** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(MarkOne)**

** **

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended September 30, 2006**

**Or**

**o**                                 TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                   to**

**CommissionFile Number 1-7516**

**KEANE, INC.**

(Exact name ofregistrant as specified in its charter)

| **MASSACHUSETTS**                                               |   | **04-2437166**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (IRS Employer  Identification No.) |
| ** **                                                      |   | ** **                         |
| **100  City Square, Boston, Massachusetts**                     |   | **02129**                          |
| (Address of  principal executive offices)                       |   | (Zip Code)                         |

 

Registrant’stelephone number, including area code**(617)241-9200**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes**  **x**  **No  o

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

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

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes**  **oNo  x

As of October 31, 2006, there were 58,653,437 shares of the registrant’sCommon Stock, $.10 par value per share, and no shares of the registrant’sClass B Common Stock, $.10 par value per share, issued and outstanding.

 

----

**Keane, Inc.**

**Table ofContents**
| **Part I.**   | **Financial  Information**                                                                                                      | ** ** |
|---------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
|          |                                                                                                                            |       |
| Item 1.       | Unaudited Condensed  Consolidated Statements of Income for the three and nine months ended  September 30, 2006 and 2005    |       |
|          |                                                                                                                            |       |
|          | Unaudited  Condensed Consolidated Balance Sheets as of September 30, 2006 and December  31, 2005                                |       |
|          |                                                                                                                            |       |
|          | Unaudited Condensed Consolidated Statements of Cash  Flows for the nine months ended September 30, 2006 and 2005 |       |
|          |                                                                                                                            |       |
|          | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                 |       |
|          |                                                                                                                            |       |
| Item 2.       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                     |       |
|          |                                                                                                                            |       |
| Item 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                                     |       |
|          |                                                                                                                            |       |
| Item 4.       | Controls and Procedures                                                                                                         |       |
|          |                                                                                                                            |       |
| **Part II.**  | **Other Information**                                                                                                           |       |
|          |                                                                                                                            |       |
| Item 1.       | Legal Proceedings                                                                                                               |       |
|          |                                                                                                                            |       |
| Item  1A.     | Risk Factors                                                                                                                    |       |
|          |                                                                                                                            |       |
| Item 2.       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                    |       |
|          |                                                                                                                            |       |
| Item 6.       | Exhibits                                                                                                                        |       |
|          |                                                                                                                            |       |
| Signatures    |                                                                                                                            |       |
|          |                                                                                                                            |       |
| Exhibit Index |                                                                                                                            |       |

 

2

----

**Part I.Financial Information**

**Item1. Financial Statements**

**Keane, Inc.Unaudited Condensed Consolidated Statements of Income**
| ** **                                                                       | ** ** | **Three Months Ended September 30,**             | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                                             | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | **(In thousands except per share amounts)** | ** ** |
| **Revenues**                                                                     |       | $                                                                    | 231,956    |                                                    | $          | 239,563 |   | $ | 718,168 |   | $ | 709,585 |   |
| ** **                                                                       | ** ** | ** **                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating expenses**                                                           | ** ** | ** **                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries, wages,  and other direct costs                                         |       | 166,361                                                              |       | 171,016                                                 |       | 511,122 |   | 499,670 |   |
| Selling,  general, and administrative expenses                                   |       | 48,419                                                               |       | 54,495                                                  |       | 155,907 |   | 164,971 |   |
| Amortization of  intangible assets                                               |       | 3,742                                                                |       | 3,780                                                   |       | 11,448 |   | 11,710 |   |
| Restructuring  charges, net                                                      |       | 135                                                                  |       | —                                                  |       | 2,796 |   | — |   |
| **Operating income**                                                             |       | 13,299                                                               |       | 10,272                                                  |       | 36,895 |   | 33,234 |   |
|                                                                             |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Other income (expense)**                                                       | ** ** | ** **                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and  dividend income                                                    |       | 1,402                                                                |       | 1,121                                                   |       | 3,887 |   | 3,354 |   |
| Interest expense                                                                 |       | (1,542                                                               | )          | (1,403                                                  | )          | (4,610 | ) | (4,225 | ) |
| Other income  (expense), net                                                     |       | 97                                                                   |       | (367                                                    | )          | (24 | ) | (557 | ) |
| Minority  interest                                                               |       | 41                                                                   |       | 158                                                     |       | 25 |   | 1,031 |   |
| **Income before income taxes**                                                   |       | 13,297                                                               |       | 9,781                                                   |       | 36,173 |   | 32,837 |   |
| Provision for income  taxes                                                      |       | 4,894                                                                |       | 895                                                     |       | 12,981 |   | 9,633 |   |
| **Net income**                                                                   |       | $                                                                    | 8,403      |                                                    | $          | 8,886 |   | $ | 23,192 |   | $ | 23,204 |   |
|                                                                             |       |                                                                 |       |                                                    |       |   |   |   |   |
| Basic earnings per  share                                                        |       | $                                                                    | 0.15       |                                                    | $          | 0.15 |   | $ | 0.40 |   | $ | 0.38 |   |
|                                                                             |       |                                                                 |       |                                                    |       |   |   |   |   |
| Diluted earnings per  share                                                      |       | $                                                                    | 0.13       |                                                    | $          | 0.14 |   | $ | 0.37 |   | $ | 0.36 |   |
|                                                                             |       |                                                                 |       |                                                    |       |   |   |   |   |
| Basic weighted average common  shares outstanding                                |       | 57,704                                                               |       | 59,897                                                  |       | 58,144 |   | 61,265 |   |
| Diluted weighted average common shares and common share equivalents  outstanding |       | 66,565                                                               |       | 68,638                                                  |       | 66,835 |   | 70,074 |   |

 

*Theaccompanying notes are an integral part of the unaudited condensed consolidatedfinancial statements.*

3

----

**Keane, Inc.Unaudited Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                                 | ** ** | **September 30,**                                                               | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                 | ** ** | **2006**                                                                             | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                 | ** ** | **(Dollars in thousands,   except per share amounts)** | ** ** |
| **Assets**                                                                                                                                                 | ** ** | ** **                                                                           | ** ** | ** **            | ** ** |
| Current:                                                                                                                                                   |       |                                                                                 |       |                  |       |
| Cash and cash  equivalents                                                                                                                                 |       | $                                                                                    | 78,717     |                  | $          | 71,570 |   |
| Restricted cash                                                                                                                                            |       | 236                                                                                  |       | 1,745                 |       |
| Marketable  securities                                                                                                                                     |       | 74,411                                                                               |       | 95,796                |       |
| Accounts  receivable, net                                                                                                                                  |       | 181,415                                                                              |       | 160,019               |       |
| Prepaid expenses  and deferred taxes                                                                                                                       |       | 27,867                                                                               |       | 16,954                |       |
| Total current  assets                                                                                                                                      |       | 362,646                                                                              |       | 346,084               |       |
| Marketable securities,  long-term                                                                                                                          |       | 12,325                                                                               |       | —                |       |
| Property and equipment,  net                                                                                                                               |       | 73,313                                                                               |       | 77,583                |       |
| Goodwill                                                                                                                                                   |       | 316,469                                                                              |       | 314,536               |       |
| Customer lists, net                                                                                                                                        |       | 32,062                                                                               |       | 41,050                |       |
| Other intangible  assets, net                                                                                                                              |       | 3,734                                                                                |       | 6,173                 |       |
| Deferred contract costs  related to the TTA agreement                                                                                                      |       | 30,052                                                                               |       | 8,550                 |       |
| Other assets, net                                                                                                                                          |       | 13,540                                                                               |       | 13,318                |       |
| Total assets                                                                                                                                               |       | $                                                                                    | 844,141    |                  | $          | 807,294 |   |
| ** **                                                                                                                                                 | ** ** | ** **                                                                           | ** ** | ** **            | ** ** |
| **Liabilities**                                                                                                                                            | ** ** | ** **                                                                           | ** ** | ** **            | ** ** |
| Current:                                                                                                                                                   |       |                                                                                 |       |                  |       |
| Short-term debt                                                                                                                                            |       | $                                                                                    | 3          |                  | $          | 7 |   |
| Accounts payable                                                                                                                                           |       | 5,591                                                                                |       | 11,489                |       |
| Accrued expenses  and other liabilities                                                                                                                    |       | 47,850                                                                               |       | 46,529                |       |
| Accrued  restructuring                                                                                                                                     |       | 1,831                                                                                |       | 2,781                 |       |
| Accrued  compensation                                                                                                                                      |       | 31,030                                                                               |       | 44,835                |       |
| Deferred revenue                                                                                                                                           |       | 14,300                                                                               |       | 6,932                 |       |
| Total current  liabilities                                                                                                                                 |       | 100,605                                                                              |       | 112,573               |       |
| Long-term debt                                                                                                                                             |       | 150,000                                                                              |       | 150,001               |       |
| Accrued long-term  building costs                                                                                                                          |       | 38,567                                                                               |       | 39,004                |       |
| Accrued long-term  restructuring                                                                                                                           |       | 2,352                                                                                |       | 2,823                 |       |
| Other long-term  liabilities                                                                                                                               |       | 16,026                                                                               |       | 16,493                |       |
| Deferred long-term  revenue                                                                                                                                |       | 23,688                                                                               |       | 11,155                |       |
| Deferred income taxes                                                                                                                                      |       | 36,096                                                                               |       | 30,864                |       |
| Total  liabilities                                                                                                                                         |       | 367,334                                                                              |       | 362,913               |       |
| Minority interest                                                                                                                                          |       | 3,744                                                                                |       | 3,769                 |       |
|                                                                                                                                                       |       |                                                                                 |       |                  |       |
| Commitments and  contingencies                                                                                                                             |       |                                                                                 |       |                  |       |
| ** **                                                                                                                                                 | ** ** | ** **                                                                           | ** ** | ** **            | ** ** |
| **Stockholders’ Equity**                                                                                                                              | ** ** | ** **                                                                           | ** ** | ** **            | ** ** |
| Preferred Stock, par  value $.01, authorized 2,000,000 shares, issued none                                                                                 |       | —                                                                               |       | —                |       |
| Common Stock, par value  $.10, authorized 200,000,000 shares, 58,633,624 issued and outstanding at  September 30, 2006 and 58,135,289 at December 31, 2005 |       | 5,863                                                                                |       | 5,814                 |       |
| Additional paid-in  capital                                                                                                                                |       | 5,498                                                                                |       | —                |       |
| Accumulated other  comprehensive loss                                                                                                                      |       | (6,974                                                                               | )          | (12,124               | )          |
| Retained earnings                                                                                                                                          |       | 468,676                                                                              |       | 449,349               |       |
| Unearned compensation                                                                                                                                      |       | —                                                                               |       | (2,427                | )          |
| Total  stockholders’ equity                                                                                                                           |       | 473,063                                                                              |       | 440,612               |       |
| Total liabilities and  stockholders’ equity                                                                                                           |       | $                                                                                    | 844,141    |                  | $          | 807,294 |   |

 

*Theaccompanying notes are an integral part of the unaudited condensed consolidatedfinancial statements.*

4

----

**Keane, Inc.Unaudited Condensed Consolidated Statements of Cash Flows**
| ** **                                                                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                                                                           | ** ** | **(Dollars in thousands)**                    | ** ** |
| **Cash flows from operating  activities:**                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net income                                                                                           |       | $                                                       | 23,192     |   | $ | 23,204 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                   |       |                                                    |       |   |   |
| Depreciation and  amortization                                                                       |       | 23,373                                                  |       | 21,260 |   |
| Deferred income  taxes                                                                               |       | 3,362                                                   |       | 7,548 |   |
| Provision for  doubtful accounts                                                                     |       | 10,603                                                  |       | 4,388 |   |
| Minority  interest                                                                                   |       | (25                                                     | )          | (1,031 | ) |
| (Gain) on sale  of property and equipment                                                            |       | (443                                                    | )          | (168 | ) |
| Excess tax  benefits from stock-based compensation                                                   |       | (1,160                                                  | )          | — |   |
| Loss on sale of  investments                                                                         |       | 111                                                     |       | 157 |   |
| Stock-based  compensation                                                                            |       | 2,414                                                   |       | 423 |   |
| Other charges,  net                                                                                  |       | 1,405                                                   |       | (788 | ) |
| Changes in  operating assets and liabilities, net of acquisitions:                                   |       |                                                    |       |   |   |
| (Increase) in  accounts receivable                                                                   |       | (31,999                                                 | )          | (31,710 | ) |
| (Increase) in  prepaid expenses and other assets                                                     |       | (31,198                                                 | )          | (13,950 | ) |
| Increase  (decrease) in accounts payable, accrued expenses, deferred revenue, and other  liabilities |       | 5,962                                                   |       | (2,727 | ) |
| Increase in  income taxes payable                                                                    |       | —                                                  |       | 770 |   |
| **Net  cash provided by operating activities**                                                       |       | 5,597                                                   |       | 7,376 |   |
| ** **                                                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| **Cash flows from investing  activities:**                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Purchase of  investments                                                                             |       | (75,070                                                 | )          | (35,363 | ) |
| Sale and  maturities of investments                                                                  |       | 84,790                                                  |       | 58,172 |   |
| Purchase of  property and equipment                                                                  |       | (8,278                                                  | )          | (10,721 | ) |
| Restricted cash                                                                                      |       | 438                                                     |       | 5 |   |
| Proceeds from  the sale of property and equipment                                                    |       | 1,552                                                   |       | 790 |   |
| Payments for  current year acquisitions, net of cash acquired                                        |       | —                                                  |       | (1,668 | ) |
| Payments for  prior years acquisitions, net of cash acquired                                         |       | (3,333                                                  | )          | (3,132 | ) |
| **Net  cash provided by for investing activities**                                                   |       | 99                                                      |       | 8,083 |   |
| ** **                                                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| **Cash flows from financing  activities:**                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Debt issuance  costs                                                                                 |       | —                                                  |       | (1,279 | ) |
| Excess tax  benefits from stock-based compensation                                                   |       | 1,160                                                   |       | — |   |
| Principal  payments under capital lease obligations                                                  |       | (5                                                      | )          | (215 | ) |
| Proceeds from  issuance of common stock                                                              |       | 9,684                                                   |       | 4,374 |   |
| Repurchase of  common stock                                                                          |       | (9,290                                                  | )          | (42,113 | ) |
| **Net  cash provided by (used for) financing activities**                                            |       | 1,549                                                   |       | (39,233 | ) |
|                                                                                                 |       |                                                    |       |   |   |
| Effect of exchange rate  changes on cash                                                             |       | (98                                                     | )          | (217 | ) |
| **Net increase (decrease) in cash  and cash equivalents**                                            |       | 7,147                                                   |       | (23,991 | ) |
| **Cash and cash equivalents at  beginning of period**                                                |       | 71,570                                                  |       | 67,488 |   |
| **Cash and cash equivalents at  end of period**                                                      |       | $                                                       | 78,717     |   | $ | 43,497 |   |
| ** **                                                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| **Supplemental information:**                                                                        | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Income taxes paid                                                                                    |       | $                                                       | 16,250     |   | $ | 19,450 |   |
| Interest paid                                                                                        |       | $                                                       | 1,500      |   | $ | 1,505 |   |

 

*Theaccompanying notes are an integral part of the unaudited condensed consolidatedfinancial statements.*

5

----

**Keane, Inc.**

**Notesto Unaudited Condensed Consolidated Financial Statements**

**Note 1.     Basis of Presentation**

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and, accordingly, do not include all of the information andfootnotes required by generally accepted accounting principles for completefinancial statements. The accompanying unaudited condensed consolidatedfinancial statements include the accounts of Keane, Inc. and our whollyand majority owned subsidiaries. In the opinion of management, all adjustments,consisting primarily of normal recurring accruals, considered necessary for afair presentation of the results of operations for the interim periods reportedand of our financial condition as of the date of the interim balance sheet havebeen included. During the Third Quarter ended September 30, 2006, we recorded arevenue reduction of approximately $2.1 million to adjust in the current periodrevenue that had been recorded incorrectly in prior quarterly periods, of whichapproximately $1.6 million related to the Second Quarter ended June 30, 2006.Operating results for the three and nine months ended September 30, 2006 arenot necessarily indicative of the results that may be expected for the yearending December 31, 2006 or for any other period.

The balance sheetat December 31, 2005 has been derived from our audited consolidatedfinancial statements at that date but does not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements.

Certainreclassifications have been made to the 2005 financial statements to conform tothe 2006 presentation.  These reclassifications have no effect on previouslyreported net income or stockholder’s equity.

For furtherinformation, refer to the consolidated financial statements and footnotesthereto included in our Annual Report on Form 10-K for the year endedDecember 31, 2005 filed with the Securities and Exchange Commission onMarch 16, 2006.

**Note2.     Recent Accounting Pronouncements**

On September 29, 2006, the FASB issued Statement No.158 (“SFAS 158”), “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and132(R).” SFAS 158 represents the completion of the first phase in the FASB’spostretirement benefits accounting project and requires an entity to:

·                  recognize in itsstatement of financial position an asset for a defined benefit postretirementplan’s overfunded status or a liability for a plan’s underfunded status,

·                  measure adefined benefit postretirement plan’s assets and obligations that determine itsfunded status as of the end of the employer’s fiscal year, and

·                  recognizechanges in the funded status of a defined benefit postretirement plan incomprehensive income in the year in which the changes occur.

SFAS 158 does notchange the amount of net periodic benefit cost included in net income oraddress the various measurement issues associated with postretirement benefitplan accounting. The requirement to recognize the funded status of a definedbenefit postretirement plan and the disclosure requirements are effective forfiscal years ending after December 15, 2006 for public entities. Therequirement to measure plan assets and benefit obligations as of the date ofthe employer’s fiscal year-end statement of financial position is effective forfiscal years ending after December 15, 2008.

The new standardamends FASB Statement No. 87 (“SFAS 87”), “Employers’ Accounting for Pensions”,  Statement No. 88, (“SFAS 88”), “Employers’Accounting for Settlements and Curtailments of Defined Benefit Pension Plansand for Termination Benefits,” Statement No. 106 (“SFAS 106”), “Employers’Accounting for Postretirement Benefits Other Than Pensions” and Statement No.132 (revised 2003) (“SFAS 132 (R)”), “Employers’ Disclosures about Pensions andOther Postretirement Benefits” and applies to all plan sponsors who offerdefined benefit postretirement benefit plans. We do not expect the adoption of SFAS 158 will have a significant impacton our consolidated financial position, results of operations and cash flows.

On September15, 2006 the FASB issued FASB Statement No. 157 (“SFAS 157”), “Fair ValueMeasurement.” The standard provides guidance for using fair value to measureassets and liabilities. The standard also responds to investors’ requests forexpanded information about the extent to which companies measure assets andliabilities at fair value, the information used to measure fair value, and theeffect of fair value measurements on earnings. SFAS 157 applies whenever otherstandards require (or permit) assets or liabilities to be measured at fairvalue. SFAS 157 does not expand the use of fair value in any newcircumstances.   SFAS 157 is effectivefor financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. We are evaluating theimpact of SFAS 157 on our consolidated financial position, results ofoperations and cash flows.

6

----

In July 2006, theFASB issued FASB Interpretation (“FIN”) No. 48 (“FIN 48”), “Accounting forUncertainty in Income Taxes - An Interpretation of FASB Statement No. 109.” FIN48 clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with FASB Statement No. 109, “Accountingfor Income Taxes.” FIN 48 also prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return and providesguidance on derecognition, classification, interest and penalties, andaccounting in interim periods, disclosure, and transition.

The evaluation ofa tax position in accordance with FIN 48 is a two-step process. The first stepis a recognition process whereby the enterprise determines whether it is morelikely than not that a tax position will be sustained upon examination,including resolution of any related appeals or litigation processes, based onthe technical merits of the position. In evaluating whether a tax position hasmet the more-likely-than-not recognition threshold, the enterprise shouldpresume that the position will be examined by the appropriate taxing authoritythat has full knowledge of all relevant information. The second step is ameasurement process whereby a tax position that meets the more-likely-than-notrecognition threshold is calculated to determine the amount of benefit torecognize in the financial statements. The tax position is measured at thelargest amount of benefit that is greater than 50% likely of being realizedupon ultimate settlement.

The provisions of FIN 48 are effective for fiscalyears beginning after December 15, 2006. The provisions of FIN 48 are to beapplied to all tax positions upon initial adoption of this standard. Only taxpositions that meet the more-likely-than-not recognition threshold at theeffective date may be recognized or continue to be recognized upon adoption ofFIN 48. The cumulative effect of applying the provisions of FIN 48 should bereported as an adjustment to the opening balance of retained earnings (or otherappropriate components of equity or net assets in the statement of financialposition) for that fiscal year. We are evaluating the impact of FIN 48 on ourconsolidated financial position, results of operations and cash flows.

InFebruary 2006, the FASB issued SFAS No. 155 (“SFAS 155”), “Accountingfor Certain Hybrid Instruments.” This Statement amends FASB StatementsNo. 133, “Accounting for Derivative Instruments and Hedging Activities”,and No. 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities”. SFAS 155 resolves issues addressed inStatement 133 Implementation Issue No. D1, “Application of Statement 133to Beneficial Interests in Securitized Financial Assets.”  This Statementis effective for all financial instruments acquired or issued after thebeginning of an entity’s first fiscal year that begins after September 15,2006. We do not believe the adoption of SFAS 155 will have a material impact onour consolidated financial position, results of operations or cash flows.

**Note 3.      Stock Based Compensation**

EffectiveJanuary 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”)No. 123 (revised 2004) (“SFAS 123(R)”), “Share Based Payment.” Generally,the approach in SFAS 123(R) is similar to the approach described in SFASNo 123 (“SFAS 123”), “Accounting for Stock Based Compensation.” However, SFAS123(R) requires all share-based payments granted to employees that areultimately expected to vest and do actually vest, including grants of employeestock options, to be recognized in the income statement based on their fairvalue at the date of grant. Pro forma disclosure is no longer an alternative.

We adopted SFAS123(R) under the modified prospective method. Under this method, beginningon January 1, 2006, we recognized compensation cost for all share-basedpayments to employees based on the grant date estimate of fair value for thoseawards. We have used the Black-Scholes option-pricing model to determine fairvalue for all share-based payments. Prior period financial information has notbeen restated.

As ofSeptember 30, 2006, we had several share-based compensation plans that aredescribed below. The adoption of SFAS 123(R) on January 1, 2006 hadthe following impact on our results of operations for the three and nine monthsended September 30, 2006: income before income taxes was lower byapproximately $0.9 million and $2.4 million, respectively, net income was lowerby approximately $0.6 million and $1.6 million, respectively, basic earningsper share (“EPS”) was lower by approximately $.01 and $.03, respectively, anddiluted EPS was lower by $.01 and $.03, respectively. The total income taxbenefit recognized in the income statement for share-based compensationagreements for the three and nine months ended September 30, 2006wasapproximately $0.4 million and $0.9 million, respectively.  The taxbenefit realized from stock options exercised during the three and nine monthsended September 30, 2006 was $0.4 million and $1.2 million, respectively. We received $2.6 million and $7.0 million from stock option exercises for thethree and nine months ended September 30, 2006. As of September 30, 2006,we had approximately $2.3 million of unrecognized compensation cost related tostock option awards that we expect to recognize as expense over a weightedaverage period of 3.1 years.

**Modificationsand Termination**

On May 10, 2006,we entered into a Resignation and Consulting Agreement with Brian T. Keane, ourformer President and Chief Executive Officer. Pursuant to the Resignation andConsulting Agreement, we modified the terms of certain of Mr. Keane’s stockawards. We extended the exercise period for his vested stock options untilDecember 31, 2006 and provided that 10,000 shares of restricted stock thatwould otherwise vest on December 16, 2006 would continue to vest despite hisresignation.

7

----

On June 13, 2006, we entered into a SettlementAgreement with Georgina Fisk, our Vice President of Marketing, Brian T. Keane,our former President and Chief Executive Officer, John Keane, Sr., the Chairmanof our Board of Directors, and John Keane, Jr., a member of our Board ofDirectors (the “Settlement Agreement”). The Settlement Agreement was enteredinto in connection with the resolution of Ms. Fisk’s previously reportedallegations concerning Brian Keane. Pursuant to the Settlement Agreement, wemodified the terms of certain of Ms. Fisk’s stock awards. We extended theexercise period for her vested stock options until December 31, 2006 andprovided that 2,500 shares of restricted stock that would otherwise vest onDecember 16, 2006 would continue to vest despite her resignation as of June 30,2006. As a result of these modifications and the forfeiture of Mr. Keane’s andMs. Fisk’s remaining unvested restricted stock and stock options, during theThird Quarter and nine months ended September 30, 2006, we recognized $0.1million and $0.3 million, respectively, of incremental stock-based compensationexpense.

On September 29,2006, we announced that Richard S. Garnick, President of North AmericanServices and Global Business Lines and a member of the Company’s Office of thePresident, was dismissed for cause effective on that date. As a result of hisdismissal and the forfeiture of Mr. Garnick’s unvested restricted stock andstock options, we recognized a reduction $0.5 million of stock-basedcompensation in the Third Quarter ended September 30, 2006.  See Note 12 “Related Parties, Commitments andContingencies” for a discussion on litigation associated with Mr. Garnick’sdismissal.

