** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**Washington, D.C. 20549

----

** **

**FORM 10-Q**

(Mark One)

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

**For the quarterly periodended June 30, 2006**

o                    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**For the transition period from ________ to ________**

**CommissionFile Number 000-50954**

----

**NESS TECHNOLOGIES, INC.**(Exactname of registrant as specified in its charter)
| **Delaware**                     | **98-0346908**          |
|----------------------------------|-------------------------|
| (State or other  jurisdiction of | (I.R.S. Employer        |
| incorporation or  organization)  | Identification  Number) |

** **

**Ness TowerAtidim High-Tech Industrial ParkBuilding 4Tel Aviv 61580, IsraelTelephone: +972 (3) 766-6800**(Addressof registrant’s principal executive offices and registrant’s telephone number,including area code)

----

** **

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   x Yes      o   No

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

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

As of July 31, 2006, 35,838,816 shares of commonstock, $0.01 par value per share, were outstanding.

 

 

 

 

 

----

**NESS TECHNOLOGIES, INC. AND SUBSIDIARIES**

**INDEX**
| PART I — FINANCIAL  INFORMATION                                                                               | 3      |
|--------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                               |   |
| Item 1. Financial  Statements                                                                                      | 3      |
|                                                                                                               |   |
| Condensed  Consolidated Balance Sheets — December 31, 2005 and June 30, 2006 (Unaudited)                      | 3      |
| Condensed  Consolidated Statements of Income — Three and six months ended June 30, 2005  and 2006 (Unaudited) | 5      |
| Condensed  Consolidated Statements of Cash Flows — Six months ended June 30, 2005 and  2006 (Unaudited)       | 6      |
| Notes to Interim Condensed  Consolidated Financial Statements — June 30, 2006 (Unaudited)                     | 8      |
|                                                                                                               |   |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations               | 25     |
|                                                                                                               |   |
| Overview                                                                                                           | 25     |
| Recent Developments                                                                                                | 26     |
| Consolidated  Results of Operations                                                                                | 26     |
| Three Months  Ended June 30, 2006 Compared to the Three Months Ended June 30, 2005                                 | 26     |
| Six Months  Ended June 30, 2006 Compared to the Six Months Ended June 30, 2005                                     | 29     |
| Results by Business  Segment                                                                                       | 31     |
| Liquidity and  Capital Resources                                                                                   | 32     |
| Forward-Looking  Statements and Risk Factors                                                                       | 34     |
|                                                                                                               |   |
| Item 3.  Quantitative and Qualitative Disclosure about Market Risk                                                 | 34     |
|                                                                                                               |   |
| Item 4. Controls and Procedures                                                                                    | 35     |
|                                                                                                               |   |
| Evaluation of  Disclosure Controls and Procedures                                                                  | 35     |
| Changes in Internal  Control                                                                                       | 35     |
|                                                                                                               |   |
| PART II —  OTHER INFORMATION                                                                                  | 36     |
|                                                                                                               |   |
| Item 1. Legal Proceedings                                                                                          | 36     |
|                                                                                                               |   |
| Item 1A. Risk Factors                                                                                              | 36     |
|                                                                                                               |   |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                               | 36     |
|                                                                                                               |   |
| Item 3.  Defaults upon Senior Securities.                                                                          | 36     |
|                                                                                                               |   |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                       | 36     |
|                                                                                                               |   |
| Item 5. Other Information                                                                                          | 36     |
|                                                                                                               |   |
| Item 6. Exhibits                                                                                                   | 36     |
|                                                                                                               |   |
| SIGNATURES                                                                                                         | 38     |
|                                                                                                               |   |
| EXHIBIT  INDEX                                                                                                     | 39     |

 

2

----

**PART I — FINANCIALINFORMATION**

***Item 1. FinancialStatements***
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**  |
|---------------------------------------------------|
| **Interim Condensed Consolidated Balance Sheets** |
| **U.S. dollars in thousands**                     |

** **

 
| ** **                                                                                                                                         | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                         | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                         | ** ** | ** **            | ** ** | **(Unaudited)**   | ** ** |
| ASSETS                                                                                                                                             |       |                  |       |              |       |
|                                                                                                                                               |       |                  |       |              |       |
| CURRENT ASSETS:                                                                                                                                    |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                                                         |       | $                     | 33,579     |              | $          | 32,821 |   |
| Short-term bank  deposits                                                                                                                          |       | 39,561                |       | 24,134            |       |
| Marketable  securities                                                                                                                             |       | 2,651                 |       | —            |       |
| Trade  receivables (net of allowance for doubtful accounts of $2,320 and $2,700 at  December 31, 2005 and June 30, 2006 (unaudited), respectively) |       | 99,097                |       | 109,378           |       |
| Unbilled  receivables                                                                                                                              |       | 21,500                |       | 32,502            |       |
| Other accounts  receivable and prepaid expenses                                                                                                    |       | 13,664                |       | 15,501            |       |
| Inventories and  work in progress                                                                                                                  |       | 2,506                 |       | 599               |       |
|                                                                                                                                               |       |                  |       |              |       |
| Total current assets                                                                                                                               |       | 212,558               |       | 214,935           |       |
|                                                                                                                                               |       |                  |       |              |       |
| LONG-TERM ASSETS:                                                                                                                                  |       |                  |       |              |       |
| Long-term  prepaid expenses                                                                                                                        |       | 4,816                 |       | 6,044             |       |
| Marketable  securities                                                                                                                             |       | 32                    |       | 126               |       |
| Unbilled  receivables                                                                                                                              |       | 7,045                 |       | 9,310             |       |
| Deferred income  taxes                                                                                                                             |       | 5,271                 |       | 4,534             |       |
| Severance pay  fund                                                                                                                                |       | 35,845                |       | 39,149            |       |
|                                                                                                                                               |       |                  |       |              |       |
| Total long-term assets                                                                                                                             |       | 53,009                |       | 59,163            |       |
|                                                                                                                                               |       |                  |       |              |       |
| PROPERTY AND EQUIPMENT,  NET                                                                                                                       |       | 21,308                |       | 23,972            |       |
|                                                                                                                                               |       |                  |       |              |       |
| INTANGIBLE ASSETS, NET                                                                                                                             |       | 7,938                 |       | 9,713             |       |
|                                                                                                                                               |       |                  |       |              |       |
| GOODWILL                                                                                                                                           |       | 159,421               |       | 174,745           |       |
|                                                                                                                                               |       |                  |       |              |       |
| Total assets                                                                                                                                       |       | $                     | 454,234    |              | $          | 482,528 |   |

 

The accompanying notesare an integral part of the interim condensed consolidated financialstatements.

3

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                 |
|------------------------------------------------------------------|
| **Interim Condensed Consolidated Balance Sheets**                |
| **U.S. dollars in thousands (except share and par  value data)** |

 
| ** **                                                                                                                                                                                                | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                                                                                | ** ** | ** **            | ** ** | **(Unaudited)**   | ** ** |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                 |       |                  |       |              |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| CURRENT LIABILITIES:                                                                                                                                                                                      |       |                  |       |              |       |
| Short-term bank credit                                                                                                                                                                                    |       | $                     | 21,011     |              | $          | 44,485 |   |
| Current maturities of long-term debt                                                                                                                                                                      |       | 6,862                 |       | 6,598             |       |
| Trade payables                                                                                                                                                                                            |       | 35,259                |       | 24,221            |       |
| Advances from customers                                                                                                                                                                                   |       | 7,670                 |       | 10,829            |       |
| Other accounts payable and accrued expenses                                                                                                                                                               |       | 82,657                |       | 69,820            |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| Total current  liabilities                                                                                                                                                                                |       | 153,459               |       | 155,953           |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                    |       |                  |       |              |       |
| Long-term debt, net of current maturities                                                                                                                                                                 |       | 6,294                 |       | 4,939             |       |
| Excess of losses over investment in affiliates                                                                                                                                                            |       | 257                   |       | 451               |       |
| Accrued severance pay                                                                                                                                                                                     |       | 39,722                |       | 42,909            |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| Total long-term  liabilities                                                                                                                                                                              |       | 46,273                |       | 48,299            |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| COMMITMENTS AND  CONTINGENT LIABILITIES                                                                                                                                                                   |       |                  |       |              |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                |       |                  |       |              |       |
| Common stock of  $0.01 par value -                                                                                                                                                                        |       |                  |       |              |       |
| Authorized: 76,500,000 shares at December 31, 2005  and at June 30, 2006 (unaudited);  Issued and outstanding: 34,771,837 shares at December 31, 2005 and 35,832,882  shares at June 30, 2006 (unaudited) |       | 348                   |       | 358               |       |
| Additional paid-in capital                                                                                                                                                                                |       | 282,642               |       | 290,604           |       |
| Accumulated other comprehensive loss                                                                                                                                                                      |       | (13,559               | )          | (10,044           | )          |
| Accumulated deficit                                                                                                                                                                                       |       | (14,929               | )          | (2,642            | )          |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| Total  stockholders’ equity                                                                                                                                                                          |       | 254,502               |       | 278,276           |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                          |       | $                     | 454,234    |              | $          | 482,528 |   |

 

The accompanying notesare an integral part of the interim condensed consolidated financialstatements.

4

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**         |
|----------------------------------------------------------|
| **Interim Condensed Consolidated Statements of  Income** |
| **U.S. dollars in thousands (except per share  data)**   |

** **
| ** **                                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                    | ** ** | **(Unaudited)**                                 | ** ** | **(Unaudited)**                               | ** ** |
| ** **                                    | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                      |       | $                                               | 94,218     |                                          | $          | 116,614 |   | $ | 182,623 |   | $ | 223,656 |   |
| Cost of revenues  (*)                         |       | 68,046                                          |       | 83,981                                        |       | 130,624 |   | 159,697 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Gross profit                                  |       | 26,172                                          |       | 32,633                                        |       | 51,999 |   | 63,959 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Operating  expenses:                          |       |                                            |       |                                          |       |   |   |   |   |
| Selling and marketing                         |       | 7,002                                           |       | 8,733                                         |       | 14,033 |   | 17,224 |   |
| General and administrative (*)                |       | 14,253                                          |       | 16,426                                        |       | 27,194 |   | 31,356 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Total operating  expenses                     |       | 21,255                                          |       | 25,159                                        |       | 41,227 |   | 48,580 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Operating income                              |       | 4,917                                           |       | 7,474                                         |       | 10,772 |   | 15,379 |   |
| Financial  expenses, net                      |       | (494                                            | )          | (577                                          | )          | (914 | ) | (638 | ) |
| Other income,  net                            |       | 10                                              |       | 483                                           |       | 4 |   | 444 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Income before  taxes on income                |       | 4,433                                           |       | 7,380                                         |       | 9,862 |   | 15,185 |   |
| Taxes on income                               |       | 423                                             |       | 1,340                                         |       | 1,025 |   | 2,808 |   |
| Equity in net  losses of affiliates           |       | (27                                             | )          | (90                                           | )          | (29 | ) | (90 | ) |
| Minority  interests in losses of a subsidiary |       | —                                          |       | —                                        |       | 101 |   | — |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Net income                                    |       | $                                               | 3,983      |                                          | $          | 5,950 |   | $ | 8,909 |   | $ | 12,287 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Basic net  earnings per share                 |       | $                                               | 0.12       |                                          | $          | 0.17 |   | $ | 0.26 |   | $ | 0.35 |   |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Diluted net earnings  per share               |       | $                                               | 0.11       |                                          | $          | 0.16 |   | $ | 0.25 |   | $ | 0.34 |   |

----

(*)   Expenses include stock-basedcompensation, as follows:
| ** **                  | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                  | ** ** | **(Unaudited)**                                 | ** ** | **(Unaudited)**                               | ** ** |
| ** **                  | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenues            |       | $                                               | —     |                                          | $          | — |   | $ | 98 |   | $ | — |   |
| General and  administrative |       | 1,286                                           |       | 164                                           |       | 1,799 |   | 291 |   |
|                             |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of the interim condensed consolidated financialstatements.

