and 2005, respectively, after giving effect to purchase accountingadjustments, including amortization of identifiable intangible assets. The proforma financial information is not necessarily indicative of the combinedresults that would have been attained had the acquisitions taken place at thebeginning of 2005 and 2004, respectively, nor is it necessarily indicative offuture results.

| ** **           | ** ** | **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 |   |

 

9.     DiscontinuedOperations:

In November 2003, the Group decided todiscontinue the operations of one of its subsidiaries. The facts andcircumstances leading to this disposal included the generation of losses fromoperations during previous years and the characterization of the operations ofthis subsidiary which was substantially different from the Group’s corebusiness. The Group ceased the operations and disposed of all assets that couldnot be used elsewhere by this subsidiary. The operations and cash flows of thissubsidiary have been eliminated from the operations of the Company as a resultof the disposal. The Group’s plan of discontinuance involved (i) terminationof all employees whose time was substantially devoted to this business and whocould not be used elsewhere in the Company’s operations, including payment ofall statutory and contractual severance amounts, by the end of the fourthquarter of 2003 and (ii) disposal of the equipment that could not be usedelsewhere, because the Company has no reasonable expectation of being able tosell such equipment for any amounts substantially greater than the cost ofdisposal or shipping. As of December 31, 2003, these operations wereactually terminated. The discontinued operations were accounted for in accordancewith SFAS No.144, “Accounting for the Impairment or Disposal of Long-LivedAssets” (“SFAS No. 144”).

The results of operations, including revenue,operating expenses and other expenses of the discontinued business for 2003,have been reclassified in the accompanying statements of operations asdiscontinued operations. As of December 31, 2004 and 2005, no relatedbalance sheet liabilities or assets existed.

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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)**

Summary operating results from the discontinuedoperations for the year ended December 31, 2003 are as follows:

| ** **                             | ** ** | **Year ended**             | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **December 31, 2003** | ** ** |
| Revenues                               |       |                            | $          | 1,150 |   |   |
| Cost of revenues                       |       |                            | 1,289      |   |   |
| Gross loss                             |       |                            | (139       | ) |   |
| Selling and  marketing expenses        |       |                            | 15         |   |   |
| General and  administrative expenses   |       |                            | 885        |   |   |
| Operating loss                         |       |                            | (1,039     | ) |   |
| Other expenses                         |       |                            | 66         |   |   |
| Net loss from  discontinued operations |       |                            | $          | (1,105 | ) |   |

 

10.   Revenuesfrom agencies of the government of Israel:

For the years ended December 31,2003, 2004 and 2005, the percentage of the Group’s revenues derived, inaggregate, from agencies of the government of Israel was 14%, 12% and 11%,respectively.

**NOTE 2—SIGNIFICANTACCOUNTING POLICIES**

The consolidatedfinancial statements have been prepared in accordance with United Statesgenerally accepted accounting principles (“U.S. GAAP”).

a.      Use ofestimates:

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.     Financialstatements in U.S. dollars:

The Company’s subsidiaries’ transactions are recordedin local currencies. The Company has determined 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.

Accordingly, for companies with transactions incurrencies other than their functional currency, monetary accounts maintainedin other currencies are re-measured into their functional currency, inaccordance with SFAS No. 52, “Foreign Currency Translation.” Alltransaction gains and losses of the re-measured monetary balance sheet itemsare reflected in the statement of income as financial income or expenses, asappropriate.

For those foreign subsidiaries whose functionalcurrency has been determined to be their local currency, assets and liabilitiesare translated at year-end exchange rates and statement of income items aretranslated at average exchange rates prevailing during the year. Suchtranslation adjustments are recorded as a separate component of accumulatedother comprehensive income (loss) in stockholders’ equity.

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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 financialstatements of affiliates reported using the equity method of accounting, whosefunctional currency has been determined to be their local currency, have beentranslated into U.S. dollars. All balance sheet accounts have been translatedusing the exchange rates in effect at the balance sheet date. Statement ofincome amounts have been translated using the average exchange rate for theyear. The resulting aggregate translation adjustments are reported as aseparate component of accumulated other comprehensive income (loss) instockholders’ equity.

c.      Principlesof consolidation:

The consolidatedfinancial statements include the accounts of the Company and it’s wholly andmajority owned subsidiaries. Inter-company transactions and balances, includingprofit from inter-company sales not yet realized outside the Group, have beeneliminated 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.

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, 2005, all marketablesecurities are classified as available-for-sale and are carried at fair value,with the unrealized gains and losses, net of income taxes, reported as aseparate component of stockholders’ equity, in accumulated other comprehensiveincome (loss). Realized gains and losses on sales of investments, as determinedon a specific identification basis, are included in the consolidated statementsof income, and have been immaterial to date.

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

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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 accordance with SFAS No. 115, the Group hasdesignated certain of its marketable securities as trading securities as of December 31,2004. Trading securities are held for resale in anticipation of short-termmarket movements. Under SFAS No. 115, marketable securities classified astrading securities are stated at the quoted market prices at each balance sheetdate. Gains and losses (realized and unrealized) related to trading securitiesas well as interest on such securities are included as financial income orexpenses, as appropriate.

f.      Inventories:

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

Work in progress includes costs incurred related tolong-term IT services  contracts asdetermined by the completed work method of accounting.

g.      Investmentin affiliates:

Investment in an affiliate reflects a 50% investmentin the Ordinary shares of a privately held company, in which the Company canexercise significant influence over operating and financial policies, but doesnot assume control. The investment in this affiliate is accounted for by theequity method. As the Company guaranteed the obligations of this entity and providesfurther financial support, reflecting its share of ownership it recorded anexcess of losses over this investment.

Investment in another affiliate reflects the currentlyreduced voting interest of 19%in a former wholly-owned subsidiary. The reductions in the investment in theother affiliate, in 2004 and 2005, are due to two rounds of financing (in theamounts of $ 6,000 and $ 10,000, respectively) by venture capitalinvestors. This investment could be reduced further to under 14% pending thegrant and exercise of warrants and options. As the investors were issuedpreferred shares with dividend rights and liquidation preferences, no gain wasrecognized by the Company.

Differences betweenthe balances of excess of losses over investments in affiliates as of December 31,2004 and 2005 derive from accumulated net losses and foreign currencytranslation adjustments.

h.     Propertyand equipment:

Property and equipment are stated at cost, net ofaccumulated depreciation. Depreciation is calculated by the straight-linemethod over the estimated useful lives of the assets, at the following annualrates:

| ** **                          | ** ** | **%**                                                               | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------------|------------|
| 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 |       |

 

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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)**

The Group accounts for costs of computer softwaredeveloped or obtained for internal use in accordance with Statement of Position(“SOP”) No. 98-1, “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use.” SOP No. 98-1 requires thecapitalization of certain costs incurred in connection with developing orobtaining internal use software. Since these assets are not considered readyfor their intended use they are not being amortized as of December 31,2005.

i.      Other intangible assets:

Intangible assets areamortized over their useful lives using a method of amortization that reflectsthe pattern in which the economic benefits of the intangible assets areconsumed or otherwise used up, in accordance with SFAS No. 142. Customerrelated intangible assets are amortized over a period of 5 years.

j.       Impairment of long-lived assets:

TheGroup’s long-lived assets and certain identifiable intangibles are reviewed forimpairment in accordance with SFAS No. 144, whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset 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. As of December 31,2005, no impairment losses have been identified.

k.     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. The test was based onthe Group’s single operating segment and reporting unit structure. Fair valueis determined using discounted cash flows and market capitalization. Significantestimates used in the methodologies include estimates of future cash flows,future short-term and long-term growth rates, and weighted average cost ofcapital for the reportable unit. The Company has elected to perform itsanalysis of goodwill during the fourth quarter of the year. As of December 31,2005, no impairment losses were identified.

l.      Derivative instruments:

Financial AccountingStandards Board Statement No. 133, “Accounting for Derivative Instrumentsand Hedging Activities” (“SFAS No. 133”), requirescompanies to recognize all of its derivative instruments aseither assets or liabilities in the statement of financial position at fairvalue. For those derivative instruments that are designated and qualify ashedging instruments, a company must designate the hedging instrument, basedupon theexposure being hedged, as a fair value hedge, cash flow hedge ora hedge of a net investment in a foreign operation. For derivative instrumentsthat are designated and 

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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)**

qualifyas a fair value hedge (i.e., hedging the exposure to changes in the fair valueof an asset or a liability or an identified portion thereof that isattributable to a particular risk), the gain or losson the derivative instrument as well as the offsetting loss orgain on the hedged item attributable to the hedged risk are recognized incurrent earnings during the period of the change in fair values.