The followingtable illustrates the effect on net income and earnings per share as if we hadapplied the fair value recognition provisions of SFAS 123 to our stock-basedemployee compensation for the three and nine months ended September 30, 2005.
| ** **                                                                                                                                                  | ** ** | **Three Months Ended   September 30, 2005** | ** ** | **Nine months Ended   September 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| Net income—as reported (1)                                                                                                              |       | $                                                                    | 8,886      |                                                                | $          | 23,204 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net  of related tax effects                                      |       | 85                                                                   |       | 251                                                                 |       |
| Deduct: Total  stock-based employee compensation expense determined  under the fair value method for all awards, net of related tax  effects |       | (1,626                                                               | )          | (4,430                                                              | )          |
|                                                                                                                                                        |       |                                                                 |       |                                                                |       |
| Net income — pro  forma                                                                                                                                |       | $                                                                    | 7,345      |                                                                | $          | 19,025 |   |
|                                                                                                                                                        |       |                                                                 |       |                                                                |       |
| Earnings per  share:                                                                                                                                        |       |                                                                 |       |                                                                |       |
| Basic—as reported                                                                                                                                      |       | $                                                                    | 0.15       |                                                                | $          | 0.38 |   |
| Basic—pro forma                                                                                                                                        |       | $                                                                    | 0.12       |                                                                | $          | 0.31 |   |
| Diluted—as  reported (1)                                                                                                                               |       | $                                                                    | 0.14       |                                                                | $          | 0.36 |   |
| Diluted—pro forma (1)                                                                                                                                  |       | $                                                                    | 0.12       |                                                                | $          | 0.30 |   |

 

----

(1)          See Note 4 “EarningsPer Share Data” for reconciliation of net income as reported to net income usedin calculation of diluted earnings per share.

For periods priorto the adoption of SFAS 123(R), we elected to follow Accounting PrinciplesBoard Opinion (“APB”) No. 25 (“APB 25”), “Accounting for Stock Issuedto Employees,” and related FASB Interpretation No. 44 (“FIN 44”), “Accountingfor Certain Transactions Involving Stock Compensation”, in accounting for ourshare based payment awards. Under APB 25, since the exercise price of ouremployee stock options equaled the market price of the underlying stock on thedate of the grant, no compensation expense was recorded in our financialstatements.  However, compensation expense related to restricted stockawards and certain Keane Worldzen stock options was recorded ratably over therestriction and vesting period, respectively, and was included in the selling,general, and administrative expenses in the accompanying unaudited condensedconsolidated statements of income.

Prior to theadoption of SFAS 123(R) and during the Fourth Quarter of 2005, weaccelerated the vesting of certain stock options in which the exercise price ofthe awards exceeded the market price of the stock on the date ofmodification. As a result of the acceleration, approximately 2.1 millionshares subject to options, constituting approximately 47% of the total ofunvested options outstanding at that time became immediately exercisable. Theacceleration impacted approximately 570 employees. Under APB 25 and FIN 44, nocompensation expense was recognized in our financial statements for theacceleration of vesting of these options since the closing price per share ofour common stock on the dates of acceleration was greater than the exerciseprices of the unvested options that we accelerated. The primary purpose of theaccelerated vesting was to enable us to avoid recognizing in our incomestatement non-cash compensation expense associated with these options in futureperiods, upon our adoption of SFAS 123(R) on January 1, 2006.Absent the acceleration of the options described above, from and after our adoptionof SFAS 123(R), we would have been required to recognize approximately$10.5 million in pre-tax non-cash compensation expense over the remainingvesting terms of the stock options, based on valuation calculations using theBlack-Scholes option pricing model.

8

----

**ShareBased Compensation Plans:**

**Stock IncentivePlans**

Our 1998 Stock Incentive Plan, amended inDecember 1999, provides for grants of stock options and restricted stockfor up to 7,000,000 shares of our common stock to our employees, officers, directors,consultants, and advisors. The contractual life of options granted under thisplan ranges from five to ten years from the date of grant; the plan requires apurchase price of not less than 100% of the fair market value of the stock asof the date of grant; and the options may be exercisable at such time or timesas our Board of Directors in each case determines. In general, our stockoptions vest over a five-year period on a graded vesting schedule and theircompensation cost is recorded on a straight-line basis over the share-vestingperiod.  Our restricted stock awards typically vest over a five-yearperiod on a graded vesting schedule. We value restricted stock awards based onthe closing price of our common stock on the date of grant, less the nominalconsideration received. We record compensation cost on a straight-line basisover the share-vesting period. The cumulative amount of compensation costrecorded on stock options and restricted stock at any date is at least equal tothe fair value of the awards that have actually vested as of that date.

In December 2000, we initiated a “TimeAccelerated Restricted Stock Award Plan” (“TARSAP”) under our 1998 StockIncentive Plan, whereby the vesting of certain stock options is directlyimpacted by our performance. The vesting of stock options granted under theTARSAP accelerates when we achieve specified profitability criteria. If thesecriteria are not met, these options will vest five years after the date ofgrant and expire at the end of 10 years. Since our TARSAP awards vestbased upon performance or service, we use the Black-Scholes option pricingmodel to value these awards. We recognize compensation expense for TARSAPawards on a straight-line basis over the vesting period unless we determine thatthe achievement of the performance criteria is probable. Once probable, werecognize all remaining unrecognized compensation over the remaining periodfrom which it becomes probable to the performance achievement date.

Our 2001 Stock Incentive Plan provides for grants ofstock options for up to 7,000,000 shares of our common stock to our employees,officers, directors, and advisors. The contractual life of options grantedunder the plan ranges from five to ten years from the date of grant; the planrequires a purchase price of not less than 100% of the fair market value of thestock as of the date of grant; and the options may be exercisable at suchtime or times as our Board of Directors in each case determines.  Thevesting of stock options under this plan is done on a pro-rata basis over theservice life of the award. We recognize compensation expense for awards underthis plan on a straight-line basis over the vesting period of the entire award.

Under all of our stock plans, we may grant optionsthat are intended to qualify as incentive stock options under Section 422of the Internal Revenue Code (“incentive stock options”) or nonstatutoryoptions not intended to qualify as incentive stock options.

Upon exercise ofstock options, we issue shares from our authorized, but unissued shares.

**StockRepurchases**

InOctober 2005, we announced the approval by our Board of Directors of aprogram for the repurchase of 3.0 million shares of our common stock (“theOctober 2005 Program”). The repurchases may be made on the open market orin negotiated transactions, and the timing and amount of shares to be purchasedwill be determined by our management based on its evaluation of market andeconomic conditions and other factors. As of September 30, 2006, therewere approximately 1.8 million shares that remained available for repurchaseunder this program.  On October 25, 2006,the share repurchase program expired, with 1.8 million shares remainingunpurchased.  On October 24, 2006, weannounced the approval by our Board of Directors of a program for therepurchase of an additional 3.0 million shares of our common stock (“theOctober 2006 Program”).

**Employee Stock Purchase Plan**

Our Employee Stock Purchase Plan (“ESPP”) provides forthe purchase of 6,550,000 shares of our common stock. Effective January 1,2006, we modified our ESPP to allow qualifying employees to purchase shares at95% of the market value of our common stock on the last day of each six-monthpurchase period. Previously, qualifying employees were able to purchase stockat 85% of the market value of the stock on the offering commencement date orthe last day of the purchase period, whichever was lower. Prior toJanuary 1, 2006, our ESPP was non-compensatory as defined in APB 25, andaccordingly, we did not recognize compensation expense in our consolidatedfinancial statements. However, our ESPP would have been compensatory under SFAS123(R) had we not modified its terms. Our modification of the ESPPeffective January 1, 2006 reduced the purchase discount to 5% of themarket value of our common stock and removed the look-back provision andtherefore, the ESPP is non-compensatory under SFAS 123(R).

On February 13, 2003, our Board of Directorsapproved a UK ESPP. We allocated 500,000 shares of the total number of sharesreserved under our ESPP for issuance under the UK ESPP. Our modification of theESPP was also effective for the UK ESPP. Consistent with the terms of our ESPP,the options under the UK ESPP are non-compensatory under SFAS 123(R) andaccordingly, we have not recognized any stock-based compensation expenseassociated with our ESPP or UK ESPP during the Third Quarter ended September30, 2006 or the nine months ended September 30, 2006.

The fair market value of each stock option isestimated using the Black-Scholes option-pricing model, assuming no expecteddividends with the following weighted-average assumptions:

9

----

 
| ** **                              | ** ** | **For the Three   Months Ended  September 30,  2006 (1)** | ** ** | **For the Three   Months Ended  September 30,  2005** | ** ** | **For the Nine   Months Ended  September 30,  2006** | ** ** | **For the Nine   Months Ended  September 30,   2005** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| Options granted                         |       | —                                                                                  |       | 998,700                                                                        |       | 521,000                                                                       |       | 1,075,200                                                                           |       |
| Weighted-average  exercise price        |       | $                                                                                       | —     |                                                                           | $          | 12.16                                                                         |       | $                                                                                   | 11.75      |   | $ | 12.20 |   |
| Weighted-average  grant date fair value |       | $                                                                                       | —     |                                                                           | $          | 5.72                                                                          |       | $                                                                                   | 4.84       |   | $ | 5.59 |   |
| Expected life (in  years)               |       | —                                                                                  |       | 5.22                                                                           |       | 4.52                                                                          |       | 5.14                                                                                |       |
| Expected stock  price volatility        |       | —                                                                                  | %          | 48.71                                                                          | %          | 41.63                                                                         | %          | 48.43                                                                               | %          |
| Risk-free interest rate                 |       | —                                                                                  | %          | 3.96                                                                           | %          | 4.30                                                                          | %          | 3.95                                                                                | %          |

 

----

(1)                                Therewere no stock options granted during the Third Quarter ended September 30,2006.

We derived our estimateof an expected option life based on a review of our historic option holdingperiods, including a consideration of the holding period inherent in currentlyvested but unexercised options. We believe that this historical data iscurrently the best estimate of the expected term of a new option. We reviewedhistorical data for groups of employees and determined that the type of awardwas an indicator of the exercise behavior.  For 2006, the expected optionlives range from 3.3 to 5.5 years.

We derived the estimatedstock price volatility based on a review of our actual historic stock pricescommensurate with the expected life of the award.  We believe that the historical stock pricevolatility is an accurate indicator of future stock price performance.

SFAS 123(R) requiresthat we estimate forfeitures at the time of grant and that we revise theforfeiture rate, if necessary, in subsequent periods if actual forfeituresdiffer from these estimates. The term “forfeitures” is distinct from “cancellations”or “expirations” and represents only the unvested portion of the surrenderedoption. Similar to the analysis for the expected option life, we reviewedhistorical forfeiture data for groups of employees and determined theappropriate forfeiture rate ranges from 0-23% for the applicable employeegroup. Therefore, upon adoption of SFAS 123(R) we applied an annual forfeiturerate of 0-23% to all unvested options as of December 31, 2005. We willre-evaluate this analysis quarterly and adjust the forfeiture rate asnecessary. Ultimately, the actual expense recognized over the vesting periodwill only be for those shares that vest.

The risk-free interest rate is the yield onzero-coupon U.S. Treasury securities for a period that is commensurate with theexpected life assumption that is used as the risk-free interest rate.

A summary of stock option activity under all of ourplans for the nine months ended September 30, 2006 is as follows:
| ** **                                      | ** ** | **Shares** | ** ** | **Weighted   Average   Exercise   Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------------------|------------|------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | ** ** | ** ** | ** **                                               | ** ** | ** **                                                    | ** ** | ** **                      | ** ** |
| Options  outstanding at December 31, 2005  |       | 4,880,930  |       | $                                                        | 12.04      |                                                          | —     |                            | $          | — |   |
|                                            |       |       |       |                                                     |       |                                                          |       |                            |       |
| Granted                                         |       | 521,000    |       | $                                                        | 11.75      |                                                          | —     |                            | —     |   |
|                                            |       |       |       |                                                     |       |                                                          |       |                            |       |
| Exercised                                       |       | (728,974   | )          | $                                                        | 10.35      |                                                          | —     |                            | —     |   |
|                                            |       |       |       |                                                     |       |                                                          |       |                            |       |
| Forfeited /  Expired                            |       | (1,014,063 | )          | $                                                        | 11.35      |                                                          | —     |                            | —     |   |
|                                            |       |       |       |                                                     |       |                                                          |       |                            |       |
| Options  outstanding at September 30, 2006 |       | 3,658,893  |       | $                                                        | 12.59      |                                                          | 4.9        |                            | $          | 9,004,135 |   |
|                                            |       |       |       |                                                     |       |                                                          |       |                            |       |
| Options  exercisable at September 30, 2006 |       | 2,688,953  |       | $                                                        | 13.63      |                                                          | 4.3        |                            | $          | 4,451,327 |   |

 

The totalintrinsic value of options exercised (i.e., the difference between the marketprice at exercise and the price paid by the employee to exercise the options)during the nine months ended September 30, 2006 and 2005, wasapproximately $2.7 million and $0.4 million, respectively. The aggregateintrinsic value of options outstanding and options exercisable as ofSeptember 30, 2006 is based on the difference between the closing price ofour common stock on September 30, 2006, which was $14.41, and the exerciseprice of the applicable option. In calculating the aggregate intrinsic value,we excluded those options whose exercise price was greater than the closingprice per share of our common stock as of September 30, 2006. We had9,332,998 shares available for future issuance under our stock option plans atSeptember 30, 2006.

10

----

**Restricted Stock**
|                                       | ** ** | **Shares** | ** ** | **Weighted average   grant date   fair value** | ** ** |
|---------------------------------------|------------|------------|------------|-------------------------------------------------------------------------|------------|
| Nonvested at  December 31, 2005  |       | 190,000    |       | $                                                                       | 14.16      |   |
| Granted                               |       | 285,000    |       | $                                                                       | 11.87      |   |
| Vested                                |       | (27,500    | )          | $                                                                       | 11.12      |   |
| Forfeited                             |       | (120,000   | )          | $                                                                       | 12.97      |   |
| Nonvested at  September 30, 2006 |       | 327,500    |       | $                                                                       | 12.86      |   |

 

The majority ofour restricted stock awards vest over a five-year period on a graded vestingschedule. We have valued the restricted stock awards based on the closing priceof our common stock on the date of grant, less the nominal considerationreceived. We record compensation cost on a straight-line basis over theshare-vesting period. There were no grants of restricted stock awards duringthe Third Quarter ended September 30, 2006. The weighted average grant date fair value of restricted stock awardsgranted during the nine months ended September 30, 2006 was $11.87. Werecorded expense associated with our restricted stock awards of approximately$0.7 million and $0.9 million for the three and nine months endedSeptember 30, 2006, respectively. For the three and nine months endedSeptember 30, 2005, we recorded expense associated with our restricted stockawards of approximately $0.1 million and $0.3 million, respectively.  Forthe nine months ended September 30, 2006, the fair value of restricted stockawards that were vested was $0.3 million. As of September 30, 2006, we had approximately $3.0 million ofunrecognized compensation cost related to restricted stock awards that weexpect to recognize as expense over a weighted average period of 2.3 years. Asof September 30, 2006, we had 27,500 shares of vested restricted stock awards.

**Note 4.     Earnings Per Share Data**

Basic earnings pershare is computed using only the weighted-average number of common sharesoutstanding during the period. Diluted earnings per share is computed using theweighted-average number of common shares outstanding during the period, plusthe dilutive effect of potential future issuances of common stock relating to stockoption awards and other potentially dilutive securities. In calculating dilutedearnings per share, the dilutive effect of stock options is computed using theaverage market price for the applicable period. Potential shares related tocertain of our outstanding stock options and restricted stock awards wereexcluded from the computation of earnings per share because they wereanti-dilutive in the periods presented, but could be dilutive in the future.The following table sets forth the computation of basic and diluted earningsper share (in thousands, except per share data):
| ** **                                                                                                                            | ** ** | **Three Months Ended   September  30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2006**                                                         | ** ** | **2005**                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income used  for basic earnings per share                                                                                         |       | $                                                                | 8,403      |                                                      | $          | 8,886 |   | $ | 23,192 |   | $ | 23,204 |   |
| Interest expense  associated with convertible debentures, including amortization of debt  issuance costs                              |       | 971                                                              |       | 970                                                       |       | 2,911 |   | 2,911 |   |
| Related tax  effect                                                                                                                   |       | (397                                                             | )          | (396                                                      | )          | (1,189 | ) | (1,189 | ) |
| Net income used  for diluted earnings per share                                                                                       |       | $                                                                | 8,977      |                                                      | $          | 9,460 |   | $ | 24,914 |   | $ | 24,926 |   |
|                                                                                                                                  |       |                                                             |       |                                                      |       |   |   |   |   |
| Weighted average  number of common shares outstanding used in calculation of basic earnings per  share                                |       | 57,704                                                           |       | 59,897                                                    |       | 58,144 |   | 61,265 |   |
| Incremental  shares from restricted stock, employee stock purchase plan, and the assumed  exercise of dilutive stock options          |       | 686                                                              |       | 566                                                       |       | 516 |   | 634 |   |
| Incremental  shares from assumed conversion of convertible debentures                                                                 |       | 8,175                                                            |       | 8,175                                                     |       | 8,175 |   | 8,175 |   |
| Weighted average  number of common shares and common share equivalents outstanding used in  calculation of diluted earnings per share |       | 66,565                                                           |       | 68,638                                                    |       | 66,835 |   | 70,074 |   |
|                                                                                                                                  |       |                                                             |       |                                                      |       |   |   |   |   |
| Earnings per  share                                                                                                                   |       |                                                             |       |                                                      |       |   |   |   |   |
| Basic                                                                                                                                 |       | $                                                                | 0.15       |                                                      | $          | 0.15 |   | $ | 0.40 |   | $ | 0.38 |   |
| Diluted                                                                                                                               |       | $                                                                | 0.13       |                                                      | $          | 0.14 |   | $ | 0.37 |   | $ | 0.36 |   |
|                                                                                                                                  |       |                                                             |       |                                                      |       |   |   |   |   |
|  Anti dilutive common stock equivalents  related to stock options                                                                |       | 1,287                                                            |       | 1,695                                                     |       | 1,713 |   | 1,700 |   |
|  Anti-dilutive restricted stock                                                                                                  |       | —                                                           |       | 145                                                       |       | 95 |   | 145 |   |

 

Our 2.0% Convertible Subordinated Debentures due 2013(the “Debentures”) are convertible at the option of the holder into shares ofour common stock at an initial conversion rate of 54.4989 shares of commonstock per $1,000 principal amount of Debentures, which is equivalent to aninitial conversion price of approximately $18.349 per share. Approximately 8.2million shares of our common stock would be issuable upon the conversion of allof the outstanding Debentures. In accordance with the Emerging Issues TaskForce’s (“EITF”) Issue No 04-8, “The Effect of Contingently Convertible Debt onDiluted Earnings per Share,” we are required to include contingentlyconvertible debt in the calculation of diluted earnings per share using theif-converted method 

11

----

regardless of whether themarket price trigger has been met. See Note 10 “Convertible SubordinatedDebentures” for further discussion on the Debentures and their conversion features.

**Note 5.     Comprehensive Income and Accumulated Other Comprehensive Loss**

SFAS No. 130 (“SFAS 130”), “ReportingComprehensive Income,” establishes rules for the reporting and display ofcomprehensive income and its components. Components of comprehensive incomeinclude net income and certain transactions that have generally been reportedin the consolidated statement of stockholders’ equity. Other comprehensiveincome is comprised of currency translation adjustments, available-for-salesecurities valuation adjustments, and adjustments related to a foreign definedbenefit plan.

Total comprehensive income (i.e., net income plusavailable-for-sale securities valuation adjustments, currency translationadjustments and adjustments related to a foreign defined benefit plan, net oftax) was $8.7 million and $28.3 million for the three and nine months endedSeptember 30, 2006, respectively, and was $10.3 million and $23.6 millionfor the three and nine months ended September 30, 2005, respectively.  SeeNote 7 “Pension Plan” for a discussion of the minimum pension liabilityadjustments.

The following table summarizes the components ofaccumulated other comprehensive loss, net of taxes (dollars in thousands):
| **As of**                            | ** ** | **September 30,   2006** | ** ** | **December 31,   2005** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| Foreign currency  translation adjustments |       | $                                  | 4,077      |                              | $          | 1,551 |   |
| Securities  valuation adjustment          |       | (377                               | )          | (732                              | )          |
| Minimum pension  liability adjustment     |       | (10,674                            | )          | (12,943                           | )          |
|                                      |       |                               |       |                              |       |
| Accumulated other  comprehensive loss     |       | $                                  | (6,974     | )                                 | $          | (12,124 | ) |

 

**Note6.      Significant Contracts**

*VictoriaTTA Contract*

On July 26, 2005, Keane Australia MicropaymentConsortium Pty Ltd (“Kamco”), a wholly-owned subsidiary of Keane, and thePublic Transport Ticketing Body trading as Transport Ticketing Authority (the “TTA”)of the State of Victoria, Australia, entered into a $494.0 million AUD, orapproximately $367.0 million (based on the exchange rate on that date of$.74285 AUD per $1.00), contract (the “Victoria TTA contract”) to deliver apublic transit ticketing system for the State of Victoria. Keane hasestablished and is leading a consortium of four transit and technology expertsto design, build, implement and maintain a micropayment smartcard technologysystem and related equipment for the TTA. Keane’s consortium includes automaticfare collection specialists ACS Solutions Schweiz AG (a subsidiary ofAffiliated Computer Services, Inc.), ERG, and Giesecke & DevrientAustralasia (“G&D”).

The Victoria TTA contract has a term of approximatelytwelve years, including two years of development work, referred to as the Buildphase, and ten years of operation and maintenance, referred to as the Operatephase. The Build phase represents the development and implementation of thecomprehensive solution including hardware, card distribution and software. TheOperate phase represents the maintenance of the software, hardware andcomprehensive solution, refurbishments and replacements, hosting and managementof the subcontractors. The TTA has an option to extend the contract for anadditional two years at the completion of the Operate phase. The Build phase ofthe project is comprised of twelve phases beginning with the mobilization phaseand ending with the operational proving phase. Each phase during the Buildphase requires acceptance by the TTA. At the end of the fifth year of theOperate phase, the TTA can cancel the Victoria TTA contract at its option. Inconnection with the Victoria TTA contract, Keane delivered a guarantee to theTTA (the “Guarantee”) pursuant to which Keane has guaranteed certainobligations of Kamco under the Victoria TTA contract.

Payments under the Victoria TTA contract during theBuild phase are based on the completion of milestones during the Build phase.Payments during the Operate phase are based on the level of service providedand are billed monthly. During the Operate phase the TTA may benchmark ratesfollowing the fourth and ninth anniversary dates of the Victoria TTA contractand negotiate adjustments if the rates exceed prevailing market costs forcomparable services.

The TTA may terminate the Victoria TTA contract forconvenience at any time and pay only for work completed, subject to specifiedtermination fees. These termination fees consist primarily of 1% of theremaining amount of contractual revenues over the twelve-year term. During thecontract term, the TTA may terminate the Victoria TTA contract for events ofdefault, subject to Kamco’s right to cure. Upon the failure to perform by Kamcoor its subcontractors, the TTA may step in and take over the role of primecontractor in place of Kamco.

12

----

Kamco has obligations under the Victoria TTA contractwith respect to both project management and performance of subcontractors.There are numerous indemnification provisions within the Victoria TTA contract,some of which are customarily included through the normal course of business.We have agreed to hold TTA harmless against losses arising from a breach ofrepresentations related to such matters as title to assets sold and licensed orcertain intellectual property rights, improper disclosures of confidentialinformation, personal injuries or property damages. As the prime contractor forthe Victoria TTA contract, in certain cases Kamco is entitled to the benefit ofcorresponding indemnifications from its subcontractors. We also retain theright to enforce the subcontracts and to seek damages for nonperformance fromour subcontractors. Subject to a number of exclusions, Kamco’s maximumliability is capped at $75.2 million ($100 million AUD). Under theVictoria TTA contract, liquidated damages, for which Kamco may be liable, areassessed at $37,590 ($50,000 AUD) per day for each day the specified phasecompletion is behind schedule, but are limited to $7.5 million($10 million AUD). The first $3.8 million ($5 million AUD) inliquidated damages is split evenly amongst Kamco and certain subcontractors.The next $3.8 million ($5 million AUD) is apportioned based onresponsibility for the delay.

The Victoria TTA contract also requires that Kamcoprovide security and performance bonds in the amount of $22.5 million($30 million AUD) during the two-year Build phase and in the amount of$11.3 million ($15 million AUD) during the twelve-year term. One ofthe banks associated with our credit facility issued a $33.8 million($45 million AUD) letter of credit dated July 14, 2005 against ourcredit facility in fulfillment of the security and performance bonds. Keane hasguaranteed performance and payment by Kamco in the event that Kamco is unableto complete the work or meet its payment obligations.

Under EITF No. 00-21 (“EITF 00-21”), “RevenueArrangements with Multiple Deliverables,” in order to account for thedeliverables within a contract separately, all delivered items must havestandalone value, the vendor must have objective and reliable evidence of fairvalue of the undelivered item(s) and if the client has a general right ofreturn relative to the delivered item, delivery or performance of theundelivered items must be probably and substantially within the vendor’scontrol. We have concluded that objective evidence of fair value does not existfor all of the elements within the Operate phase. Accordingly, the elementswithin the Build and Operate phases cannot be separated into multiple units ofaccounting and therefore, must be accounted for as a single unit of accounting.As a result, we are deferring all revenues and costs directly associated withthe delivery of services during the Build phase and we will recognize allrevenues and direct costs for the contract over the ten-year period of theOperate phase, currently estimated to begin in mid-2007.