5

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**             |
|--------------------------------------------------------------|
| **Interim Condensed Consolidated Statements of  Cash Flows** |
| **U.S. dollars in thousands**                                |

 
| ** **                                                                                            | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                      | ** ** | **2006** | ** ** |
| ** **                                                                                            | ** ** | **(Unaudited)**                               | ** ** |
| **Cash flows from operating activities:**                                         | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                                                            |       | $                                             | 8,909      |   | $ | 12,287 |   |
| Adjustments required to reconcile net income to net  cash used in operating activities:               |       |                                          |       |   |   |
| Stock-based compensation-related expenses                                                             |       | 2,009                                         |       | 103 |   |
| Equity in net losses of affiliates                                                                    |       | 29                                            |       | 90 |   |
| Minority interests in losses of a subsidiary                                                          |       | (101                                          | )          | — |   |
| Currency fluctuation of long-term debt                                                                |       | 1,670                                         |       | 421 |   |
| Accrued interest on long-term debt                                                                    |       | (892                                          | )          | (1,207 | ) |
| Depreciation and amortization                                                                         |       | 3,809                                         |       | 5,641 |   |
| Deferred income taxes, net                                                                            |       | (2,078                                        | )          | (586 | ) |
| Gain on sale of property and equipment                                                                |       | (409                                          | )          | (139 | ) |
| Increase in trade receivables                                                                         |       | (10,923                                       | )          | (3,622 | ) |
| Increase in unbilled receivables                                                                      |       | (6,172                                        | )          | (11,581 | ) |
| Decrease (increase) in other accounts receivable and  prepaid expenses                                |       | (118                                          | )          | 332 |   |
| Decrease (increase) in inventories and work in  progress                                              |       | (762                                          | )          | 2,080 |   |
| Increase in long-term prepaid expenses                                                                |       | (1,748                                        | )          | (614 | ) |
| Decrease in trade payables                                                                            |       | (3,752                                        | )          | (13,844 | ) |
| Increase in advances from customers                                                                   |       | 1,191                                         |       | 2,802 |   |
| Increase (decrease) in other accounts payable and  accrued expenses                                   |       | 1,618                                         |       | (11,052 | ) |
| Increase (decrease) in accrued severance pay, net                                                     |       | 511                                           |       | (242 | ) |
|                                                                                                  |       |                                          |       |   |   |
| Net cash used in  operating activities                                                                |       | (7,409                                        | )          | (19,131 | ) |
|                                                                                                  |       |                                          |       |   |   |
| Cash flows from  investing activities:                                                                |       |                                          |       |   |   |
| Net cash paid for acquisition of consolidated  subsidiaries (a)                                       |       | (3,187                                        | )          | (13,683 | ) |
| Additional payments in connection with acquisitions  of subsidiaries in prior periods                 |       | —                                        |       | (5,277 | ) |
| Acquisition of minority interest in a subsidiary (b)                                                  |       | (114                                          | )          | — |   |
| Proceeds from maturity of short-term bank deposits                                                    |       | —                                        |       | 16,089 |   |
| Proceeds from sale of available-for-sale marketable  securities                                       |       | —                                        |       | 2,779 |   |
| Proceeds from sale of property and equipment                                                          |       | 600                                           |       | 651 |   |
| Purchase of property and equipment and  capitalization of software development costs for internal use |       | (4,587                                        | )          | (4,514 | ) |
| Capitalization of software development costs                                                          |       | (1,483                                        | )          | (255 | ) |
|                                                                                                  |       |                                          |       |   |   |
| Net cash used in  investing activities                                                                |       | (8,771                                        | )          | (4,210 | ) |
|                                                                                                       |            |                                               |            |  |  |  |  |

 

The accompanyingnotes are an integral part of the interim condensed consolidated financialstatements.

6

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**             |
|--------------------------------------------------------------|
| **Interim Condensed Consolidated Statements of  Cash Flows** |
| **U.S. dollars in thousands**                                |

** **
| ** **                                                    | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                      | ** ** | **2006** | ** ** |
| ** **                                                    | ** ** | **(Unaudited)**                               | ** ** |
| **Cash flows from financing activities:** | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Exercise of options and warrants                              |       | $                                             | 8,848      |   | $ | 5,954 |   |
| Short-term bank loans and credit, net                         |       | (986                                          | )          | 20,014 |   |
| Principal payments of long-term debt                          |       | (1,493                                        | )          | (1,487 | ) |
|                                                          |       |                                          |       |   |   |
| Net cash  provided by financing activities                    |       | 6,369                                         |       | 24,481 |   |
|                                                          |       |                                          |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | (2,511                                        | )          | (1,898 | ) |
|                                                          |       |                                          |       |   |   |
| Decrease in cash  and cash equivalents                        |       | (12,322                                       | )          | (758 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 104,229                                       |       | 33,579 |   |
|                                                          |       |                                          |       |   |   |
| Cash and cash  equivalents at the end of the period           |       | $                                             | 91,907     |   | $ | 32,821 |   |
|                                                          |       |                                          |       |   |   |
| Supplemental  disclosures of cash flows information:          |       |                                          |       |   |   |
|                                                          |       |                                          |       |   |   |
| Cash paid during the period for:                              |       |                                          |       |   |   |
| Interest                                                      |       | $                                             | 656        |   | $ | 434 |   |
| Taxes                                                         |       | $                                             | 374        |   | $ | 10,254 |   |

----

| ** ** | *** ***                                                                                                                                                                                                                            | *** ***                                                                     | *** *** | *** ***                       | *** *** | *** ***                                      |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------|--------------|------------------------------------|--------------|---------------------------------------------------|
| (a)        | *In conjunction with the acquisitions, the fair  values of the assets acquired and liabilities assumed at the date of the  related acquisition were as follows:*                                                                        | * *                                                                         | * *     | * *                           | * *     | * *                                          |
|       |                                                                                                                                                                                                                                    |                                                                             |         |                               |         |                                              |   |
|       |                                                                                                                                                                                                                                    | Working  capital (capital deficiency), net (excluding cash and cash equivalents) |         | $                                  | (1,995       | )                                                 | $ | (1,640 | ) |
|       |                                                                                                                                                                                                                                    | Long-term  assets                                                                |         | —                             |         | 434                                               |   |
|       |                                                                                                                                                                                                                                    | Property  and equipment                                                          |         | 2,306                              |         | 2,342                                             |   |
|       |                                                                                                                                                                                                                                    | Other  assets                                                                    |         | 48                                 |         | —                                            |   |
|       |                                                                                                                                                                                                                                    | Long-term  loans                                                                 |         | (1,601                             | )            | (266                                              | ) |
|       |                                                                                                                                                                                                                                    | Customer  relations and backlog                                                  |         | 680                                |         | 2,488                                             |   |
|       |                                                                                                                                                                                                                                    | Goodwill                                                                         |         | 3,749                              |         | 10,325                                            |   |
|       |                                                                                                                                                                                                                                    | Net  cash used in acquisitions of consolidated subsidiaries                      |         | $                                  | 3,187        |                                              | $ | 13,683 |   |
|       |                                                                                                                                                                                                                                    |                                                                             |         |                               |         |                                              |   |
| (b)        | *In conjunction with the acquisition of the minority  interest in a subsidiary during the six months ended June 30, 2005, the fair  values of the assets acquired and liabilities assumed at the date of  acquisition were as follows:* |                                                                             |         |                               |         |                                              |
|       | * *                                                                                                                                                                                                                                |                                                                             |         |                               |         |                                              |
|       |                                                                                                                                                                                                                                    | Minority interest                                                                |         | $     197 |         | $       — |   |
|       |                                                                                                                                                                                                                                    | Goodwill                                                                         |         | 3,196                              |         | —                                            |   |
|       |                                                                                                                                                                                                                                    | Customer-related intangible assets                                               |         | 139                                |         | —                                            |   |
|       |                                                                                                                                                                                                                                    |                                                                             |         | 3,532                              |         | —                                            |   |
|       |                                                                                                                                                                                                                                    | Issuance of shares                                                               |         | (3,418)                            |         | —                                            |   |
|       |                                                                                                                                                                                                                                    | Net cash used in acquisition of a consolidated subsidiary                        |         | $     114 |         | $       — |   |
|       |                                                                                                                                                                                                                                    |                                                                             |         |                               |         |                                              |   |
| (c)        |                                                                                                                                                                                                                                    | *Non-cash financing activity:*                                                   |         |                               |         |                                              |   |
|       |                                                                                                                                                                                                                                    |                                                                             |         |                               |         |                                              |   |
|       |                                                                                                                                                                                                                                    | Capitalization of  redeemable options accrual upon partial exercise of options   |         | $                                  | —       |                                              | $ | 1,868 |   |

 

 

The accompanyingnotes are an integral part of the interim condensed consolidated financialstatements.

7

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

***Note 1: General***

Ness Technologies, Inc. was incorporated under thelaws of the State of Delaware in March 1999. We operate through oursubsidiaries in Israel, the United States, Europe and Asia.

We are a global provider of information technology (“IT”)services and solutions designed to help clients improve their competitivenessand effectiveness. Our portfolio of solutions and services includes systemintegration and application development, outsourcing, software and consulting,and quality assurance and training. We and our subsidiaries primarily serve thefollowing vertical markets: government and defense, financial services, lifesciences and healthcare, telecommunications and utilities, and independentsoftware vendors.

***Note 2: Significant Accounting Policies***

##### a.               UnauditedInterim Financial Information

The accompanying condensed consolidated balance sheet as of June 30,2006, the condensed consolidated statements of income for the three and sixmonths ended June 30, 2005 and 2006, and the condensed consolidated statementsof cash flows for the six months ended June 30, 2005 and 2006 are unaudited.These unaudited interim condensed consolidated financial statements have beenprepared in accordance with U. S. generally accepted accounting principles forinterim financial information. In the opinion of management, the unauditedinterim condensed consolidated financial statements include all adjustments ofa normal recurring nature necessary for a fair presentation of our consolidatedfinancial position as of June 30, 2006, our consolidated results of operationsfor the three and six months ended June 30, 2005 and 2006, and our consolidatedcash flows for the six months ended June 30, 2005 and 2006.

The balance sheet at December 31, 2005 has been derived from theaudited consolidated financial statements at that date but does not include allof the information and footnotes required by U. S. generally acceptedaccounting principles for complete financial statements.

These consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements and accompanying notes forthe year ended December 31, 2005 included in our Annual Report on Form 10-Kfiled with the U.S. Securities and Exchange Commission (“SEC”) on March 15,2006.

Results for the three and six months ended June 30, 2006 are notnecessarily indicative of results that may be expected for the year endingDecember 31, 2006.

Unless otherwise noted, (1) all references to “dollars” or “$” are toUnited States dollars and all references to “NIS” are to New Israeli Shekelsand (2) all references to shares of our common stock and per share informationhave been adjusted to reflect the 0.7193-for-one reverse stock split effectedon September 20, 2004.

##### b.              Use of estimates

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes. Actual results could differ from those estimates.

8

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

##### c.               Financialstatements in U.S. dollars

Our subsidiaries’ transactions are recorded in local currencies. Wehave designated the U.S. dollar as the primary functional currency of ouroperations in the United States, the NIS as the primary functional currency ofour subsidiaries’ operations in Israel, and local currencies as the primaryfunctional currencies of our operations elsewhere. Accordingly, for allsubsidiaries of which the dollar is the functional currency, monetary accountsmaintained in other currencies are re-measured into U.S. dollars, in accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 52 “ForeignCurrency Translation.” All transaction gains and losses of the re-measuredmonetary balance sheet items are reflected in the statements of income asfinancial income or expenses, as appropriate.

For those foreign subsidiaries whose functional currency has beendetermined to be their local currency, assets and liabilities are translated atperiod-end exchange rates and statements of income items are translated ataverage exchange rates prevailing during that period. Such translationadjustments are recorded as a separate component of accumulated othercomprehensive income (loss) in stockholders’ equity.

The financial statements of affiliates reported using the equity methodof accounting, whose functional currency has been determined to be their localcurrency, have been translated into dollars. All balance sheet accounts havebeen translated using the exchange rates in effect at the balance sheet date.Statements of income amounts have been translated using the average exchangerate for the period. The resulting aggregate translation adjustments arereported as a separate component of accumulated other comprehensive income(loss) in stockholders’ equity.

##### d.              Principles ofconsolidation

Our consolidated financial statements include the accounts of thecompany and its wholly and majority owned subsidiaries, or the group.Inter-company transactions and balances, including profit from inter-companysales not yet realized outside the group, have been eliminated inconsolidation.