The Company recognizedlosses of $ 195 during the year ended December 31, 2005. All amounts havebeen included in finance expenses in the statement of income. As of December 31,2005, the Company has not recorded accumulated other comprehensive income sincethere are no open hedging transactions as of that date.

Fair Value HedgingStrategy:

The Company enters intoforward exchange contracts to hedge a portion of its trade payables andreceivables for a period of one to three months. The purpose of the Company’sforeign currency hedging activities is to protect the fair value of its tradepayables and receivables due to foreign exchange rates. As of December 31, 2005, there are noopen hedging transactions.

m.    Revenue recognition:

TheGroup’s portfolio of solutions and services includes: 1) system integration andapplication development services for which revenues are generated from eitherlong term fixed-price basis or time-and-materials basis contracts; 2)outsourcing, consultation, quality assurance and training services for whichrevenues are generated from either fixed-price basis or time-and-materialsbasis contracts; and; 3) sales of third party software licenses.

1)     Under fixed-price contracts, the Group agrees to perform certainwork for a fixed price. Fixed-price basis engagements generally involve aperiod between the signing of the contract and the final customer acceptanceexceeding one year. Fees are payable upon completion of agreed upon milestones,and subject to customer acceptance. Following customer acceptance for a certainmilestone and only thereafter, services could be performed for the nextmilestone. Such projects that require significant customization, integrationand installation are recognized in accordance with SOP No. 81-1 “Accountingfor Performance of Construction-Type and Certain Production-Type Contracts,”using contract accounting on a percentage of completion method, in accordancewith the “Input Method.” The amounts of revenues recognized are based on thetotal fees under the agreement and the percentage to completion achieved. Thepercentage to completion is measured by monitoring progress using records ofactual time, materials and subcontractor costs incurred to date in the projectcompared to the total estimated project requirement, which corresponds to thecosts related to earned revenues. Estimates of total project requirements arebased on prior experience of customization, delivery and acceptance of similarservices, and are reviewed and updated regularly by management. Provisions forestimated losses on uncompleted contracts are made in the period in which suchlosses are first determined, in the amount of the estimated loss on the entirecontract.

Estimated gross profit orloss from long-term contracts may change due to changes in estimates resultingfrom differences between actual performance and original forecasts. Suchchanges in estimated 

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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)**

grossprofit are recorded in results of operations when they are reasonablydeterminable by management, on a cumulative catch-up basis.

The Group believes thatthe use of the percentage of completion method is appropriate as the Group hasthe ability to make reasonably dependable estimates of the extent of progresstowards completion, contract revenues and contract costs. In addition,contracts executed include provisions that clearly specify the enforceablerights regarding services to be provided and received by the parties to thecontracts, the consideration to be exchanged and the manner and the terms ofsettlement, including in cases of terminations for convenience. In all casesthe Group expects to perform its contractual obligations and its customers areexpected to satisfy their obligations under the contract. In cases whereenforceable rights could not be demonstrated, revenues are recognized inaccordance with the completed-contract-cost method.

According to SOP No. 81-1,costs that are incurred for a specific anticipated contract are deferred,subject to evaluation of their probable recoverability, and only if the costscan be directly associated with a specific anticipated contract. Such deferredcosts are recorded as unbilled contract costs.

Amounts recognized asrevenue in advance of contractual billing are recorded as unbilled receivables.

Advances from customersinclude unearned amounts under system integration and application developmentservices.

2)     Other engagements are performed under time-and-materials basiscontracts. Under time-and-materials contracts, the Group is reimbursed forlabor hours at negotiated hourly billing rates. Such service contracts are notin the scope of SOP No. 81-1, and accordingly, related revenues arerecognized in accordance with SEC Staff Accounting Bulletin (“SAB”)No. 104, “Revenue Recognition.” If a contract involves the provision of asingle element, revenues are recognized as those services are performed or overthe term of the related agreements, provided that, an evidence of anarrangement has been obtained, fees are fixed and determinable andcollectibility is reasonably assured.

If contact involves theprovision of multiple service elements, total estimated contract revenue isallocated to each element based on the relative fair value of each element. Thefair value of those elements is determined based on the price charged for thoseelements when sold separately. The Group’s accounting policy complies with therevenue determination requirements set forth in EITF No. 00-21,“Revenue Arrangement with Multiple Deliverables,” relating to the separation ofmultiple deliverables into individual accounting units with determinable fairvalues.

Deferred revenue includesunearned amounts under time-and-materials basis contracts.

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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)**

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 CertainTransactions.” SOP No. 98-9 requires that revenue be recognizedunder the “residual method” when Vendor Specific Objective Evidence (“VSOE”) offair value exists for all undelivered elements, VSOE does not exist for all ofthe delivered elements and all other SOP No. 97-2 criteria are met.Under the residual method, any discount in the arrangement is allocated to thedelivered elements.

Revenues are recognized when persuasive evidence of anagreement exists, delivery of the product has occurred, no significantobligations with regard to implementation remain, the fee is fixed ordeterminable and collectibility 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.

In respect of sucharrangements the Group follows the guidance of EITF No. 99-19, “ReportingRevenue Gross as a Principal versus Net as an Agent.” The Group records revenueon a gross basis representing the amount that has been billed to a customerwhen the Group bears the risks and rewards of ownership including the risk ofloss for collection, latitude in establishing product pricing above a specificminimum price and the credit risk in the event collection is not made from acustomer. When the Group performs as an agent without assuming the risk and rewardsof ownership, revenues are recorded on a net basis.

n.     Accountingfor stock-based compensation:

The Company has elected to follow AccountingPrinciples Board Opinion (“APB”) No. 25 “Accounting for Stock Issued toEmployees” and FASB Interpretation (“FIN”) No. 44 “Accounting for CertainTransactions Involving Stock Compensation” in accounting for its employee stockoptions plans. Under APB No. 25, when the exercise price of the Company’sstock options is less than the market price of the underlying shares on thedate of grant, compensation expense is recognized.

The Company adopted the disclosure provisions of SFAS No. 148,“Accounting for Stock-Based Compensation—transition and disclosure,” whichamended certain provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” to provide alternative methods of transition for an entity thatvoluntarily changes to the fair value based method of accounting forstock-based employee compensation, effective as of the beginning of the priorfiscal year. The Company continues to apply the provisions of APB No. 25in accounting for stock-based compensation.

Pro forma information regarding the Company’s netincome and net earnings per Common share is required by SFAS No. 123 andhas been determined as if the Company had accounted for its employee stockoptions under the fair value method prescribed by SFAS No. 123.

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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)**

The fair value of optionsgranted in 2003, 2004 and 2005 is amortized over their vesting period andestimated at the date of grant using a Black-Scholes options pricing model withthe following weighted average assumptions:

| ** **               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield           |       | 0        | %          | 0        | %          | 0        | %          |
| Expected  volatility     |       | 0.52     |       | 0.50     |       | 0.33     |       |
| Risk-free  interest      |       | 2.5      | %          | 2.5      | %          | 4.3      | %          |
| Expected life (in years) |       | 4        |       | 4        |       | 2.64     |       |

 

Proforma information under SFAS No. 123, is as follows:

| ** **                                                                                                    | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income  available to Common stock—as   reported                                                      |       | $                                          | 2,009      |   | $ | 13,021 |   | $ | 21,689 |   |
| Add— allocation  of undistributed earnings on Class B Convertible Preferred stock—as  reported |       | 1,445                                      |       | 1,356 |   | — |   |
| Deduct—pro forma  allocation of undistributed earnings on Class B Convertible Preferred  stock      |       | (1,117                                     | )          | (1,022 | ) | — |   |
| Add—stock-based  employee compensation—intrinsic value                                         |       | 105                                        |       | 247 |   | 1,992 |   |
| Deduct—stock-based  employee compensation—fair value                                      |       | (1,931                                     | )          | (3,299 | ) | (8,254 | ) |
| Pro forma net  income                                                                                         |       | $                                          | 511        |   | $ | 10,303 |   | $ | 15,427 |   |
| Basic net  earnings per share as reported                                                                     |       | $                                          | 0.13       |   | $ | 0.58 |   | $ | 0.63 |   |
| Diluted net  earnings per share as reported                                                                   |       | $                                          | 0.12       |   | $ | 0.53 |   | $ | 0.61 |   |
| Pro forma basic  net earnings per share                                                                       |       | $                                          | 0.03       |   | $ | 0.46 |   | $ | 0.43 |   |
| Pro forma diluted net  earnings per share                                                                     |       | $                                          | 0.03       |   | $ | 0.41 |   | $ | 0.42 |   |

 

The Company applies SFAS No. 123and EITF No. 96-18, “Accounting for Equity Instruments That AreIssued to Other Than Employees for Acquiring, or in Conjunction with Selling,Goods or Services,” with respect to options and warrants issued tonon-employees. SFAS No. 123 requires the use of option valuation models tomeasure the fair value of the options and warrants at the measurement date asdefined in EITF No. 96-18.