                      The mobilization phase of the project iscomplete and during the Fourth Quarter of 2005, we received our first milestonepayment of $8.5 million USD ($12 million AUD). In June of 2006, wereceived milestone payments of $13.3 million ($18.1 million AUD) from the TTAfor performance to date under the terms of the contract. For the nine monthsended September 30, 2006 and for the year ended December 31, 2005, wedeferred all revenues and costs directly associated with the delivery ofproducts and services and expensed approximately $2.1 million and$3.4 million, respectively, in indirect costs. As of September 30,2006 and December 31, 2005, there was approximately $­­­21.6 million($28.7 million AUD) and $8.8 million ($12.0 million AUD), respectively, ofdeferred long-term revenue and approximately $30.1 million ($40.0 million AUD)and $8.6 million ($11.7 million AUD), respectively, of deferred costsincluded in the accompanying unaudited condensed consolidated balance sheets.The deferred long-term revenue consists of cash payments received to date. SeeNote 13 “Segment Information” for a discussion on the determination ofreportable segments.

*PacifiCare*

On December 20, 2005, UnitedHealth GroupIncorporated, an affiliate of United HealthCare Services, Inc. (“UnitedHealthCare”), completed its acquisition of PacifiCare. On January 20,2006, we entered into a five-year master services agreement with UnitedHealthCare effective January 1, 2006. Simultaneously, we and PacifiCareterminated our Information Technology Services Agreement, datedJanuary 11, 2002, effective January 1, 2006. Our original InformationTechnology Services Agreement with PacifiCare provided for an outsourcingarrangement with a ten-year term and $500 million in contract value. As aresult of the ending of the original agreement with PacifiCare we will receivea $10.1 million payment in two equal installments on July 30, 2006and July 30, 2007.   In July 2006,we received the first of the two payments in the amount of $5.05 million.  The first half will be recognized over the 18month period from January 1, 2006 to June 30, 2007. The second halfwill be recognized at such time the amount becomes due in management’sjudgment. If additional services are procured pursuant to the master servicesagreement, any remaining portion of the payments will be recognized over theperiod such services are provided. Under the new master services agreement withUnited HealthCare we will receive approximately $21 million for aspecified level of services provided from January 1, 2006 throughJune 30, 2007. Revenues from PacifiCare in the Third Quarter and ninemonths ended September 30, 2006, were approximately $6.3 million and $8.3million lower than revenues from PacifiCare in the same periods in 2005.

**Note7.      Pension Plan**

Our United Kingdom (“UK”) defined benefit plan (“DBP”)provides pension benefits to employees of our UK subsidiary who were active onAugust 4, 1999, and not to employees who joined after that date. Benefits underthe UK DBP are based on the employees’ compensation and service.  Ourpolicy is to fund amounts required by applicable government regulations. The measurement date for the UK DBP is December 31.

13

----

As a result of theavailability of more recent measurements of both the plan assets andobligations under the UK DBP, during the nine months ended September 30, 2006,we recorded a net decrease to the required minimum liability under the DBP ofapproximately $2.3 million through Accumulated other comprehensive loss. As of September 30, 2006 and December 31, 2005, the unfunded UK pensionliability was approximately $14.7 million and $15.3 million, respectively, andis recorded in Other long-term liabilities in the accompanying unauditedcondensed consolidated balance sheets.  As a result of recent legislationin the UK, we agreed with the trustees of the UK DBP to increase the employercontributions by approximately $0.2 million for 2006, for a total of approximately$0.4 million in employer contributions for 2006 and to increase the employercontributions in the future based on the financial performance of the UKsubsidiary. In addition, we will incur a pension levy of approximately $0.3million per year.  Net periodic pensioncost of the UK DBP for the three and nine months ended September 30, 2006 and2005 is presented as follows (dollars in thousands):
| ** **                               | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                                   | ** ** | **2005**                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                             |       | $                                                          | 15         |                                                      | $          | 14 |   | $ | 44 |   | $ | 44 |   |
| Interest cost                            |       | 549                                                        |       | 475                                                       |       | 1,597 |   | 1,448 |   |
| Expected return  on plan assets          |       | (547                                                       | )          | (437                                                      | )          | (1,592 | ) | (1,333 | ) |
| Amortization of  prior service cost      |       | —                                                     |       | —                                                    |       | — |   | — |   |
| Amortization of  transitional obligation |       | —                                                     |       | —                                                    |       | — |   | — |   |
| Recognized actuarial  loss               |       | 150                                                        |       | 111                                                       |       | 436 |   | 338 |   |
| Net periodic  pension cost               |       | $                                                          | 167        |                                                      | $          | 163 |   | $ | 485 |   | $ | 497 |   |

 

**Note 8.     Business Acquisitions**

*CrestaTesting, Inc.*

           On June 1, 2005, we acquired CrestaTesting, Inc. (“Cresta”), a software testing company that specializes inmanaged services, test strategy and training, and functional and performancetesting. In exchange for all of the outstanding capital stock of Cresta, wepaid $0.6 million in cash, of which $60,000 was held back to secureindemnification obligations of the Cresta stockholders. We also agreed to payup to an additional $0.5 million in earn-out consideration over two yearsfrom the acquisition date, contingent upon the achievement of certain futurefinancial targets. The earn-out consideration is also dependent on theemployment of a certain Cresta employee; therefore, in accordance with SFASNo. 141 (“SFAS 141”), “Business Combinations,” we will record anyadditional earn-out consideration as compensation expense. The $60,000 heldback was initially deposited as restricted cash and in September 2006 wasdelivered to the former Cresta shareholders. The acquisition has been accounted for under the purchase method inaccordance with SFAS 141 and SFAS No. 142 (“SFAS 142”), “Goodwilland Other Intangible Assets.” The total cost of the acquisition throughSeptember 30, 2006 was $0.6 million, which included net assetsacquired of approximately $0.4 million. Total assets acquired of$0.7 million consisted primarily of cash of $0.1 million and accountsreceivable of $0.6 million. The purchase price allocation was finalized asof December 31, 2005. The operating results of Cresta were included in ourconsolidated statement of operations beginning June 2, 2005.

*ArcStreamSolutions, Inc.*

On April 4, 2005, we acquired certain assets andassumed specified liabilities of ArcStream Solutions, Inc. (“ArcStream”)for a base purchase price of zero ($0.00) dollars, subject to a working capitaladjustment, and an additional earn-out consideration based on the performanceof the ArcStream business during the remainder of 2005. The earn-out periodended on December 31, 2005 and no earn-out consideration was paid.ArcStream was a business and technology consulting firm based in Watertown,Massachusetts, that specialized in helping organizations compete through theuse of advanced technologies and process improvement. As a former stockholderof ArcStream, John Keane, Jr. would have been entitled to a portion of anyadditional consideration. John Keane, Jr. was the founder, President andChief Executive Officer of ArcStream. He is also the brother of Brian Keane,our former President and CEO, the son of John Keane, Sr., the Chairman ofour Board, and a member of our Board of Directors. In addition, in connectionwith the transaction, John Keane, Jr., agreed to guarantee certainindemnification obligations of ArcStream and we paid John Keane, Jr.$21,875 pursuant to a consulting arrangement to assist in the transition of theacquired business. The transaction was approved by both our Audit Committee andour Board of Directors. The operating results of the acquired ArcStream assetswere included in our consolidated statement of operations beginningApril 5, 2005.

*netNuminaSolutions, Inc.*

On February 28, 2005, we acquired netNuminaSolutions, Inc. (“netNumina”), a software development company based inCambridge, Massachusetts that specialized in technology strategy, architecture,and custom development, to enhance our capabilities in Development andIntegration services. In exchange for all of the outstanding capital stock ofnetNumina, we agreed to pay $5.7 million, of which $0.6 millionwas held back to secure indemnification obligations of the netNuminastockholders. As of 

14

----

September 30, 2006,we had paid the $5.1 million not held back and during the First Quarter of2006, the $0.6 million held back was delivered to the former NetNuminashareholders. The acquisition has been accounted for under the purchase methodin accordance with SFAS 141 and SFAS 142. The total cost of the transactionthrough September 30, 2006 was $4.8 million, which included netassets of approximately $5.2 million. Total assets acquired of$7.8 million consisted primarily of cash of $4.6 million and accounts receivable of$2.3 million. In connection with the purchase price allocation we recordeda $0.5 million fair value adjustment to reduce property and equipment thatresulted from an excess book value of the assets acquired over the purchaseprice and recorded deferred tax assets of $2.0 million. As a result, wehave not recorded any goodwill or intangible assets in connection with thisacquisition. The valuation and purchase price allocation were finalized as ofDecember 31, 2005. The operating results of netNumina were included in ourconsolidated statements of income beginning March 1, 2005.

At the date of the acquisition of NetNumina, weentered into a plan to reduce its workforce by eight non-billable employees. Asa result, we initially recorded a restructuring liability of $1.0 millionrelated to severance, all of which has been paid as of September 30, 2006. Inaccordance with EITF Issue No. 95-3 (“EITF 95-3”), “Recognition ofLiabilities in Connection with a Purchase Business Combination,” these costs,which are not associated with the generation of future revenues and have nofuture economic benefit, were reflected as assumed liabilities in theallocation of the purchase price to the net assets acquired.

*FastTrack Holdings Limited*

On July 13, 2004, we acquired Fast Track HoldingsLimited (“Fast Track”), a privately held consulting firm based in the UnitedKingdom that manages the design, integration, and deployment of large-scale SAPimplementations. In exchange for all of Fast Track’s outstanding capital stock,we paid approximately $3.4 million in cash, which included transactioncosts and $0.6 million which was held in escrow to secure indemnificationobligations of the Fast Track shareholders. We also agreed to pay up to anadditional approximately $5.0 million in earn-out consideration over thetwo years from acquisition, contingent upon the achievement of certain futurefinancial targets. We delivered the hold back to the former Fast Trackshareholders in August 2006.  Based onFast Track’s financial results through July 31, 2005, the first earn-outtotaling approximately $2.0 million was not achieved. Payment for earn-outconsideration earned through July 31, 2006, could have been up toapproximately $2.9 million, but based on the financial performance throughJuly 2006, the second earn-out was not achieved. The acquisition was accountedfor under the purchase method in accordance with SFAS 141 andSFAS 142. The portion of the purchase price related to the intangibleassets was finalized and identified utilizing standard valuation procedures andtechniques. The total cost of the acquisition through September 30, 2006was $4.1 million, which included net assets acquired of approximately($0.2) million, goodwill of approximately $3.1 million and intangibleassets of approximately $1.1 million, the majority of which was amortizedon a straight-line basis over two years, and approximates the expected periodof benefit. Total assets acquired of $2.1 million consisted primarily ofaccounts receivable of $1.9 million. The operating results of Fast Track wereincluded in our consolidated statement of operations beginning July 14,2004.

At the date of acquisition, we entered into a plan toexit certain activities, to consolidate facilities and to implement a workforcereduction. As a result, we recorded a restructuring liability of$0.3 million related to the lease obligations and certain other costs forthose facilities and $0.1 million related to severance and retention, allof which has been paid as of September 30, 2006. In accordance with EITF95-3, these costs, which are not associated with the generation of futurerevenues and have no future economic benefit, were reflected as assumedliabilities in the allocation of the purchase price to the net assets acquired.

*NimsAssociates, Inc.*

On February 27, 2004, we acquired NimsAssociates, Inc. (“Nims”), an information technology and consultingservices company with offices in the Midwest and Advanced Development Centers (“ADCs”)in Indianapolis and Dallas, to expand our client base, primarily in the financialand insurance industries. In exchange for all of Nims’ outstanding capitalstock, we paid $18.2 million in cash to the shareholders of Nims, with thepotential to pay up to an additional $15.0 million in earn-outconsideration over the next three years, contingent upon the achievement ofcertain future financial targets. The acquisition was accounted for under thepurchase method in accordance with SFAS 141 and SFAS 142. Theadditional payments for earn-out consideration will be accounted for asadditional purchase price. The first earn-out was achieved as of March 1,2005 and, as a result, we paid $3.3 million in earn-out consideration inApril 2005 and recorded a corresponding increase in Goodwill. Based on thefinancial performance as of December 31, 2005, the second earn-out of $3.3million was also achieved and paid in April 2006. As of September 30,2006, there is $8.3 million in earn-out consideration remaining that couldbe achieved over the next five months. The total cost of the acquisition throughSeptember 30, 2006 was $29.5 million, which includes net assets acquiredof approximately $5.4 million, goodwill of approximately$17.1 million and intangible assets of $7.0 million. The intangibleassets are primarily amortized on a straight-line basis over 10 years,which approximates the expected period of benefit. Total assets acquired of$8.8 million consisted primarily of accounts receivable of$5.6 million. The portion of the purchase price related to the intangibleassets was finalized and identified by utilizing standard valuation proceduresand techniques.

At the date of acquisition, we entered into a plan toexit certain activities, to consolidate facilities and to implement a workforcereduction of 22 non-billable employees. As a result, we recorded arestructuring liability of $1.3 million related to the lease obligationsand certain other costs for those facilities and $0.3 million related toseverance and retention, of which all of the severance was paid and $0.8million for the lease obligations was paid as of September 30, 2006. Inaccordance with EITF 95-3, these costs, 

15

----

which were not associatedwith the generation of future revenues and had no future economic benefit, werereflected as assumed liabilities in the allocation of the purchase price to thenet assets acquired. As of September 30, 2006, the plan has been completedand there is no remaining liability associated with the lease obligation costs.

*KeaneWorldzen*

On October 17, 2003, we acquired a controllinginterest in Keane Worldzen Inc. (“Keane Worldzen”), a privately held BusinessProcess Outsourcing (“BPO”) firm. In connection with the acquisition, we paid$9.0 million to acquire the Series A preferred shares of WorldzenHoldings Limited held by an unrelated third party. We contributed to KeaneWorldzen our Worldzen Holdings Limited shares, $4.3 million in cash andcertain assets of our Keane Consulting Group (“KCG”), our business consultingarm. This transaction was accounted for under the purchase method in accordancewith SFAS 141 and SFAS 142. As a result of the initial transaction,we owned approximately 62% of Keane Worldzen’s outstanding capital stock. Theformer majority shareholders of Worldzen Holdings Limited contributed theirWorldzen Holdings Limited shares to Keane Worldzen in exchange forapproximately 38% of Keane Worldzen’s outstanding capital stock and arecurrently members of Keane Worldzen’s management. The assets and liabilitiescontributed to Keane Worldzen were recorded in relation to each shareholder’sownership percentage in Keane Worldzen as follows: (i) carryover basisrelated to assets and liabilities contributed to Keane Worldzen for which theindividual shareholder had a prior interest; and (ii) fair value forassets and liabilities for which an individual shareholder had no priorinterest. The acquisition was intended to strengthen our position in the BPOmarket. As a result, we initially recorded goodwill of approximately$13.8 million in the accompanying consolidated balance sheets.

On April 1, 2005, we increased our equityposition in Keane Worldzen pursuant to the purchase option discussed below toapproximately 81% with an additional capital contribution of approximately$5.0 million in cash and $3.0 million from the conversion of existingcash advances to equity. We purchased approximately 36.0 million shares ata cost of approximately $.22 per share. As a result of the additional capitalcontribution, we continue to consolidate the results of Keane Worldzen, but arealso able to consolidate its results for tax purposes beginning April 1,2005. Upon our additional capital contribution, the minority interestshareholders owned approximately 19% of the issued and outstanding capitalstock of Keane Worldzen. In December 2005, the minority shareholders executedtheir right under the first put option to require us to purchase approximately5% of their shares for a stated value of $2.8 million as discussed below.As a result, we paid the $2.8 million for an additional 5% ownershipinterest associated with the first put option and as of September 30,2006, own approximately 86% of the issued and outstanding capital stock ofKeane Worldzen.

In connection with our acquisition of a controllinginterest in Keane Worldzen in October 2003, we obtained the right topurchase certain of the remaining shares held by the minority shareholders ofKeane Worldzen at different times during 2006 to 2009 (“call options”) and theright to acquire additional shares directly from Worldzen at a fixed pricestated at the acquisition date through 2005 (“purchase option”). Our purchaseoption allowed us to purchase additional shares directly from Worldzen toobtain up to 80% of the total outstanding shares of Worldzen throughDecember 31, 2005. Our first call option is exercisable during the periodbeginning on January 1, 2006 and ending on December 31, 2006, isbased on the same fixed price as is the purchase option and allows us toacquire up to 80% of the total outstanding shares of Worldzen at the time thefirst call option is exercised. The fair value of the purchase and first calloption, using a Black-Scholes valuation model, was approximately$3.8 million and was recorded at the original acquisition date. During2005, we acquired 80% of the outstanding shares of Keane Worldzen through theexercise of the purchase option and reclassified the value of the purchase andfirst call option to goodwill. The other call options are exercisable at thefair market value of the underlying shares to obtain specified ownership levelsduring the call periods, which are exercisable at certain times during theperiod January 1, 2007 through December 31, 2009. Since these othercall options can only be exercised at the fair value of the underlying shares,no amounts have been recorded for these call options in our consolidatedfinancial statements.

Also in connection with the acquisition, the minorityshareholders were given the right to require us to purchase certain of theirremaining shares at various times (“put options”) subject to the achievement ofcertain operating and financial milestones related to Keane Worldzen’s businessperformance. The first put option, the term of which was October 17, 2003through December 31, 2005, was exercisable based on a stated value for theunderlying shares of $2.8 million and was exercised and paid inDecember 2005. The fair value of this put option, using a Black-Scholesvaluation model, was approximately $279,000 at the acquisition date and wasrecognized as compensation expense in the accompanying consolidated financialstatements through December 31, 2005. The other put options areexercisable at fair market value for the underlying shares during the putperiods, which are exercisable at certain times during the periodJanuary 1, 2008 through March 1, 2010. Because these other putoptions can only be exercised at the fair value of the underlying shares, noamounts have been recorded as of September 30, 2006 for these put options inour consolidated financial statements.

The results of operations of these acquired companieshave been included in our consolidated statements of income from the dates ofacquisition. The excess of the purchase price over the fair value of the netassets has been allocated to identifiable intangible assets and goodwill.Identifiable intangible assets associated with these acquisitions are beingamortized on a straight-line basis over periods ranging from two to10 years and approximate the expected periods of benefit. Pro formaresults of operations for Cresta, ArcStream, and netNumina have not beenprovided since these acquisitions were not material either individually or inthe aggregate in the year of acquisition.

16

----

**Note 9.     Restructurings**

*Workforcereductions*

We are continuingthe implementation of a multi-faceted internal reorganization, which we callthe “One Keane Transformation.” Our goals in implementing the One KeaneTransformation include: the replacement of our current regional operationsstructure with an overlapping structure including regional client relationshiporganizations, delivery organizations based on global practices and verticalindustry expertise, and global shared services for sales and human resources,aimed at lowering cost.

During the ThirdQuarter ended September 30, 2006, we reduced our workforce by seven employeesdue to our One Keane Transformation, who have expected termination dates in theFourth Quarter of 2006.  The employees affectedin the reductions are all non-billable and we believe were employees whoseroles could be reduced based upon the current business needs in theirrespective locations.   As a result, werecorded approximately $0.1 million of severance costs.

Also in connectionwith the One Keane Transformation, during the Second Quarter of 2006 we reducedour workforce at certain locations by 59 employees, most of whom had anexpected termination date in the Second and Third Quarters of 2006. Theemployees affected in the reduction were non-billable and billable and webelieve were employees whose roles could be reduced based upon the currentbusiness needs in their respective locations.  As a result, we recordedapproximately $1.4 million for severance costs during the Second Quarter endedJune 30, 2006 in the accompanying unaudited condensed consolidated financialstatements.

Additionally, inconnection with the One Keane Transformation, during the First Quarter of 2006we reduced our workforce at certain locations by 53 employees most of whom hadan expected termination date in the First Quarter of 2006. The employeesaffected in the reduction were both non-billable and billable and we believewere employees whose roles could be reduced based upon the current business needsin their respective locations. As a result, we recorded approximately $1.3million for severance costs in the accompanying unaudited condensedconsolidated financial statements. Of this amount, approximately $0.5 millionrelated to personnel in the United Kingdom and approximately $0.8 millionrelated to personnel from our locations in the U.S.  As of September 30,2006, the remaining liability related to these charges from the First, Secondand Third Quarters of 2006 is $0.2 million, which we expect to pay by the FirstQuarter of 2007. Cash expenditures during the nine months ended September 30,2006 related to workforce reductions for the nine months ended September 30,2006 were approximately $2.6 million.  Inaccordance with SFAS No. 146 (“SFAS 146”), “Accounting for CostsAssociated with Exit or Disposal Activities,” for those employees whose serviceperiod was greater than 60 days, the expense is being booked ratably over theservice period, which we expect to continue through the First Quarter of 2007.

In connection withthe netNumina acquisition discussed in Note 8 “Business Acquisitions”, weentered into a plan to reduce the workforce by eight employees, most of whomhad an expected termination date in the Second Quarter of 2005. The employeesaffected in the reduction were non-billable personnel whose responsibilitieshave been integrated into our existing operations to realize the synergies ofthe two operations. We recorded a liability of $1.0 million associatedwith severance and other termination benefits and the plan was complete as ofSeptember 30, 2005. In accordance with EITF 95-3, these costs were reflected asassumed liabilities in the allocation of the purchase price to the net assetsacquired**.  **Cashexpenditures related to NetNumina severance costs during the nine months endedSeptember 30, 2006 and September 30, 2005were $0.2 million and $0.8 million,respectively. As of September 30, 2006, there was no liability remaining.

In connection withthe Fast Track acquisition discussed in Note 8 “Business Acquisitions”, weentered into a plan to reduce the workforce by seven employees, most of whomhad a termination date of October 31, 2004. The employees affected in thereduction were non-billable personnel whose responsibilities were integratedinto our existing operations to realize the synergies of the two operations. Werecorded a liability of approximately $0.1 million associated with severance,retention, and other termination benefits, completed the plan by March 31,2005, and paid the entire $0.1 million in severance and retention. Inaccordance with EITF 95-3, these costs were reflected as assumed liabilities inthe allocation of the purchase price to the net assets acquired**.**

In connection withthe Nims acquisition discussed in Note 8 “Business Acquisitions”, weentered into a plan to reduce the workforce by 22 employees, most of whom had atermination date of April 30, 2004. The employees affected in thereduction were non-billable personnel whose responsibilities were integratedinto our existing operations to realize the synergies of the two operations. Werecorded a liability of $0.3 million associated with severance, retention andother termination benefits and, by March 31, 2005, had completed the planand paid $0.3 million in severance and retention. In accordance with EITF 95-3,these costs were reflected as assumed liabilities in the allocation of thepurchase price to the net assets acquired**.**

*Branchoffice closures*

During December 2005, in accordance withSFAS 146, we accrued $0.6 million for a restructuring of one of ourreal estate locations that we vacated. Also during the Fourth Quarter of 2005,we performed an evaluation of our restructuring balances for propertiesrestructured in prior periods and determined we had approximately$0.6 million in excess cost over our current needs. This change inestimate was a result of negotiating early lease terminations, obtaining asubtenant, or lower facility costs. The net impact of 

17

----

these actions did nothave an effect on our consolidated statement of income. Cash expenditures forthe nine months ended September 30, 2006 related to the 2005 propertyrestructuring were $0.4 million. As of September 30, 2006 and December 31,2005, the remaining reserve balances were $0.2 million and $0.6 million,respectively.

During December 2004, in accordance withSFAS 146, we accrued $2.3 million for a restructuring of one of ourreal estate locations that we vacated. Additionally, during the Fourth Quarterof 2004, we performed an evaluation of our restructuring balances forproperties restructured in prior periods and determined that we had excesscosts-accrued of $2.4 million, as a result of negotiating early leaseterminations or obtaining a subtenant. The net impact of these actions resultedin a net expense reduction to the restructuring charge of $0.1 million inthe Fourth Quarter of 2004 in our consolidated statement of income. Cashexpenditures during the nine months ended September 30, 2006 and September 30,2005 related to the 2004 property restructurings totaled approximately $0.2million and $0.3 million, respectively, net of sublease income of approximately$0.1 million and $15,000, respectively.  As of September 30, 2006 andDecember 31, 2005, the remaining reserve balances were $1.8 million and$2.1 million, respectively.

In connection withthe Fast Track acquisition noted above, we entered into a plan to exit certainactivities and to consolidate certain facilities. As a result, we recorded arestructuring liability of $0.4 million related to the lease obligationand certain other costs for one facility. In accordance with EITF 95-3, thesecosts, which were not associated with the generation of future revenues and hadno future economic benefit, were reflected as assumed liabilities in the allocationof the purchase price to the net assets acquired. The total restructuringliability was paid in the First Quarter of 2005.