##### e.               Acquisition ofsubsidiaries

1.  Ness U.S.A. Inc. (“Ness U.S.A.”)

On November 12, 2004, we filed a Form S-4 Registration Statement inrespect of an exchange offer for the remaining shares of Ness U.S.A. which wedid not already own. The offer commenced on January 31, 2005 and ended onFebruary 28, 2005. 96 of 98 offerees accepted the offer bringing our holdingsin Ness U.S.A. following the offer to 99.9%. On March 1, 2005, we issued260,316 shares to the offerees, for the consideration of $3,532. Theacquisition was accounted for under the purchase method of accounting accordingto SFAS No. 141, “Business Combinations.”

In September 2005, Ness U.S.A. purchased the outstanding shares of NessU.S.A.’s common stock from the remaining two offerees in a private transaction,and it immediately thereafter retired the shares, since which time we have held100% of the shares of common stock of Ness U.S.A.

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

9

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

Basedupon a valuation of tangible and intangible assets acquired and liabilitiesassumed, we have allocated the total cost of the acquisition to Ness U.S.A.’sassets and liabilities (as of the acquisition date) as follows:

| Cash and cash equivalents                                   |   | $      | 426    |   |
|-------------------------------------------------------------|--------|--------|--------|--------|
| Trade receivables                                           |   | 277    |   |
| Unbilled receivable                                         |   | 185    |   |
| Other accounts  receivable                                  |   | 64     |   |
| Other long-term  tangible assets                            |   | 20     |   |
| Deferred tax liability                                      |   | (40    | )      |
| Property and equipment                                      |   | 18     |   |
| Total tangible assets  acquired                             |   | 950    |   |
|                                                        |   |   |   |
| Customer-related  intangible asset (five years useful life) |   | 139    |   |
| Goodwill                                                    |   | 3,236  |   |
| Total intangible assets  acquired                           |   | 3,375  |   |
|                                                        |   |   |   |
| Total tangible and  intangible assets acquired              |   | 4,325  |   |
|                                                        |   |   |   |
| Accounts payable                                            |   | 148    |   |
| Other accounts payable                                      |   | 280    |   |
| Related parties, net                                        |   | 365    |   |
|                                                        |   |   |   |
| Total liabilities  assumed                                  |   | 793    |   |
|                                                        |   |   |   |
| Net assets acquired                                         |   | $      | 3,532  |   |

 

The allocation of the purchase price reflected in the consolidatedbalance sheet is according to a valuation of Ness U.S.A.’s current assets,current liabilities, long-term tangible assets, property and equipment andintangible assets.

2.     Ness Romania

On April 1, 2005, we acquired all of the outstanding shares of RadixCompany SA (“Radix”), a provider of IT services and solutions based in Romania.The purchase price was €4 million, or $5,385, consisting of €2 million paid incash at the closing and €2 million placed in escrow for six months contingenton the verification of the accuracy of certain representations made by thesellers. Additional payments of €1.5 million, or $1,775, were made in April2006 based on achievement of certain revenue and operating income milestones in2005. The additional payments were accrued for and recorded as goodwill in theDecember 31, 2005 consolidated balance sheet. An additional payment of up to €1.5million will be required to be made in April 2007 based on achievement ofcertain revenue and operating income milestones for 2006. Currently, we cannotestimate the probability of achieving the 2006 milestones. Radix became awholly-owned subsidiary of our Dutch subsidiary, Ness Technologies, B.V., and,accordingly, its results of operations have been included in our consolidatedfinancial statements since the acquisition date. Upon completion of the acquisition,Radix Company SA changed its name to Ness Romania.

10

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their related fair values. We haveallocated the total cost of the acquisition to Ness Romania’s assets andliabilities (as of the acquisition date, except for goodwill, which was updatedto include the additional payments) as follows: 

| Cash and cash equivalents                    |   | $      | 2,511  |   |
|----------------------------------------------|--------|--------|--------|--------|
| Trade receivables                            |   | 933    |   |
| Inventories                                  |   | 137    |   |
| Deferred tax  liability                      |   | (204   | )      |
| Property and  equipment                      |   | 2,094  |   |
| Other accounts  receivable                   |   | 97     |   |
| Intangible assets:                           |   |   |   |
| Customer  relations                          |   | 420    |   |
| Backlog                                      |   | 260    |   |
| Work force                                   |   | 730    |   |
| Goodwill                                     |   | 4,659  |   |
| Total assets acquired                        |   | 11,637 |   |
| Liabilities assumed:                         |   |   |   |
| Accounts payable  and other accrued expenses |   | 1,420  |   |
| Other current  liabilities                   |   | 1,506  |   |
| Long-term  liabilities                       |   | 1,551  |   |
| Total liabilities  assumed                   |   | 4,477  |   |
| Net assets acquired                          |   | $      | 7,160  |   |

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

The value assigned to the tangible assets, intangible assets andliabilities has been determined as follows:

a.               Radix’s current assets and liabilities were recordedat their carrying amounts. The carrying amounts of the current assets andliabilities were reasonable proxies for their market values due to theirshort-term maturity. Property and equipment were presented at currentreplacement cost. Long-term liabilities are presented at present value ofamounts to be paid determined at appropriate current interest rates.

b.              The value assigned to the customer-related intangiblesamounted to $420. The fair value of Radix’s customer-related intangibles wasdetermined using the Income Approach.

3.     Ness DM a.s.

On June 1, 2005, we acquired all of the outstanding shares of Efcona.s. (“Efcon”), a provider of IT services and solutions based in the CzechRepublic. The purchase price was €0.6 million, or $738, consisting of €350,000paid at closing and €250,000 paid in July 2005. An additional payment of €0.2million, or $237, was made in February 2006 based on achievement of certain 

11

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

2005 performance goals. The additional payment was accrued for andrecorded as goodwill in the December 31, 2005 consolidated balance sheet. Efconbecame a wholly-owned subsidiary of Ness Czech s.r.o., a part of our NessEurope group, and, accordingly, its results of operations have been included inour consolidated financial statements since the acquisition date. Following theacquisition, Efcon changed its name to Ness DM a.s.

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their related fair values. We haveallocated the total cost of the acquisition to Ness DM’s assets and liabilities(as of the acquisition date, except for goodwill, which was updated to includethe additional payment) as follows:

| Cash and cash equivalents                    |   | $      | 426    |   |
|----------------------------------------------|--------|--------|--------|--------|
| Trade  receivables                           |   | 314    |   |
| Inventories                                  |   | 33     |   |
| Property and  equipment                      |   | 212    |   |
| Deferred tax  liabilities                    |   | (19    | )      |
| Other accounts  receivable                   |   | 446    |   |
| Intangible assets:                           |   |   |   |
| Work force                                   |   | 278    |   |
| Customer  relations                          |   | 64     |   |
| Goodwill                                     |   | 253    |   |
| Other                                        |   | 48     |   |
| Total assets acquired                        |   | 2,055  |   |
| Liabilities assumed:                         |   |   |   |
| Accounts payable  and other accrued expenses |   | 442    |   |
| Other current  liabilities                   |   | 588    |   |
| Long term  liabilities                       |   | 50     |   |
| Total liabilities assumed                    |   | 1,082  |   |
| Net assets acquired                          |   | $      | 975    |   |

 

The allocation of the purchase price reflected in the consolidatedbalance sheet is according to a valuation of Ness DM’s current assets, currentliabilities, long-term liabilities, property and equipment and intangibleassets.

The value assigned to the tangible assets, intangible assets andliabilities has been determined as follows:

a.               Ness DM’s current assets and liabilities were recordedat their carrying amounts. The carrying amounts of the current assets andliabilities were reasonable proxies for their market values due to theirshort-term maturity. Property and equipment were presented at currentreplacement cost. Long-term liabilities are presented at present value ofamounts to be paid determined at appropriate current interest rates.

b.              The value assigned to the customer-related intangiblesamounted to $64. The fair value of Ness DM’s customer-related intangibles wasdetermined using the Income Approach.

12

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

4.     NTR

On September 12, 2005, we acquired all of the outstanding shares ofN.T.R. Holding Ltd. (“NTR”), a provider of IT services and solutions based inIsrael. The purchase price was $1,350. Additional payments of $150 were made inJune 2006 based on achievement of certain 2005 performance goals. Theadditional required payments were accrued for and recorded as goodwill in theDecember 31, 2005 consolidated balance sheet. NTR became a wholly-ownedsubsidiary of Ness A.T., a part of our Ness Israel group, and, accordingly, itsresults of operations have been included in the consolidated financialstatements since September 12, 2005.

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their related fair values. Based upona preliminary valuation of tangible and intangible assets acquired andliabilities assumed, we have allocated the total cost of the acquisition to NTR’sassets and liabilities (as of the acquisition date, except for goodwill, whichwas updated to include the additional payments) as follows:

| Cash and cash equivalents                    |   | $      | 173    |   |
|----------------------------------------------|--------|--------|--------|--------|
| Trade  receivables                           |   | 408    |   |
| Property and  equipment                      |   | 47     |   |
| Deferred tax  liability                      |   | (139   | )      |
| Other accounts  receivable                   |   | 391    |   |
| Intangible assets:                           |   |   |   |
| Backlog                                      |   | 119    |   |
| Customer  relations                          |   | 345    |   |
| Goodwill                                     |   | 889    |   |
| Total assets acquired                        |   | 2,233  |   |
| Liabilities assumed:                         |   |   |   |
| Accounts payable  and other accrued expenses |   | 25     |   |
| Other current  liabilities                   |   | 443    |   |
| Long-term  liabilities                       |   | 265    |   |
| Total liabilities  assumed                   |   | 733    |   |
| Net assets acquired                          |   | $      | 1,500  |   |

 

The allocation of the purchase price reflected in the consolidatedbalance sheet is according to a valuation of NTR’s current assets, currentliabilities, long-term liabilities, property and equipment and intangibleassets.

The value assigned to the tangible assets, intangible assets andliabilities has been determined as follows:

a.               NTR’s current assets and liabilities were recorded attheir carrying amounts. The carrying amounts of the current assets andliabilities were reasonable proxies for their market values due to theirshort-term maturity. Property and equipment were presented at currentreplacement cost. Long-term liabilities are presented at present value ofamounts to be paid determined at appropriate current interest rates.

13

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

b.              The value assigned to the customer-related intangiblesamounted to $464. The fair value of NTR’s customer-related intangibles wasdetermined using the Income Approach.

5.     Delta

On October 3, 2005, we acquired all the outstanding shares of DeltaElectronic Services a.s. (“Delta”), a provider of IT services and solutions inSlovakia. We acquired the outstanding shares for cash consideration of $8,000and related purchase costs of approximately $115. In addition, as Deltaachieved certain business goals by the end of 2005, we paid an additionalamount of $3,000 during 2006. Upon completion of the acquisition, Delta changedits name to Ness Slovakia, and it operates as a part of Ness Europe. Deltabecame a wholly-owned subsidiary of Ness B.V., a part of the Ness Europe group,and, accordingly, its results of operations have been included in theconsolidated financial statements since October 3, 2005.

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assets acquiredand liabilities assumed based on their related fair values. Based upon avaluation of tangible and intangible assets acquired and liabilities assumed,we have allocated the total cost of the acquisition to Delta’s assets andliabilities (as of the acquisition date, except for goodwill, which was updatedto include the additional payment) as follows:

| Cash and cash equivalents                    |   | $      | 2,158  |   |
|----------------------------------------------|--------|--------|--------|--------|
| Trade  receivables                           |   | 1,476  |   |
| Property and  equipment                      |   | 575    |   |
| Other accounts  receivable                   |   | 1,176  |   |
| Deferred tax  liabilities                    |   | (564   | )      |
| Intangible assets:                           |   |   |   |
| Customer  relations                          |   | 1,616  |   |
| Backlog                                      |   | 265    |   |
| Workforce                                    |   | 1,290  |   |
| Goodwill                                     |   | 6,408  |   |
| Total assets acquired                        |   | 14,400 |   |
| Liabilities assumed:                         |   |   |   |
| Accounts payable  and other accrued expenses |   | 1,235  |   |
| Other current  liabilities                   |   | 1,925  |   |
| Long-term  liabilities                       |   | 125    |   |
| Total liabilities  assumed                   |   | 3,285  |   |
| Net assets acquired                          |   | $      | 11,115 |   |

 

The allocation of the purchase price reflected in the consolidatedbalance sheet is according to a valuation of Delta’s current assets, currentliabilities, long-term liabilities, property and equipment and intangibleassets.