See Note 14b5 foracceleration of vesting and a grant of fully vested options during 2005.

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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)**

o.     Research and development costs:

SFAS No. 86, “Accounting for the Costs ofComputer Software to be Sold, Leased or Otherwise Marketed,” requirescapitalization of certain software development costs, subsequent to theestablishment 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 and developmentcosts incurred in the process of developing product improvements or newproducts, are generally charged to expenses as incurred, net of participationof the Office of the Chief Scientist of the Israeli Ministry of Industry andTrade (the “OCS”), when applicable. Significant costs incurred by the Groupbetween completion of the working model or a detailed program design and thepoint at which the product is ready for general release, have been capitalized.Capitalized software costs will be amortized by the greater of the amountcomputed using the: (i) ratio that current gross revenues from sales ofthe software bears to the total of current and anticipated future grossrevenues from sales of that software, or (ii) the straight-line methodover the estimated useful life of the product (up to three years). As of December 31,2005, capitalized software development costs have not been amortized sincerelated products were not yet ready for general release. The Group assesses therecoverability of this intangible asset on a regular basis by determiningwhether the amortization of the asset over its remaining life can be recoveredthrough undiscounted future operating cash flows from the specific softwareproduct sold. Based on its most recent analyses, management believes that noimpairment of capitalized software development costs exists as of December 31,2005

p.     Royalty-bearing grants:

Royalty-bearinggrants from the Government of Israel for funding approved research anddevelopment projects are recognized at the time the Company’s subsidiaries areentitled to such grants, on the basis of the costs incurred and included as adeduction of research and development costs (see also Note 17a).

q.     Net earnings per share:

Basic net earnings pershare are computed based on the weighted average number of shares of Commonstock outstanding during each year, plus dilutive convertible Preferred stockconsidered outstanding during each year, in accordance with the guidance ofEITF No. D-95, “Effect of Participating Convertible Securities onthe Computation of Basic Earnings Per Share.” Diluted net earnings per shareare computed based on the weighted average number of shares of Common stockoutstanding during each year, plus dilutive potential shares of Common stockconsidered outstanding during the year, in accordance with SFAS No. 128, “EarningsPer Share.”

The total weighted averagenumber of shares related to the outstanding options, warrants, Preferred stockand convertible loan from stockholders excluded from the calculations ofdiluted net earnings per share, as they would have been anti-dilutive for allperiods presented, was 4,870,696, 186,401 and 1,521,226 for the years ended December 31,2003, 2004 and 2005, respectively.

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

r.      Incometaxes:

The Group accountsfor income taxes in accordance with SFAS No. 109, “Accounting for IncomeTaxes.” This statement prescribes the use of the liability method wherebydeferred tax assets and liability account balances are determined based ondifferences between financial reporting and tax bases of assets and liabilitiesand are measured using the enacted tax rates and laws that will be in effectwhen the differences are expected to reverse. Deferred tax assets are reducedby a valuation allowance if it is more likely than not that some portion or allof the deferred tax asset will not be realized.

s.      Concentrationsof credit risk:

Financialinstruments that potentially subject the Group to concentrations of credit riskconsist principally of cash and cash equivalents, short-term bank deposits,marketable securities, trade receivables and unbilled receivables.

Cash and cash equivalents and short-term bank depositsare mainly invested with major banks in Israel, the United States and Europe.Cash and cash equivalents in the United States may be in excess of insuredlimits and are not insured in other jurisdictions. Management believes that thefinancial institutions that hold the Group’s funds are financially sound, andaccordingly minimal credit risk exists with respect to these funds.

The Group’s marketable securities include investmentsin government structured notes of issuers that are considered by management tobe financially sound. The Company’s investments in debt securities arediversified among high-quality credit securities.

Trade receivables and unbilled receivables of theGroup are derived from sales to customers located throughout the world. TheGroup performs ongoing credit evaluations of its clients and, to date, has notexperienced any material losses. In certain cases the Company requires lettersof credit, other collateral or additional guarantees. An allowance for doubtfulaccounts is determined with respect to those amounts that the Group hasdetermined to be doubtful of collection, and in accordance with an aging key.

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

t.      Severancepay:

Certain of the Company’s Israeli subsidiaries’liability for severance pay is calculated pursuant to Israeli severance pay lawbased on the most recent salary of the employees multiplied by the number ofyears of employment, as of the balance sheet date. Employees are entitled toone month’s salary for each year of employment or a portion thereof. Thesecompanies’ liability for all of their employees is fully provided for bymonthly deposits with severance pay funds, insurance policies and by accrual.The value of these policies is recorded as an asset in the Group’s balancesheet.

The deposited funds include profits accumulated up tothe balance sheet date. The deposited funds may be withdrawn only upon thefulfillment of the obligation pursuant to Israeli severance pay law or laboragreements. The value of the deposited funds is based on the cash surrenderedvalue of these policies and includes immaterial profits.

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—SIGNIFICANTACCOUNTING POLICIES (Continued)**

Severance expenses for the years ended December 31,2003, 2004 and 2005 were $ 2,208,$ 2,516 and $ 4,414, respectively.

u.     Fair valueof financial instruments:

The following methods and assumptions were used by theGroup in estimating fair value and disclosures for financial instruments:

(i)            The carrying amountsof cash and cash equivalents, short-term bank deposits, trade receivables,unbilled receivables, short-term bank credit and trade payables approximatetheir fair values due to the short-term maturity of such instruments.

(ii)        The fair market value ofmarketable securities is based on quoted market prices (see Note 3).

(iii)    The carrying amounts of theGroup’s long-term debt and long-term lease deposits approximate their fairvalue, estimated by discounting the future cash flows, using incrementalborrowing rates for similar type of arrangements.

v.      Advertising costs:

Advertising costs are charged as expenses to thestatement of income, as incurred. Advertising expenses for the years ended December 31,2003, 2004 and 2005 were $ 922, $ 821 and $ 1,527 respectively.

w.     Impact ofrecently issued accounting pronouncements:

On December 16, 2004, the FASB issued SFAS No. 123R(revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which is arevision of SFAS No. 123, “Accounting for Stock-Based Compensation,” whichrequires companies to recognize in the statements of income, all share-basedpayments to employees, including grants of employee stock options, based ontheir fair values. Accounting for share-based compensation transactions usingthe intrinsic method supplemented by pro forma disclosures will no longer bepermissible. The new statement will be effective for public entities as of thebeginning of the first interim or annual reporting period of the first fiscalyear beginning after June 15, 2005. The Company will adopt the newstatement on January 1, 2006.

SFAS No. 123Rpermits public companies to adopt its requirements using one of two methods:

1.      A “modifiedprospective” method in which compensation cost is recognized beginning with theeffective date (a) based on the requirements of SFAS No. 123R for allshare base payments granted after the effective date and (b) based on therequirements of SFAS No. 123 for all awards granted to employees prior tothe effective date of SFAS No. 123R that remain unvested on the effectivedate.

2.      A “modifiedretrospective” method which includes the requirements of the modifiedprospective method, described above, which also permits entities to restate,based on the amounts previously recognized under SFAS No. 123 for purposesof pro forma disclosures, either (a) all prior periods presented or (b) priorinterim periods of the year of adoption.

The Company plans to adopt SFAS No. 123R usingthe modified prospective method.

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)**

The Companybelieves that the adoption of this new statement will have an impact on itsresults of operations and net earnings per share as the Company will berequired to expense the fair value of all share-based payments. However, theCompany’s assessment of the estimated compensation charges is affected by theCompany’s stock price as well as assumptions regarding a number of complex andsubjective variables and the related tax impact. These variables include, butare not limited to, the volatility of the Company’s stock price and employeestock option exercise behaviors.