In connection with the Nims acquisition noted above,we entered into a plan to exit certain activities and to consolidate certainfacilities. As a result, we recorded an initial restructuring liability of$1.4 million related to the lease obligation and certain other costs foreight facilities. During the Fourth Quarter of 2004, we revised our originalestimate for Nims-related lease obligations and reduced the accrual by$0.1 million. In accordance with EITF 95-3, these costs, which were notassociated with the generation of future revenues and had no future economicbenefit, were reflected as assumed liabilities in the allocation of thepurchase price to the net assets acquired. Cash expenditures for the ninemonths ended September 30, 2006 and September 30, 2005 related to allNims-related branch office closings totaled approximately $0.1 million and $0.2million, respectively, which is net of approximately $0.1 million, for eachperiod, of sublease payments received. As of September 30, 2006 andDecember 31, 2005, the remaining reserve balances were $0.4 million and$0.5 million, respectively.

DuringDecember 2003, in accordance with SFAS 146, we accrued$0.9 million for a restructuring of two of our real estate locations fromwhich we no longer were receiving economic benefit. Additionally, during theFourth Quarter of 2003, we performed an evaluation of our restructuring balancesfor properties restructured in prior periods and determined as a result ofnegotiating early lease terminations or obtaining a subtenant had approximately$1.0 million in excess costs accrued. In prior years, in accordance withEITF Issue No. 94-3 (“EITF 94-3”), “Liability Recognition for CertainEmployee Termination Benefits and Other Costs to Exit an Activity (IncludingCertain Costs Incurred in a Restructuring),” we performed reviews of ourbusiness strategy and concluded that consolidating some of our branch officeswas key to our success. Cash expenditures for the nine months endedSeptember 30, 2006 and September 30, 2005 for all branch officeclosings relating to restructuring charges in 2003 and prior years were $0.7million and $1.7 million, respectively, which is net of approximately$0.6 million and $0.9 million, respectively, of sublease paymentsreceived. As of September 30, 2006 and December 31, 2005, the totalremaining reserve balance for branch office closings relating to restructuringin 2003 and prior years was $1.5 million and $2.3 million, respectively.

The activity for the nine months ended September 30,2006 and September 30, 2005 associated with restructuring charges is as follows(in thousands, except per share data):
| ** **                                                           | ** ** | **January 1,   2005   Balance** | ** ** | **Cash   Expenditures,   Net** | ** ** | **Acquisition   Related   Charges in   Fiscal 2005** | ** ** | **September 30,   2005   Balance** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **Branch  office closures and other expenditures by year of action** | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                                                    | ** ** | ** **                                        | ** ** |
| 1999                                                                 |       | $                                              | 19         |                                     | $          | —                                                                        |       | $                                                 | —     |   | $ | 19 |   |
| 2000                                                                 |       | 5                                              |       | 42                                       |       | —                                                                        |       | 47                                                |       |
| 2001                                                                 |       | 559                                            |       | (221                                     | )          | —                                                                        |       | 338                                               |       |
| 2002                                                                 |       | 4,278                                          |       | (1,354                                   | )          | —                                                                        |       | 2,924                                             |       |
| 2003                                                                 |       | 234                                            |       | (140                                     | )          | —                                                                        |       | 94                                                |       |
| 2004                                                                 |       | 3,491                                          |       | (988                                     | )          | —                                                                        |       | 2,503                                             |       |
|                                                                 |       | 8,586                                          |       | (2,661                                   | )          | —                                                                        |       | 5,925                                             |       |
| **2004  Workforce reduction**                                        |       | 91                                             |       | (91                                      | )          | —                                                                        |       | —                                            |       |
| **2005  Workforce reduction**                                        |       | —                                         |       | (815                                     | )          | 985                                                                           |       | 170                                               |       |
| ** **                                                           | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                                                    | ** ** | ** **                                        | ** ** |
| **Total Restructuring Balance**                                      |       | $                                              | 8,677      |                                     | $          | (3,567                                                                        | )          | $                                                 | 985        |   | $ | 6,095 |   |

 

18

----

 
| ** **                                                           | ** ** | **January 1,   2006   Balance** | ** ** | **Cash   Expenditures,   Net** | ** ** | **Charges in   Fiscal 2006** | ** ** | **September 30,   2006,   Balance** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------------|------------|
| **Branch  office closures and other expenditures by year of action** | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                  | ** ** | ** **                                         | ** ** |
| ** **                                                           | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                  | ** ** | ** **                                         | ** ** |
| 2000                                                                 |       | $                                              | 78         |                                     | $          | (9                                          | )          | $                                                  | —     |   | $ | 69 |   |
| 2001                                                                 |       | 243                                            |       | (52                                      | )          | —                                      |       | 191                                                |       |
| 2002                                                                 |       | 1,935                                          |       | (661                                     | )          | —                                      |       | 1,274                                              |       |
| 2003                                                                 |       | 15                                             |       | —                                   |       | —                                      |       | 15                                                 |       |
| 2004                                                                 |       | 2,588                                          |       | (344                                     | )          | —                                      |       | 2,244                                              |       |
| 2005                                                                 |       | 581                                            |       | (385                                     | )          | —                                      |       | 196                                                |       |
|                                                                 |       | 5,440                                          |       | (1,451                                   | )          | —                                      |       | 3,989                                              |       |
| **2005  Workforce reduction**                                        |       | 164                                            |       | (164                                     | )          | —                                      |       | —                                             |       |
| **2006  Workforce reduction**                                        |       | —                                         |       | (2,602                                   | )          | 2,796                                       |       | 194                                                |       |
| ** **                                                           | ** ** | ** **                                     | ** ** | ** **                               | ** ** | ** **                                  | ** ** | ** **                                         | ** ** |
| **Total Restructuring Balance**                                      |       | $                                              | 5,604      |                                     | $          | (4,217                                      | )          | $                                                  | 2,796      |   | $ | 4,183 |   |

 

The restructuring balanceis included in current accrued restructuring and accrued long-termrestructuring costs in the accompanying condensed unaudited consolidatedbalance sheets.

**Note 10.     Convertible Subordinated Debentures**

In June 2003, we issued in a private placement$150.0 million principal amount of 2.0% Convertible SubordinatedDebentures due 2013. The Debentures are unsecured and subordinated in right ofpayment to all of our senior indebtedness. The Debentures accrue regularinterest at a rate of 2.0% per year. Interest is payable semi-annually inarrears on June 15 and December 15 of each year, beginningDecember 15, 2003. Beginning with the six-month interest period commencingJune 15, 2008, we will pay additional contingent interest during anysix-month interest period if the trading price of the Debentures for each ofthe five trading days immediately preceding the first day of the interestperiod equals or exceeds 120% of the principal amount of the Debentures. Duringany interest period when contingent interest is payable, the contingentinterest payable per $1,000principal amount of Debentures will equal 0.35% calculated on the averagetrading price of $1,000 principal amount of Debentures during the five tradingdays immediately preceding the first day of the applicable six-month interestperiod and will be payable in arrears.

The Debenture holders have the right to require us to repurchaseall or a portion of their Debentures on June 15, 2008. The Debentureholders may also require us to repurchase all or a portion of their Debenturesupon a designated event, as defined in the indenture governing the Debentures.In addition, on or after June 15, 2008, we may, by providing at least30-day notice to the holders, redeem any of the Debentures at a redemptionprice equal to 100% of the principal amount of the Debentures, plus accruedinterest and unpaid interest, if any, and liquidated damages, if any, to, butexcluding, the redemption date.

The Debentures areconvertible at the option of the holder into shares of our common stock at aninitial conversion rate of 54.4989 shares per $1,000 principal amount ofDebentures, which is equivalent to an initial conversion price of approximately$18.349 per share, subject to adjustments, prior to the close of business onthe final maturity date only under the following circumstances: (a) duringany fiscal quarter commencing after September 30, 2003, and only duringsuch fiscal quarter, if the closing sale price per share of our common stockexceeds 120% of the conversion price (approximately $22.019) for at least 20trading days in the 30 consecutive trading day period ending on the lasttrading day of the preceding fiscal quarter; (b) during the five businessdays after any five consecutive trading day period in which the trading priceper $1,000 principal amount of Debentures for each day of that period was lessthat 98% of the product of the closing sale price per share of our common stockand the number of shares issuable upon conversion of $1,000 principal amount ofthe Debentures; (c) if the Debentures have been called for redemption; or(d) upon the occurrence of specified corporate transactions. See Note 4 “EarningsPer Share Data” for further discussion of the Debentures. Debt issuance costsrelated to the debentures were approximately $4.4 million and are includedin Other assets, net, in the accompanying unaudited condensed consolidated balancesheets. These costs are being amortized to interest expense over five years ona straight-line basis. As of September 30, 2006 and December 31, 2005, theunamortized debt issuance costs were approximately $1.5 million and $2.2million, respectively.

**Note 11.     Capital Stock**

OnOctober 25, 2005, we announced that our Board of Directors had authorizedus to repurchase an additional 3 million shares of our common stock overthe subsequent twelve months effective October 20, 2005. BetweenMay 1999 and September 30, 2006, we invested approximately $324.0million to repurchase approximately 25.9 million shares of our common stockunder twelve separate authorizations. The additional paid in capital wasreduced to zero as of December 31, 2005 as a result of our cumulativeshare repurchases. During the nine months ended September 30, 2006, werepurchased a total of approximately 726,800 shares of common stock forapproximately $9.3 million. See Note 15 “Subsequent Event” and “Management’sDiscussion and Analysis of Financial 

19

----

Condition and Results ofOperations — Liquidity and Capital Resources” for further discussion on sharerepurchases.

During the ninemonths ended September 30, 2006, a total of 977,636 shares of our common stockwere exercised or purchased by participants under our stock option plans, ESPPand UK ESPP. In addition, we granted 285,000 shares of restricted stock duringthe nine months ended September 30, 2006.

**Note 12.     Related Parties, Commitments, and Contingencies**

*RelatedParty Transactions*

Our principalexecutive office is located at 100 City Square in Boston, Massachusetts (the “NewFacility”). In October 2001, we entered into a lease with GatewayDevelopers LLC (“Gateway LLC”) for a term of 12 years, pursuant to whichwe agreed to lease approximately 95,000 square feet of office and developmentspace in the New Facility. We lease approximately 57% of the New Facility andthe remaining 43% is, or will be, occupied by other tenants. John Keane FamilyLLC is a member of Gateway LLC. The members of John Keane Family LLC are trustsfor the benefit of John F. Keane, Chairman of our Board of Directors, andhis immediate family members.

OnOctober 31, 2001, Gateway LLC entered into a $39.4 millionconstruction loan with Citizens Bank of Massachusetts (the “Gateway Loan”) inconnection with the New Facility and an adjacent building located at 20 CitySquare, Boston, Massachusetts. John Keane Family LLC and John F. Keane areeach liable for certain obligations under the Gateway Loan if and to the extentGateway LLC requires funds to comply with its obligations under the GatewayLoan. Stephen D. Steinour, who was a member of our Board of Directors, wasChief Executive Officer of Citizens Bank of Pennsylvania. On November 17,2005, Mr. Steinour resigned as a member of the Board of Directors due tohis promotion to President of Citizens Financial Group, Inc. and theresultant travel demands. Citizens Bank of Massachusetts and Citizens Bank ofPennsylvania are subsidiaries of Citizens Financial Group, Inc.Mr. Steinour was not involved in the approval process for the GatewayLoan. In June 2005, the Gateway Loan was refinanced to a non-recoursepermanent loan with CitiGroup.

We began occupyingthe New Facility and making lease payments in March 2003. Based upon ourknowledge of lease payments for comparable facilities in the Boston area, webelieve that the lease payments under the lease for the New Facility, whichwill be approximately $3.2 million per year ($33.00 per square foot forthe first 75,000 square feet and $35.00 per square foot for the remainder ofthe premises) for the first six years of the lease term and approximately$3.5 million per year ($36.00 per square foot for the first 75,000 squarefeet and $40.00 per square foot for the remainder of the premises) for theremainder of the lease term, plus specified percentages of any annual increasesin real estate taxes and operating expenses, were, at the time we entered intothe lease, as favorable to us as those which could have been obtained from anindependent third party. Lease payments to Gateway LLC during the nine monthsended September 30, 2006 and 2005 were approximately $2.7 million and $2.6million, respectively.

In view of theserelated party transactions, we concluded that, during the construction phase ofthe New Facility, the estimated construction in progress costs for the NewFacility would be capitalized in accordance with EITF Issue No. 97-10, “TheEffect of Lessee Involvement in Asset Construction.” A liability in the sameamount was included in the caption “Accrued long-term building costs” in theaccompanying consolidated balance sheets. For purposes of the consolidatedstatements of cash flows, we characterized this treatment as a non-cashfinancing activity.

As a result of thecompletion of the construction phase and our current occupancy, the relatedcapitalized costs are now classified as “Building” and are included in propertyand equipment, net, in the accompanying consolidated balance sheets. Aliability for the same amount appears as accrued expenses and other liabilitiesand accrued long-term building costs, representing our short and long-termcomponents. The costs of the building are being amortized on a straight-linebasis over a 39-year useful life. Additionally, the obligation will be reducedover the life of the lease at an interest rate of 8.67%. The net effect of theamortization that is included in the operating results approximates the rentexpense resulting from the contractual payments we are required to make underthe lease.

InFebruary 1985, we entered into a lease, which subsequently was extended toa term of 20 years, with City Square Limited Partnership (“City Square”),pursuant to which we leased approximately 34,000 square feet of office anddevelopment space in a building located at Ten City Square, in Boston,Massachusetts. As of December 31, 2005, we leased approximately 88% ofthis building and the remaining 12% was leased by other tenants. John F.Keane, Chairman of our Board of Directors, and Philip J. Harkins, a memberof our Board of Directors, are limited partners of City Square. Based upon ourknowledge of lease payments for comparable facilities in the Boston area, webelieve that the lease payments under this lease, which were approximately $1.0 millionper year ($30.00 per square foot) at the end of the lease term (which expiredin February 2006), plus specified percentages of any annual increases inreal estate taxes and operating expenses, which were approximately$0.2 million per year, were, at the time we entered into the lease, asfavorable to us as those which could have been obtained from an independentthird party. As a result of our occupancy of the New Facility (as describedabove), we vacated and obtained a subtenant for approximately 17% of Ten CitySquare.

As a result of thevacancy at Ten City Square in December 2002, we reserved the remaininglease payments due to City 

20

----

Square for the remainderof the lease term, resulting in a charge of approximately $3.9 million inthe Fourth Quarter of 2002. In February 2006, our lease for Ten CitySquare expired and the building was sold to a third party. For the nine monthsended September 30, 2006 and 2005, we paid approximately $0.2 million and$0.9 million, respectively, in lease payments and as of September 30, 2006had a remaining reserve balance of $0.2 million.

InJanuary 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidationof Variable Interest Entities,” as amended by FASB InterpretationNo. 46(R) (“FIN 46(R)”) in December 2003, which requires theconsolidation of a variable interest entity, as defined, by its primarybeneficiary. Primary beneficiaries are those companies that are subject to amajority of the risk of loss or entitled to receive a majority of the entity’sresidual returns, or both. In determining whether it is the primary beneficiaryof a variable interest entity, an entity with a variable interest shall treatvariable interests in that same entity held by its related parties as its owninterests.

We have evaluatedthe applicability of FIN 46(R) to our relationship with each of CitySquare and Gateway LLC and determined that we are not required to consolidatethese entities within our consolidated financial statements. We have determinedthat Gateway LLC is not a variable interest entity as the equity investment issufficient to absorb the expected losses and the holders of the equityinvestment do not lack any of the characteristics of a controlling interest. Wehave concluded that as we no longer occupy the space at Ten City Square and nolonger derive any benefit from leasing the space, we would not be determined tobe the related party most closely associated with City Square. As a result, wewill continue to account for our leases with City Square and Gateway LLCconsistent with our historical practices in accordance with generally acceptedaccounting principles. We believe that we do not have an interest in anyvariable interest entities that would require consolidation.

In July 2003, our Audit Committee approved arelated-party transaction involving a member of our Board of Directors.  Wesub-contracted with ArcStream to develop and assist in the implementation of awireless electronic application at two client sites. In accordance with thistransaction, we agreed to pay ArcStream a royalty fee for potential futureinstallations during the seven-year license period. John F.Keane, Jr., a member of our Board of Directors, was Chief ExecutiveOfficer, a director, and founder of ArcStream. John F. Keane, Jr. isthe son of John F. Keane, Sr., Chairman of our Board of Directors,and the brother of Brian T. Keane, our former President, Chief ExecutiveOfficer and director. Effective June 21, 2004, our Audit Committeeapproved the termination of our agreement with ArcStream and a payment of$150,000 by us to ArcStream in exchange for a release of all parties from anyfurther performance or payment obligations under the original agreement. Thetermination was for convenience and was not related to ArcStream’s performanceunder the agreement. On April 4, 2005, we acquired certain assets andassumed specified liabilities of ArcStream for a base purchase price of ($0.00)dollars, subject to a working capital adjustment and additional considerationbased on the performance of the ArcStream business during the remainder of2005. In addition, in connection with the transaction, John Keane, Jr.agreed to guarantee certain indemnification obligations of ArcStream and wepaid John Keane, Jr. $21,875 pursuant to a consulting arrangement toassist in the transition of the acquired business. See Note 8 “BusinessAcquisitions” for a further discussion of the acquisition.

In July 2005,our Audit Committee approved a related party transaction authorizing us toprovide services to Citizens Bank, N.A., in connection with the development ofan internet application and related support services. As discussed above,Stephen D. Steinour was previously a member of our Board of Directors and as ofNovember 2005 was promoted to President of Citizen’s FinancialGroup, Inc. an affiliate of Citizens Bank, N.A. Under the terms of thisapproval, the engagement value is estimated to be approximately$1.6 million. The rates charged under this engagement are comparable tothose charged to an independent third party. We have not performed any work in2006, therefore, for the nine months ended September 30, 2006, we did notreceive any payments under the agreement and had no accounts receivableoutstanding. For the nine months ended September 30, 2005, we did not receiveany payments, but had approximately $0.2 million in accounts receivablesoutstanding.

*Commitmentsand Contingencies*

We lease the NewFacility from Gateway LLC as described above. We lease additional office spaceand apartments in approximately 55 locations in North America, the UK,Australia and India under operating leases and capital leases, some of whichmay be renewed for periods up to five years, subject to increased rental fees.

We are a guarantorwith respect to a line of credit for Innovate EC, an entity in which weacquired a minority equity position as a result of a previous acquisition. Thetotal line of credit is for $600,000. We guarantee $300,000 of this obligation.The line is subject to review by the lending institution. We would be requiredto meet our guarantor obligation in the event the lending institution refusesto extend the credit facility and Innovate EC is unable to satisfy itsobligation.

InFebruary 2003, we entered into a $50.0 million unsecured revolvingcredit facility (the “credit facility”) with two banks. The terms of the creditfacility required us to maintain a maximum total funded debt and otherfinancial ratios. The credit facility also included covenants that, subject tocertain specific exceptions and limitations, among other things, restricted ourability to incur additional debt, make certain acquisitions or disposition ofassets, create liens, and pay dividends. Between June 2003 andJuly 2005, we and the two banks amended certain provisions of the creditfacility including the allowable limit for letters of credit within the totalfacility and for the purposes of issuing a letter of credit to satisfy bankguarantees with respect to the Victoria TTA contract with the 

21

----

State of Victoria,Australia. One of the banks issued $33.8 million ($45 million AUD)letters of credit dated July 14, 2005 against our credit facility inconnection with our Victoria TTA contract. This credit facility was terminatedin connection with our entrance into a new credit facility, described below, onSeptember 15, 2005.

On September 15, 2005, we entered into afive-year revolving credit facility (the “new credit facility”) with asyndicate of banks (the “lenders”) in the amount of $200.0 million, plusan additional amount of up to $50.0 million subject to certain terms andconditions (the “loan amount”). The new credit facility has variousnonfinancial and financial covenants, which include a total leverage ratio, asenior leverage ratio and a quick ratio. The new credit facility replaced ourprevious $50.0 million unsecured revolving credit facility. Pursuantto the new credit facility, we may borrow funds from the lenders up to the loanamount with a $50.0 million sub limit for letters of credit. During theFirst Quarter of 2006, we amended the new credit facility to allow for certainforeign currency hedging at the subsidiary level. The annual commitment feepayable quarterly is at an initial rate of 0.20% per annum on the unused amountof revolving credit commitments, subject to adjustment based on a seniorleverage ratio as defined in the new credit facility and up to a maximum perannum rate of 0.25%. To the extent there are letters of credit outstandingunder the new credit facility, we will pay the administrative agent a letter ofcredit fee, initially 1.0% annually, subject to adjustment based on the seniorleverage ratio as defined and up to a maximum per annum rate of 1.5%. Inconnection with the new credit facility, we paid $1.3 million in relateddebt issuance costs. Our borrowing capacity is based on certain financialratios as defined in the new credit facility. As of September 30, 2006, therewas approximately $130.0 million available for borrowing after considering$34.6 million of outstanding letters of credit and after considering certainfinancial ratios. These letters of credit include the $33.8 million($45 million AUD) letter of credit issued in July 2005 against ourprevious credit facility in connection with our Victoria TTA contract.

During the ThirdQuarter ended September 30, 2002, in connection with an acquisition of abusiness complementary to our own, we initially recorded $3.0 million asdeferred revenue related to contingent service credits and issued a$3.0 million non-interest bearing note payable as partial consideration.During the nine months ended September 30, 2005, we recognized revenue ofapproximately $1.2 million in relation to the contingent service creditsand reduced each of the related deferred revenue and note by approximately $0.6 million.The note had a one-year term with a one-year extension, which expired onSeptember 25, 2005. As of September 30, 2006 and December 31,2005, the deferred revenue and note payable balances were each zero. Inconnection with the Nims acquisition and based on the financial performancerelated to the first earn-out, we paid $3.3 million in earn-outconsideration in April 2005 and recorded a corresponding increase toGoodwill. The second earn-out was achieved as of December 31, 2005. As aresult, we accrued the related $3.3 million in earn-out consideration asof December 31, 2005 with a corresponding increase to Goodwill, which waspaid in April of 2006. As of September 30, 2006, there is anadditional potential $8.3 million in earn-out consideration remaining thatcould be achieved over the next five months.

*Guaranteesand Indemnifications*

In connection withcertain contracts, we have been required to deliver security or performancebonds for the benefit of our clients. These bonds give the beneficiary the rightto obtain payment from the issuer of the bond if certain specified events occuror fail to occur. In addition, we have various agreements in which we may beobligated to indemnify our clients or third parties with respect to certainmatters. Generally, these indemnification provisions are included in contractsarising in the normal course of business under which we customarily agree tohold the indemnified party harmless against losses arising from a breach ofrepresentations related to such matters as title to assets sold and licensed orcertain intellectual property rights, improper disclosures of confidentialinformation, personal injuries, or property damages. Typically, there are nospecific dollar limits associated with indemnifications. In general, the termof the indemnifications will correspond to the contract term such that the harmor damage must occur during the contract period. Therefore, claims may beraised after completion of the contract associated with the indemnificationprovision, but the damage must have been caused during the contract term. As aprime contractor under certain contracts, we are responsible for theperformance of our subcontractors and would be required to arrange forperformance in the event the subcontractors failed to perform. However, wewould retain our right to enforce the subcontracts and to seek damages fornonperformance from our subcontractors. A limited number of our contractsinclude liquidated damages provisions, which would require us to make per diempayments for late deliveries. Further, our obligations under these agreementsmay be limited in terms of time and/or amount and, in some instances, we mayhave recourse against third parties, including our subcontractors, for certainpayments made by us. It is not possible to predict the maximum potential amountof future payments under these indemnification agreements due to theconditional nature of our obligations and the unique facts of each particularagreement.

Kamco hasobligations under the Victoria TTA contract with respect to both projectmanagement and performance of subcontractors. There are numerousindemnification provisions within the Victoria TTA contract, some of which arecustomarily included through the normal course of business. We have agreed tohold TTA harmless against losses arising from a breach of representationsrelated to such matters as title to assets sold and licensed or certainintellectual property rights, improper disclosures of confidential information,personal injuries, or property damages. As the prime contractor for theVictoria TTA contract, in certain cases, Kamco is entitled to correspondingindemnifications from its subcontractors. Subject to a number of exclusions, Kamco’s maximum liability is cappedat $75.2 million ($100 million AUD). Under the Victoria TTA contract,liquidated damages, for which Kamco may be liable, are assessed at $37,590($50,000 AUD) per day for each day the specified phase completion is behindschedule, but are limited to $7.5 million ($10 million AUD). Thefirst $3.8 million ($5 million AUD) in liquidated damages is splitevenly amongst Kamco and certain subcontractors. The next $3.8 million($5 million AUD) is apportioned based on responsibility for the delay. Inaddition, we have a total of $33.8 million ($45 million AUD) lettersof credit issued against the new facility as surety bonds 

22

----

to ensure due and properperformance of our obligations under the Victoria TTA contract.

*Settlementand Termination*

On May 10, 2006,Brian T. Keane resigned, effective as of that date, as President, ChiefExecutive Officer and a director of Keane. In connection with Mr. Keane’sresignation, we entered into a Resignation and Consulting Agreement with Mr.Keane, effective May 10, 2006. Pursuant to the agreement, Mr. Keane resigned,and we accepted his resignation as President, Chief Executive Officer and adirector and from all other positions including offices, directorships oremployment he held with us or any of our affiliates or related entities. Mr.Keane may not permit himself to be considered for election to our board ofdirectors at any time prior to December 31, 2010.