The value assigned to the tangible assets, intangible assets andliabilities has been determined as follows:

14

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

a.               Delta’s current assets and liabilities were recordedat their carrying amounts. The carrying amounts of the current assets andliabilities were reasonable proxies for their market values due to theirshort-term maturity. Property and equipment were presented at currentreplacement cost. Long-term liabilities are presented at present value ofamounts to be paid determined at appropriate current interest rates.

b.              The value assigned to the customer-related intangiblesamounted to $1,881. The fair value of Delta’s customer-related intangibles wasdetermined using the Income Approach.

6.     Innova

On February 28, 2006, we acquired all of the outstanding shares of OlasSoftware Solutions, Inc., d/b/a Innova Solutions (“Innova”), a provider of ITservices and solutions based in the United States and India. We acquired theoutstanding shares for cash consideration of $15,000 and related purchase costsof approximately $249. Additional payments of up to $10,000 are required to bemade in April 2007 and April 2008 based on achievement of certain revenue andoperating income milestones for the years 2006 and 2007, respectively.Currently, we cannot estimate the probability of achieving these milestones.

Innova became a wholly-owned subsidiary of Ness Technologies, Inc. and,accordingly, its results of operations are included in our consolidatedfinancial statements since the acquisition date. Upon completion of theacquisition, Innova changed its name to Ness Innovative Business Services.

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their relative fair values. Basedupon a preliminary valuation of tangible and intangible assets acquired andliabilities assumed, we have allocated the total cost of the acquisition toInnova’s assets and liabilities (as of the acquisition date) as follows:

| Cash and cash equivalents                    |   | $      | 1,566  |   |
|----------------------------------------------|--------|--------|--------|--------|
| Trade  receivables                           |   | 3,527  |   |
| Property and  equipment                      |   | 2,342  |   |
| Other accounts  receivable                   |   | 1,829  |   |
| Intangible assets:                           |   |   |   |
| Customer  relations                          |   | 1,848  |   |
| Backlog                                      |   | 640    |   |
| Workforce.                                   |   | 4,773  |   |
| Goodwill                                     |   | 5,552  |   |
| Total assets acquired                        |   | 22,077 |   |
| Liabilities assumed:                         |   |   |   |
| Accounts payable  and other accrued expenses |   | 4,606  |   |
| Other current  liabilities                   |   | 1,956  |   |
| Long-term  liabilities                       |   | 266    |   |
| Total liabilities assumed                    |   | 6,828  |   |
| Net assets acquired                          |   | $      | 15,249 |   |

 

15

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

Customer relations is amortized over its useful life, preliminarilyestimated as 4.83 years. Backlog is amortized according to its expectedrevenue recognition schedule.

The allocation of the purchase price reflected in the consolidatedbalance sheet is preliminary. We have arranged to obtain a valuation of Innova’scurrent assets, current liabilities, long-term tangible assets, property andequipment, intangible assets and liabilities. Management expects to obtain suchcompleted report during 2006.

Pro forma information in accordance with SFAS No. 141 has not beenprovided, since the revenues and net income of Ness Innovative BusinessServices were not material in relation to our total consolidated revenues andnet income.

##### f.                 Goodwill

On January 1, 2006, we began segment reporting, and therefore weallocated our goodwill balance as of January 1, 2006 to our reportable segmentsbased on their relative fair value as of that date.

We have elected to perform our annual goodwill impairment test duringthe fourth quarter of the year. No indications of impairment were identifiedduring the three and six months ended June 30, 2006.

##### g.              Accounting forstock-based compensation

On January 1, 2006, we adopted Statement of Financial AccountingStandards No. 123(R), “Share-Based Payment” (SFAS 123(R)) utilizing themodified prospective transition method. SFAS 123(R) requires employee stockoptions to be valued at fair value on the date of grant and charged to expenseover the applicable service period. Under the modified prospective method,compensation expense is recognized for all share-based payments issued on orafter January 1, 2006 and for all share-based payments issued to employeesprior to January 1, 2006 that remain unvested.

Our results of operations for the three and six months ended June 30,2006 include expenses of $164 and $291, respectively, in operating expenserelated to the adoption of SFAS 123(R). In accordance with the modifiedprospective method, our consolidated financial statements for prior periodshave not been restated to reflect, and do not include, the impact of SFAS123(R).

Adoption of SFAS 123(R) did not change our accounting for share-basedpayments issued to non-employees.

Prior to the adoption of SFAS 123(R), we accounted for share-basedawards to employees and directors using the intrinsic value method inaccordance with Accounting Principles Board (APB) Opinion No. 25, “Accountingfor Stock Issued to Employees.” Additionally, prior to January 1, 2006, weprovided pro forma disclosure amounts in accordance with SFAS No. 148, “Accountingfor Stock-Based Compensation — Transition and Disclosure” (“SFAS No. 148”), asif the fair value method defined by SFAS 123 had been applied to stock-basedcompensation. Under APB Opinion No. 25, the exercise price of stock optionsgranted to employees and directors equaled the fair market value of theunderlying stock at the grant date, therefore, no share-based compensationexpense was recognized in our condensed consolidated statement of income.

SFAS 123(R) requires companies to estimate the fair value ofshare-based awards on the date of grant using an option-pricing model, whereapplicable. Share-based compensation expense recognized in our condensedconsolidated statement of income for the first and second quarters of fiscal2006 includes compensation expense for share-based awards granted (i) prior to,but not yet vested as of, December 31, 

16

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

2005, based on the grant date fair value estimated inaccordance with the original provisions of SFAS 123, “Accounting forStock-Based Compensation” (“SFAS 123”), and (ii) subsequent to December 31,2005, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R). We recognize these compensation costs net of aforfeiture rate and recognize the compensation costs for only those sharesexpected to vest on a straight-line basis over the requisite service period ofthe award, which is generally the option vesting term of three to four years.SFAS 123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. In our pro forma information required under SFAS 123 forperiods prior to fiscal 2006, we accounted for forfeitures as they occurred.

As of June 30, 2006, approximately $282 of total unrecognizedcompensation cost related to stock based compensation is expected to berecognized over a weighted-average period of 2.5 years. The total unrecognizedstock-based compensation cost to be recognized in future periods as of June 30,2006 does not consider the effect of stock options that may be issued insubsequent periods.

The fair value of each option grant was estimated at the date of grantusing the Black-Scholes option pricing model. The fair value for options grantedin the three and six month periods ended June 30, 2005 is amortized over theirvesting periods and estimated at the date of grant using the Black-Scholesoption pricing model with the following weighted average assumptions.  During the three and six month periods endedJune 30, 2006, no options were granted.        

|                          | ** ** | **Three months ended  June 30, 2005** | ** ** | **Six months ended  June 30, 2005** | ** ** |
|--------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **               | ** ** | **(Unaudited)**                                           | ** ** | **(Unaudited)**                                         | ** ** |
| Dividend yield           |       | 0                                                         | %          | 0                                                       | %          |
| Expected volatility      |       | 0.39                                                      |       | 0.39                                                    |       |
| Risk-free interest       |       | 2.5                                                       | %          | 2.5                                                     | %          |
| Expected life (in years) |       | 4                                                         |       | 4                                                       |       |

 

The pro forma information regarding net income and earnings per share requiredby SFAS No. 123 has been determined as if we accounted for our stock-basedcompensation plans under the fair value method. Had compensation cost for ourstock-based compensation plans been determined in accordance with SFAS No. 123,as amended by SFAS No. 148, our net income and earnings per share would havebeen reduced to the pro forma amounts indicated below:

|                                                              | ** ** | **Three months ended  June 30, 2005** | ** ** | **Six months ended  June 30, 2005** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                   | ** ** | **(Unaudited)**                                           | ** ** | **(Unaudited)**                                         | ** ** |
| Net income available to  common stock, as reported           |       | $                                                         | 3,983      |                                                    | $          | 8,909 |   |
| Add: Stock-based  employee compensation—intrinsic value |       | 1,286                                                     |       | 1,897                                                   |       |
| Deduct: Stock-based  employee compensation—fair value   |       | (2,093                                                    | )          | (3,492                                                  | )          |
| Pro forma net  income                                        |       | $                                                         | 3,176      |                                                    | $          | 7,314 |   |
|                                                         |       |                                                      |       |                                                    |       |
| Basic net earnings per  share, as reported                   |       | $                                                         |  0.12 |                                                    | $          | 0.26 |   |
| Diluted net earnings  per share, as reported                 |       | $                                                         |  0.11 |                                                    | $          |  0.25 |   |
|                                                         |       |                                                      |       |                                                    |       |
| Pro forma basic net  earnings per share                      |       | $                                                         |  0.09 |                                                    | $          |  0.21 |   |
| Pro forma diluted net earnings per share                     |       | $                                                         |  0.09 |                                                    | $          |  0.21 |   |

 

17

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

##### h.              Impact ofrecently issued accounting pronouncements

In June 2006, the Financial Accounting Standards Board issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”).FIN 48 creates a single model to address uncertainty in tax positions. FIN 48clarifies the accounting for income taxes by prescribing the minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. In addition, FIN 48 clearlyscopes out income taxes from Financial Accounting Standards Board Statement No.5, “Accounting for Contingencies.” FIN 48 utilizes a two-step approach forevaluating tax positions. Recognition (step one) occurs when an enterpriseconcludes that a tax position, based solely on its technical merits, ismore-likely-than-not to be sustained upon examination. Measurement (step two)is only addressed if step one has been satisfied (i.e., the position ismore-likely-than-not to be sustained). FIN 48 applies to all tax positionsrelated to income taxes subject to Financial Accounting Standards BoardStatement No. 109, “Accounting for Income Taxes.”  This includes taxpositions considered to be “routine” as well as those with a high degree ofuncertainty. Derecognition of a tax position that was previously recognizedwould occur when a company subsequently determines that a tax position nolonger meets the more-likely-than-not threshold of being sustained. FIN 48specifically prohibits the use of a valuation allowance as a substitute forderecognition of tax positions. FIN 48 is effective for fiscal years beginningafter December 15, 2006.  Management isin the process of evaluating the possible impact of the adoption of FIN 48 onour consolidated financial statements.

In March 2006, the FASB issued FASB Statement No. 156, “Accounting forServicing of Financial Assets,” (“FAS 156”) which amends FASB Statement No.140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities.” This statement addresses the recognition andmeasurement of separately recognized servicing assets and liabilities, such asthose common with mortgage securitization activities, and provides an approachto simplify efforts to obtain hedge-like accounting. It also clarifies when anobligation to service financial assets should be separately recognized as aservicing asset or servicing liability and requires that those separately recognizedassets or liabilities be initially measured at fair value, if practicable. FAS156 permits an entity to choose either the amortization method or the fairvalue method for subsequent measurement and also permits a servicer that usesderivative financial instruments to offset risks on servicing to report boththe derivative financial instrument and related servicing asset or liability byusing a consistent measurement attribute — fair value. This statement shall beeffective for all separately recognized servicing assets and liabilitiesacquired or issued after the beginning of an entity’s first fiscal yearbeginning after September 15, 2006, with early adoption permitted. Managementbelieves this statement will not have a material effect on our consolidatedfinancial statements.

In February 2006, the FASB issued FASB Statement No. 155, “Accountingfor Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and140.” This statement amends FASB Statements No. 133, “Accounting for DerivativeInstruments and Hedging Activities” (“FAS 133”), and No. 140, “Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities”(“FAS 140”). This statement allows financial instruments that have embeddedderivatives to be accounted for as a whole (eliminating the need to bifurcatethe derivative from its host) if the holder elects to account for the wholeinstrument on a fair value basis. It also clarifies which interest-only stripsand principal-only strips are not subject to the requirements of FAS 133;establishes a requirement to evaluate interests in securitized financial assetsto identify interest that are freestanding derivatives or that are hybridfinancial instruments that contain an embedded derivative requiring bifurcation;clarifies that concentrations of credit risk in the form of subordination arenot embedded derivatives; and amends FAS 

18

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

140 to eliminate the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. This statement shall be effective for all financial instrumentsacquired or issued after the beginning of an entity’s first fiscal yearbeginning after September 15, 2006. Management believes this statement will nothave a material effect on our consolidated financial statements.

##### i.                  Reclassification

Certain prior period amounts have been reclassified to conform to thecurrent period presentation.