In March 2005, the SEC released Staff AccountingBulletin No. 107, “Share-Based Payment” (“SAB 107”). SAB 107 provides theSEC staff position regarding the application of SFAS No. 123R. SAB 107contains interpretive guidance related to the interaction between SFAS No. 123Rand certain SEC rules and regulations, as well as provides the Staff’sviews regarding the valuation of share-based payment arrangements for publiccompanies. SAB 107 also highlights the importance of disclosures made relatedto the accounting for share-based payment transactions. The Company expectsthat the adoption of SAB 107 will have an impact on its results of operationsand net earnings per share as the Company will be required to expense the fairvalue of all share-based payments.

In May 2005, the FASB issued FASB Statement No. 154,“Accounting Changes and Error Corrections” (“SFAS  154”) which replaces APB Opinion No. 20,“Accounting Changes,” and FASB Statement No. 3, “Reporting AccountingChanges in Interim Financial  Statements.”  Among other changes, SFAS 154 requires that avoluntary change in accounting principles or a change required by a newaccounting pronouncement that does not include specific transition provisionsbe applied retrospectively with all prior period financial statements presentedon the new accounting principle, unless it is impracticable to do so. SFAS 154also provides that (1) a change in method of depreciating or amortizing along-lived non-financial asset be accounted for as a change in estimate(prospectively) that was affected by a change in accounting principle, and (2) correctionof errors in previously issued financial statements should be termed a “restatement.”  SFAS 154 is effective for accounting changesand correction of errors made in fiscal years beginning after June 15,2005.

Accordingly, the Company is required to adopt theprovisions of SFAS 154 in the first quarter of fiscal 2006, beginning on January 1,2006. The Company is currently evaluating the effect that the adoption of SFAS154 will have on its consolidated results of operations and financial conditionbut the Company does not expect SFAS 154 to have a material impact.

The adoption of thefollowing recent accounting pronouncements did not have a material impact onthe Company’s results of operations and financial condition:

·       SFASNo. 151, ‘‘Inventory Costs—An Amendment of ARB No. 43, Chapter 4;’’

·       SFASNo. 153, ‘‘Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29;’’and

·       FASBInterpretations No. 47, ‘‘Accounting for Conditional Asset RetirementObligations, an interpretation of FASB Statement No. 143.’’

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)**

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

In November 2005, the FASB issued FASB StaffPosition (“FSP”) Financial Accounting Standard (“FAS”) 115-1 and FAS 124-1,“The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments” (“FSP 115-1”), which provides guidance on determining wheninvestments in certain debt and equity securities are considered impaired,whether that impairment is other-than-temporary, and on measuring suchimpairment loss. FSP 115-1 also includesaccounting considerations subsequent to the recognition of an other-than temporaryimpairment and requires certain disclosures about unrealized losses that havenot been recognized as other-than-temporary impairments. FSP 115-1 isrequired to be applied to reporting periods beginning after December 15,2005 and is required to be adopted by the Company in the second quarter offiscal 2006. The Company does not expect the adoption of FSP 115-1 tohave a significant effect on its consolidated financial statements.

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, 2004** | ** ** | **December 31, 2005** | ** ** |
|------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **Cost**                        | ** ** | **Gross  Unrealized  Losses**   | ** ** | **Estimated  fair  value** | ** ** | **Cost** | ** ** | **Gross  unrealized  losses and  impairment** | ** ** | **Estimated  fair  value** | ** ** |
| Long-term equity  securities |       | $                               | 211        |                            |       | $ | (142 | ) |   |   | $ | 69 |   |   | $ | 218 |   |   | $ | (186 | ) |   |   | $ | 32 |   |   |
| Short-term government notes  |       | —                          |       |                            | —     |   |   |   | — |   |   | $ | 2,693 |   |   | $ | (42 | ) |   |   | $ | 2,651 |   |   |
|                              |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The change in the value of available-for-salemarketable securities, excluding those resulting from gross unrealized losses,is related to foreign currency translation adjustments.

The fair value of the Group’s trading securities as ofDecember 31, 2004 and 2005 was $ 383 and none, respectively.

During 2003, 2004 and2005, the Company recorded losses of $ 42, $ 32 and $ 20respectively, on trading securities under financial expenses, net.

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)**

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

| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Government authorities                    |       | $                     | 852        |   | $ | 833 |   |
| Deferred income taxes (see also Note 12e) |       | 3,653                 |       | 6,229 |   |
| Employees (1)                             |       | 823                   |       | 361 |   |
| Prepaid expenses                          |       | 2,224                 |       | 4,005 |   |
| Others                                    |       | 1,570                 |       | 2,236 |   |
|                                      |       | $                     | 9,122      |   | $ | 13,664 |   |

----

(1)          Loansto employees bear 4% interest and are linked to the Israeli Consumer PriceIndex (“CPI”). Certain employee loans are forgiven upon certain conditionsincluding their continued employment with the Company and accordingly arerecognized as an expense as they are earned by the employees. Immediately aftercompletion of the Company’s Initial Private Offering (“IPO”), all loans toofficers were repaid.

**NOTE 5—PROPERTY ANDEQUIPMENT, NET**

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

| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Cost:                              |       |                  |       |   |   |
| Computers and peripheral equipment |       | $                     | 26,961     |   | $ | 41,306 |   |
| Motor vehicles                     |       | 181                   |       | 1,479 |   |
| Office furniture and equipment     |       | 5,422                 |       | 5,332 |   |
| Leasehold improvements             |       | 9,745                 |       | 4,345 |   |
|                               |       | 42,309                |       | 52,426 |   |
| Accumulated depreciation           |       | 23,430                |       | 31,154 |   |
| Depreciated cost                   |       | $                     | 18,879     |   | $ | 21,308 |   |

 

Depreciation expenses for the years endedDecember 31, 2003, 2004 and 2005 were $ 3,162, $ 4,734 and $6,699, respectively.

b.     Cost ofcomputers and peripheral equipment at December 31, 2004 and 2005 includecosts of computer software development for internal use in the amounts of$ 811 and $ 1,945, respectively, which are not being amortized yet.

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

d.     As forliens and charges, see Note 11d.

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 6—INTANGIBLE ASSETS,NET**

a.      Intangible assets: 

| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Cost:                                  |       |                  |       |   |   |
| Capitalized software development costs |       | $                     | 2,425      |   | $ | 4,512 |   |
| Deferral of costs                      |       | 167                   |       | 600 |   |
| Customer related intangible assets     |       | 2,287                 |       | 4,478 |   |
|                                   |       | 4,879                 |       | 9,590 |   |
| Accumulated  amortization:             |       |                  |       |   |   |
| Capitalized software development costs |       | —                |       | 183 |   |
| Customer related intangible assets     |       | 682                   |       | 1,469 |   |
|                                   |       | 682                   |       | 1,652 |   |
| Amortized cost                         |       | $                     | 4,197      |   | $ | 7,938 |   |

 

b.     Amortizationexpenses of customer related intangible assets for the years ended December 31,2003, 2004 and 2005 amounted to $ 287, $ 383 and $ 729, respectively,and were included in selling and marketing expenses. Amortization ofcapitalized software development costs for the years ended December 31,2003, 2004 and 2005 amounted to $ 0, $ 0 and $ 183,respectively, and were included in cost of revenues.

c.      The following are estimated amortizationexpenses of customer related intangible assets for the years ending:

| **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|------------|------------|
| 2006                  |       | $          | 1,003      |       |
| 2007                  |       | 1,003      |       |
| 2008                  |       | 579        |       |
| 2009                  |       | 186        |       |
| 2010                  |       | 164        |       |
| 2011                  |       | 74         |       |
|                  |       | $3,009     |       |
|                       |            |            |            |            |            |  |

 

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 7—GOODWILL**

a.      The changes in the carrying amount ofgoodwill for the years ended December 31, 2004 and 2005 are as follows:

| ** **                                | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------|------------|
| Balance as of  January 1, 2004       |       | $         | 147,592    |   |
| Foreign currency  translation adjustments |       | 1,566     |       |
| Balance as of  December 31, 2004     |       | 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    |   |

 

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,** | ** ** |
| ** **                                                     | ** ** | **2004**               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                     | ** ** | **%**                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| In, or linked to,  dollar                                      |       |                   | 4          |                  |       |   | 4.5 |   |   | $ | 1,143 |   | $ | 21,011 |   |
| In Euro                                                        |       |                   | 5          |                  |       |   | — |   |   | 132 |   | — |   |
|                                                           |       |                   |       |                  |       |   |   |   |   | $ | 1,275 |   | $ | 21,011 |   |
| (1) Total  authorized credit lines (including guarantees) |       |                   |       |                  |       |   |   |   |   | $ | 55,914 |   | $ | 139,800 |   |

 

The Company has unusedlines of credit in the aggregate amount of approximately $ 82,500 as ofDecember 31, 2005.