Pursuant to the Resignation and Consulting Agreement,from June 1, 2006 until December 31, 2007, Mr. Keane has agreed to provide upto a maximum of 150 days of consulting services to us as may be requested byour board of directors.  We will pay Mr. Keane an aggregate of $494,000 for his consultingservices, payable in equal monthly installments of $26,000 from June 1, 2006through December 31, 2007. After January 1, 2007, Mr. Keane may terminate hisagreement to provide consulting services upon 30 days written notice to us andwe will cease making monthly consulting payments to Mr. Keane upon any suchtermination.

In addition, pursuant tothe Resignation and Consulting Agreement:

·                  Wehave agreed to provide Mr. Keane with the right to continue to participate inour group medical and dental benefit plans to the extent permitted by andsubject to the Consolidated Omnibus Budget Reconciliation Act, or “COBRA”.

·                  Wehave agreed to pay toward the premium for such coverages the same amount as wepay toward the premiums for our active eligible employees with the same levelof coverages.

·                  Allof Mr. Keane’s outstanding stock options and restricted stock awards ceased tovest after May 10, 2006, except that 10,000 shares of restricted stock thatwould otherwise vest on December 16, 2006 will continue to vest despite hisresignation.

·                  Weagreed to extend the exercise period for Mr. Keane’s vested stock options toDecember 31, 2006.

·                  Mr. Keane agreedto release us from any claims he may have against us or our affiliates,including claims relating to  Mr. Keane’s employment with us and hisresignation, provided that the release will not affect any right he may have toseek indemnification under our restated articles of incorporation.

On May 10, 2006,our Board of Directors appointed John J. Leahy, our Executive Vice President ofFinance and Administration and Chief Financial Officer, to serve as ourPresident and Chief Executive Officer on an interim basis effectiveimmediately.  In addition, to ensure clear leadership and continuityduring this period of transition, the Board formed the Office of the President,consisting of Richard S. Garnick, former President, North American Services andGlobal Business Lines; Russell J. Campanello, Senior Vice President, HumanResources; and John J. Leahy. The Board is conducting a search for a permanentCEO and expects this search to include both internal and external candidates. Aspecial committee of Directors, including Larry Begley and Maria Cirino, isworking closely with the Office of the President to ensure that this transitionwill not disrupt the Company’s focus on customers, the One Keane Transformationinitiative, and the creation of shareholder value.

On June 8,2006, we entered into a Settlement Agreement with Georgina Fisk, the Company’sformer Vice President of Marketing, Brian Keane, the former Chief ExecutiveOfficer, John Keane, Sr., the Chairman of our Board of Directors, and JohnKeane, Jr., a member of the our Board of Directors (the “SettlementAgreement”). The Settlement Agreement was entered into in connection with theresolution of Ms. Fisk’s previously reported allegations concerning BrianKeane. The Settlement Agreement includes the following terms:

·                      Ms. Fisk’sresignation as our Vice President of Marketing effective June 30, 2006;

·                      Paymentby us and/or our insurer to Ms. Fisk of $1,140,000;

·                      Theextension of Ms. Fisk’s right to exercise any vested stock options held byher until December 31, 2006;

·                      Agreementby us not to exercise our right to repurchase 2,500 shares of restricted stockheld by Ms. Fisk which vest on December 16, 2006 until afterDecember 31, 2006;

·                      Mutualreleases between Ms. Fisk and the Company, Brian Keane, JohnKeane, Sr. and John Keane, Jr.;

·                      Mutualagreements by all parties as to confidentiality and non-disparagement; and

·                      Waiverby us of our right to enforce non-competition provisions of Ms. Fisk’sagreement with us concerning confidential information and our right to enforcenon-solicitation provisions of such agreement after January 1, 2007.

On September 29,2006, we announced that Richard S. Garnick, President of North AmericanServices and Global Business Lines and a member of the Company’s Office of thePresident, was dismissed for cause effective on that date. On October 3, 2006,Mr. Garnick filed a lawsuit against the Company and Mr. Leahy, asserting claimsfor breach of contract with damages of approximately $2.0 million, defamation,invasion of privacy, and tortious interference with contractual relations withunspecified damages. The Company intends to vigorously defend against theclaim.

23

----

We are involved inother litigation and various legal matters, which have arisen in the ordinarycourse of business. We do not believe that the ultimate resolution of thesematters will have a material adverse effect on our financial condition, resultsof operations, or cash flows.

**Note 13.     Segment Information**

Based on qualitative and quantitative criteriaestablished by SFAS No. 131 (“SFAS 131”), “Disclosures about Segmentsof an Enterprise and Related Information,” we operate within two reportablesegments: Professional Services and Transportation Ticketing Solutions. Inthese segments, we offer an integrated mix of end-to-end business solutions,such as Outsourcing, Development and Integration, and Other services. Keanedelivers these services through an integrated network of regional profitcenters in North America, the UK, and Australia and through ADC’s in the U.S.,Canada and India. The Chief Operating Decision Maker (“CODM”) evaluatesperformance and determines the allocation of resources based on the operatingprofit or loss at the regional profit center level. Within ProfessionalServices, each branch is set-up to deliver all of our service offerings and theexpectation is to provide a consistent level of profitability with eachoffering type. No individual regional profit center meets the quantitativecriteria established by SFAS 131 and therefore have been presented in onereportable segment.

With the entranceinto the Transportation Ticketing Solution market in 2005 as a result of ourentering into the Victoria TTA contract, we have determined that the economiccharacteristics of the services and the distinct client base would require aseparate reportable segment. The expertise required for the development andmanagement of the Victoria TTA contract is unique to its delivery. We haveevaluated our provision of solutions and services under the Victoria TTAcontract under the qualitative and quantitative criteria established bySFAS 131 and have concluded these services represent a new reportablesegment, in addition to our existing reportable segment Professional Services.As of and for the nine months ended September 30, 2006, we have notrecognized any revenues or direct costs for this segment, there wasapproximately $1.2 million of property, plant and equipment associated withKamco. For the nine months ended September 30, 2006 and September 30, 2005, werecognized approximately $2.1 million and $2.0 million, respectively, inindirect expenses for this segment. As a result, we have not provided anyadditional segment data.

See Note 6 “SignificantContracts” for a discussion of the Victoria TTA contract.

In accordance withthe enterprise-wide disclosure requirements of SFAS 131, our geographicinformation is as follows (dollars in thousands):
|                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **      | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:       |       |                                                     |       |                                                    |       |   |   |   |   |
| Domestic        |       | $                                                        | 219,773    |                                                    | $          | 224,174 |   | $ | 682,317 |   | $ | 665,196 |   |
| International   |       |                                                     |       |                                                    |       |   |   |   |   |
| UK              |       | 7,800                                                    |       | 9,579                                                   |       | 22,241 |   | 31,010 |   |
| Other           |       | 4,383                                                    |       | 5,810                                                   |       | 13,610 |   | 13,379 |   |
| Subtotal        |       | 12,183                                                   |       | 15,389                                                  |       | 35,851 |   | 44,389 |   |
| Total Revenues: |       | $                                                        | 231,956    |                                                    | $          | 239,563 |   | $ | 718,168 |   | $ | 709,585 |   |

 
| ** **                      | ** ** | **At September 30, 2006** | ** ** | **At December 31, 2005** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| **Property  & Equipment:**  | ** ** | ** **                               | ** ** | ** **                              | ** ** |
| Domestic                        |       | $                                        | 59,062     |                                    | $          | 63,234 |   |
| International                   |       |                                     |       |                                    |       |
| UK                              |       | 198                                      |       | 232                                     |       |
| Other                           |       | 14,053                                   |       | 14,117                                  |       |
| Subtotal                        |       | 14,251                                   |       | 14,349                                  |       |
| Total Property  & Equipment |       | $                                        | 73,313     |                                    | $          | 77,583 |   |

 

Geographicrevenues are presented net of intercompany revenues between the geographiclocations. We have no single client that provides revenues that equal or exceed10 percent of our consolidated revenues, except for the various agenciesof the Federal Government, which represented an aggregate of approximately 11.7% and 9.8% for the three months ended September 30, 2006 and 2005,respectively.  For the nine months ended September 30, 2006 and 2005, thevarious agencies of the Federal government accounted for 11.1% and 9.5% of ourconsolidated revenues for the nine months ended September 30, 2006 and2005, respectively.

**Note 14.     Income Taxes**

Our policy is toestablish reserves for taxes that may become payable in future years as aresult of an examination by tax 

24

----

authorities. Inaccordance with SFAS No. 5 (“SFAS 5”), “Accounting for Contingencies,” weestablish the reserves based upon our assessment of exposure associated withpermanent tax differences and interest expense applicable to both permanent andtemporary difference adjustments. The tax reserves are analyzed periodicallyand adjusted as events occur to warrant adjustment to the reserves, such aswhen the statutory period for assessing tax on a given tax return or periodexpires, at which time the reserve associated with that period is reduced. Inaddition, the adjustment to the reserve may reflect additional exposure basedon current calculations. Similarly, if tax authorities provide administrativeguidance or a decision is rendered in the courts, appropriate adjustments willbe made to the tax reserve.

The provision forincome taxes represents the amounts we owe for federal, state, and foreigntaxes. Our effective tax rate was 36.8% for the Third Quarter ended September30, 2006 and was 35.9% for the nine months ended September 30, 2006. Oureffective tax rate was 9.2% for the Third Quarter ended September 30, 2005 and29.3% the nine months ended September 30, 2005. Our effective tax rate for theThird Quarter and nine months ended September 30, 2006 was impacted by a changein geographic mix of income and the recognition of a foreign deferred taxbenefit in the Second Quarter of 2006. The foreign deferred tax benefit relatesto the expiration of an India tax holiday and as a result income is now taxablein that jurisdiction. During the Second Quarter ended June 30, 2006, werecorded a net deferred tax benefit as a result of taxable timing differencesin that jurisdiction.  During the Third Quarter ended September 30,2005, we recorded a $2.8 million reduction to our tax reserves due to theexpiration of certain statutes of limitation. In accordance with SFAS 5 andSFAS No. 109 (“SFAS 109”), “Accounting for Income Taxes,” we adjusted ourtax reserves in the period where the conditions under SFAS 5 are no longer met,which resulted in a reduction of our tax provision.  In addition, as aresult of owning greater than 80% of the outstanding voting stock of KeaneWorldzen, beginning April 1, 2005, we are able to record a tax benefit onthe losses associated with Keane Worldzen, thereby reducing our annualeffective tax rate. See Note 8 “Business Acquisitions” for further discussionon our ownership in Keane Worldzen. The determination of the provision forincome tax expense, deferred tax assets and liabilities and related valuationallowance involves judgment. As a global company, we are required to calculateand provide for income taxes in each of the tax jurisdictions where we operate.This involves making judgments regarding the recoverability of deferred taxassets, which can affect the overall effective tax rate. In addition, changesin the geographic mix or estimated level of pre-tax income can affect theoverall effective tax rate.

**Note15.        Subsequent Event**

On October 24, 2006, we announced the approval byour Board of Directors of the repurchase of 3.0 million shares of our commonstock pursuant to a stock repurchase program (“the October 2006 Program”). The repurchases may be made on the open market or in negotiated transactions,and the timing and amount of shares to be purchased will be determined by ourmanagement based on its evaluation of market and economic conditions and otherfactors. Unless terminated earlier by resolution of our Board of Directors, theOctober 2006 Program will expire upon the earlier of the date werepurchase all shares authorized for repurchase thereunder or October 23, 2007.

**Item2.      Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

This QuarterlyReport on Form 10-Q contains forward-looking statements within the meaningof Section 21E of the Securities Exchange Act of 1934, as amended, andSection 27A of the Securities Act of 1933, as amended. For purposes ofthese Acts, any statement that is not a statement of historical fact may bedeemed a forward-looking statement. For example, statements containing thewords “believes,” “anticipates,” “plans,” “expects,” “estimates,” “intends,” “may,”“projects,” “will,” “would” and similar expressions may be forward-lookingstatements. We caution investors not to place undue reliance on anyforward-looking statements in this Quarterly Report on Form 10-Q. Weundertake no obligation to publicly update any forward-looking statements,whether as a result of new information, future events or otherwise. There are anumber of factors that could cause our actual results to differ materially fromthose indicated by these forward-looking statements, including withoutlimitation the factors set forth in Part II, Item 1A under the caption “RiskFactors.”  These factors and the other cautionary statements made in thisquarterly report should be read as being applicable to all relatedforward-looking statements wherever they appear in this quarterly report. Ifone or more of these factors materialize, or if any underlying assumptionsprove incorrect, our actual results, performance, or achievements may varymaterially from any future results, performance or achievements expressed orimplied by these forward-looking statements. The following discussion andanalysis should be read in conjunction with the unaudited condensedconsolidated financial statements and related notes included elsewhere in thisQuarterly Report on Form 10-Q and the audited consolidated financialstatements and related notes included in our Annual Report on Form 10-Kfor the year ended December 31, 2005, and with the information under theheading “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in our Annual Report on Form 10-K for the year endedDecember 31, 2005.

**STRATEGY**

Our goal is to berecognized as one of the world’s premier business process and IT serviceproviders by our clients, employees, and shareholders. We believe that we canachieve this goal by helping clients transform their IT and business operationsthrough the consistent delivery of high-value consulting, development, andoutsourcing services. Specifically, we believe that applications services andbusiness process services are large and synergistic growth markets, and that asignificant business trend is corporations leveraging Application Services,Business Process Services (“BPS”), and global delivery to achieve meaningfulcost reductions and business improvement. We believe that our depth ofcapability in each of these areas, along with our vertical expertise, 

25

----

strong clientrelationships and process management capabilities, position us well tocapitalize on this market opportunity. In support of this evolution in marketdemand, we are migrating Keane’s organizational structure from a geographicnetwork of local branches to an integrated global matrix. We have termed theprocess for this transformation “One Keane.” In the future we plan to alignclient relationships and business development activities by geographic Region andVerticals, but business solutions will be designed and delivered by integratedGlobal Practices. We believe that this new organization better positions Keaneto deliver high-value, transformational solutions that bundle verticalexpertise, business process and applications services, intellectual propertythrough a technology platform or a proprietary reference architecture, and costeffective global delivery. Moreover we expect it will increase Keane’sflexibility and scalability, eliminate redundancy and excess costs, and improvethe career growth opportunities that we offer our employees.

**OVERVIEW**

**CriticalAccounting Policies**

*Stock-BasedCompensation*

Our adoption ofStatement of Financial Accounting Standard No. 123 (revised 2004)  (“SFAS 123(R)”) , “Share Based Payment,” inthe First Quarter of 2006 requires that we recognize stock-based compensationexpense associated with stock options in our statement of income, rather thandisclose it in a pro forma footnote to our consolidated financial statements.Determining the amount of stock-based compensation to be recorded requires usto develop estimates to be used in calculating the grant-date fair value ofstock options. We calculate the grant-date fair values using the Black-Scholesvaluation model. The use of valuation models requires us to make estimates ofthe following assumptions:

Expectedvolatility — We derived the estimated stock price volatility based on a reviewof our actual historic stock prices commensurate with the expected life of theaward.  We believe that the historicalstock price volatility is an accurate indicator of future stock priceperformance.

Expected optionlife — Our estimate of an expected option life was derived based on a review ofour historic option holding periods, including a consideration of the holdingperiod inherent in currently vested but unexercised options. We believe thatthis historical data is currently the best estimate of the expected term of anew option. We reviewed historical data for groups of employees and determinedthat the type of award was an indicator of the exercise behavior.

Risk-free interestrate — We used the yield on zero-coupon U.S. Treasury securities for a periodthat is commensurate with the expected term assumption as the risk-freeinterest rate. The amount of stock-based compensation recognized during aperiod is based on the value of the portion of the awards that are ultimatelyexpected to vest. SFAS 123(R) requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. The term “forfeitures” is distinctfrom “cancellations” or “expirations” and represents only the unvested portionof the surrendered option. Similar to the analysis for the expected optionlife, we reviewed historical forfeiture data for groups of employees anddetermined the appropriate forfeiture rate ranges from 0-23% for the applicableemployee group. Therefore, we have applied an annual forfeiture rate of 0-23%to all unvested options as of December 31, 2005. We will re-evaluate thisanalysis quarterly and adjust the forfeiture rate as necessary. Ultimately, wewill recognize the actual expense over the vesting period only for the sharesthat vest.

There were no other changes in our Critical AccountingPolicies during the nine months ended September 30, 2006.

**Componentsof Revenues**

We seek to helpclients improve their business and IT effectiveness. We classify our serviceofferings into the following three categories: Outsourcing,Development & Integration, and Other Services. We have not recordedany revenue associated with Transport Ticketing Solutions. See Note 6 “SignificantContracts” for a discussion of the Victoria TTA contract.

*Outsourcing:  *Our outsourcing services include Application Services and Business ProcessOutsourcing (“BPO”). Our Application Services help clients manage existingbusiness systems more efficiently and more reliably, improving the performanceof these applications while frequently reducing costs. Under our ApplicationService offering, we assume responsibility for managing a client’s businessapplications with the goal of instituting operational efficiencies that enhanceflexibility, free up client personnel resources, and achieve higher user satisfaction.We enter into large, long-term contracts for the provision of ApplicationServices, which generally do not require any capital outlay by us. Thesecontracts usually span three to five years with the ability to renew. Wetypically receive a fixed monthly fee in return for meeting or exceeding acontractually agreed upon service level. However, because our clients typicallyhave the ability to reduce services under their contracts, our monthly fees maybe reduced from the stated contract amounts. Outsourcing services also includesongoing maintenance related to the product sales for our Healthcare SolutionsDivision.

Through our globaldelivery model we can offer clients the flexibility and economic advantage ofallocating work among a variety of delivery options. These include onsite at aclient’s facility, nearshore in Halifax, Nova Scotia, and Toronto, Ontario, and

26

----

offshore at one of ourfour development centers in India. This integrated, flexible mix ofcost-effective onsite, nearshore, and offshore delivery is now a component ofmost of our new Application Services engagements. The distribution of workacross multiple locations is typically based on a client’s cost, technology,and risk management requirements.

Our BPS areprovided by our majority owned subsidiary, Keane Worldzen, which we acquired onOctober 17, 2003. Keane Worldzen specializes in providing BPS to clientswith complex processes in the financial services, insurance, and healthcareindustries, and to clients with back-office processes in several industries.Keane Worldzen’s BPS are designed to reduce the cost and increase theefficiency of our clients’ business transactions, enabling companies to focuson their more profitable activities and avoid the distraction of non-coreback-office processes. Keane Worldzen provides these low-cost, high-valueoutsourcing services from operations in both the U.S. and India.

*Development &Integration:*   As application software becomes morecomplex, it requires sophisticated integration between front-end and back-endsystems to enhance access to critical corporate data, enable processimprovements, and improve client service. Many of our Development &Integration projects focus on solutions for the integration of enterpriseapplications, supply chain, and client service problems. We also provideDevelopment & Integration services to the public sector, whichincludes agencies within the U.S. Federal Government, various states, and otherlocal government entities. Additionally, our Healthcare Solutions Divisionprovides software solutions and integration support to both acute and long-termcare providers.

*OtherServices:*   Other Services are primarily comprisedof IT consulting, business consulting, project management, and supplementalstaff engagements that are principally billed on a time and materials basis.

Global economicand political conditions may cause companies to be cautious about increasingtheir use of consulting and IT services, but we continue to see a demand forour services. We continue to experience pricing pressure from competitors aswell as from clients facing pressure to control costs. In addition, the growinguse of offshore resources to provide lower-cost service delivery capabilitieswithin our industry continues to be a source of pressure on revenues. We alsoexperience wage inflation, primarily in India, as the demand for thoseresources increases. In order for us to remain successful in the near term, wemust continue to maintain and grow our client base, provide high-quality serviceand satisfaction to our existing clients, and take advantage of cross-sellingopportunities. In the current economic environment, we must provide our clientswith service offerings that are appropriately priced, satisfy their needs, andprovide them with measurable business benefits.

There is a great deal of competition in the provisionof Outsourcing services. We believe our evolving go-to-market strategy, wherewe seek to provide high value, repeatable business solutions to our clients,differentiates us from our competitors. We offer solutions that combine variousKeane services and capabilities in response to a specific industry or clientneed.

We believe thatour deep industry knowledge differentiates us from our competitors, allowing usto go beyond simply delivering cost and performance improvements to ourclients, and allowing us to deliver transformational business benefits and,ultimately, help grow our business and integrate our comprehensivecapabilities.

**Componentsof Operating Expenses**

The primary categories of our operating expensesinclude: salaries, wages, and other direct costs; selling, general, andadministrative expenses; and amortization of intangible assets. Salaries,wages, and other direct costs are primarily driven by the cost ofclient-service personnel, which consists mainly of compensation,sub-contractor, and other personnel costs, and other non-payroll costs. Sellingexpenses are driven primarily by business development activities and clienttargeting, image-development and branding activities. General andadministrative expenses primarily include costs for non-client facingpersonnel, information systems, and office space, which we seek to manage atlevels consistent with changes in the activity levels in our business. We continue toanticipate changes in demand for our services and to identify cost managementinitiatives to balance our mix of resources to meet current and projectedfuture demand in our markets. We will also continue to use our global sourcingas part of our cost-effective delivery model.

We evaluate ourimprovement in profitability by comparing gross margins and selling, general,and administrative (“SG&A”) expenses as a percentage of revenues. Other keymetrics that we use to manage and evaluate the performance of our businessinclude new contract bookings, the number of billable personnel, andutilization rates. We calculate utilization rates by dividing the totalbillable hours per consultant by the total hours available, including sick,holiday, and vacation, from the consultant.

**EMPLOYEES**

As ofSeptember 30, 2006, we had 9,242 total employees, including 8,105 businessand technical professionals whose services are billable to clients. Thisincludes a base of 2,741 employees in India, including our Keane Worldzenoperations. We sometimes supplement our technical staff by utilizingsubcontractors, which as of September 30, 2006, consisted of 417 full-timeprofessionals.

27

----

**NEWCONTRACT BOOKINGS**

New contract bookings for the three months endedSeptember 30, 2006 were $214.7 million, a decrease of $385.8 million, or 64.2%,compared to new contract bookings of $600.4 million for the same period in2005. For the three months ended September 30, 2006, Outsourcing bookingsdecreased 79.2% to $71.2 million, Development & Integration bookingsdecreased 56.0% to $68.3 million, and Other services bookings decreased 27.0%to $75.1 million compared to the same period in 2005.

New contract bookings forthe nine months ended September 30, 2006 were $697.9 million, a decrease of$429.8 million, or 38.1%, compared to new contract bookings of $1.1 billion forsame period in 2005. For the nine months ended September 30, 2006,Outsourcing bookings decreased 58.2% to $246.4 million, Development &Integration bookings decreased 33.3% to $161.4 million, and Other servicesbookings decreased 2.0% to $290.1 million, compared to the same period in 2005.

New contract bookings for the three months and ninemonths ended September 30, 2005 include the $367.0 million TransportTicketing Authority (“TTA”) contract with the State Government of Victoria,Australia; $256.9 million of the TTA contract is included in Outsourcingbookings and $110.1 million of the TTA contract is included inDevelopment & Integration bookings.

We provide informationregarding our bookings because we believe it represents useful informationregarding changes in the volume of our new business over time. However,information regarding our new bookings is not comparable to, nor should it besubstituted for, an analysis of our revenues. Cancellations and/or reductionsin existing contracted amounts are not reflected in new contract bookings.

**CONSOLIDATEDRESULTS OF OPERATIONS**

**2006Compared to 2005**
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Increase**   | ** ** | **Nine months ended** | ** ** | **Increase**   | ** ** |
|--------------------------------|------------|----------------------------------|------------|----------------|------------|---------------------------------|------------|----------------|------------|
| ** **                     | ** ** | **September 30,**           | ** ** | **(Decrease)** | ** ** | **September 30,**          | ** ** | **(Decrease)** | ** ** |
| ** **                     | ** ** | **2006**                         | ** ** | **%**          | ** ** | **2005**                        | ** ** | **%**          | ** ** | **$** | ** ** | **%** | ** ** | **2006** | ** ** | **%** | ** ** | **2005** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| Outsourcing                    |       | $                                | 118,735    |           | 51         |                            | $          | 118,655        |       | 50 |   | $ | 80 |   | 0.1 |   | $ | 362,441 |   | 50 |   | $ | 355,028 |   | 50 |   | $ | 7,413 |   | 2.1 |   |
| Development &  Integration |       | 38,958                           |       | 17             |       | 43,052                          |       | 18             |       | (4,094 | ) | (9.5 | ) | 119,923 |   | 17 |   | 127,062 |   | 18 |   | (7,139 | ) | (5.6 | ) |
| Other IT Services              |       | 74,263                           |       | 32             |       | 77,856                          |       | 32             |       | (3,593 | ) | (4.6 | ) | 235,804 |   | 33 |   | 227,495 |   | 32 |   | 8,309 |   | 3.7 |   |
| Total                          |       | $                                | 231,956    |           | 100        | %                               | $          | 239,563        |       | 100 | % | $ | (7,607 | ) | (3.2 | ) | $ | 718,168 |   | 100 | % | $ | 709,585 |   | 100 |   | $ | 8,583 |   | 1.2 |   |

 

**Revenues**

Revenues for the ThirdQuarter ended September 30, 2006 were $232.0 million compared to revenues of$242.6 million for the Second Quarter ended June 30, 2006 and compared torevenues of $239.6 million for the Third Quarter ended September 30, 2005.Sequentially, revenues decreased by $10.7 million compared to the SecondQuarter of 2006. The decrease in revenues compared to the Second Quarterof 2006 was mainly due to lower revenues from PacifiCare (as discussed below)and other existing customers. The decrease in revenues compared to the ThirdQuarter ended September 30, 2005 was due to lower revenues from PacifiCare, thedecrease in revenues from IBM and a higher level of revenue reserves than in2005.  We recorded provisions for amounts deemed uncollectible in theThird Quarter ended September 30, 2006 as revenue reductions in the ThirdQuarter ended September 30, 2006. In addition, during the Third Quarter ended September30, 2006, we recorded a revenue reduction of approximately $2.1 million toadjust in the current period revenue that had been recorded incorrectly inprior quarterly periods, of which approximately $1.6 million related to theSecond Quarter ended June 30, 2006. In the Third Quarter endedSeptember 30, 2005, we sold our IBM business to another provider. Theselower volumes from IBM and the sale of the IBM contracts resulted in a revenuereduction of approximately $4.5 million for the Third Quarter endedSeptember 30, 2006 compared to the same period in 2005.