#### ***Note 3: Long-Term Debt***

##### a.               Composition

Our long-term debt is comprised as follows:

|                          | ** ** | **December 31,  2005** | ** ** | **June 30,  2006** | ** ** |
|--------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **               | ** ** | ** **                  | ** ** | **(Unaudited)**         | ** ** |
| Banks (1)                |       | $                           | 11,610     |                    | $          | 9,976 |   |
| Loans from  others       |       | 1,546                       |       | 1,561                   |       |
|                     |       | 13,156                      |       | 11,537                  |       |
| Less current  maturities |       | 6,862                       |       | 6,598                   |       |
|                     |       | $                           | 6,294      |                    | $          | 4,939 |   |

----

(1) The long-term loansdefault upon the failure of any of our subsidiaries named as borrowers underthe loans to satisfy certain conditions and comply with covenants. As ofDecember 31, 2005 and June 30, 2006, management believes that the subsidiariesare in compliance with foregoing conditions. The weighted average interest rateon the bank loans as of December 31, 2005 was 6.75% and as of June 30, 2006 was5.7%.

##### b.              Classification

Classified by currency, linkage terms and interest rates, the totalamount of the liabilities (before deduction of current maturities) is asfollows:

|                          | ** ** | **Interest rate (%)** | ** ** | **Amount**        | ** ** |
|--------------------------|------------|---------------------------------|------------|-------------------|------------|
| ** **               | ** ** | **December 31,**           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **               | ** ** | **2005**                        | ** ** | **2006**          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **               | ** ** | ** **                      | ** ** | **(Unaudited)**   | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| In, or linked to  dollar |       | 5-6                             |       | 5-6               |       | $ | 2,169 |   | $ | 1,561 |   |
| In NIS - linked  to CPI  |       | 6-8                             |       | 6-8               |       | 10,987 |   | 9,976 |   |
|                     |       |                            |       |              |       | $ | 13,156 |   | $ | 11,537 |   |

 

##### c.               Maturities

The liabilities mature as follows:

19

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

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

 

#### ***Note 4: Commitments and Contingent Liabilities***

##### a.               Litigation

There are several outstanding claims filed against our subsidiaries byex-employees and others. Our management believes that the provision in ourconsolidated financial statements and our insurance coverage are adequate tocover probable costs arising from these matters.

##### b.              Guarantees

Guarantees are contingent commitments issued by us generally toguarantee our performance in different projects to our customers, such astenders. The term of a guarantee generally is equal to the term of the relatedprojects, which can be as short as 30 days or as long as 5 years. The maximumpotential amount of future payments we could be required to make under ourguarantees at December 31, 2005 and June 30, 2006, is $36,168 and $37,568,respectively. We do not hold collateral to support guarantees when deemednecessary.

##### c.               Liens andcharges

To secure our liabilities, we and our subsidiaries recorded fixed andfloating charges on our holdings in subsidiaries, and on our and oursubsidiaries’ property and equipment and goodwill.

#### ***Note 5: Stockholders’ Equity***

##### a.               Redeemableoptions:

Our Executive Committee approved and resolved on August 31, 2004 toprovide to certain optionees (specifically, those who exchanged their options intwo previously public entities acquired by us for options in Ness) the right toredeem their options for a cash payment. The grant date occurred during thefourth quarter of 2004.

The redemption right was exercisable from October 1, 2004 until May 31,2006. Each option subject to the redemption right was transferable by theemployee to us for a cash payment linked, at the employee’s sole discretion,either to the Israeli CPI with NIS interest at the rate of 5% per year, or tothe U.S. dollar with U.S. dollar interest at the rate of 6% per year,calculated from the original option grant date of September 23, 1999 or October3, 1999 up to the redemption date. Each of 272,976 options were exercisable toacquire one share of our common stock at a price of $3.49 and were redeemableat the NIS equivalent amount of $10.12 per option as of May 31, 2006. Each of 77,382options were exercisable to acquire one share of our common stock at a price of$7.45 and were redeemable at the NIS equivalent amount of $7.63 per option asof May 31, 2006.

We accounted for the rights following the guidance of FIN No. 28, “Accountingfor Stock Appreciation Rights and Other Variable Stock Option or Award Plans,”relating to tandem awards and EITF No. 00-23, “Issues Related to the Accountingfor Stock Compensation under APB No. 25 and FIN No. 44.” Accordingly, once webelieved it was likely that the rights would be exercised in the future, a 

 

20

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

liability was recorded at the then value of theredemption rights with a corresponding charge to compensation expense.

On  May 31, 2006, the redemptionvalue of the redeemable options was higher than the difference between themarket price of our shares and the strike price of the options. Although we hadpreviously recorded all the expected redemption value, the holders of 289,836 optionspreferred to exercise their options and sell their shares and receive from usin cash only the difference between the redemption values and the proceeds theyreceived from the sale. The holders of the remaining 60,522 options elected tofully redeem the options.

The net cash payment was therefore only $1,485 and the remainingbalance of the previously recorded liability, or $1,868, was classified asequity.

##### b.              Totalcomprehensive income:

|                                                                            | ** ** | **Three months ended  June 30,** | ** **  | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|-------------|-----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                        | ** **  | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                 | ** ** | **(Unaudited)**                                 | ** **  | **(Unaudited)**                               | ** ** |
| Net income                                                                 |       | $                                               | 3,983  |                                          | $          | 5,950 |   | $ | 8,909  |   | $ | 12,287 |   |
| Foreign currency  translation adjustments, net                             |       | (5,420                                          | )           | 6,350                                         |       | (9,211 | ) | 3,535 |   |
| Net unrealized  losses (gains) on available-for-sale marketable securities |       | 9                                               |        | 39                                            |       | (58 | ) | (21 | ) |
| Comprehensive income  (loss)                                               |       | $                                               | (1,428      | )                                             | $          | 12,339 |   | $ | (360 | ) | $ | 15,801 |   |

####  

#### ***Note 6: Segment Reporting***

Our segment information has been prepared inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information.” Operating segments are defined as components of an enterpriseengaging in business activities about which separate financial information isavailable that is evaluated regularly by our chief operating decision-maker indeciding how to allocate resources and assess performance.

At the end of 2005, we completed the reorganization ofour operations into operating segments. Our chief operating decision-maker isour chief executive officer, who evaluates our performance and allocatesresources based on segment revenues and operating profit.

Our operating segments are:

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

2. **Technologies & Systems Group**, whichincludes system integration and application development, real-time systemsdevelopment, consulting and outsourcing services for the defense, governmentand homeland security vertical, as well as systems for the telecommunicationsvertical.

3. **Ness Europe**, which includes systemintegration and application development, outsourcing and software andconsulting for Eastern European and Western European customers, includingnear-shore services from 

 

21

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

Eastern Europe forWestern European customers. Verticals served by this segment are:telecommunications and utilities, financial services and others.

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

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

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

The table below presents financial information for ourfive reportable segments. Prior period data is presented on a pro forma basis,as we were not organized into SFAS No. 131 operating segments at that time.

|                                        | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)**                                   | ** ** |
| **Revenues:**                          |       |                                                |       |                                              |       |   |   |   |   |
| Managed Strategic Services (MSS)       |       | $                                                   | 21,754     |                                              | $          | 22,331 |   | $ | 41,377 |   | $ | 41,894 |   |
| Technologies & Systems Group (TSG) |       | 11,104                                              |       | 12,635                                            |       | 22,751 |   | 27,420 |   |
| Ness Europe                            |       | 14,048                                              |       | 21,174                                            |       | 21,700 |   | 39,613 |   |
| Ness Israel                            |       | 41,192                                              |       | 44,255                                            |       | 83,870 |   | 88,314 |   |
| Other                                  |       | 6,120                                               |       | 16,219                                            |       | 12,925 |   | 26,415 |   |
|                                   |       | $                                                   | 94,218     |                                              | $          | 116,614 |   | $ | 182,623 |   | $ | 223,656 |   |

 

|                                        | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)**                                   | ** ** |
| **Operating  Income (Loss):**          |       |                                                |       |                                              |       |   |   |   |   |
| Managed Strategic Services (MSS)       |       | $                                                   | 1,903      |                                              | $          | 3,027 |   | $ | 3,352 |   | $ | 5,387 |   |
| Technologies & Systems Group (TSG) |       | 1,302                                               |       | 1,331                                             |       | 3,083 |   | 3,192 |   |
| Ness Europe                            |       | 1,685                                               |       | 2,404                                             |       | 2,482 |   | 3,917 |   |
| Ness Israel                            |       | 2,542                                               |       | 1,401                                             |       | 5,759 |   | 4,537 |   |
| Other                                  |       | (103                                                | )          | 1,101                                             |       | (424 | ) | 1,595 |   |
| Unallocated Expenses                   |       | (2,412                                              | )          | (1,790                                            | )          | (3,480 | ) | (3,249 | ) |
|                                   |       | $                                                   | 4,917      |                                              | $          | 7,474 |   | $ | 10,772 |   | $ | 15,379 |   |

 

Our total revenues are attributed to geographic areasbased on the location of the end customer.

22

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

The following presents total revenues for the threeand six month periods ended June 30, 2005 and 2006, and long-lived assets as ofJune 30, 2005 and 2006:

|                                                 | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | **(Unaudited)**                                 | ** ** | **(Unaudited)**                               | ** ** |
| Revenues from  sales to unaffiliated customers: |       |                                            |       |                                          |       |   |   |   |   |
| Israel                                          |       | $                                               | 48,464     |                                          | $          | 52,577 |   | $ | 100,172 |   | $ | 105,502 |   |
| United States                                   |       | 23,402                                          |       | 33,825                                        |       | 44,154 |   | 61,142 |   |
| Europe                                          |       | 16,472                                          |       | 24,603                                        |       | 26,849 |   | 45,879 |   |
| Asia and the Far East                           |       | 4,460                                           |       | 4,445                                         |       | 8,816 |   | 8,960 |   |
| Others                                          |       | 1,420                                           |       | 1,164                                         |       | 2,632 |   | 2,173 |   |
|                                            |       | $                                               | 94,218     |                                          | $          | 116,614 |   | $ | 182,623 |   | $ | 223,656 |   |

 

|                       | ** ** | **June 30,** | ** ** |
|-----------------------|------------|-------------------|------------|
| ** **            | ** ** | **2005**          | ** ** | **2006** | ** ** |
| ** **            | ** ** | **(Unaudited)**   | ** ** |
| Long-lived  assets:   |       |              |       |   |   |
| Israel                |       | $                 | 99,503     |   | $ | 106,032 |   |
| United States         |       | 60,243            |       | 72,943 |   |
| Europe                |       | 8,738             |       | 19,974 |   |
| Asia and the Far East |       | 8,602             |       | 9,468 |   |
| Others                |       | 7                 |       | 13 |   |
|                  |       | $                 | 177,093    |   | $ | 208,430 |   |

 

#### ***Note 7: Basic and Diluted Net Earnings per Share***

Basic net earnings per share are computed based on theweighted average number of shares of common stock outstanding during eachperiod. Diluted net earnings per share are computed based on the weightedaverage number of shares of common stock outstanding during each period, plusdilutive potential shares of common stock considered outstanding during the period,in accordance with SFAS No. 128, “Earnings per Share.”

The total weighted average number of shares related tothe outstanding options and warrants excluded from the calculations of dilutednet earnings per share, as they would have been anti-dilutive for all periodspresented, was 1,521,226, 1,143,316, 2,381,833, 581,536, and 2,381,833 for theyear ended December 31, 2005, the three months ended June 30, 2005 and 2006,and the six months ended June 30, 2005 and 2006, respectively.