**NOTE 9—OTHER ACCOUNTSPAYABLE AND ACCRUED EXPENSES**

| ** **                                                   | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                   | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Employees and  payroll accruals                              |       | $                     | 15,167     |   | $ | 16,764 |   |
| Accrued vacation  pay and employee benefits                  |       | 7,333                 |       | 9,100 |   |
| Government  authorities                                      |       | 13,471                |       | 19,002 |   |
| Accrued expenses                                             |       | 17,085                |       | 23,930 |   |
| Deferred revenues                                            |       | 9,128                 |       | 6,981 |   |
| Estimated losses  on uncompleted contracts                   |       | 640                   |       | 408 |   |
| Promissory note  with respect to acquisition cost (Note 1b2) |       | 750                   |       | — |   |
| Payables in  connection with acquisitions of subsidiaries    |       | —                |       | 5,162 |   |
| Others                                                       |       | 697                   |       | 1,310 |   |
|                                                         |       | $                     | 64,271     |   | $ | 82,657 |   |

 

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 10—LONG-TERM DEBT**

a.      Composed as follows:

| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Long-term bank  loans (1)     |       | $                     | 48,292     |   | $ | 11,610 |   |
| Loans from others             |       | 990                   |       | 1,546 |   |
| Loan from  stockholders       |       | 1,000                 |       | — |   |
|                          |       | 50,282                |       | 13,156 |   |
| Less—current  maturities |       | 13,364                |       | 6,862 |   |
|                          |       | $                     | 36,918     |   | $ | 6,294 |   |

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(1)          The long-term bank loansdefault upon the failure of any of the Company’s subsidiaries named asborrowers under the loans to satisfy certain conditions and comply withcovenants. As of December 31, 2005, management believes that thesubsidiaries are in compliance with foregoing conditions. The weighted averageinterest rate on the bank loans as of December 31, 2004 and 2005 is 6% and6.75%, respectively. The interest rates were both fixed and variable.

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,** | ** ** |
| ** **                 | ** ** | **2004**               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **%**                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| In, or linked to  dollar   |       |                   | 5-8        |                  |       |   | 5-6 |   |   | $ | 7,507 |   | $ | 2,169 |   |
| In NIS—linked to  CPI |       |                   | 6-8        |                  |       |   | 6-8 |   |   | 42,775 |   | 10,987 |   |
|                       |       |                   |       |                  |       |   |   |   |   | $ | 50,282 |   | $ | 13,156 |   |

 

c.      The loans mature as follows:

| **December 31,**    | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|------------|------------|
| 2006 (current  maturity) |       | $          | 6,862      |       |
| 2007                     |       | 4,158      |       |
| 2008                     |       | 1,080      |       |
| 2009                     |       | 1,056      |       |
|                     |       | $          | 13,156     |       |

 

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)**

**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**             | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2006                 |       | $          | 18,399     |       |
| 2007                 |       | 15,749     |       |
| 2008                 |       | 12,115     |       |
| 2009                 |       | 6,608      |       |
| 2010 and  thereafter |       | 23,219     |       |
|                 |       | $          | 76,089     |       |

 

Totalrent expenses for the years ended December 31, 2003, 2004 and 2005amounted to $ 6,473, $ 7,654 and $ 8,534, respectively.

b.     Litigation:

During2003, 2004 and 2005, several employees filed lawsuits against subsidiaries ofthe Company claiming payments due to them in the total amount of $ 86. TheCompany’s management and its legal advisor believe that the provision in theconsolidated financial statements is adequate to cover probable costs arisingfrom these matters.

c.      Guarantees:

Guaranteesare contingent commitments issued by the Company generally to guarantee theperformance of the Group in different projects to its customers, such astenders. The term of a guarantee generally is equal to the term of the relatedprojects, which can be as short as 30 days or as long as 5 years. The maximumpotential amount of future payments the Group could be required to make underits guarantees at December 31, 2005 is $ 36,168. The Group does not holdcollateral to support guarantees when deemed necessary.

d.     Liens and charges:

To secure its liabilities,the Group recorded fixed and floating charges on the Company’s holdings insubsidiaries, and on the property and equipment and goodwill of the Group.

e.      For contingencies related to acquisitions of subsidiaries seeNote 1b.

f.      For the bank covenants for one of the subsidiaries, see Note10a1.

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**

a.      Income (loss) before taxes consists of the following:

| ** ** | ** ** | **Year ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Domestic   |       | $                                          | (2,486     | ) | $ | 2,178 |   | $ | 1,239 |   |
| Foreign    |       | 6,980                                      |       | 15,322 |   | 23,437 |   |
|       |       | $                                          | 4,494      |   | $ | 17,500 |   | $ | 24,676 |   |

 

b.     Taxes onincome are comprised as follows:

| ** **                       | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Current taxes                    |       | $                                          | 2,094      |   | $ | 2,930 |   | $ | 6,631 |   |
| Taxes in respect  of prior years |       | —                                     |       | — |   | 158 |   |
| Deferred income  tax benefit     |       | (2,148                                     | )          | (610 | ) | (3,271 | ) |
|                             |       | $                                          | (54        | ) | $ | 2,320 |   | $ | 3,518 |   |
| Domestic                         |       | $                                          | (591       | ) | $ | 276 |   | $ | 566 |   |
| Foreign                          |       | 537                                        |       | 2,044 |   | 2,952 |   |
|                             |       | $                                          | (54        | ) | $ | 2,320 |   | $ | 3,518 |   |

 

c.      Deferred taxes on income:

Deferred income taxesreflect the net tax effect of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts used for income tax purposes. Significant components of the Group’sdeferred tax liabilities and assets are as follows:

| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Deferred tax  assets:                              |       |                  |       |   |   |
| Reserves and  allowances                           |       | $                     | 2,938      |   | $ | 4,906 |   |
| Different  depreciation rates                      |       | 121                   |       | 166 |   |
| Net operating  loss carry forwards of subsidiaries |       | 9,180                 |       | 8,599 |   |
| Net deferred tax  asset before valuation allowance |       | 12,239                |       | 13,671 |   |
| Valuation  allowance                               |       | (3,764                | )          | (2,171 | ) |
| Net deferred tax  asset                            |       | $                     | 8,475      |   | $ | 11,500 |   |
| Domestic                                           |       | $                     | 1,244      |   | $ | 624 |   |
| Foreign                                            |       | 7,231                 |       | 10,876 |   |
|                                               |       | $                     | 8,475      |   | $ | 11,500 |   |

 

d.     As of December 31, 2005, the Company’s subsidiaries inIsrael, the United Kingdom, and the Netherlands have estimated total availablecarry forward tax losses of $ 7,923, $ 9,310 and $ 10,693, respectively,to offset against future taxable profits. The U.S. subsidiaries have anestimated total available carry forward tax losses of $ 677.

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)**

**NOTE 12—INCOMETAXES**

Utilization of U.S. netoperating losses may be subject to substantial annual limitation due to the “changein ownership” provisions of the Internal Revenue Code of 1986 and similar stateprovisions. The annual limitation may result in the expiration of net operatinglosses before utilization.

Management currentlybelieves that since certain of the Company’s subsidiaries have a history oflosses it is more likely than not that some of the deferred tax assetsregarding the loss carry forwards will not be utilized in the foreseeablefuture. Thus, a valuation allowance was provided to reduce deferred tax assetsto their realizable value. During the year 2005, the net change in valuationallowance was in the amount of $ 1,593.