Revenues for the ninemonths ended September 30, 2006 were $718.2 million compared to revenues of$709.6 million for the nine months ended September 30, 2005. Thisincrease in revenues was mainly due to higher revenues from existing clientsresulting from increased client demand and higher market share of Keaneconsultants, but was partially offset by the decrease in revenues from IBM andPacifiCare (as discussed below), lower revenues from the UK and a higher levelof revenue reserves than in 2005.We recorded provisions in 2006 for amountsdeemed uncollectible as revenue reductions in the same period that thedetermination was made that the amounts were uncollectible. The lower volumesfrom IBM and the sale of the IBM contracts resulted in a revenue reduction ofapproximately $18.6 million for the nine months ended September 30, 2006compared to the same period in 2005. Additionally, effective March 31,2006, we sold certain components of our Puerto Rico operations. Thisdivestiture resulted in approximately $3.2 million of lower revenues in thenine months ended September 30, 2006 compared to 2005.

We have concluded thatobjective evidence of fair value does not exist for all of the elements withinthe Victoria TTA contract. Accordingly, each of the elements cannot beseparated into multiple units of accounting and therefore, must be accountedfor as a single unit of accounting. As a result, we are deferring all revenuesand costs directly associated with the delivery of products and services duringtwo years of development work, referred to as the Build phase, and we willrecognize all revenues and direct costs for

28

----

the contract over theten-year period of operation and maintenance, referred to as the Operate phase,currently estimated to begin in mid-2007. In 2005 and for the nine months endedSeptember 30, 2006, all revenues and direct and incremental costs associatedwith the delivery of products and services have therefore been deferred. See Note6 “Significant Contracts” in the notes to the accompanying unaudited condensedconsolidated financial statements for further discussion of our accounting forthe TTA contract.

*Outsourcing*.  Outsourcing service revenues for the Third Quarter ended September 30,2006 were $118.7 million, a decrease of $4.6 million, or 3.8%, compared to theSecond Quarter ended June 30, 2006. The sequential decrease wasprimarily due to decreased revenues generated from existing clients from ourApplication Services and lower revenues from PacifiCare.  Outsourcingrevenues for the Third Quarter ended September 30, 2006 were unchanged comparedto the Third Quarter ended September 30, 2005.  Outsourcing revenues forthe nine months ended September 30, 2006 increased $7.4 million, or 2.1%, overthe same period in 2005.  The increase in Outsourcing service revenues forthe Third Quarter and nine months ended September 30, 2006 were primarily dueto increased IT demand from existing customers, compared to the same periodsin 2005.

On December 20,2005, UnitedHealth Group Incorporated, an affiliate of United HealthCareServices, Inc. (“United HealthCare”), completed its acquisition ofPacifiCare. On January 20, 2006, we entered into a five-year masterservices agreement with United HealthCare effective January 1, 2006.Simultaneously, we and PacifiCare terminated our Information TechnologyServices Agreement, dated January 11, 2002, effective January 1,2006. Our original Information Technology Services Agreement with PacifiCareprovided for an outsourcing arrangement with a ten-year term and$500 million in contract value. As a result of the ending of the originalagreement with PacifiCare we will receive a $10.1 million payment in twoequal installments on July 30, 2006 and July 30, 2007. In July 2006,we received the first of the two payments in the amount of $5.05 million.  The first half will be recognized over the 18month period from January 1, 2006 to June 30, 2007. The second halfwill be recognized at such time as the amount becomes due in management’sjudgment. If additional services are procured pursuant to the master servicesagreement, any remaining portion of the payments will be recognized over theperiod such services are provided. Under the new master services agreement withUnited HealthCare we will receive approximately $21 million for aspecified level of services provided from January 1, 2006 throughJune 30, 2007. Revenues from PacifiCare in the three and nine months endedSeptember  30, 2006, were approximately $6.3 million and $8.3 millionlower than revenues from PacifiCare during the same periods in 2005.

*Development &Integration*.   Development & Integrationservice revenues for the Third Quarter ended September 30, 2006 were $39.0million, a decrease of $1.0 million, or 2.5% compared to the Second Quarterended June 30, 2006.  The sequential decrease was primarily due to lowerrevenues from a few existing clients in the Third Quarter ended September 30,2006. Development & Integration service revenues decreased $4.1million, or 9.5% compared to the Third Quarter ended September 30, 2005.  Development & Integration revenues forthe nine months ended September 30, 2006 decreased $7.1 million, or 5.6%,compared to the same period in 2005.  These decreases in revenues wereattributable to the termination of a client and lower revenues from the UK,which were offset in part by increased revenues from existing clients driven bymore effective client penetration strategies.

*Other Services*.  Other Services revenues for the Third Quarter ended September 30, 2006were $74.3 million, a decrease of $5.1 million, or 6.4%, compared to the SecondQuarter ended June 30, 2006. This sequential decrease was primarily due todecreased revenues for supplemental staffing placements. Other Servicesrevenues for the Third Quarter ended September 30, 2006 decreased $3.6 million,or 4.6%, and for the nine months ended September 30, 2006, increased $8.3million or 3.7%, over the same periods in 2005.  The decrease for theThird Quarter ended September 30, 2006 was due to decreased revenues fromsupplemental staffing placements and decreased revenues from IBM.  The increase for the nine months endedSeptember 30, 2006 was primarily due to overall increases in additionalsupplemental staffing placements with existing clients, which were partiallyoffset by decreased revenues from IBM.

The following tablesummarizes certain line items from our unaudited condensed consolidatedstatements of income (dollars in thousands):
| ** **                                    | ** ** | ** **                                          | ** ** | **Increase**   | ** ** | **Nine Months Ended** | ** ** | **Increase**   | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|----------------|------------|---------------------------------|------------|----------------|------------|
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** | **(Decrease)** | ** ** | **September 30,**          | ** ** | **(Decrease)** | ** ** |
| ** **                                    | ** ** | **2006**                                            | ** ** | **2005**       | ** ** | **$**                           | ** ** | **%**          | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                      |       | $                                                   | 231,956    |           | $          | 239,563                         |       | $              | (7,607     | ) | (3.2 | ) | $ | 718,168 |   | $ | 709,585 |   | $ | 8,583 |   | 1.2 |   |
| Salaries, wages,  and other direct costs |       | 166,361                                             |       | 171,016        |       | (4,655                          | )          | (2.7           | )          | 511,122 |   | 499,670 |   | 11,452 |   | 2.3 |   |
| Gross margin                                  |       | $                                                   | 65,595     |           | $          | 68,547                          |       | $              | (2,952     | ) | (4.3 | ) | $ | 207,046 |   | $ | 209,915 |   | $ | (2,869 | ) | (1.4 | ) |
| Gross margin%                                 |       | 28.3                                                | %          | 28.6           | %          |                            |       |           |       | 28.8 | % | 29.6 | % |   |   |   |   |

 

**Salaries,wages, and other direct costs**

Salaries, wages, andother direct costs for the Third Quarter ended September 30, 2006 were $166.4million, a decrease of $5.1 million, or 3.0%, compared to the Second Quarterended June 30, 2006.  Salaries, wages, and other direct costs for the ThirdQuarter ended September 30, 2006 decreased $4.7 million, or 2.7%, and for thenine months ended September 30, 2006 increased

29

----

$11.5 million, or 2.3%,over the same periods in 2005. The decrease for the Third Quarter endedSeptember 30, 2006 compared to the same period in 2005 was due to lower costsas a result of fewer U.S. and UK based billable employees,  partially offset by the increase in India andCanada based billable employees. The reduction in U.S. based billable employeeswas primarily related to the loss of business from IBM and PacifiCare asdiscussed above and the workforce reductions associated with our One KeaneTransformation.  For the nine monthsended September 30, 2006, the increase was primarily a result of the highercosts of client service personnel to support increased service revenuescompared to the same period in 2005.  Salaries, wages, and other directcosts were 71.7% of total revenues for the Third Quarter ended September 30,2006, and for the nine months ended September 30, 2006 were 71.2% of totalrevenues, compared to 71.4% and 70.4% of total revenues for the same periods in2005, respectively.

Total billable employeesfor all operations were 8,105 as of September 30, 2006, compared to 8,164 as ofJune 30, 2006 and 7,598 total billable employees as of September 30, 2005. Thisincludes 2,536 billable employees in India, which includes Keane Worldzen, andrepresents a decrease of two employees, or 0.1%, over the Second Quarter endedJune 30, 2006 and an increase of 626 employees, or 32.8%, over the ThirdQuarter ended September 30, 2005.  In addition to these employees, weoccasionally use subcontract personnel to augment our billable staff, whichrepresented 417 full-time professionals as of September 30, 2006. Overallutilization rates for all three periods remained stable as we increased thenumber of billable employees.

**Grossmargin**

Our management believesgross margin*(revenues less salaries, wages,and other direct costs)* provides an important measure of ourprofitability. Gross margin for the Third Quarter ended September 30, 2006decreased $5.5 million sequentially from the Second Quarter ended June 30,2006. Gross margin for the Third Quarter ended September 30, 2006 decreased$3.0 million, or 4.3%, and for the nine months ended September 30, 2006decreased $2.9 million, or 1.4%, over the same periods in 2005.  Grossmargin as a percentage of revenues for the Third Quarter ended September 30,2006 was 28.3% compared to 29.3% for the Second Quarter ended June 30, 2006 and28.6% for the same period in 2005. Gross margin as a percentage of revenues forthe nine months ended September 30, 2006 was 28.8% compared to 29.6% for thesame period in 2005.  The decreases in gross margin as a percentage ofrevenues during the Third Quarter and nine months ended September 30, 2006,when compared to the same periods in 2005, were partially due to the provisionsfor amounts deemed uncollectible that were recorded as revenue reductions inthe Second Quarter ended June 30, 2006 and Third Quarter ended September 30,2006 and a $1.9 million revenue reduction recorded in the First Quarter endedMarch 31, 2006.  We continue to closely monitor utilization rates andother direct costs in an effort to avoid adverse impacts on our gross margin.

**Selling,general, and administrative expenses**
| ** **                                                | ** ** | **Three Months  Ended September 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|--------------------------|------------|
| ** **                                                | ** ** | **2006**                                        | ** ** | **2005**                 | ** ** | **$**                                               | ** ** | **%**                    | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| Selling,  general, and administrative expenses (SG&A) |       | $                                               | 48,419     |                     | $          | 54,495                                              |       | $                        | (6,076     | ) | (11.1 | ) | $ | 155,907 |   | $ | 164,971 |   | $ | (9,064 | ) | (5.5 | ) |
| SG&A as a%  of revenue                                |       | 20.9                                            | %          | 22.7                     | %          |                                                |       |                     |       | 21.7 | % | 23.2 | % |   |   |   |   |
|                                                           |            |                                                 |            |                          |            |                                                     |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

SG&A expenses includesalaries for our corporate and administrative employees, sales and marketingexpenses, as well as the cost of our administrative facilities, includingrelated depreciation expense. SG&A expenses for the Third Quarter endedSeptember 30, 2006 decreased $3.2 million, or 6.2%, compared to the SecondQuarter ended June 30, 2006. SG&A expenses for the Third Quarter endedSeptember 30, 2006 decreased $6.1 million, or 11.1%, and for the nine monthsended September 30, 2006 decreased $9.1 million, or 5.5%, over the same periodsin 2005. The decreases in SG&A expenses compared to 2005 were due to lowerpersonnel costs, including salaries, benefit costs and sales commissions, andlower travel costs. These decreases in SG&A expenses offset $0.8 million ofhigher stock-based compensation for the Third Quarter ended September 30, 2006and for the nine months ended September 30, 2006, $2.0 million of higherstock-based compensation and the $1.3 million of settlement and legal costs,net of insurance proceeds, incurred in the Second Quarter of 2006 related tothe allegations against our former CEO. SG&A expenses for the Third Quarter and nine months ended September30, 2006 were 20.9% and 21.7% of total revenues, respectively, as compared to22.7% and 23.2% of total revenues, respectively, for the same periods in 2005.The decrease in SG&A expenses as a percentage of revenue for the ThirdQuarter and nine month ended September 30, 2006 was due to the lower personnelcosts.

*Stock-BasedCompensation*

On January 1, 2006,we adopted SFAS 123(R) using the modified prospective application method.We calculate compensation cost on the date of grant using the fair value of theoptions as determined by the Black-Scholes valuation model. The Black-Scholesvaluation model requires us to determine several assumptions as noted aboveunder “Critical Accounting Policies”.

The adoption of SFAS 123(R)had the following impact on our results of operations for the Third Quarter andnine months

30

----

ended September 30, 2006:income before income taxes was lower by $0.9 million and $2.4 million,respectively, net income was lower by approximately $0.6 million and $1.6million respectively, basic earnings per share (“EPS”) was lower byapproximately $.01 and $.03, respectively, and diluted EPS was lower by $.01and $.03, respectively.

On May 10, 2006, weentered into a Resignation and Consulting Agreement with Brian T. Keane, ourformer President and Chief Executive Officer. Pursuant to the Resignation andConsulting Agreement, we modified the terms of certain of Mr. Keane’s stockawards. We extended the exercise period for his vested stock options untilDecember 31, 2006 and provided that 10,000 shares of restricted stock thatwould otherwise vest on December 16, 2006 would continue to vest despite hisresignation. On June 13, 2006, we entered into a Settlement Agreement withGeorgina Fisk, our Vice President of Marketing, Brian T. Keane, our formerChief Executive Officer, John Keane, Sr., the Chairman of our Board ofDirectors, and John Keane, Jr., a member of our Board of Directors (the “SettlementAgreement”). The Settlement Agreement was entered into in connection with theresolution of Ms. Fisk’s previously reported allegations concerning BrianKeane. Pursuant to the Settlement Agreement, we modified the terms of certainof Ms. Fisk’s stock awards.  We extended the exercise period for hervested stock options until December 31, 2006 and provided that 2,500 shares ofrestricted stock that would otherwise vest on December 16, 2006 would continueto vest despite her resignation effective June 30, 2006. As a result of thesemodifications and the forfeiture of Mr. Keane’s and Ms. Fisk’s remainingunvested restricted stock and stock options during the Third Quarter and ninemonths ended September 30, 2006, we recognized $0.1 million and $0.3 million,respectively, of incremental stock-based compensation expense.

On September 29, 2006, weannounced that Richard S. Garnick, President of North American Services andGlobal Business Lines and a member of the Company’s Office of the President,was dismissed for cause effectively immediately. As a result of his dismissal andthe forfeiture of Mr. Garnick’s unvested restricted stock and stock options, werecognized a reduction $0.5 million of stock-based compensation in the ThirdQuarter ended September 30, 2006.

Prior to the adoption ofSFAS 123(R), we accounted for share-based payments to employees usingAccounting Principles Board Opinion No. 25’s (“APB 25”), “Accounting forStock Issued to Employees,” intrinsic value method and, as such, generallyrecognized no compensation cost for employee stock options. The adoption ofSFAS 123(R) under the modified prospective application method allowed usto recognize compensation cost beginning with the effective date (a) basedon the requirement of SFAS 123(R) for all share-based payments grantedafter the effective date and (b) based on the requirements of SFAS 123 forall awards granted to employees prior to the effective date of SFAS123(R) that remain unvested on the effective date. Under the modifiedprospective application method, prior periods are not restated for the effect ofSFAS 123(R).

Prior to the adoption of SFAS 123(R), during theFourth Quarter of 2005, we accelerated the vesting of certain stock options inwhich the exercise price of the award exceeded the market price of thestock on the date of acceleration. As a result of the acceleration,approximately 2.1 million shares subject to options constitutingapproximately 47% of the total of unvested options outstanding at that timebecame immediately exercisable. The acceleration impacted approximately 570employees. Under APB 25 and Financial Accounting Standards Board (“FASB”)Interpretation No. 44 (“FIN 44”), “Accounting for Certain TransactionsInvolving Stock Compensation”, no compensation expense was recognized in thefinancial statements for the acceleration of vesting of these options since theclosing common stock price per share on the dates of acceleration were greaterthan the exercise prices of the unvested options accelerated. The primarypurpose of the accelerated vesting was to enable us to avoid recognizing in ourincome statement non-cash compensation expense associated with these options infuture periods, upon our adoption of SFAS 123(R) on January 1,2006. Absent the acceleration of the options described above, from and afterour adoption of SFAS 123(R), we would have been required to recognizeapproximately $10.5 million in pre-tax non-cash compensation expense overthe remaining vesting terms of the stock options, based on valuationcalculations using the Black-Scholes option pricing model.

As of September 30, 2006,we had approximately $2.3 million of unrecognized compensation cost related tostock option awards that we expect to recognize as expense over a weightedaverage period of 3.1 years. As of September 30, 2006, we had approximately$3.0 million of unrecognized compensation cost related to restricted stockawards that we expect to recognize as expense over a weighted average period of2.3 years.

See Note 3 “Stock-BasedCompensation” in the notes to the accompanying unaudited condensed consolidatedfinancial statements for further information regarding our adoption of SFAS123(R).

**Amortizationof intangible assets**

Amortization ofintangible assets for the Third Quarter ended September 30, 2006 was $3.7million, which remained relatively unchanged compared to the same period in2005.  Amortization for the nine months ended September 30, 2006 was $11.4million, a decrease of $0.3 million or 2.2% over the same period in 2005. The decrease in amortization of intangible assets was primarily due to certainintangibles becoming fully amortized.

**Restructuringcharges, net**

During the First, Secondand Third Quarters of 2006, we reduced our workforce at certain locations by53, 59 and 7

31

----

employees, respectively,most of whom had an expected termination date within the quarter of thereduction. The employees affected by the reductions were both non-billable andbillable employees whose roles could be reduced based upon the business needsin their respective locations. As a result, we expensed $1.3 million, $1.4million and $0.1 million in the First, Second and Third Quarters of 2006,respectively, in severance costs related to our One Keane Transformation.During the nine months ended September 30, 2006, we paid $2.6 million ofseverance related to these workforce reductions. The remaining liability of$0.2 million is expected to be paid by the end of the First Quarter of2007.  While we currently do not have aformally approved plan of restructuring, we could incur additionalrestructuring costs throughout the remainder of 2006 as we continue with ourOne Keane Transformation.

The following tablesummarizes the non-operating items from our unaudited condensed consolidatedstatements of income (dollars in thousands):
| ** **                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|--------------------------|------------|
| ** **                       | ** ** | **2006**                                             | ** ** | **2005**                 | ** ** | **$**                                               | ** ** | **2006**                 | ** ** | **2005** | ** ** | **$** | ** ** |
| **Other  income (expense)**      | ** ** | ** **                                           | ** ** | ** **               | ** ** | ** **                                          | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and  dividend income    |       | $                                                    | 1,402      |                     | $          | 1,121                                               |       | $                        | 281        |   | $ | 3,887 |   | $ | 3,354 |   | $ | 533 |   |
| Interest expense                 |       | (1,542                                               | )          | (1,403                   | )          | (139                                                | )          | (4,610                   | )          | (4,225 | ) | (385 | ) |
| Other income  (expense)          |       | 97                                                   |       | (367                     | )          | 464                                                 |       | (24                      | )          | (557 | ) | 533 |   |
| Minority  interest               |       | 41                                                   |       | 158                      |       | (117                                                | )          | 25                       |       | 1,031 |   | (1,006 | ) |
| **Other  income (expense), net** |       | $                                                    | (2         | )                        | $          | (491                                                | )          | $                        | 489        |   | $ | (722 | ) | $ | (397 | ) | $ | (325 | ) |

 

**Interestand dividend income**

Interest and dividendincome for the Third Quarter ended September 30, 2006 was $1.4 million and forthe nine months ended September 30, 2006 was $3.9 million compared to $1.1million and $3.4 million for the same periods in 2005, respectively. For the ThirdQuarter and nine months ended September 30, 2006, the increases in interest anddividend income were primarily attributable to a change in the holdings of ourinvestment portfolio and higher interest rates compared to the Third Quarterand nine months ended September 30, 2005.  To the extent we use our cashand marketable securities to fund acquisitions, our operations, and capitalinvestments, our interest income will decline in future periods.

**Interestexpense**

Interest expense for the Third Quarter ended September30, 2006 was $1.5 million and was $4.6 million for the nine months ended September 30, 2006, an increaseof $0.1 million and $0.4 million, respectively, when compared to the sameperiods in 2005. Interest expense increased for the three and nine monthsended September 30, 2006 due to fees related to our line of credit, which weobtained in the Third Quarter ended September 30, 2005.  We also recordinterest expense on the accrued building costs associated with our corporatefacility as explained in Note 12 “Related Parties, Commitments, andContingencies” in the notes to the accompanying unaudited condensedconsolidated financial statements.

**Other(expense) income, net**

Other income, net was$0.1 million for the Third Quarter ended September 30, 2006, compared to otherexpense of $0.4 million for the same period in 2005.  For the nine monthsended September 30, 2006, other expense was approximately $24,000 compared toother expense of $0.6 million for the same period in 2005.  The increasein other income, net and the decrease in other expense, net for the ThirdQuarter and nine months ended September 30, 2006, respectively, were primarilydue to net foreign exchange gains recognized in 2006 compared to net foreignexchange losses recognized in 2005.

**MinorityInterest**

Minority interest incomewas approximately $41,000 and $25,000 for the Third Quarter and nine monthsended September 30, 2006, respectively, a decrease of $0.1 million and $1.0million compared to the same periods in 2005, respectively. The decreases inminority interest income were partly due to the improved profitability of KeaneWorldzen in 2006 compared to 2005. In addition, for the nine months endedSeptember 30, 2006, the decrease in minority interest income was partly due to Keane’shigher ownership percentage in Keane Worldzen effective April 1, 2005. Theamount in minority interest income represents the loss attributable to minorityshareholders of Keane Worldzen for the period presented.  We completed ouracquisition of a controlling interest in Keane Worldzen in the Fourth Quarterof 2003, which resulted in an initial equity position of approximately 62% ofthe issued and outstanding capital stock of Keane Worldzen and ourconsolidation of the results of Keane Worldzen. Consistent with the right toincrease our ownership position over time, we increased our equity position toapproximately 81% in April 2005 with an additional capital contribution ofapproximately $5.0 million in cash and $3.0 million from the conversion of anoutstanding loan to equity. Consistent with the minority shareholders’ rights,the minority shareholders exercised their first put option inDecember 2005, which required us to purchase approximately 5% of theiroutstanding shares for $2.8 million. As a result of our additional capitalcontribution and the minority shareholders’ exercise of the first put option,we own approximately 86% of the outstanding capital stock of Keane Worldzen andthe

32

----

minority interestshareholders own approximately 14% of the issued and outstanding capital stockof Keane Worldzen. We continue to consolidate the results of Keane Worldzen butrecognize 86% of the results of operations. The put options are explained infurther detail in Note 8 “Business Acquisitions” in the notes to theaccompanying condensed consolidated financial statements.