The following table sets forth the computation ofbasic and diluted net earnings per share of common stock (in thousands):

23

----

 
| **NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**                             |
|------------------------------------------------------------------------------|
| **Notes to Interim Condensed Consolidated  Financial Statements**            |
| **U.S. dollars in thousands (except share and per  share data) (Unaudited)** |

 

|                                                                                                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                                   | ** ** | **(Unaudited)**                                 | ** ** | **(Unaudited)**                               | ** ** |
| Numerator:                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Net income, numerator for basic and diluted per  share                                                       |       | $                                               | 3,983      |                                          | $          | 5,950 |   | $ | 8,909 |   | $ | 12,287 |   |
|                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Denominator:                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average number of shares of common stock                                                            |       | 34,541                                          |       | 35,602                                        |       | 34,147 |   | 35,239 |   |
| Denominator for basic net earnings per share                                                                 |       | 34,541                                          |       | 35,602                                        |       | 34,147 |   | 35,239 |   |
| Effect of dilutive securities:                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Employee stock options and warrants                                                                          |       | 1,103                                           |       | 1,116                                         |       | 1,447 |   | 1,096 |   |
| Denominator for  diluted net earnings per share—adjusted weighted average assuming exercise of  options |       | 35,644                                          |       | 36,718                                        |       | 35,594 |   | 36,335 |   |
|                                                                                                              |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

 

24

----

***Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations***

*You should read the followingdiscussion and analysis together with our unaudited consolidated financialstatements and the accompanying notes. This discussion contains forward-lookingstatements, within the meaning of Section 27A of Securities Act of 1933, asamended, Section 21E of the Securities Exchange Act of 1934, as amended, andthe Private Securities Litigation Reform Act of 1995, including statements regardingour expected financial position, business and financing plans. These statementsinvolve risks and uncertainties. Our actual results could differ materiallyfrom the results described in or implied by these forward-looking statements asa result of various factors, including those discussed below and elsewhere inour Annual Report on Form 10-K filed with the SEC on March 15, 2006,particularly under the headings “Disclosure Statement” and “Risk Factors.”*

**Overview**

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

We have operations in 15 countries across NorthAmerica, Europe and Asia. We combine our deep vertical expertise and strongtechnical capabilities to provide a complete range of high quality services ona global scale. By integrating our local and international personnel in focusedbusiness and project teams, our global delivery model leverages our corporateknowledge and experience, intellectual property and global infrastructure todevelop innovative solutions for clients across the geographies and verticalswe serve. We complement this global delivery model with our offshore deliverycapabilities to achieve meaningful cost reductions or other benefits for ourclients.

Our revenues increased to $116.6 million and $223.7million for the three and six months ended June 30, 2006, respectively, from$94.2 million and $182.6 million for the three and six months ended June 30,2005, respectively. Net income increased to $6.0 million and $12.3 million forthe three and six months ended June 30, 2006, respectively, from $4.0 millionand $8.9 million for the three and six months ended June 30, 2005, respectively.

Our revenue growth is attributable to a number offactors, including acquisitions we made, increases in the number and size ofprojects for existing clients and the addition of new clients. Our client baseis diverse, and we are not dependent on any single client. In the three and sixmonths ended June 30, 2006, no client accounted for more than 4% of ourrevenues and our largest twenty clients together accounted for approximately38% of our revenues. For the three and six months ended June 30, 2006, the percentageof our revenues generated from agencies of the government of Israel was 9% and9%, respectively. Existing clients from prior years generated more than 85% ofour revenues in the three and six months ended June 30, 2006.

Our backlog as of June 30, 2006 was $532 millioncompared to $418 million as of June 30, 2005. This $114 million increase in ourbacklog was due primarily to new bookings. We achieve backlog through newsignings of IT services projects and outsourcing contracts, including for new andrepeat customers. We recognize backlog as revenue when we perform the servicesrelated to backlog.

For the three and six months ended June 30, 2006, thepercentage of our revenues derived from clients in Israel was 45% and 47%,respectively; in the United States, 29% and 27%, respectively; in Europe, 21%and 21%, respectively; in Asia and the Far East, 4% and 4%, respectively; andin other countries, 1% and 1%, respectively.

25

----

For the three and six months ended June 30, 2006, wederived 45% and 44%, respectively, of our revenues from outsourcing (includingoffshore development); 32% and 32%, respectively, from system integration andapplication development; 15% and 14%, respectively, from software andconsulting; 7% and 7%, respectively, from quality assurance and training; and2% and 2%, respectively, from our other offerings.

As of June 30, 2006, we had approximately 7,160employees, including approximately 6,280 IT professionals. Of the 7,160employees, approximately 3,300 were in Israel, 2,225 were in India, 510 were inNorth America, 795 were in Europe and 330 were in the Asia Pacific region.

**RecentDevelopments**

There have been no significant developments since June30, 2006.

**ConsolidatedResults of Operations**

The following table sets forth the items in ourconsolidated statements of income as a percentage of revenues for the periodspresented.

 

|                                               | ** ** | **Three months ended  June 30,** | ** ** | **Three months ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                        | ** ** | **2006**                                        | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                      |       | 100.0                                           | %          | 100.0                                           | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                              |       | 72.2                                            |       | 72.0                                            |       | 71.5 |   | 71.4 |   |
| Gross profit                                  |       | 27.8                                            |       | 28.0                                            |       | 28.5 |   | 28.6 |   |
| Operating  expenses:                          |       |                                            |       |                                            |       |   |   |   |   |
| Selling and marketing                         |       | 7.4                                             |       | 7.5                                             |       | 7.7 |   | 7.7 |   |
| General and administrative                    |       | 15.1                                            |       | 14.1                                            |       | 14.9 |   | 14.0 |   |
| Total operating expenses                      |       | 22.6                                            |       | 21.6                                            |       | 22.6 |   | 21.7 |   |
| Operating income                              |       | 5.2                                             |       | 6.4                                             |       | 5.9 |   | 6.9 |   |
| Financial  expenses, net                      |       | (0.5                                            | )          | (0.5                                            | )          | (0.5 | ) | (0.3 | ) |
| Other income,  net                            |       | 0.0                                             |       | 0.4                                             |       | 0.0 |   | 0.2 |   |
| Income before  taxes on income                |       | 4.7                                             |       | 6.3                                             |       | 5.4 |   | 6.8 |   |
| Taxes on income                               |       | 0.4                                             |       | 1.1                                             |       | 0.6 |   | 1.3 |   |
| Equity in net  losses of affiliates           |       | 0.0                                             |       | (0.1                                            | )          | 0.0 |   | 0.0 |   |
| Minority  interests in losses of a subsidiary |       | —                                          |       | —                                          |       | 0.1 |   | — |   |
| Net income                                    |       | 4.2                                             |       | 5.1                                             |       | 4.9 |   | 5.5 |   |

 

**Three Months EndedJune 30, 2006 Compared to the Three Months Ended June 30, 2005**

The following table summarizes certain line items fromour consolidated statements of income (dollars in thousands):

 

|                  | ** ** | **Three months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------|------------|-------------------------------------------------|------------|--------------------------|------------|
| ** **       | ** ** | **2005**                                        | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues         |       | $                                               | 94,218     |                     | $          | 116,614 |   | 22,396 |   | 23.8 |   |
| Cost of revenues |       | 68,046                                          |       | 83,981                   |       | 15,935 |   | 23.4 |   |
| Gross profit     |       | $                                               | 26,172     |                     | $          | 32,633 |   | 6,461 |   | 24.7 |   |
| Gross margin     |       | 27.8                                            | %          | 28.0                     | %          |   |   |   |   |

####  

***Revenues***

Our revenues increased from $94.2 million in the threemonths ended June 30, 2005 to $116.6 million in the three months ended June 30,2006, representing an increase of $22.4 million, or 23.8%. A significantportion of the $16.4 million of revenue growth attributable to acquisitionsmade in the last twelve months was due to post-

 

26

----

acquisition growth resulting from synergies with Ness.Of the $22.4 million increase in revenues, $9.3 million represents growth inoutsourcing and offshore engagements and $13.1 million represents growth in ourother offerings, comprised of system integration and application development,software and consulting, and quality assurance and training. Revenues fromoutsourcing and offshore services increased as a result of volume growth due toour sales initiatives related to these offerings, including the hiring of keypersonnel and aligning of our organizational structure. There was nosignificant change in our billing rates, or prices, from the three months endedJune 30, 2005 to the three months ended June 30, 2006.

***Cost of revenues***

Our cost of revenues, including salaries, wages andother direct and indirect costs, increased from $68.0 million in the threemonths ended June 30, 2005 to $84.0 million in the three months ended June 30,2006, representing an increase of $15.9 million, or 23.4%. Approximately $12.2million of this increase was attributable to acquisitions made in the lasttwelve months, a significant portion of which was due to growth in our deliverystaff needed to support post-acquisition revenue growth resulting from synergieswith Ness, and $3.7 million was due to normal growth in our delivery staffneeded to support our increased revenues.

***Gross Profit***

Our gross profit (revenues less cost of revenues)increased from $26.2 million in the three months ended June 30, 2005 to $32.6million in the three months ended June 30, 2006, representing an increase of$6.5 million, or 24.7 %. The increase was primarily due to our increase inrevenues. A significant portion of the $4.2 million of gross profit increaseattributable to acquisitions made in the last twelve months was due topost-acquisition revenue growth resulting from synergies with Ness, and $2.3million was related to our other revenue growth. Gross margin for the threemonths ended June 30, 2006 was 28.0%, compared to 27.8% in the three monthsended June 30, 2005. This increase in gross margin was not significant.

The following table summarizes certain line items fromour consolidated statements of income (dollars in thousands):

 

|                             | ** ** | **Three months ended  June 30,** | ** **  | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|-------------------------------------------------|-------------|--------------------------|------------|
| ** **                  | ** ** | **2005**                                        | ** **  | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                               |  7,002 |                     | $          | 8,733 |   | 1,731 |   | 24.7 |   |
| General and  administrative |       | 14,253                                          |        | 16,426                   |       | 2,173 |   | 15.3 |   |
| Total operating  expenses   |       | 21,255                                          |        | 25,159                   |       | 3,904 |   | 18.4 |   |
| Operating income            |       | $                                               | 4,917       |                     | $          | 7,474 |   | 2,557 |   | 52.0 |   |

####  

***Selling and marketing***

Selling and marketing expenses increased from $7.0million in the three months ended June 30, 2005 to $8.7 million in the threemonths ended June 30, 2006, representing an increase of $1.7 million, or 24.7%.This increase was due primarily to the inclusion of marketing and salesexpenses from our acquisitions in the last twelve months, representing $0.3million, amortization of backlog and customer relations related toacquisitions, representing $0.6 million, and an increase in marketing expenses,sales commissions and sales expenses needed to support our revenue growth,representing $0.8 million.

***General and administrative***

General and administrative expenses increased from$14.3 million in the three months ended June 30, 2005 to $16.4 million in thethree months ended June 30, 2006, representing an increase of $2.2 million, or15.3%. This increase was due primarily to our acquisitions in the last twelvemonths, representing $2.2 million, and general and administrative expensesassociated with the reorganization of our Ness Israel segment, representing$0.4 million, offset by lower stock-based compensation expenses, representing$1.0 million.

27

----

***Operating Income***

Operating income increased from $4.9 million in thethree months ended June 30, 2005 to $7.5 million in the three months ended June30, 2006, representing an increase of $2.6 million, or 52.0%. The major factorscontributing to this increase were the growth in operating income of ourManaged Strategic Services, Ness Europe and Other segments, representing $1.1million, $0.7 million and $1.2 million, respectively, and a decrease inunallocated expenses, representing $0.6 million, offset by a decrease in theoperating income of our Ness Israel segment, representing $1.1 million. Seealso “—Results by Business Segment.”

The following table summarizes certain line items fromour consolidated statements of income (dollars in thousands):

 

|                                     | ** ** | **Three months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|--------------------------|------------|
| ** **                          | ** ** | **2005**                                        | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                    |       | $                                               | 4,917      |                     | $          | 7,474 |   | 2,557 |   | 52.0 |   |
| Financial  expenses, net            |       | (494                                            | )          | (577                     | )          | (83 | ) | 16.8 |   |
| Other income,  net                  |       | 10                                              |       | 483                      |       | 473 |   | 4,730 |   |
| Income before  taxes on income      |       | 4,433                                           |       | 7,380                    |       | 2,947 |   | 66.5 |   |
| Taxes on income                     |       | 423                                             |       | 1,340                    |       | 917 |   | 216.7 |   |
| Equity in net  losses of affiliates |       | (27                                             | )          | (90                      | )          | (63 | ) | 233.3 |   |
| Net income                          |       | $                                               | 3,983      |                     | $          | 5,950 |   | 1,967 |   | 49.4 |   |

####  

***Financial expenses, net***

Financial expenses, net, increased from $0.5 millionin the three months ended June 30, 2005 to $0.6 million in the three monthsended June 30, 2006, representing an increase of $0.1 million, or 16.7%. Theincrease was due primarily to the significant decrease in net cash to a levelof $0.9 million, which resulted in an increase in interest expense on loans, representing$0.1 million, and the effects of foreign exchange rate changes as moderated byour hedging of foreign currencies, representing $0.2 million, offset by anincrease in interest income on deposits, representing $0.2 million.