The cumulative amount ofundistributed earnings of foreign subsidiaries, which is intended to bepermanently reinvested and for which U.S. income taxes have not been provided,totaled approximately$ 15,600 and $ 26,870 at December 31, 2004 and 2005, respectively.

e.      The Company has tax benefits that India provides to the exportof IT services. These benefits provide a complete exemption from corporateincome tax for exported IT services, compared to an ordinary corporate tax rateof approximately 34%. These tax benefits are expected to be valid until March 31,2009.

f.      In February 2006, the Company paid the Israeli TaxAuthority (“ITA”) a sum of $ 3,400 in full payment of an assessment agreementwith ITA regarding a tax assessment of the Israeli subsidiaries of the Companyfor the years 1999 through 2003. Since the agreed tax payment was fullyprovided for in the Company’s consolidated balance sheet as of December 31,2005 and 2004, the agreement did not result in additional tax expense in theyear ended December 31, 2005.

g.      Areconciliation between the theoretical tax expenses, assuming all income istaxed at the statutory tax rate applicable to income of the Company and theactual tax expense as reported in the consolidated statements of income, is asfollows:

| ** **                                                                      | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Income before taxes, as reported  in the consolidated statements of income      |       | $                                          | 4,494      |   | $ | 17,500 |   | $ | 24,676 |   |
| Statutory tax rate                                                              |       | 35                                         | %          | 35 | % | 35 | % |
| Theoretical tax expenses  on the above amount at the federal statutory tax rate |       | $                                          | 1,573      |   | $ | 6,125 |   | $ | 8,637 |   |
| Effect of tax holiday                                                           |       | (103                                       | )          | (1,604 | ) | (2,195 | ) |
| Effect of foreign  subsidiaries with different tax rates                        |       | (167                                       | )          | (26 | ) | (1,659 | ) |
| Deferred taxes on losses  for which valuation allowance was provided            |       | (1,731                                     | )          | (2,674 | ) | (1,629 | ) |
| Non-deductible expenses                                                         |       | 220                                        |       | 440 |   | 791 |   |
| Others                                                                          |       | 154                                        |       | 59 |   | (427 | ) |
| Actual tax expense  (benefit)                                                   |       | $                                          | (54        | ) | $ | 2,320 |   | $ | 3,518 |   |
| Basic net earnings per  share related to tax holiday                            |       | $                                          | 0.01       |   | $ | 0.07 |   | $ | 0.06 |   |
| Diluted net earnings per share related to tax  holiday                          |       | $                                          | 0.01       |   | $ | 0.06 |   | $ | 0.06 |   |

 

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)**

**NOTE13—RELATED PARTIES BALANCES**

| ** **                                                                                                                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Balances with  related parties:                                                                                                           |       |                  |       |   |   |
| Long-term loan,  convertible loan and related maturities from related party (interest  accumulated is included in other accounts payable) |       | $                     | 1,007      |   | $ | — |   |
| Non-consolidated  affiliate current balance                                                                                               |       | $                     | —     |   | $ | 582 |   |

 

**NOTE14—STOCKHOLDERS’ EQUITY**

a.      General:

On September 29,2004, the Securities and Exchange Commission declared effective the Company’sRegistration Statement in respect of its IPO. The closing of the Company’s IPOoccurred on October 4, 2004. Upon the closing, the Company received fromthe underwriters of the IPO a net amount of $ 73,129 and issued 6,552,774 newshares of Common stock. Certain stockholders sold 5,119,226 shares of Commonstock for a net sum of $ 57,131. Upon the closing, all the shares of Preferredstock were converted to shares of Common stock. The Company issued to theholders of the Class B Preferred stock 541,946 shares of Common stock ascumulative accumulated dividend at the price of $ 18.07 per share. The Companyalso issued to the holders of the Class C Preferred stock 1,492,880 sharesof Common stock pursuant to the ratchet described below. The Company appointedthree new directors. On October 5, 2004, the underwriters exercised infull the 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 stockholdersapproved on September 2, 2004, to adopt a 0.7193-for-1 reversesplit of the Company’s shares of Common stock, to be effected on the effective date of filingan amendment to the Company’s certificate of incorporation in respect of thereverse split. Such filing became effective on September 20, 2004. AllCommon stock, options, warrants and per share data included in these financialstatements for all periods presented as well as the exchange ratios for thePreferred stock and convertible loan from stockholders have been retroactivelyadjusted to reflect this 0.7193-for-1 reverse split.

Commonstock confers upon its holders the right to receive notice to participate andvote in the stockholders meetings of the Company, the right to receivedividends, if and when declared, and the right to receive the assets of the Company upon liquidation.

b.     Stock option plans:

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

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)**

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 of December 31,2005, under these Israeli Plans is 5,575,526, and options to purchase 175,206shares 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, 2005, under these U.S. Plans is1,399,347 and options to purchase 334,660 shares are available for futuregrant.

3.      Options granted under the Israeli Plans and the U.S. Plans areexercisable between five to ten years from the date of grant. The exerciseprice of the options granted under the Israeli Plans may not be less than thepar value of the shares for which the options are exercisable. The minimumexercise price of the options granted under the U.S. Plans may not be less thana price ranging from 80% to 110% of the fair market value, depending on theapplicable circumstances, of the shares for which the options are exercisable.Any options that are canceled or forfeited before expiration become availablefor future grants.

4.      On September 2, 2004, the Board of Directors of theCompany and its stockholders approved an increase of 400,000 options to theU.S. Stock Option Plan and 600,000 options to the 2003 Israeli Stock OptionPlan.

5.      A summary of the Company’s employees’ stock option activity andrelated information is as follows:

| ** **                                  | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                  | ** ** | ** **                                 | ** ** | **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   |       | 4,323,719                                  |       |   | $ | 7.86 |   |   | 5,217,834 |   |   | $ | 7.55 |   |   | 6,268,136 |   |   | $ | 8.32 |   |   |
| Granted                                     |       | 1,162,532                                  |       |   | $ | 6.22 |   |   | 1,143,166 |   |   | $ | 11.82 |   |   | 1,571,800 |   |   | $ | 11.69 |   |   |
| Exercised                                   |       | (176,228                                   | )          |   | $ | 6.64 |   |   | (23,247 | ) |   | $ | 1.78 |   |   | (1,314,206 | ) |   | $ | 7.39 |   |   |
| Forfeited                                   |       | (92,189                                    | )          |   | $ | 4.89 |   |   | (69,617 | ) |   | $ | 10.23 |   |   | (212,424 | ) |   | $ | 10.19 |   |   |
| Outstanding at  the end of the year    |       | 5,217,834                                  |       |   | $ | 7.55 |   |   | 6,268,136 |   |   | $ | 8.32 |   |   | 6,313,306 |   |   | $ | 9.29 |   |   |
| Exercisable options at  the end of the year |       | 3,486,998                                  |       |   | $ | 7.21 |   |   | 4,067,023 |   |   | $ | 8.20 |   |   | 5,878,250 |   |   | $ | 9.28 |   |   |

----

*)               Including theoptions granted to the employees of Ness GSG (see Note 14b8).

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)**

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

The options outstanding asof December 31, 2005 have been classified by exercise price, as follows:

| **Exercise price** | ** ** | ** ** | ** ** | **Options  outstanding  as of  December 31,  2005** | ** ** | **Weighted  average  remaining  contractual  life** | ** ** | **Weighted  average  exercise  price** | ** ** | **Options  Exercisable  as of  December 31,  2005** | ** ** | **Weightedaverage  exercise  price of  options  exercisable** | ** ** |
|-------------------------|------------|------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Years**                                                     | ** ** | ** **                                          | ** ** | ** **                             | ** ** | ** **                                                    | ** ** |
| $ 0.01             |       |       | 18,964     |                                                          |       |                                                | 1.04       |                                   |       |                                                          | $          | 0.01                                                               |       |   |   | 18,964 |   |   |   | $ | 0.01 |   |   |
|    0.58  |       |       | 86,316     |                                                          |       |                                                | 0.58       |                                   |       |                                                          | 0.58       |                                                               |       |   | 86,316 |   |   |   | 0.58 |   |   |
|    1.78  |       |       | 89,844     |                                                          |       |                                                | 4.73       |                                   |       |                                                          | 1.78       |                                                               |       |   | 89,844 |   |   |   | 1.78 |   |   |
|    3.49  |       |       | 278,932    |                                                          |       |                                                | 0.41       |                                   |       |                                                          | 3.49       |                                                               |       |   | 278,932 |   |   |   | 3.49 |   |   |
|    5.57  |       |       | 68,147     |                                                          |       |                                                | 6.67       |                                   |       |                                                          | 5.57       |                                                               |       |   | 64,151 |   |   |   | 5.57 |   |   |
|    7.45  |       |       | 85,609     |                                                          |       |                                                | 0.46       |                                   |       |                                                          | 7.45       |                                                               |       |   | 85,609 |   |   |   | 7.45 |   |   |
|    8.47  |       |       | 3,159,168  |                                                          |       |                                                | 1.81       |                                   |       |                                                          | 8.47       |                                                               |       |   | 2,902,908 |   |   |   | 8.47 |   |   |
|  10.12             |       |       | 125,000    |                                                          |       |                                                | 5.00       |                                   |       |                                                          | 10.12      |                                                               |       |   | — |   |   |   | 10.12 |   |   |
|  11.82             |       |       | 2,356,326  |                                                          |       |                                                | 4.91       |                                   |       |                                                          | 11.82      |                                                               |       |   | 2,341,526 |   |   |   | 11.82 |   |   |
|  12.75             |       |       | 45,000     |                                                          |       |                                                | 6.06       |                                   |       |                                                          | 12.75      |                                                               |       |   | 10,000 |   |   |   | 12.75 |   |   |
|                    |       |       | 6,313,306  |                                                          |       |                                                | 3.06       |                                   |       |                                                          | $          | 9.29                                                               |       |   |   | 5,878,250 |   |   |   | $ | 9.28 |   |   |

 

Where the Company has recorded deferred stockcompensation for options issued with an exercise price below the fair marketvalue of the Common stock at the date of grant, the deferred stock compensationhas been amortized and recorded as compensation expense ratably over thevesting period of the options. Compensation expense of approximately$ 105, $ 213 and $ 125 was recognized during the years ended December 31,2003, 2004 and 2005, respectively.