**Incometaxes**

The following tablesummarizes the changes in provision for income taxes included in our condensedconsolidated statements of income (dollars in thousands):
|                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                            | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Income before  income taxes           |       | $                                | 13,297     |                            | $          | 9,781 |   | $ | 36,173 |   | $ | 32,837 |   |
| Provision for  income taxes           |       | 4,894                            |       | 895                             |       | 12,981 |   | 9,633 |   |
| Net Income                            |       | $                                | 8,403      |                            | $          | 8,886 |   | $ | 23,192 |   | $ | 23,204 |   |
|                                  |       |                             |       |                            |       |   |   |   |   |
| **Reported  Tax Rate**                |       | 36.8                             | %          | 9.2                             | %          | 35.9 | % | 29.3 | % |
| **Impact of certain discrete  items** |       | 0.0                              | %          | 28.7                            | %          | 0.9 | % | 8.6 | % |

 

The provision for income taxes represents the amountsowed for federal, state, and foreign taxes.  Our effective tax rate was36.8% for the Third Quarter ended September 30, 2006 and was 35.9% for thefirst nine months of 2006, compared to 9.2% and 29.3% for the same periods in2005. Our effective tax rate for the Third Quarter and nine months endedSeptember 30, 2006 was impacted by the change in geographic mix of income. Oureffective tax rate for the nine months ended September 30, 2006 was alsoimpacted by the recognition of a foreign deferred tax benefit. The foreigndeferred tax benefit relates to the expiration of an India tax holiday and as aresult income is now taxable in that jurisdiction.  During the SecondQuarter ended June 30, 2006, we recorded a net deferred tax benefit as a resultof taxable timing differences in that jurisdiction.  During the Third Quarter endedSeptember 30, 2005, we recorded a $2.8 million reduction to our taxreserves due to the expiration of certain statutes of limitation. In accordancewith SFAS 5 and SFAS No. 109 (“SFAS 109”), “Accounting for Income Taxes,”we adjusted our tax reserves in the period where the conditions under SFAS 5are no longer met, which resulted in a reduction of our tax provision.  Inaddition, as a result of owning greater than 80% of the outstanding votingstock of Keane Worldzen, beginning April 1, 2005, we are able to record atax benefit on the losses associated with Keane Worldzen, thereby reducing ourannual effective tax rate.  Thedetermination of the provision for income tax expense, deferred tax assets andliabilities and related valuation allowance involves judgment by ourmanagement. As a global company, we are required to calculate and provide forincome taxes in each of the tax jurisdictions where we operate. This involvesmaking judgments regarding the recoverability of deferred tax assets, which canaffect the overall effective tax rate. In addition, changes in the geographicmix or estimated level of pre-tax income can affect the overall effective taxrate.

**Netincome**

Net income decreased to $8.4 million for the ThirdQuarter ended September 30, 2006 compared to $8.9 million for the Third Quarterended September 30, 2005. Net income for the Third Quarter ended September 30,2005 included a $2.8 million non-recurring tax benefit resulting from thereduction of our tax reserves due to the expiration of certain statutes oflimitation. The decrease in net income is primarily due to the absence of thisnon-recurring tax benefit that was partially offset by higher operating incomein 2006. Net income was unchanged for the nine months ended September 30, 2006compared to the same period in 2005.

**RECENTACCOUNTING PRONOUNCEMENTS**

On September 29, 2006, the FASB issued Statement No.158 (“SFAS 158”), “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and132(R).” SFAS 158 represents the completion of the first phase in the FASB’spostretirement benefits accounting project and requires an entity to:

·                  recognize in its statement offinancial position an asset for a defined benefit postretirement plan’soverfunded status or a liability for a plan’s underfunded status,

·                  measure a defined benefitpostretirement plan’s assets and obligations that determine its funded statusas of the end of the employer’s fiscal year, and

·                  recognize changes in the fundedstatus of a defined benefit postretirement plan in comprehensive income in theyear in which the changes occur.

33

----

SFAS 158 does not changethe amount of net periodic benefit cost included in net income or address thevarious measurement issues associated with postretirement benefit planaccounting. The requirement to recognize the funded status of a defined benefitpostretirement plan and the disclosure requirements are effective for fiscalyears ending after December 15, 2006 for public entities. The requirement tomeasure plan assets and benefit obligations as of the date of the employer’sfiscal year-end statement of financial position is effective for fiscal yearsending after December 15, 2008.

The new standard amends FASB Statement No. 87, (“SFAS87”), “Employers’ Accounting for Pensions”, Statement No. 88 (“SFAS 88”), “Employers’ Accounting for Settlements andCurtailments of Defined Benefit Pension Plans and for Termination Benefits,”Statement No. 106 (“SFAS 106”), “Employers’ Accounting for PostretirementBenefits Other Than Pensions,” and Statement No. 132 (revised 2003) (“SFAS 132(R)”), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”and applies to all plan sponsors who offer defined benefit postretirementbenefit plans.  We do not expect theadoption of SFAS 158 will have a significant impact on our consolidatedfinancial position, results of operations and cash flows.

OnSeptember 15, 2006, the FASB issued FASB Statement No. 157 (“SFAS 157”), “FairValue Measurement.” The standard provides guidance for using fair value tomeasure assets and liabilities. The standard also responds to investors’requests for expanded information about the extent to which companies measureassets and liabilities at fair value, the information used to measure fairvalue, and the effect of fair value measurements on earnings. SFAS 157 applieswhenever other standards require (or permit) assets or liabilities to bemeasured at fair value. SFAS 157 does not expand the use of fair value in anynew circumstances. SFAS 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years. We are evaluating the impact of SFAS 157 on ourconsolidated financial position, results of operations and cash flows.

In July 2006, the FASBissued FASB Interpretation (“FIN”) No. 48 (“FIN 48”), “Accounting forUncertainty in Income Taxes - An Interpretation of FASB Statement No. 109.” FIN48 clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with FASB Statement No. 109, “Accountingfor Income Taxes.” FIN 48 also prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return and providesguidance on derecognition, classification, interest and penalties, andaccounting in interim periods, disclosure, and transition.

The evaluation of a taxposition in accordance with FIN 48 is a two-step process. The first step is arecognition process whereby the enterprise determines whether it is more likelythan not that a tax position will be sustained upon examination, includingresolution of any related appeals or litigation processes, based on thetechnical merits of the position. In evaluating whether a tax position has metthe more-likely-than-not recognition threshold, the enterprise should presumethat the position will be examined by the appropriate taxing authority that hasfull knowledge of all relevant information. The second step is a measurementprocess whereby a tax position that meets the more-likely-than-not recognitionthreshold is calculated to determine the amount of benefit to recognize in thefinancial statements. The tax position is measured at the largest amount ofbenefit that is greater than 50% likely of being realized upon ultimatesettlement.

The provisions of FIN 48are effective for fiscal years beginning after December 15, 2006. Theprovisions of FIN 48 are to be applied to all tax positions upon initialadoption of this standard. Only tax positions that meet themore-likely-than-not recognition threshold at the effective date may berecognized or continue to be recognized upon adoption of FIN 48. The cumulativeeffect of applying the provisions of FIN 48 should be reported as an adjustmentto the opening balance of retained earnings (or other appropriate components ofequity or net assets in the statement of financial position) for that fiscalyear. We are evaluating the impact of FIN 48 on our consolidated financialposition, results of operations and cash flows.

In February 2006,the FASB issued SFAS No. 155 (“SFAS 155”), “Accounting for Certain HybridInstruments.” This Statement amends FASB Statements No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.” SFAS 155 resolves issues addressed in Statement 133Implementation Issue No. D1, “Application of Statement 133 to BeneficialInterests in Securitized Financial Assets.”  This Statement is effectivefor all financial instruments acquired or issued after the beginning of anentity’s first fiscal year that begins after September 15, 2006. We do notbelieve the adoption of SFAS 155 will have a material impact on ourconsolidated financial position, results of operations or cash flows.

**LIQUIDITYAND CAPITAL RESOURCES**

**ConsolidatedFinancial Condition (in thousands)**
| **Nine Months Ended September 30,** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash Flows  Provided By (Used For)                      |       |     |       |     |       |
| Operating  activities                                   |       | $        | 5,597      |     | $          | 7,376 |   |
| Investing  activities                                   |       | 99       |       | 8,083    |       |
| Financing  activities                                   |       | 1,549    |       | (39,233  | )          |
| Effect of  exchange rate on cash                        |       | (98      | )          | (217     | )          |
|                                                    |       |     |       |     |       |
| Increase (decrease) in  Cash and cash equivalents       |       | $        | 7,147      |     | $          | (23,991 | ) |

 

34

----

We have historicallyfinanced our operations with cash generated from operations. In addition, in2003, we raised $150.0 million in proceeds from the issuance of our debentures.We use the net cash generated from these sources to fund capital expenditures,mergers and acquisitions, and stock repurchases. If we were to experience adecrease in revenue as a result of a decrease in demand for our services or adecrease in our ability to collect receivables, we would be required to reducediscretionary spending related to SG&A expenses and adjust our workforce inan effort to maintain profitability. As of September 30, 2006, we had $165.7million in cash and cash equivalents and marketable securities. In addition, onSeptember 15, 2005, we entered into a $200 million five-year creditfacility. Our borrowing capacity is based on certain financial ratios asdefined in the credit facility. As of September 30, 2006, there was approximately$130.0 million available for borrowing after considering $34.6 million ofoutstanding letters of credit and after considering certain financial ratios.We intend to continue to use our cash and cash equivalents and marketablesecurities for general corporate purposes, which may include additionalrepurchases of our common stock under existing or future share repurchaseprograms and the funding of future acquisitions and other corporatetransactions.

**Cashflows provided by operating activities**

Net cash provided byoperating activities totaled $5.6 million for the nine months ended September30, 2006 compared to net cash provided by operating activities of $7.4 millionfor the nine months ended September 30, 2005.  The decrease in net cashprovided by operating activities was driven by slower accounts receivablecollection, timing of cash payments made and approximately $10.0 million ofpayments made associated with the TTA contract. The impact of the lowercollection of accounts receivable was partially offset by the receipt of thefirst $5.05 million payment from PacifiCare associated with the termination ofour original agreement effective January 1, 2006. We completed theimplementation of the Time Reporting, Contracts Management, Project Accounting,and Billing PeopleSoft modules for our North American Services during theSecond Quarter of 2006. As a result, we experienced delays in invoicing ourcustomers. These delays, combined with the changes in personnel resulting fromthe One Keane Transformation, resulted in slower collection of our accountsreceivable. Days Sales Outstanding (“DSO”), an indicator of the effectivenessof our accounts receivable collections, was 70 days as of September 30, 2006,compared to 58 days as of December 31, 2005 and 56 days as of September 30,2005. We calculate DSO using the trailing three months total revenue divided bythe number of days in the quarter to determine daily revenue.  The averageaccounts receivable balance for the three-month period is then divided by dailyrevenue.

**Cashflows provided by investing activities**

Net cash provided byinvesting activities for the nine months ended September 30, 2006 was $0.1million compared to net cash provided by investing activities of $8.1 millionfor the nine months ended September 30, 2005.

*MarketableSecurities:* During the nine months ended September 30, 2006,we purchased $75.1 million and sold $84.8 million in marketable securities,generating a net source of cash of $9.7 million, compared to purchases of $35.4million and sales of $58.2 million, which generated a net source of cash of$22.8 million in the first nine months of 2005.  The net proceeds fromthese transactions were used to fund our share repurchases and our operationalrequirements.

*Propertyand Equipment:* We invested $8.3 million in property andequipment for the nine months ended September 30, 2006, primarily to purchasesoftware, computers and computer related equipment for our U.S. operations andproperty and equipment to support our growing operations in Australia andIndia.  During the nine months ended September 30, 2005, we invested $10.7million into property and equipment and capitalized software costs inconnection with the implementation of our PeopleSoft Enterprise ResourcePlanning applications.  During the nine months ended September 30, 2006,we received proceeds of $1.6 million related to the sale of severalcondominiums that had been in the past used as an employee benefit.

*BusinessAcquisitions:* On June 1, 2005, we acquired Cresta.  In exchangefor all of the outstanding capital stock of Cresta, we paid $0.6 million incash, of which $60,000 was held back to secure indemnification obligations ofthe Cresta stockholders, with the potential to pay up to an additional $0.5million in earn-out consideration over the two years from acquisition,contingent upon the achievement of certain future financial targets. The$60,000 held back was initially deposited as restricted cash and accrued inAccrued expenses and other liabilities in the accompanying unaudited condensedconsolidated balance sheet. We delivered the $60,000 to the former Crestastockholders during the Third Quarter ended September 30, 2006.

On February 28, 2005, weacquired netNumina. In exchange for all of the outstanding capital stock ofnetNumina, we agreed to pay $5.7 million, of which $0.6 million was held backto secure indemnification obligations of the netNumina stockholders andacquired $4.6 million in cash.  As of September 30, 2005, we had paid the$5.1 million not held back based on the NetNumina stock certificatessurrendered for cancellation.  The $0.6 million held back was initiallydeposited as restricted cash and during the First Quarter of 2006 was deliveredto the former NetNumina stockholders.

On February 27, 2004,we acquired Nims Associates Inc. (“Nims”). We paid $18.2 million in cash,including transaction costs and net of cash acquired, for all of theoutstanding capital stock of Nims. The purchase price may increase with thepotential to pay up to an additional $15.0 million in earn-outconsideration over three years from the acquisition, contingent upon theachievement

35

----

of certain futurefinancial targets. The first earn-out was achieved as of March 1, 2005and, as a result, we paid $3.3 million in earn-out consideration inApril 2005. Based on Nims’ financial performance as of December 31,2005, the second earn-out was achieved. As a result, we accrued an additional$3.3 million in earn-out consideration as of December 31, 2005, whichwe paid in April of 2006. In addition to the first two earn-outs,there is an additional potential $8.3 million in earn-out considerations that,as of September 30, 2006, could be achieved over the next five months.

On July 13, 2004, we acquired Fast Track HoldingsLimited (“Fast Track”), a privately held consulting firm based in the UnitedKingdom that manages the design, integration, and deployment of large-scale SAPimplementations. In exchange for all of Fast Track’s outstanding capital stock,we paid approximately $3.4 million in cash, including transaction costsand $0.6 million which was held in escrow to secure indemnification obligationsof the Fast Track shareholders. We also agreed to pay up to an additionalapproximately $5.0 million in earn-out consideration over the two yearsfrom acquisition, contingent upon the achievement of certain future financialtargets. No earn-out consideration was paid. Additionally, we delivered thehold back to the former Fast Track shareholders in August 2006.

**Cashflows provided by (used for) financing activities**

Net cash flows providedby financing activities was $1.5 million for the nine months ended September30, 2006, compared to net cash used for financing activities of $39.2 millionfor the nine months ended September 30, 2005. Net cash flows related tofinancing activities for both 2006 and 2005 were primarily for the repurchaseof our common stock, and were partially offset by proceeds received from theissuance of stock associated with our employee stock purchase and stock option plans. In addition, as a result of the adoption of FAS 123(R), cash flows provided byfinancing activities include a $1.2 million tax benefit associated withstock-option exercises. The following is a summary of our repurchase activityfor the nine months ended September 30, 2006 and 2005 (dollars in thousands):
| ** **                                    | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                    | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
|                                          |       |       |       |       |       |   |   |   |   |
| Prior year  authorizations at January 1, |       | 2,553,900  |       |       |       | 2,871,600 |   |   |   |
| Authorizations                                |       | —     |       |       |       | 3,000,000 |   |   |   |
| Repurchases paid                              |       | (726,800   | )          | $          | 9,290      |   | (3,367,220 | ) | $ | 42,113 |   |
| Repurchases  accrued                          |       | —     |       |       |       | (150,000 | ) | $ | 1,700 |   |
| Expirations                                   |       | —     |       |       |       | (1,763,900 | ) |   |   |
| Shares remaining as of  September 30,    |       | 1,827,100  |       |       |       | 590,480 |   |   |   |
|                                               |            |            |            |            |            |  |  |  |  |  |  |

 

On October 24, 2006, we announced the approval byour Board of Directors of a program for the repurchase of 3.0 million shares ofour common stock (“the October 2006 Program”).  The repurchases maybe made on the open market or in negotiated transactions, and the timing andamount of shares to be purchased will be determined by our management based onits evaluation of market and economic conditions and other factors. Unlessterminated earlier by resolution of our Board of Directors, theOctober 2006 Program will expire upon the earlier of the date werepurchase all shares authorized for repurchase thereunder or October 23,2007.

On October 25, 2005,we announced the approval by our Board of Directors of a program for therepurchase of 3.0 million shares of our common stock (“the October 2005Program”), which authorized repurchases to be made on the open market or innegotiated transactions, and the timing and amount of shares to be purchased tobe determined by our management based on its evaluation of market and economicconditions and other factors. The October 2005 Program will expired onOctober 25, 2006.

These share repurchasesmore than offset the shares issued under our various stock incentive programs.Under these stock incentive programs, we issued 977,636 shares and 399,347shares and received proceeds of $9.7 million and $4.4 million for the ninemonths ended September 30, 2006 and 2005, respectively. BetweenMay 1999 and September 30, 2006, we have invested approximately$324.0 million to repurchase approximately 25.9 million shares of our commonstock under twelve separate authorizations.

In February 2003, weentered into a $50.0 million unsecured revolving credit facility (the “creditfacility”) with two banks. The terms of the credit facility required us tomaintain a maximum total funded debt and other financial ratios. The creditfacility also included covenants that, subject to certain specific exceptionsand limitations, among other things, restricted our ability to incur additionaldebt, make certain acquisitions or dispositions of assets, create liens, andpay dividends. Between June 2003 and July 2005, we and the two banksamended certain provisions of the credit facility including the allowable limitfor letters of credit within the total facility and for the purposes of issuinga letter of credit to satisfy bank guarantees with respect to the TransportTicketing Authority (“TTA”) contract with the State of Victoria, Australia. Oneof the banks issued a $33.8 million ($45 million AUD) letter of credit datedJuly 14, 2005 against our credit facility in connection with our VictoriaTTA contract. This credit facility was terminated in connection with ourentrance into a new credit facility, described below, in September 2005.

On September 15, 2005, we entered into afive-year revolving credit facility (the “new credit facility”) with asyndicate of banks (the “lenders”) in the amount of $200.0 million, plus anadditional amount of up to $50.0 million subject to certain terms and

36

----

conditions (the “loanamount”). The new credit facility has various nonfinancial and financialcovenants, which include a total leverage ratio, a senior leverage ratio and aquick ratio. Our borrowing capacity is based on certain financial ratios asdefined under the new credit facility. The new credit facility replaced ourprevious $50.0 million unsecured revolving credit facility. Pursuant to the newcredit facility, we may borrow funds from the lenders up to the loan amountwith a $50.0 million sub limit for letters of credit. During the First Quarterof 2006, we amended the new credit facility to allow for certain foreigncurrency hedging at the subsidiary level. The annual commitment fee payablequarterly is at an initial rate of 0.20% per annum on the unused amount ofrevolving credit commitments, subject to adjustment based on a senior leverageratio as defined in the new credit facility and up to a maximum per annum rateof 0.25%. To the extent there are letters of credit outstanding under the newcredit facility, we will pay the administrative agent a letter of credit fee,initially 1.0% annually, subject to adjustment based on the senior leverageratio as defined in the new credit facility, and up to a maximum per annum rateof 1.5%. In connection with the new credit facility, we paid $1.3 million inrelated debt issuance costs. As of September 30, 2006, we had no debt outstanding underthe new credit facility. However, there are $34.6 million of outstandingletters of credit against the new credit facility, which include the $33.8million ($45 million AUD) letters of credit issued in July 2005 againstour previous credit facility in connection with our Victoria TTA contract.

Based on our currentoperating plan, we believe that our cash and cash equivalents on hand,marketable securities, cash flows from operations, and our new credit facility willbe sufficient to meet our current capital requirements for at least the next12 months.

In connection withcertain contracts, we have been required to deliver security or performancebonds for the benefit of our clients. These bonds give the beneficiary theright to obtain payment from the issuer of the bond if certain specified eventsoccur or fail to occur. In addition, we have various agreements in which we maybe obligated to indemnify our clients or third parties with respect to certainmatters. Generally, these indemnification provisions are included in contractsarising in the normal course of business under which we customarily agree tohold the indemnified party harmless against losses arising from a breach ofrepresentations related to such matters as title to assets sold and licensed orcertain intellectual property rights, improper disclosures of confidentialinformation, personal injuries or property damages. Typically, there are nospecific dollar limits associated with indemnifications. In general, the termof the indemnifications will correspond to the contract term such that the harmor damage must occur during the contract period. Therefore, claims may beraised after completion of the contract associated with the indemnificationprovision, but the damage must have been caused during the contract term. As aprime contractor under certain contracts, we are responsible for theperformance of our subcontractors and would be required to arrange forperformance in the event the subcontractors failed to perform. However, wewould retain our right to enforce the subcontracts and to seek damages fornonperformance from our subcontractors. A limited number of our contractsinclude liquidated damages provisions, which would require us to make per diempayments for late deliveries. Further, our obligations under these agreementsmay be limited in terms of time and/or amount and, in some instances, we mayhave recourse against third parties, including our subcontractors, for certainpayments made by us. It is not possible to predict the maximum potential amountof future payments under these indemnification agreements due to theconditional nature of our obligations and the unique facts of each particularagreement.

We have agreed tonumerous indemnification provisions in connection with the Victoria TTAcontract. As the prime contractor for the Victoria TTA contract, Kamco is thebeneficiary of corresponding indemnifications obligations by itssubcontractors. Subject to a number of exclusions, Kamco’s maximum liability iscapped at $75.2 million ($100 million AUD). Under the Victoria TTAcontract, liquidated damages, for which Kamco may be liable, are assessed at$37,590 ($50,000 AUD) per day for each day the specified phase completion isbehind schedule, but are limited to $7.5 million ($10 million AUD).The first $3.8 million ($5 million AUD) in liquidated damages issplit evenly amongst Kamco and certain subcontractors. The next$3.8 million ($5 million AUD) is apportioned based onresponsibility for the delay. In addition, we have a total of$33.8 million ($45 million AUD) letters of credit issued against thenew facility as surety bonds to ensure due and proper performance of ourobligations under the Victoria TTA contract.

**Increase(Decrease) in Cash and Cash Equivalents**

Our cash and cashequivalents totaled $78.7 million and $43.5 million at September 30, 2006, and2005, respectively.

**IMPACTOF INFLATION AND CHANGING PRICES**

Inflationary increases incosts have not been material in recent years and, to the extent permitted bycompetitive pressures, are passed on to clients through increased billingrates. Rates charged by us are based on the cost of labor and market conditionswithin the industry.

**Item 3.            Quantitativeand Qualitative Disclosures About Market Risk**

We do not engage intrading market risk, sensitive instruments or purchasing hedging instruments or“other than trading” instruments that are likely to expose us to market risk,whether interest rate, foreign currency exchange, and commodity price or equityprice risk. We have not purchased options or entered into swaps or forward orfutures contracts. However, on October 20, 2005, our Board of Directorsapproved our foreign exchange risk management policy, which allows us to investin hedging instruments for

37

----

the purpose of hedgingforeign currency risk.

*InterestRate Risk*

We invest primarily inU.S. government obligations as well as corporate bonds and tax-exempt municipalbonds. As a result, our primary market risk exposure is that of interest raterisk to our investments, which would affect the carrying value of thoseinvestments. During 2004, the United States Federal Reserve Board beganincreasing benchmark interest rates and at the June 2006 meeting of theFederal Open Market Committee increased rates for the seventeenth time, a totalof 425 basis points. A significant increase in interest rates would increasethe rate of return on our cash and cash equivalents, but would have a negativeimpact on the carrying value of our marketable securities. For the nine monthsended September 30, 2006, our interest income would increase by approximately$0.8 million with a 100 basis point increase in rates, and decrease byapproximately $0.6 million with a 100 basis point decrease in rates.  For the nine months ended September 30,2005, our interest income would change by approximately $0.6 millionrespectively, for each 100 basis point increase or decrease in interestrates. The fair value of our investment portfolio at September 30, 2006would decrease by approximately $0.3 million for a 100 basis point increase inrates and decrease by approximately $0.2 million for a 100 basis point increasein rates.  The fair value of ourinvestment portfolio at December 31, 2005 would decrease by approximately$1.0 million for a 100 basis point increase in rates and increase byapproximately $0.9 million for each 100 basis point decrease in rates.

Changes in market ratesand the related impact on the fair value of our investments would not generallyaffect net income as our investments are fixed rate securities and areclassified as available-for-sale. Investments classified as available-for-saleare carried at fair value with unrealized gains and losses recorded as acomponent of accumulated other comprehensive loss in the accompanyingconsolidated balance sheets. However, when the investments are sold, theunrealized losses are recorded as realized losses and included in net income inthe accompanying consolidated statements of income.

As of September 30,2006 we held available-for-sale securities that had aggregate gross unrealizedlosses of approximately $0.6 million, which represents a decrease ofapproximately $0.6 million and $0.7 million from December 31, 2005 andSeptember 30, 2005, respectively. In November 2005, the FASB issued StaffPosition No. FAS 115-1 (“FSP 115-1”), “The Meaning ofOther-Than-Temporary Impairment and its Application to Certain Investments.”FSP 115-1 provides accounting guidance for determining and measuringother-than-temporary impairments of debt and equity securities, and confirmsthe disclosure requirements for investments in unrealized loss positions asoutlined in EITF 03-01. We analyze our investments for impairments on anongoing basis. Factors considered in determining whether a loss is temporaryinclude the length of time and extent to which the securities have been in anunrealized loss position and our ability and intent to hold the investment fora period of time sufficient to allow for any anticipated market recovery. All suchsecurities have been in a continuous unrealized loss position for lessthan 12 months, except for the $12.3 million of Long-term marketablesecurities included in the accompanying unaudited condensed consolidatedbalance sheet. As of September 30, 2006, we have classified thesesecurities as long-term as they have been in an unrealized loss position formore than 12 months and mature beyond September 30, 2007. We believethat the impairments to these investments are not other-than-temporary at thistime as these securities are all highly rated investments which have beensubject to routine market changes that have not been significant to date and wehave the ability and intent to hold these investments for a period of timesufficient to allow for the anticipated market recovery.