***Other income, net***

Other income, net, increased from $10,000 in the threemonths ended June 30, 2005 to $0.5 million in the three months ended June 30,2006. This increase was primarily due to consideration received for a thirdparty transaction, representing $0.4 million, net of expenses.

***Taxes on income***

Our taxes on income increased from $0.4 million in thethree months ended June 30, 2005 to $1.3 million in the three months ended June30, 2006, representing an increase of $0.9 million, or 217%. This increase wasprimarily attributable to the increase in our income before taxes, representing$0.3 million, and an increase in income before taxes from geographies withhigher tax rates as well as from higher taxes on certain revenues and otherincome, net, together representing $0.6 million.

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

Equity in net losses of affiliates increased from$27,000 for the three months ended June 30, 2005 to $0.1 million in the threemonths ended June 30, 2006. This change was not significant.

***Net Income***

Net income increased from $4.0 million in the threemonths ended June 30, 2005 to $6.0 million in the three months ended June 30,2006, representing an increase of $2.0 million, or 49.4%. The increase in netincome was due primarily to our increase in operating income of $2.6 millionand our increase in other income, net, of $0.5 million, partially offset by ourincrease in taxes on income of $0.9 million.

28

----

**Six Months EndedJune 30, 2006 Compared to the Six Months Ended June 30, 2005**

The following table summarizes certain line items fromour consolidated statements of income (dollars in thousands):

 

|                  | ** ** | **Six months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------|------------|-----------------------------------------------|------------|--------------------------|------------|
| ** **       | ** ** | **2005**                                      | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues         |       | $                                             | 182,623    |                     | $          | 223,656 |   | 41,033 |   | 22.5 |   |
| Cost of revenues |       | 130,624                                       |       | 159,697                  |       | 29,073 |   | 22.3 |   |
| Gross profit     |       | $                                             | 51,999     |                     | $          | 63,959 |   | 11,960 |   | 23.0 |   |
| Gross margin     |       | 28.5                                          | %          | 28.6                     | %          |   |   |   |   |

####  

***Revenues***

Our revenues increased from $182.6 million in the sixmonths ended June 30, 2005 to $223.7 million in the six months ended June 30,2006, representing an increase of $41.0 million, or 22.5%. A significantportion of the $28.9 million of revenue growth attributable to acquisitions wasdue to post-acquisition growth resulting from synergies with Ness. Of the $41.0million increase in revenues, $16.5 million represents growth in outsourcingand offshore engagements and $24.5 million represents growth in our otherofferings, comprised of system integration and application development,software and consulting, and quality assurance and training. Revenues fromoutsourcing and offshore services increased as a result of volume growth due toour sales initiatives related to these offerings, including the hiring of keypersonnel and aligning of our organizational structure. There was no significantchange in our billing rates, or prices, from the six months ended June 30, 2005to the six months ended June 30, 2006.

***Cost of revenues***

Our cost of revenues, including salaries, wages andother direct and indirect costs, increased from $130.6 million in the sixmonths ended June 30, 2005 to $159.7 million in the six months ended June 30,2006, representing an increase of $29.1 million, or 22.3%. Approximately $20.6million of this increase was attributable to acquisitions made in the lasttwelve months, a significant portion of which was due to growth in our deliverystaff needed to support post-acquisition revenue growth resulting fromsynergies with Ness, and $8.5 million was due to normal growth in our deliverystaff needed to support our increased revenues.

***Gross Profit***

Our gross profit (revenues less cost of revenues)increased from $52.0 million in the six months ended June 30, 2005 to $64.0million in the six months ended June 30, 2006, representing an increase of$12.0 million, or 23.0 %. The increase was primarily due to our increase inrevenues. A significant portion of the $8.3 million of gross profit increaseattributable to acquisitions made in the last twelve months was due topost-acquisition revenue growth resulting from synergies with Ness, and $3.7million was related to our other revenue growth. Gross margin for the sixmonths ended June 30, 2006 was 28.6%, compared to 28.5% in the six months endedJune 30, 2005. This increase in gross margin was not significant.

The following table summarizes certain line items fromour consolidated statements of income (dollars in thousands):

 

|                             | ** ** | **Six months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|-----------------------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **2005**                                      | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                             | 14,033     |                     | $          | 17,224 |   | 3,191 |   | 22.7 |   |
| General and  administrative |       | 27,194                                        |       | 31,356                   |       | 4,162 |   | 15.3 |   |
| Total operating  expenses   |       | 41,227                                        |       | 48,580                   |       | 7,353 |   | 17.8 |   |
| Operating income            |       | $                                             | 10,772     |                     | $          | 15,379 |   | 4,607 |   | 42.8 |   |

 

29

----

***Selling and marketing***

Selling and marketing expenses increased from $14.0million in the six months ended June 30, 2005 to $17.2 million in the sixmonths ended June 30, 2006, representing an increase of $3.2 million, or 22.7%.This increase was due primarily to the inclusion of marketing and salesexpenses from our acquisitions in the last twelve months, representing $1.5million, amortization of backlog and customer relations related toacquisitions, representing $1.3 million, and an increase in marketing expenses,sales commissions and sales expenses needed to support our revenue growth,representing $0.4 million.

***General and administrative***

General and administrative expenses increased from$27.2 million in the six months ended June 30, 2005 to $31.4 million in the sixmonths ended June 30, 2006, representing an increase of $4.2 million, or 15.3%.This increase was due primarily to our acquisitions in the last twelve months,representing $2.7 million, general and administrative expenses associated withthe reorganization of our Ness Israel segment, representing $0.9 million, andthe rollout of long-term retention programs and bonuses, representing $0.6million, offset by lower stock-based compensation expenses, representing $1.4million.

***Operating Income***

Operating income increased from $10.8 million in thesix months ended June 30, 2005 to $15.4 million in the six months ended June30, 2006, representing an increase of $4.6 million, or 42.8%. The major factorscontributing to this increase were the growth in operating income of ourManaged Strategic Services, Ness Europe and Other segments, representing $2.0million, $1.4 million and $2.0 million, respectively, and a decrease inunallocated expenses, representing $0.2 million, offset by a decrease in theoperating income of our Ness Israel segment, representing $1.2 million. Seealso “—Results by Business Segment.”

The following table summarizes certain line items fromour consolidated statements of income (dollars in thousands):

 

|                                               | ** ** | **Six months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|--------------------------|------------|
| ** **                                    | ** ** | **2005**                                      | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                              |       | $                                             | 10,772     |                     | $          | 15,379 |   | 4,607 |   | 42.8 |   |
| Financial  expenses, net                      |       | (914                                          | )          | (638                     | )          | 276 |   | (30.2 | ) |
| Other income,  net                            |       | 4                                             |       | 444                      |       | 440 |   | 11,000 |   |
| Income before  taxes on income                |       | 9,862                                         |       | 15,185                   |       | 5,323 |   | 54.0 |   |
| Taxes on income                               |       | 1,025                                         |       | 2,808                    |       | 1,783 |   | 173.9 |   |
| Equity in net  losses of affiliates           |       | (29                                           | )          | (90                      | )          | (61 | ) | 210.3 |   |
| Minority  interests in losses of a subsidiary |       | 101                                           |       | —                   |       | (101 | ) | (100.0 | ) |
| Net income                                    |       | $                                             | 8,909      |                     | $          | 12,287 |   | 3,378 |   | 37.9 |   |

####  

***Financial expenses, net***

Financial expenses, net, decreased from $0.9 millionin the six months ended June 30, 2005 to $0.6 million in the six months endedJune 30, 2006, representing a decrease of $0.3 million, or 30.2%. The decreasewas due primarily to an increase in interest income on deposits, representing$0.5 million,  partially offset by theeffects of foreign exchange rate changes as moderated by our hedging of foreigncurrencies, representing $0.2 million.

***Other income, net***

Other income, net, increased from $4,000 in the sixmonths ended June 30, 2005 to $0.4 million in the six months ended June 30,2006. This increase was primarily due to consideration received for a thirdparty transaction, representing $0.4 million, net of expenses.

***Taxes on income***

Our taxes on income increased from $1.0 million in thesix months ended June 30, 2005 to $2.8 million in the six months ended June 30,2006, representing an increase of $1.8 million, or 174%. This increase wasprimarily 

30

----

attributable to the increase in our income beforetaxes, representing $0.6 million, a lower utilization of tax loss carry forwardscompared to the year-ago period, representing $0.5, and an increase in incomebefore taxes from geographies with higher tax rates as well as from highertaxes on certain revenues and other income, net, together representing $0.7million.

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

Equity in net losses of affiliates increased from$29,000 for the six months ended June 30, 2005 to $0.1 million in the sixmonths ended June 30, 2006. This change was not significant.

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

Minority interests in losses of a subsidiary changedfrom $0.1 million in the six months ended June 30, 2005 to zero in the sixmonths ended June 30, 2006. This change was not significant.

***Net Income***

Net income increased from $8.9 million in the sixmonths ended June 30, 2005 to $12.3 million in the six months ended June 30,2006, representing an increase of $3.4 million, or 37.9%. The increase in netincome was due primarily to our increase in operating income of $4.6 million,our increase in other income, net, of $0.4 million and our decrease infinancial expenses of $0.3 million, partially offset by our increase in taxeson income of $1.8 million.

**Results byBusiness Segment**

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

At the end of 2005, we completed the reorganization ofour operations into operating segments. Our chief operating decision-maker isour chief executive officer, who evaluates our performance and allocatesresources based on segment revenues and operating profit.

Our operating segments are:

1.       **Managed Strategic Services**, which includes India-based offshoreservices as well as system integration and application development andconsulting services. Verticals served by this segment are: independent softwarevendors, life sciences and healthcare and others.

2.       **Technologies & Systems Group**, which includes system integration andapplication development, real-time systems development, consulting andoutsourcing services for the defense, government and homeland securityvertical, as well as systems for the telecommunications vertical.

3.       **Ness Europe**, which includes system integration andapplication development, outsourcing and software and consulting for EasternEuropean and Western European customers, including near-shore services fromEastern Europe for Western European customers. Verticals served by this segmentare: telecommunications and utilities, financial services and others.

4.      **Ness Israel**, which includes system integration andapplication development, outsourcing, software and consulting and qualityassurance and training for customers in Israel within the following verticals:financial services, government, life sciences and healthcare, manufacturing,retail, transportation and others.

31

----

5.       **Other**, which comprises operations representing,individually, less than 10% of our consolidated revenues and operating profit.These include our operations in the United Kingdom and Asia Pacific as well asthe recently acquired Ness Innovative Business Services division (formerlyInnova).

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

The table below presents financial information for ourfive reportable segments (dollars in thousands). Prior period data is presentedon a pro forma basis, as we were not organized into SFAS No. 131 operatingsegments at that time.
| ** **                              | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)**                                   | ** ** |
| **Segment Data:**                       |       |                                                |       |                                              |       |   |   |   |   |
| **Revenues:**                           |       |                                                |       |                                              |       |   |   |   |   |
| Managed  Strategic Services (MSS)       |       | $                                                   | 21,754     |                                              | $          | 22,331 |   | $ | 41,377 |   | $ | 41,894 |   |
| Technologies  & Systems Group (TSG) |       | 11,104                                              |       | 12,635                                            |       | 22,751 |   | 27,420 |   |
| Ness Europe                             |       | 14,048                                              |       | 21,174                                            |       | 21,700 |   | 39,613 |   |
| Ness Israel                             |       | 41,192                                              |       | 44,255                                            |       | 83,870 |   | 88,314 |   |
| Other                                   |       | 6,120                                               |       | 16,219                                            |       | 12,925 |   | 26,415 |   |
|                                    |       | $                                                   | 94,218     |                                              | $          | 116,614 |   | $ | 182,623 |   | $ | 223,656 |   |
| **Operating Income (Loss):**            |       |                                                |       |                                              |       |   |   |   |   |
| Managed  Strategic Services (MSS)       |       | $                                                   | 1,903      |                                              | $          | 3,027 |   | $ | 3,352 |   | $ | 5,387 |   |
| Technologies  & Systems Group (TSG) |       | 1,302                                               |       | 1,331                                             |       | 3,083 |   | 3,192 |   |
| Ness Europe                             |       | 1,685                                               |       | 2,404                                             |       | 2,482 |   | 3,917 |   |
| Ness Israel                             |       | 2,542                                               |       | 1,401                                             |       | 5,759 |   | 4,537 |   |
| Other                                   |       | (103                                                | )          | 1,101                                             |       | (424 | ) | 1,595 |   |
| Unallocated  Expenses                   |       | (2,412                                              | )          | (1,790                                            | )          | (3,480 | ) | (3,249 | ) |
|                                    |       | $                                                   | 4,917      |                                              | $          | 7,474 |   | $ | 10,772 |   | $ | 15,379 |   |

 

**Liquidity andCapital Resources**

***Overview***

As of June 30, 2006, we had cash, cash equivalents andshort-term bank deposits of $57.0 million compared to $73.1 million as ofDecember 31, 2005. The funds held at locations outside of the United States arefor future operating expenses and capital expenditures, and we have nointention of repatriating those funds. We are not, however, restricted inrepatriating those funds back to the United States, if necessary. While weexpect that cash generated by our non-U.S. subsidiaries will be reinvested intheir respective geographies to support expansion of our business, to theextent that funds were remitted to the United States in the form of dividendpayments, those payments may be subject to withholding taxes in theirrespective countries, and would be subject to tax in the United States.