Substantiallyall of the options were granted with exercise prices equal to or higher thanthe value on the grant date. For the excluded options, the weighted averagefair values of options granted during the years ended December 31, 2003,2004 and 2005 were:

| ** **                                  | ** ** | **Exceeds market price**         | ** ** | **Less than market price**  | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **Year ended December 31,** | ** ** | **Year ended December 31,** | ** ** |
| ** **                                  | ** ** | **2003**                                   | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted average  exercise prices           |       |                                       | $          | —                                     |       |   |   | $ | — |   |   | $ | 11.69 |   | $ | 6.26 |   | $ | 11.82 |   | $ | 11.82 |   |
| Weighted average fair  values on grant date |       |                                       | $          | —                                     |       |   |   | $ | — |   |   | $ | 2.08 |   | $ | 5.09 |   | $ | 5.73 |   | $ | 3.87 |   |

 

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

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

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)**

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

The Company’s decision to accelerate the vesting ofthose options and to grant fully vested options was based primarily upon theissuance of SFAS No. 123R, which will require the Company to treat allunvested stock options as compensation expense effective January 1, 2006.The Company believes that the acceleration of vesting of those options willenable the Company to avoid recognizing stock-based compensation expenseassociated with these options in future periods. Additional purposes of thefully vested grant and for the acceleration were to make the options moreattractive to the recipients, and to avoid discrimination between groups ofoption holders, respectively.

Theimpact of the vesting acceleration on pro forma stock based compensationrequired to be disclosed in the financial statement footnotes under theprovisions of SFAS No. 123, was to increase such disclosed compensationcost by approximately $ 374 (See Note 2n).

6.      Warrants issued to consultants:

TheCompany’s outstanding warrants to consultants as of December 31, 2005 areas follows:

| **Issuance date** | ** ** | ** ** | ** ** | **Options for   Common stock** | ** ** | **Exercise price  per share** | ** ** | **Options  exercisable** | ** ** | **Exercisable  through** | ** ** |
|------------------------|------------|------------|------------|-----------------------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| May 2000          |       |       | 25,175     |                                          |       |                                    | $          | 8.47                     |       |                     |       | 25,175 |   |   | May 31, 2007 |   |
| March 2001        |       |       | 5,205      |                                          |       |                                    | $          | 8.47                     |       |                     |       | 5,205 |   |   | March 31,  2008 |   |
|                   |       |       | 30,380     |                                          |       |                                    |       |                     |       |                     | 30,380     |   |   |   |   |

 

7.      Warrants issued for financing transactions:

In connection with loansreceived in March 2000, the Company issued to two banks in Israel warrantsto purchase an aggregate of 101,270 shares of Common stock of the Company withan exercise price of $ 10.33 per share exercisable throughMarch 2005. In November 2003, warrants to purchase 60,989 shares wereexercised resulting in the issuance of 26,132 shares of Common stock. In January 2005,the remaining warrants to purchase 40,281 shares were exercised resulting inthe issuance of 8,561 shares of Common stock.

The Company had accountedfor these warrants under APB No. 14, “Accounting for Convertible Debt andDebt Issued with Stock Purchase Warrants.” The total amount of the deemeddiscount on the loans as a result of the warrant issuance is amortized over theperiod of the loans as interest expenses. The fair value of the warrants isimmaterial.

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 14—STOCKHOLDERS’EQUITY (Continued)**

8.      Inrespect of the acquisitions of Ness GSG in 2003 and Ness CEE in 2002, theoptions of related employees assumed by the Company and of former investorswere valued by applying the Black-Scholes option pricing model to the Companyoptions, in accordance with FIN No. 44. The calculations were made usingthe following assumptions for Ness GSG and Ness CEE, respectively:(i) valuation date is June 30, 2003 and September 30, 2002,(ii) share price is $ 8.47 and $ 7.23, which represent the fair value ofthe Company’s share, (iii) risk-free interest rate is 2.5% and 3.1%,(iv) volatility is 0.52 and 0.42, (v) time to expiration is 2.5 and 7years, and (vi) annual dividend rate is 0% for both.

The fair value of vested options of Ness GSG and NessCEE was accounted for as part of the related purchase price. The intrinsicvalue of unvested options of Ness GSG has been allocated to deferred stockcompensation. No unvested options existed in Ness CEE. Such deferred stock compensationwas deducted from the fair value of the unvested options awards in determiningthe amount of the purchase price. The calculation of the deferred stockcompensation amounting to $548 was based on the number of Ness GSG unvestedoptions outstanding multiplied by the intrinsic value, which is the differencebetween the market price on June 30, 2003 of $ 8.47 and the variousexercise prices.

9.      Optionsgranted to employees of Ness GSG that were assumed by the Company are includedin the summary of employees’ stock option activity, in Note 14b5. Optionsgranted to investors of Ness CEE are included in the summary of options toinvestors from acquisitions in Note 14b10.

10.   As part ofprior business combinations during 1999 and 2002, the Company issued options torelated former investors to purchase 1,284,019 shares of Common stock of theCompany with an exercise price ranging between $ 0.01 and $ 44.50 pershare (primarily $ 0.01).

As of December 31, 2005, 631,186 options areoutstanding and exercisable.

11.   The Companydoes not intend to pay cash dividends in the foreseeable future.

12.   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 total number ofredeemable options, all of which are currently vested, is 364,541, and theaggregate redemption value as of December 31, 2005 is $ 3,400.

The redemptionright is exercisable from October 1, 2004 until May 31, 2006. Eachoption subject to the redemption right may be transferred by the employee tothe Company for a cash payment that is linked, at the employee’s solediscretion, either to the Israeli CPI and shall bear a NIS interest at the rateof 5% per year, or to the U.S. dollar with a U.S. dollar interest at the rateof 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 278,932options may be exercised to acquire one share of the Company’s Common stock ata price of $ 3.49 and are redeemable at the NIS equivalent amount of $ 9.88per option as of December 31, 2005. Each of 85,609 options may beexercised to acquire one share of the Company’s Common stock at a price of$ 7.45, and are redeemable at the NIS equivalent amount of $ 7.44 peroption as of December 31, 2005. The exercise prices and redemption amountsare subject to 

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)**

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

adjustments for stock splits, dividends,  recapitalizations and the like, as set forthin the Company’s share option plan to which each option is subject.

The Company accounts for the rights following theguidance of FIN No. 28, “Accounting for Stock Appreciation Rights andOther Variable Stock Option or Award Plans,” relating to tandem awards and EITFNo. 00-23, “Issues Related to the Accounting for Stock Compensationunder APB No. 25 and FIN No. 44.” Accordingly, once the Companybelieves it is likely that the rights would be exercised in the future, aliability will be recorded at the then value of the redemption rights, with acorresponding charge to compensation expense. The liability will be accretedperiodically to equal the amount that would be payable if the awards wereredeemed at each balance sheet date. As of December 31, 2005, the Companybelieved it was likely that the rights would be exercised, and accordingly, theCompany recorded a liability in that respect in the total amount of $ 3,400,included in other accounts payable and accrued expenses, reflecting the valueof the redemption rights at December 31, 2005. Related stock-basedcompensation expenses were recorded in the statement of income for 2005 in thetotal amount of approximately $ 1,900.