*ForeignCurrency Ris*k

We transact business inthe UK, Canada, India, and Australia and as a result have exposure associatedwith movement in foreign currency exchange rates. For the three months endedSeptember 30, 2006, the fluctuation in foreign currency exchange ratespositively impacted operating income by approximately $0.1 million as comparedto the same period in 2005.  For the ninemonths ended September 30, 2006, the fluctuation in foreign currency exchangerates negatively impacted operating income by approximately $0.4 million.  Relative to the foreign currency exposuresexisting at September 30, 2006, a 10% unfavorable movement would haveresulted in an additional $2.2 million and $6.6 million reduction of operatingincome for the three and nine months ended September 30, 2006. Netrevenues derived from our foreign operations totaled approximately 5% of ourtotal revenues for both the three and nine months ended September 30,2006, respectively, and totaled approximately 6% for both the three and ninemonths ended September 30, 2005, respectively. We have adopted a policyallowing and governing the hedging of foreign currency; however, as ofSeptember 30, 2006, we had not engaged in any hedging transactions.

**Item 4.            Controlsand Procedures**

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

Our management, with theparticipation of our Executive Vice President of Finance and Administration andChief Financial Officer, who is also our Interim President and Chief ExecutiveOfficer, evaluated the effectiveness of our disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) under the ExchangeAct) as of September 30, 2006. Based on this evaluation, our InterimPresident and Chief Executive Officer, Executive Vice President of Finance andAdministration and Chief Financial Officer concluded that, as of September 30,2006, our disclosure controls and procedures were not effective at ensuringthat the

38

----

information required tobe disclosed by the Company in reports that it files or submits under theSecurities Exchange Act of 1934, as amended, is recorded, processed,summarized, and reported as required in applicable SEC rules and forms becauseof the deficiencies in internal controls over financial reporting describedbelow.

We have concluded that,due to the significant organizational and process changes which occurred in ourfield operations as part of the One Keane reorganization initiative, as well asthe implementation of a PeopleSoft Enterprise Resource Planning system, some ofour key controls in the area of revenue recognition were not operatingeffectively. Specifically, we identified the following control deficiencies:

·                  A quality assurance process to ensurenew contracts or projects are initiated properly for revenue recognitionpurposes in our PeopleSoft ERP system was not operating consistently.

·                  The report generated by ourPeopleSoft ERP system used to analyze our unbilled work-in-process was notproviding adequately detailed data at the project level and was not agingactivity accurately.

·                  The criteria that had beenestablished for new contracts or projects which require review by our corporateaccounting organization at initiation for appropriate revenue recognitiontreatment was not sufficiently comprehensive to ensure all contracts whichcould materially impact revenue were reviewed.

These deficiencies wereidentified by our management in reviewing project level activity on twoaccounts during the third quarter.  Dueto this review we performed additional analyses and procedures and are takingthe following actions to remediate the deficiencies:

·                  New PeopleSoft queries are beingdeveloped and implemented to monitor revenue recognition related set-up acrossall reporting units at the corporate level of our business.

·                  A new Contract/Project initiationprocess is being implemented and a quality review assurance process will bere-instituted to evaluate if the contract/project has been appropriately set-upin our PeopleSoft system.

·                  The functionality of the PeopleSoftwork-in-progress report is being enhanced to provide greater detail at theproject level and accurate aging of activity.

·                  The field finance organization whichsets up new contracts and projects in our PeopleSoft system has beenre-organized and now reports to our Vice President and Controller.

Additional remediation is in process.  Specifically, we are expanding the criteriafor new contracts or projects that require review by our corporate accountingorganization for appropriate revenue recognition to include review of contractsat lower thresholds and for additional contractual scenarios.  We are enhancing our quality review assuranceprocess to include aspects of the contract/project set-up process notpreviously reviewed.  Finally, we arecontinuing to work to improve our PeopleSoft work-in-progress report to enablea more efficient review of the detail at the project level.

**Changesin Internal Control Over Financial Reporting**

We have completed theprocess of implementing a PeopleSoft Enterprise Resource Planning (“ERP”)system for our North American Services. During the Third Quarter of 2006, wecompleted the phase in of the Time Reporting, Contracts Management, ProjectAccounting, and Billing modules in our ERP system for our North AmericanServices organization.  All other changesin our internal controls over financial reporting (as defined inRules 13a-15(f) and 15d-15(f) under the Exchange Act) during thequarter ended September 30, 2006 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting are disclosed above.

**Part II.   OtherInformation**

**Item 1.    LegalProceedings**

On September 29, 2006, weannounced that Richard S. Garnick, President of North American Services andGlobal Business Lines and a member of the Company’s Office of the President,was dismissed for cause effective on that date. On October 3, 2006, Mr. Garnickfiled a lawsuit in Suffolk Superior Court in the Commonwealth of Massachusettsagainst the Company and John Leahy, our Interim President and Chief ExecutiveOfficer, asserting claims for breach of contract with damages of approximately$2.0 million, defamation, invasion of privacy, and tortious interference withcontractual relations with unspecified damages. The Company intends tovigorously defend against the claim.

39

----

**Item 1A.         RiskFactors**

The following importantfactors, among others, could cause actual results to differ materially fromthose indicated by forward-looking statements made in this Quarterly Report onForm 10-Q and presented elsewhere by management from time-to-time.

**Our“One Keane” Transformation initiative may not be successfully implemented,which could materially affect our results of operations.**    We are continuing with our a multi-faceted internalreorganization, which we call the “One Keane Transformation.” Our goals inimplementing the One Keane Transformation include: the replacement of ourcurrent regional operations structure with an overlapping structure includingregional client relationship organizations, delivery organizations based onglobal practices (such as applications services and business transformationservices) and vertical industry expertise (including financial services andhealth care) and global shared services for sales and human resources, aimed atlowering cost. We expect that the One Keane Transformation will be an ongoingprocess and will touch all areas of Keane, requiring significant internalresources, including significant attention from our management. If we areunable to successfully implement the One Keane Transformation, or a successfulimplementation does not achieve our stated objectives, it could result in lossof employee morale, an inability to lower our delivery costs and compete in theglobal market, and could materially affect our results of operations.

**Ourengagement with Melbourne, Victoria Transport Ticketing Authority, or theVictoria TTA contract, exposes us to a number of different risks inherent insuch long-term, large-scale, fixed-fee projects.**  Wehave been awarded a contract to perform services in relation to thedevelopment, operation and maintenance of a public transport ticketing systemfor the state of Victoria, Australia. This engagement will require significantmanagement attention and financial resources, and could adversely affect ourresults of operations in a number of ways. These include:

·                                          initialcosts that could potentially result in lower operating margins for the projectin the beginning stages;

·                                          difficultiesand costs of staffing and managing complex projects and operations in a newgeographic marketplace;

·                                          dependenceon subcontractors and potential subcontractor non-performance;

·                                          atcertain times, the TTA may terminate the Victoria TTA contract for convenience,subject to certain termination fees and for events of default, subject to ourwholly-owned subsidiary Kamco’s right to cure;

·                                          complexitiesin interpreting and delivering the broad range of functional and technicalrequirements required under the project contract;

·                                          difficultiesin working with multiple parties in defining these functional and technicalrequirements and achieving acceptance of deliverables;

·                                          projectdelays, which could expose us to liquidating damages;

·                                          fluctuationsin foreign currency exchange rates;

·                                          theadditional liability we have undertaken both to guarantee performance of oursubsidiary under the contract and the entrance into performance and securitybonds under our credit facility.

**Ourquarterly operating results have varied, and are likely to continue to varysignificantly. This may result in volatility in the market price of our commonstock. We have experienced and expect to continue to experiencefluctuations in our quarterly results. Our gross margins vary based on avariety of factors including employee utilization rates and the number and typeof services performed during a particular period. A variety of factorsinfluence our revenue in a particular quarter, including:**

·                                          generaleconomic conditions, which may influence investment decisions or causedownsizing;

·                                          thenumber and requirements of client engagements;

·                                          employeeutilization rates;

·                                          changesin the rates we can charge clients for services;

·                                          acquisitions;and

·                                          otherfactors, many of which are beyond our control.

A significant portion ofour expenses does not vary relative to revenue. As a result, if revenue in aparticular quarter does not meet expectations, our operating results could bematerially adversely affected, which in turn may have a material adverse impacton the market price of our common stock. In addition, many of our engagementsare terminable without client penalty. An unanticipated termination of a majorproject could result in an increase in underutilized employees and a decreasein revenue and profits.

**Wecontinue to position ourselves to achieve increasing percentages of revenuesand growth through outsourcing. If we are successful in obtaining newoutsourcing contracts, we may experience increased pressure on our overallmargins during the early stages of these contracts. **Thisstrategy could result in higher concentrations of revenues and contributions toincome from a smaller number of larger clients contracting for customizedoutsourcing solutions. If we were to receive a higher concentration of ourrevenues from a smaller number of clients, our revenues could decreasesignificantly if one or more of these clients decreased their spending.Outsourcing contracts are generally long-term contracts that require additionalstaffing in the initial

40

----

phases of the contractperiod, which often results in lower gross margins at the beginning of thesecontracts.

**Ifour clients are not satisfied with our services, we may have exposure toliabilities, which could adversely affect our profitability and financialcondition as well as our ability to compete for future work.**   If we fail to meet our contractual obligations, we could besubject to legal liability, which could adversely affect our business,operating results and financial condition. The provisions we typically includein our contracts that are designed to limit our exposure to legal claimsrelating to our services and the applications we develop may not protect us ormay not be enforceable under some circumstances or under the laws of somejurisdictions. It is possible, because of the nature of our business, that wewill be sued in the future. In addition, although we maintain professionalliability insurance, the policy limits may not be adequate to provideprotection against all potential liabilities. Moreover, as a consulting firm,we depend to a large extent on our relationships with our clients and ourreputation for high-quality services to retain and attract clients andemployees. As a result, claims made against our work may damage our reputation,which in turn, could impact our ability to compete for new work and negativelyimpact our revenue and profitability.

**The termination of a contract by asignificant client could reduce our revenue and profitability or adverselyaffect our financial condition.  **  Our five largest clients, excluding thefederal government, accounted for approximately 26.3% and 24.4% of our revenuefor the three and nine months ended September 30, 2006, respectively, althoughno individual client accounted for more than 7.5% and 6.9%, respectively, ofour total revenue for either period. The various agencies of the federal governmentrepresent our largest client, accounting for approximately 11.7% and 11.1% oftotal revenue for the three and nine months ended September 30, 2006,respectively.  We strive to develop long-term relationships with ourclients. Most individual client assignmentsare from three to twelve months; however, many of our client relationships havecontinued for many years. Our clients typically retain us on a non-exclusive,engagement-by-engagement basis. Although they may be subject to penaltyprovisions, clients may generally cancel a contract at any time. Under manycontracts, clients may reduce their use of our services under such contractswithout penalty. In addition, contracts with the federal government containprovisions and are subject to laws and regulations that provide the federalgovernment with rights and remedies not typically found in commercialcontracts. Among other things, the federal government, as well as other publicsector clients, may terminate contracts with short notice, for convenience andmay cancel multi-year contracts if funds become unavailable. The TTA also hasthe ability to terminate its contract with us for convenience, subject to thepayment of termination fees.  If contracts are terminated, our revenue maydecline and if we are unable to eliminate associated costs in a timely manner,our profitability would decline. In the three and nine months endedSeptember 30, 2006, approximately 20.2% and 19.8%, respectively, of ourrevenue was from public sector clients, including U.S. Federal, state, andlocal governments and agencies. Often government spending programs depend uponthe budgetary capability to support such programs.  Most states mustoperate under a balanced budget. As a result of such budget and deficitconsiderations, our existing and future revenues and profitability could beadversely affected by reduced government IT spending.

**Unfavorablegovernment audits could require us to refund payments we have received, toforego anticipated revenue, and could subject us to penalties andsanctions.  ** The government agencies we contract with generally have the authority toaudit and review our contracts with them. As part of that process, thegovernment agency reviews our performance on the contract, our pricingpractices, our cost structure and our compliance with applicable laws,regulations and standards. If the audit agency determines that we haveimproperly received reimbursement, we would be required to refund any suchamount. If a government audit uncovers improper or illegal activities by us orwe otherwise determine that these activities have occurred, we may be subjectto civil and criminal penalties and administrative sanctions, includingtermination of contracts, forfeitures of profits, suspension of payments, finesand suspension or disqualification from doing business with the government. Anysuch unfavorable determination could adversely impact our ability to bid fornew work.

**Wehave pursued, and intend to continue to pursue, strategic acquisitions. Failureto successfully integrate acquired businesses or assets may adversely affectour financial performance.  **  In recent years, we have grown significantlythrough acquisitions. From January 1, 1999 through September 30, 2006, wecompleted 17 acquisitions. The aggregate merger and consideration costs ofthese acquisitions totaled approximately $437.2 million. Our future growthmay be based in part on selected acquisitions. At any given time, we may be invarious stages of considering acquisition opportunities. We may not be able tofind and identify desirable acquisition targets or be successful in enteringinto a definitive agreement with any one target. In addition, even if we reacha definitive agreement with a target, we may not be able to complete any futureacquisition.

We typically anticipatethat each acquisition will bring benefits, such as an increase in revenue.Prior to completing an acquisition, however, it is difficult to determine ifthese benefits will be realized. Accordingly, there is a risk that an acquiredcompany may not achieve an increase in revenue or other benefits for us. Inaddition, an acquisition may result in unexpected costs, expenses, andliabilities. Any of these events could have a material adverse effect on ourbusiness, financial condition, and results of operations.

We have recorded asignificant amount of goodwill and other intangible assets resulting from ouracquisitions. We review our goodwill and identifiable assets for impairment inaccordance with SFAS 142 and SFAS No. 144 (“SFAS 144”), “Accounting forthe Impairment or Disposal of Long-Lived Assets,” respectively. If theestimated future cash flows of the reporting units related to the underlyingassets are not sufficient to support the carrying value of the associatedunderlying assets, we may be required to record impairment charges related togoodwill and other intangible assets. Any material loss resulting from animpairment charge could have a material adverse effect on our results ofoperations. As of September 30, 2006, our goodwill totaled $316.5 million,customer lists

41

----

totaled $32.1 million andother intangible assets totaled $3.7 million.

The process ofintegrating acquired companies into our existing business might also result inunforeseen difficulties. Unforeseen operating difficulties may absorbsignificant management attention, which we may otherwise devote to our existingbusiness. In addition, the process may require significant financial resourcesthat we might otherwise allocate to other activities, including the ongoingdevelopment or expansion of our existing operations.

Finally, futureacquisitions could result in our having to incur additional debt and/orcontingent liabilities. We may also issue equity securities in connection withacquisitions, which could have a dilutive effect on our earnings per share. Anyof these possibilities could have a material adverse effect on our business,financial condition, and result of operations.

**Weface significant competition for our services, and our failure to remain competitivecould limit our ability to maintain existing clients or attract newclients.  ** The market for our services is highly competitive. The technology forcustom software services can change rapidly. The market is fragmented, and nocompany holds a dominant position. Consequently, our competition for clientassignments and experienced personnel varies significantly from city to cityand by the type of service provided. Some of our competitors are larger andhave greater technical, financial, and marketing resources and greater namerecognition in the markets they serve than we do. In addition, clients mayelect to increase their internal information systems resources to satisfy theircustom software development and integration needs.

In the healthcare softwaresystems market, we compete with some companies that are larger in thehealthcare market and have greater financial resources than we do. We believethat significant competitive factors in the healthcare software systems marketinclude size and demonstrated ability to provide service to targeted healthcaremarkets.

We may not be able tocompete successfully against current or future competitors. In addition,competitive pressures may materially adversely affect our business, financialcondition, and results of operations.

**Weconduct business in the UK, Canada, India, and Australia, which exposes us to anumber of difficulties inherent in international activities.**  We have four software development facilities in India. As ofSeptember 30, 2006, we had approximately 2,568 technical professionals inthe India, including those at Keane Worldzen. India is currently experiencingconflicts with Pakistan over the disputed territory of Kashmir as well asclashes between different religious groups within the country. These conflicts,in addition to other unpredictable developments in the political, economic, andsocial conditions in India, could eliminate or reduce the availability of thesedevelopment and professional services. If access to these services were to beunexpectedly eliminated or significantly reduced, our ability to meetdevelopment objectives important to our strategy to add offshore deliverycapabilities to the services we provide would be hindered, and our businesscould be harmed.

If we fail to manage ourgeographically dispersed organization, we may fail to meet or exceed ourfinancial objectives and our revenues may decline. We perform developmentactivities in the U.S., Canada, and India, and have offices throughout theU.S., UK, Canada, and India. This geographic dispersion requires us to devotesubstantial management resources that locally based competitors do not need todevote to their operations.

Our operations in the UK,Canada, India and Australia are subject to currency exchange rate fluctuations,foreign exchange restrictions, changes in taxation, and other difficulties inmanaging operations internationally and overseas. We may not be successful inmanaging our international operations. In addition, there has been politicaldiscussion and debate related to worldwide competitive sourcing, particularlyfrom the United States to offshore locations. There is proposed federal andstate legislation currently pending related to this issue. It is too early todetermine whether or in what form this legislation will be adopted; however,future legislation, if enacted, could have an adverse effect on our business,results of operations and financial condition.

**Wemay be unable to re-deploy our professionals effectively if engagements are terminatedunexpectedly, which would adversely affect our results ofoperations.  ** Our clients can cancel or reduce the scope of their engagements with uson short notice. If they do so, we may be unable to reassign our professionalsto new engagements without delay. The cancellation or reduction in scope of anengagement could, therefore, reduce the utilization rate of our professionals,which would have a negative impact on our business, financial condition, andresults of operations.

As a result of these andother factors, our past financial performance should not be relied on as anindication of future performance. We believe that period-to-period comparisonsof our financial results are not necessarily meaningful and we expect that ourresults of operations may fluctuate from period-to-period in the future.

**Our growth could be limited if we areunable to attract and retain personnel in the information technology andbusiness consulting industries.  **  We believe that our future success willdepend in large part on our ability to continue to attract and retain highlyskilled technical and management personnel. The competition for such personnelis intense. We may not succeed in attracting and retaining the personnelnecessary to develop our business. If we do not, our business, financialcondition, and results of operations could be materially adversely affected.

42

----

**We may be prohibited fromrepurchasing, and may not have the financial resources to repurchase, ourDebentures on the date for repurchase at the option of the holder or upon adesignated event, as required by the indenture governing our Debentures, whichcould cause defaults under our senior revolving credit facility and any otherindebtedness we may incur in the future.  **  The Debenture holders have the right torequire us to repurchase all or a portion of their Debentures on June 15,2008. The Debenture holders may also require us to repurchase all or a portionof their Debentures upon a designated event, as defined in the indenturegoverning the Debentures. If the Debenture holders elect to require us torepurchase their Debentures on any of the above dates or if a designated eventwere to occur, we may not have enough funds to pay the repurchase price for alltendered Debentures. We are currently prohibited under our senior revolvingcredit facility from repurchasing any Debentures if a designated event were tooccur. We may also be prohibited under any indebtedness we may incur in thefuture from purchasing any Debentures prior to their stated maturity. In thesecircumstances, we will be required to repay the entire outstanding principalof, and pay any accrued and unpaid interest on, such indebtedness or to obtainthe requisite consents from the holders of any such indebtedness to permit therepurchase of the Debentures. If we are unable to repay all of suchindebtedness or are unable to obtain the necessary consents, we will be unableto offer to repurchase the Debentures, which would constitute an event ofdefault under the indenture for the Debentures, which itself could constitute adefault under our senior revolving credit facility or under the terms of anyfuture indebtedness that we may incur. In addition, the events that constitutea designated event under the indenture for the Debentures are events of defaultunder our senior revolving credit facility and may also be events of defaultunder other indebtedness that we may incur in the future.

**Weincurred indebtedness when we sold our Debentures. We may incur additionalindebtedness in the future. The indebtedness created by the sale of ourDebentures, and any future indebtedness, could adversely affect our businessand our ability to make full payment on the Debentures.  **  Our aggregate level of indebtedness increasedin connection with the sale of our Debentures. As of September 30, 2006,we had approximately $189.1 million of outstanding indebtedness and hadthe ability to incur additional debt under our revolving credit facility. Wemay also obtain additional long-term debt and working capital lines of creditto meet future financing needs, which would have the effect of increasing ourtotal leverage. Any increase in our leverage could have significant negativeconsequences, including:

·                                          increasingour vulnerability to adverse economic and industry conditions;

·                                          limitingour ability to obtain additional financing;

·                                          limitingour ability to make acquisitions;

·                                          requiringthe dedication of a substantial portion of our cash flow from operations toservice our indebtedness, thereby reducing the amount of our cash flowavailable for other purposes, including capital expenditures;

·                                          limitingour flexibility in planning for, or reacting to, changes in our business andthe industries in which we compete; and

·                                          placingus at a possible competitive disadvantage with less leveraged competitors andcompetitors that may have better access to capital resources.

Our ability to satisfy our future obligations,including debt service on our Debentures, depends on our future operatingperformance and on economic, financial, competitive, and other factors beyondour control. Our business may not generate sufficient cash flow to meet theseobligations or to successfully execute our business strategy. If we are unableto service our debt and fund our business, we may be forced to reduce or delaycapital expenditures, seek additional financing or equity capital, restructureor refinance our debt or sell assets. We may not be able to obtain additionalfinancing or refinance existing debt or sell assets on terms acceptable to usor at all.

**Item2.      Unregistered Sales of Equity Securities and Use ofProceeds**

(c)                                     Thefollowing table provides information about purchases by Keane during the threemonths ended September 30, 2006 of equity securities that are registered byKeane pursuant to Section 12 of the Exchange Act:

**ISSUERPURCHASES OF EQUITY SECURITIES**
| **Period**        | ** ** | **(a)  Total Number of  Shares (or Units)  Purchased** | ** ** | **(b)  Average Price  Paid per Share  (or Unit)** | ** ** | **(c)  Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs  (1) (2)** | ** ** | **(d)  Maximum Number of  Shares that May Yet Be  Purchased Under the  Plans or Programs  (1) (2)** | ** ** |
|-------------------|------------|----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 07/01/06-07/31/06 |       | —                                                                     |       | $                                                                     | —     |                                                                                                                                                | —     |                                                                                                                                                       | 1,827,100  |   |
| 08/01/06-08/31/06 |       | —                                                                     |       | $                                                                     | —     |                                                                                                                                                | —     |                                                                                                                                                       | 1,827,100  |   |
| 09/01/06-09/30/06 |       | —                                                                     |       | $                                                                     | —     |                                                                                                                                                | —     |                                                                                                                                                       | 1,827,100  |   |
| Total:            |       | —                                                                     |       | $                                                                     | —     |                                                                                                                                                | —     |                                                                                                                                                       | 1,827,100  |   |

 

(1)               OnOctober 25, 2005, we announced the approval by our Board of Directors of aprogram for the repurchase of 3.0 million

43

----

shares of our common stock. The repurchases may be madeon the open market or in negotiated transactions, and the timing and amount ofshares to be purchased will be determined by our management based on itsevaluation of market and economic conditions and other factors. TheOctober 2005 program expired on October 25, 2006, with 1.8 millionshares not repurchased under that program.

(2)               On October 24,2006, we announced the approval by our Board of Directors of a program for therepurchase of 3.0 million shares of our common stock pursuant to theOctober 2006 program. The amount in this column excludes the 3.0 million sharesunder the October 2006 program. The repurchases may be made on the open marketor in negotiated transactions, and the timing and amount of shares to bepurchased will be determined by our management based on its evaluation ofmarket and economic conditions and other factors. Unless terminated earlier byresolution of our Board of Directors, the October 2006 program will expireupon the earlier of the date we repurchase all shares authorized for repurchasethereunder or October 23, 2007.

44

----

**Item6.    Exhibits**
| 31.1   |   | Certification pursuant to Exchange Act  Rules 13a-14 and 15d-14 of the Chief Executive Officer.               |
|--------|--------|--------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                               |
| 31.2   |   | Certification pursuant to Exchange Act  Rules 13a-14 and 15d-14 of the Chief Financial Officer.               |
|   |   |                                                                                                               |
| 32.1   |   | Certification pursuant to 18 U.S.C.  Section 1350 of the Chief Executive Officer and Chief Financial Officer. |

 

45

----

**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                                               |   | KEANE, INC.                                                                                                                                                                                         |
|-----------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                          |   | (Registrant)                                                                                                                                                                                        |
|                                          |   |                                                                                                                                                                                                |
|  Date   November  9, 2006 |   | /s/ JOHN J. LEAHY                                                                                                                                                                                   |
|                                          |   |                                                                                                                                                                                                |
|                                          |   | John J. Leahy  Executive Vice President of Finance and  Administration and Chief Financial Officer  (Principal Financial and Accounting Officer)  and Interim President and Chief Executive Officer |

 

46

----

**Exhibit Index**
| Exhibit  No. | ** ** | **Description**                                                                                                    |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                               |
| 31.1         |       | Certification pursuant to Exchange Act  Rules 13a-14 and 15d-14 of the Chief Executive Officer.               |
|         |       |                                                                                                               |
| 31.2         |       | Certification pursuant to Exchange Act  Rules 13a-14 and 15d-14 of the Chief Financial Officer.               |
|         |       |                                                                                                               |
| 32.1         |       | Certification pursuant to 18 U.S.C.  Section 1350 of the Chief Executive Officer and Chief Financial Officer. |

 

47

----