**Cash****Flows**

The following table summarizes our cash flows for theperiods presented (dollars in thousands):

32

----

 

|                                                               | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                      | ** ** | **2006** | ** ** |
| Net cash used in  operating activities                        |       | $                                             | (7,409     | ) | $ | (19,131 | ) |
| Net cash used in  investing activities                        |       | (8,771                                        | )          | (4,210 | ) |
| Net cash provided  by financing activities                    |       | 6,369                                         |       | 24,481 |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | (2,511                                        | )          | (1,898 | ) |
| Decrease in cash  and cash equivalents                        |       | (12,322                                       | )          | (758 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 104,229                                       |       | 33,579 |   |
| Cash and cash  equivalents at the end of the period           |       | $                                             | 91,907     |   | $ | 32,821 |   |
|                                                          |       |                                          |       |   |   |

*Six months ended June 30, 2006compared to the six months ended June 30, 2005*

Net cash used in operating activities was $19.1million in the six months ended June 30, 2006, compared to $7.4 million in thesix months ended June 30, 2005. The major factors contributing to the changewere tax payments to the Israeli Tax Authority related to prior periods,representing $10.3 million and a decrease in trade payables in our Ness Europesegment associated with the entities it acquired in 2005, representing $8.5million.

Net cash used in investing activities was $4.2 millionin the six months ended June 30, 2006, compared with $8.8 million in the sixmonths ended June 30, 2005. The major factors contributing to the decrease werepayments in respect of the acquisitions we made during the first half of 2006,representing $15.8 million, net of cash acquired, offset by the sale ofshort-term bank deposits and marketable securities, representing $18.9 million.

Net cash provided by financing activities was $24.5million in the six months ended June 30, 2006, compared with $6.4 million inthe six months ended June 30, 2005. The change was primarily due to an increasein short-term bank loans and credit, representing $21.0 million, offset bylower proceeds from employee exercises of stock options, representing $2.9million.

The effect of exchange rate changes on cash and cashequivalents was ($1.9) million in the six months ended June 30, 2006,compared to ($2.5) million in the six months ended June 30, 2005. The changewas primarily due to long-term inter-company balances, representing $1.4million.

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

At June 30, 2006, we had aggregate short-term andlong-term bank and other borrowings of $56.0 million, consisting of variousnotes denominated in dollars and NIS (linked to index) with interest ratesranging from approximately 4.5% to 7.5% and a weighted average interest rate ofapproximately 5.7%, with maturities of one to four years. These aggregate bankborrowings included $23.0 million from Bank Hapoalim, with an interest rate ofapproximately 4.5% and maturity of one year; $9.5 million from Israel DiscountBank, with interest rates of approximately 6.2% to 7.5% and maturities of oneto three years; $8.6 million from Mizrahi Bank, with interest rates of 6.0% to7.0% and maturities of one to two years; $5.3 million from Bank Leumi, with aninterest rate of approximately 6.2% and maturity of one year; and $9.6 millionfrom three other lenders, in amounts ranging from $0.8 million to $2.9 million,with interest rates of approximately 5.8% to 6.8% and maturities of up to fouryears. The maximum interest rate for our dollar-linked borrowings wasapproximately 4.5%, and for NIS index linked borrowings was approximately 7.5%.

At June 30, 2006, we had a net cash position of $0.9million, compared to $40.7 as of December 31, 2005. Net cash decreased duringthe first half of 2006 primarily due to non-recurring uses of cash, such aspayments in respect of acquisitions, representing $18.8 million, net of cashacquired, and tax payments to the Israeli Tax Authority related to priorperiods, representing $10.5 million. Despite this reduction in net cash, wehave been able to maintain relatively low financial expenses.

Our only material indebtedness is amounts owed by NessTechnologies Holdings Ltd., one of our subsidiaries, to Bank Hapoalim andIsrael Discount Bank. The shares of two of our Israeli subsidiaries are 

33

----

pledged to these banks as security for borrowingsunder the agreements. We are currently in the process of canceling the pledges onthese shares. The relevant debt instruments contain customary restrictivecovenants relating to the borrower and our wholly-owned subsidiary Ness A.T.Ltd., including the following:

·                  limitations on incurring debt;

·                  prohibition on pledging assets;

·                  prohibition on distributing dividends;

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

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

·                  limitations on merging or transferringassets.

In addition, the Israel Discount Bank agreementrequires that the net cash and liquid assets of the borrower must not be lowerthan $18.0 million. As of June 30, 2006, we are in compliance and expect toremain in compliance with all of our covenants. Our failure to comply withthese covenants could lead to an event of default under the agreementsgoverning some or all of the indebtedness, permitting the applicable lender toaccelerate all borrowings under the applicable agreement and to foreclose onany collateral.

***Anticipated Needs***

We intend to fund future growth through future cashflow from operations, available bank borrowings and the remaining net proceedsof our initial public offering. We believe the remaining balance of theproceeds of our initial public offering, together with borrowings and futurecash flow from operations, will be sufficient to fund continuing operations forthe foreseeable future. In order to achieve our strategic business objectives,we may be required to seek additional financing. For example, futureacquisitions may require additional equity and/or debt financing. In addition,we may require further capital to continue to enhance our infrastructure andfor working capital purposes. These financings may not be available onacceptable terms, or at all.

***Forward-Looking Statements and RiskFactors***

This Quarterly Report on Form 10-Q, includingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995. Forward-looking statementsoften are proceeded by words such as “believes,” “expects,” “may,” “anticipates,”“plans,” “intends,” “assumes,” “will” or similar expressions. Forward-lookingstatements reflect management’s current expectations, as of the date of thisreport, and involve certain risks and uncertainties. Our actual results coulddiffer materially from those anticipated in these forward looking statements asa result of various factors. Some of the factors that could cause futureresults to materially differ from the recent results or those projected inforward-looking statements include the “Risk Factors” described in our 2005Annual Report on Form 10-K filed with the SEC on March 15, 2006.

***Item 3.Quantitative and Qualitative Disclosure about Market Risk***

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

We have direct operations in 15 different countriesand relationships in many other parts of the world. Our contracts withcustomers are in local currencies or dollars. As a result, we are subject toadverse movements in foreign currency exchange rates in those countries wherewe conduct business. Beginning in the second quarter of 2005, we entered intocertain forward foreign currency exchange contracts to hedge our exposureagainst foreign currencies which differ from the local functional currencies.In the future, we may enter into additional forward foreign currency exchangeor other derivatives contracts to further hedge our exposure to foreigncurrency exchange rates.

34

----

***Item 4. Controlsand Procedures***

**Evaluation ofDisclosure Controls and Procedures**

As of the end of the period covered by this report,our chief executive officer and chief financial officer evaluated theeffectiveness of our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended).Based on their evaluation of our disclosure controls and procedures, our chiefexecutive officer and chief financial officer, with the participation of ourmanagement, have concluded that our disclosure controls and procedures areeffectively designed to ensure that information required to be disclosed by usin the reports that we file or submit under the Securities Exchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and are operating in an effective manner.

It should be noted that any system of controls,however well designed and operated, can provide only reasonable, and notabsolute, assurance that the objectives of the system are met. In addition, thedesign of any control system is based in part upon certain assumptions aboutthe likelihood of future events. Given these and other inherent limitations ofcontrol systems, there is only reasonable assurance that our controls willsucceed in achieving their stated goals under all potential future conditions.

**Changes inInternal Control**

As of the end of the period covered by this report,there were no significant changes in our internal controls over financialreporting or in other factors that could significantly affect these controls.

35

----

** **

**PARTII — OTHER INFORMATION**

***Item 1. Legal Proceedings***

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

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

There are no material changes in the risk factorspreviously disclosed in our Annual Report on Form 10-K filed with the SEC onMarch 15, 2006.

***Item 2.Unregistered Sales of Equity Securities and Use of Proceeds***

Not applicable.

***Item 3. Defaultsupon Senior Securities.***

None.

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

The following matters were submitted to a vote of thestockholders at our 2006 Annual Meeting of Stockholders held on June 26, 2006(the “Annual Meeting”): (1) election of directors, and (2) ratification of theappointment of Kost Forer Gabbay & Kasierer, a member of Ernst & YoungGlobal, as our independent registered public accounting firm for the yearending December 31, 2006.  The number ofshares of common stock outstanding and eligible to vote as of the record dateof April 27, 2006 was 35,468,798.

Each of these matters was approved by the requisitevote of our stockholders.  Set forthbelow is the number of votes cast for, against or withheld, as well as thenumber of abstentions and broker non-votes as to the respective matters,including a separate tabulation with respect to each nominee for director:

| Nominee                  | ** ** | ** ** | ** ** | **For** | ** ** | **Withheld** |
|--------------------------|------------|------------|------------|---------|------------|--------------|
| Aharon Fogel             |       | 28,720,250 |       | 257,265 |
| Raviv Zoller             |       | 28,901,779 |       | 75,736  |
| Dr. Henry  Kressel       |       | 28,322,263 |       | 655,252 |
| Morris Wolfson           |       | 28,217,267 |       | 760,248 |
| Dr. Satyam C.  Cherukuri |       | 28,915,116 |       | 62,399  |
| Dan S. Suesskind         |       | 28,915,116 |       | 62,399  |
| Dr. Kenneth A. Pickar    |       | 28,917,229 |       | 60,286  |

 

| Proposal                 | ** ** | ** ** | ** ** | **For** | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Vote** | ** ** |
|--------------------------|------------|------------|------------|---------|------------|-------------|------------|-------------|------------|--------------------------|------------|
| Ratification of Auditors |       | 28,902,269 |       | 56,783  |       | 18,463      |       | 0           |       |

 

***Item 5.Other Information***

None.

***Item 6.Exhibits***

The following is a list of exhibits filed as part ofthis Form 10-Q:

| Exhibit Number | ** ** | **Description**                                                                                      | ** ** | ** ** |
|----------------|------------|------------------------------------------------------------------------------------------------------|------------|------------|
| 31.1           |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2           |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |

 

36

----

 

| Exhibit Number | ** ** | **Description**                                                                                                                                      | ** ** | ** ** |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 32.1           |       | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2           |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

 

37

----

**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

NESS TECHNOLOGIES, INC.(Registrant)
| Date:  |   | August 8, 2006 |   | By:    |   | /s/ Raviv Zoller                              |
|--------|--------|----------------|--------|--------|--------|-----------------------------------------------|
|   |   |           |   |   |   | Raviv Zoller                                  |
|   |   |           |   |   |   | Chief Executive Officer, President, Director  |
|   |   |           |   |   |   | (Principal executive officer)                 |
| Date:  |   | August 8, 2006 |   | By:    |   | /s/ Ytzhak Edelman                            |
|   |   |           |   |   |   | Ytzhak Edelman                                |
|   |   |           |   |   |   | Chief Financial Officer and deputy to the CEO |
|   |   |           |   |   |   | (Principal financial and accounting officer)  |

 

38

----

**EXHIBIT INDEX**
| Exhibit  Number | Description                                                                                                                                          |
|-----------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1            | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                |
| 31.2            | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                |
| 32.1            | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2            | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

38

----