**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,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                     | ** ** | **(Net earnings in thousands)**  | ** ** |
| Net income from  continuing operations as reported                                                                             |       | $                                          | 4,559      |   |   | $ | 14,377 |   |   | $ | 21,194 |   |
| Allocation of  undistributed earnings on Class B Convertible Preferred stock                                              |       | (1,445                                     | )          |   | (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 |       | 3,114                                      |       |   | 13,021 |   |   | 21,194 |   |
| Gain from  extraordinary item, net of taxes                                                                                    |       | —                                     |       |   | — |   |   | 495 |   |
| Losses from  discontinued operations                                                                                           |       | (1,105                                     | )          |   | — |   |   | — |   |
| Net income after  allocation of undistributed earnings on Class B Convertible Preferred  stock                            |       | $                                          | 2,009      |   |   | $ | 13,021 |   |   | $ | 21,689 |   |

** **

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 15—BASICAND DILUTED NET EARNINGS PER SHARE (Continued)**

2.     Denominator

| ** **                                                                                                                                       | ** ** | **Year ended December 31,**          | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                       | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                       | ** ** | **(Number of shares  in thousands)** | ** ** |
| Weighted average  number of shares of Common stock                                                                                               |       | 12,967                                              |       | 20,483 |   | 34,413 |   |
| Weighted average  number of shares of Preferred stock                                                                                            |       | 2,412                                               |       | 1,809 |   | — |   |
| Denominator for  basic net earnings per share                                                                                                    |       | 15,379                                              |       | 22,292 |   | 34,413 |   |
| Effect of dilutive  securities:                                                                                                                  |       |                                                |       |   |   |   |   |
| Stock options and warrants                                                                                                                       |       | 1,232                                               |       | 2,456 |   | 1,248 |   |
| Dilutive  potential common shares                                                                                                                |       | 1,232                                               |       | 2,456 |   | 1,248 |   |
| Denominator for diluted  net earnings per share—adjusted weighted average shares, assumed conversions  and exercise of options and warrants |       | 16,611                                              |       | 24,748 |   | 35,661 |   |

 

**NOTE 16—GEOGRAPHICINFORMATION**

The Group adopted SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information.” The Group operates inone reportable segment (see Note 1 for a brief description of the Group’sbusiness). The total revenues are attributed to geographic areas based on thelocation of the end customer.

Thefollowing presents total revenues for the years ended December 31, 2003,2004 and 2005 and long-lived assets as of December 31, 2003, 2004 and,2005:

| ** **                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues from  sales to unaffiliated customers: |       |                                       |       |   |   |   |   |
| Israel                                          |       | $                                          | 152,925    |   | $ | 172,259 |   | $ | 200,120 |   |
| United States                                   |       | 35,831                                     |       | 75,890 |   | 85,917 |   |
| Europe                                          |       | 29,505                                     |       | 39,513 |   | 74,845 |   |
| Asia and the Far  East                          |       | 6,367                                      |       | 13,844 |   | 19,426 |   |
| Others                                          |       | 1,140                                      |       | 3,019 |   | 5,128 |   |
|                                            |       | $                                          | 225,768    |   | $ | 304,525 |   | $ | 385,436 |   |

 

| ** **             | ** ** | **December 31,** | ** ** |
|------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **2003**              | ** ** | **2004** | ** ** | **2005** | ** ** |
| Long-lived  assets:    |       |                  |       |   |   |   |   |
| Israel                 |       | $                     | 155,566    |   | $ | 103,649 |   | $ | 101,313 |   |
| United States          |       | 2,400                 |       | 57,536 |   | 60,057 |   |
| Europe                 |       | 1,978                 |       | 2,845 |   | 14,102 |   |
| Asia and the Far  East |       | 4,560                 |       | 8,194 |   | 8,018 |   |
| Others                 |       | 9                     |       | 10 |   | 15 |   |
|                   |       | $                     | 164,513    |   | $ | 172,234 |   | $ | 183,505 |   |

 

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)**

**NOTE17—SELECTED STATEMENTS OF OPERATIONS DATA**

| ** ** | ** ** | ** **                                       | ** ** | **Year ended December 31,** | ** ** |
|------------|------------|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | ** **                                       | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| a.         |       | Research and development  expenses, net:         |       |                                       |       |   |   |   |   |
|       |       | Total expenses                                   |       | $                                          | 2,676      |   | $ | 2,559 |   | $ | 1,049 |   |
|       |       | Less—grants and  participations             |       | 603                                        |       | — |   | — |   |
|       |       | Less—capitalized  software development cost |       | 514                                        |       | 2,559 |   | 1,049 |   |
|       |       |                                             |       | $                                          | 1,559      |   | $ | — |   | $ | — |   |

 

| ** ** | ** ** | ** **                                    | ** ** | **Year ended December 31,** | ** ** |
|------------|------------|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | ** **                                    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| b.         |       | Financial expenses, net:                      |       |                                       |       |   |   |   |   |
|       |       | Financial  Expenses:                          |       |                                       |       |   |   |   |   |
|       |       | Interest on  short-term loans and bank credit |       | $                                          | (462       | ) | $ | (451 | ) | $ | (1,263 | ) |
|       |       | Interest on  long-term bank loans             |       | (3,393                                     | )          | (3,863 | ) | (1,942 | ) |
|       |       | Losses from  trading marketable securities    |       | (42                                        | )          | (32 | ) | — |   |
|       |       | Foreign currency exchange  losses             |       | —                                     |       | — |   | (221 | ) |
|       |       |                                          |       | (3,897                                     | )          | (4,346 | ) | (3,426 | ) |
|       |       | Financial income:                             |       |                                       |       |   |   |   |   |
|       |       | Foreign currency exchange  gain               |       | 670                                        |       | 492 |   | — |   |
|       |       | Gain from trading  marketable securities      |       | —                                     |       | — |   | 20 |   |
|       |       | Interest on  short-term bank deposits         |       | 1,776                                      |       | 393 |   | 1,885 |   |
|       |       |                                          |       | 2,446                                      |       | 885 |   | 1,905 |   |
|       |       |                                          |       | $                                          | (1,451     | ) | $ | (3,461 | ) | $ | (1,521 | ) |

 

**NOTE 18—SUBSEQUENT EVENTS(UNAUDITED)**

On February 28, 2006,the Company closed the acquisition of Innova Solutions (OLAS Software Solutions, Inc.)(“Innova”), a privately held provider of IT services and solutions based in theUnited States and India. The purchase price in the all cash transaction is $ 25,000,of which $ 10,000 will be paid during 2007 and 2008, based on theachievement of certain performance goals in 2006 and 2007, respectively. It isimpractical to disclose the additional information required by paragraph 57of SFAS No. 141.

**NOTE19—CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)**

| ** **       | ** ** | **Three months ended** | ** ** |
|------------------|------------|----------------------------------|------------|
| ** **       | ** ** | **Mar 31,  2004**           | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** |
| ** **       | ** ** | **(unaudited)**                  | ** ** |
| Revenues         |       | $                                | 71,146     |   | $ | 73,879 |   | $ | 77,152 |   | $ | 82,348 |   | $ | 88,405 |   | $ | 94,218 |   | $ | 97,719 |   | $ | 105,094 |   |
| Gross profit     |       | 22,740                           |       | 22,137 |   | 23,157 |   | 24,766 |   | 25,828 |   | 26,172 |   | 28,091 |   | 30,114 |   |
| Operating income |       | 5,206                            |       | 4,344 |   | 5,390 |   | 6,112 |   | 5,855 |   | 4,917 |   | 7,666 |   | 8,003 |   |
| Net income       |       | $                                | 2,417      |   | $ | 2,910 |   | $ | 3,691 |   | $ | 5,359 |   | 4,926 |   | $ | 3,983 |   | $ | 6,017 |   | $ | 6,764 |   |
|                  |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-49

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**SCHEDULEII—SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS**
|                                    | ** ** | **Balance at  beginning  of period** | ** ** | **Provision  for doubtful  accounts** | ** ** | **Write-off of  previously  provided  accounts** | ** ** | **Translation  adjustments** | ** ** | **Balance  at end of  period** | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------|------------|------------------------------------------|------------|
| ** **                         | ** ** | **(dollars In thousands)**           | ** ** |
| 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 | ** ** |   |
| Year ended  December 31, 2003 |       |                                           |       | ** **                                 |       |                                                  |       | ** **                   |       |                                     |       |   |   |   |   | ** ** |   |   |   | ** ** |   |
| Allowance for doubtful  accounts   |       |                                           | $          | 1,486                                      | ** ** |                                                  |       | $                            | 366        | ** **                               |       |   | $ | (212 | ) |   |   | $ | 145 | ** ** |   |   | $ | 1,785 | ** ** |   |
|                                    |            |                                                |            |                                            |            |                                                       |            |                              |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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