**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterlyperiod ended June 30, 2005**

 

** ̈****       ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from                  to                  **

 

**Commission File Number 000-50954**

 

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**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 Tower**

**Atidim High-TechIndustrial Park**

**Building 4**

**Tel Aviv 61580,Israel**

**Telephone: +972 (3) 766-6800**

**(Addressof registrant’s principal executive offices and registrant’s telephone number,including area code)**

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  ý Yes  o No

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).  o Yes  ý No

 

Indicated below is thenumber of shares outstanding of the registrant’s stock at August 9, 2005:

 
| **Title of Class**             | ** ** | **Number of Shares Outstanding** |
|--------------------------------|------------|----------------------------------|
| Common  Stock, $0.01 par value |       | 34,643,846                       |

 

 

----

 

**NESS TECHNOLOGIES, INC. AND SUBSIDIARIES**

 

**INDEX**

 
| PART I – FINANCIAL INFORMATION                                                                     | 3      |
|---------------------------------------------------------------------------------------------------------|--------|
|                                                                                                    |   |
| Item 1. Financial Statements                                                                            | 3      |
| Consolidated Balance Sheets – December 31, 2004 and June 30, 2005  (Unaudited)                     | 3      |
| Consolidated Statements of Income – Three and six months ended June 30,  2004 and 2005 (Unaudited) | 5      |
| Consolidated Statements of Cash Flows – Six months ended June 30,  2004 and 2005 (Unaudited)       | 6      |
| Notes to Interim Condensed Consolidated Financial Statements – June  30, 2005 (Unaudited)          | 8      |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations     | 21     |
| Overview                                                                                                | 21     |
| Recent Developments                                                                                     | 22     |
| Consolidated Results of Operations                                                                      | 22     |
| Three Months Ended June 30, 2005 Compared  to the Three Months Ended June 30, 2004                      | 23     |
| Six Months Ended June 30, 2005 Compared to  the Six Months Ended June 30, 2004                          | 25     |
| Liquidity and Capital Resources                                                                         | 28     |
| Forward-Looking Statements and Risk Factors                                                             | 30     |
| Item 3. Quantitative and Qualitative  Disclosure about Market Risk                                      | 30     |
| Item 4. Controls and Procedures                                                                         | 30     |
| Evaluation of Disclosure Controls and  Procedures                                                       | 30     |
| Changes in Internal Control                                                                             | 30     |
|                                                                                                    |   |
| PART II – OTHER INFORMATION                                                                        | 31     |
|                                                                                                    |   |
| Item 1. Legal Proceedings                                                                               | 31     |
| Item 2. Unregistered Sales of Equity  Securities and Use of Proceeds                                    | 31     |
| Item 3. Defaults upon Senior Securities.                                                                | 31     |
| Item 4. Submission of Matters to a Vote of  Security Holders                                            | 31     |
| Item 5. Other Information                                                                               | 31     |
| Item 6. Exhibits                                                                                        | 32     |
|                                                                                                    |   |
| SIGNATURES                                                                                              | 33     |
|                                                                                                    |   |
| EXHIBIT INDEX                                                                                           | 34     |

 

2

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# **PART I– FINANCIAL INFORMATION**

 

***Item 1. Financial Statements***

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Interim Condensed  Consolidated Balance Sheets** |
|----------------------------------------------------|

**U.S. dollars in thousands**

 
| ** **                                                                                                                                                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                                    | ** ** | ** **            | ** ** | **(Unaudited)**   | ** ** |
| ASSETS                                                                                                                                                        |       |                  |       |              |       |
|                                                                                                                                                          |       |                  |       |              |       |
| CURRENT ASSETS:                                                                                                                                               |       |                  |       |              |       |
| Cash and cash equivalents                                                                                                                                     |       | $                     | 104,229    |              | $          | 91,907 |   |
| Marketable securities                                                                                                                                         |       | 383                   |       | 387               |       |
| Trade receivables (net of allowance for  doubtful accounts of $2,154 and $2,558 at December 31, 2004, and  June 30, 2005 (unaudited), respectively) |       | 75,183                |       | 82,552            |       |
| Unbilled receivables                                                                                                                                          |       | 20,327                |       | 25,097            |       |
| Other accounts receivable and prepaid  expenses                                                                                                               |       | 9,127                 |       | 10,354            |       |
| Inventories and work in progress                                                                                                                              |       | 1,168                 |       | 2,192             |       |
|                                                                                                                                                          |       |                  |       |              |       |
| Total current assets                                                                                                                                          |       | 210,417               |       | 212,489           |       |
|                                                                                                                                                          |       |                  |       |              |       |
| LONG-TERM ASSETS:                                                                                                                                             |       |                  |       |              |       |
| Long-term prepaid expenses                                                                                                                                    |       | 3,655                 |       | 5,129             |       |
| Marketable securities                                                                                                                                         |       | 69                    |       | 164               |       |
| Deferred income taxes                                                                                                                                         |       | 4,823                 |       | 5,516             |       |
| Severance pay fund                                                                                                                                            |       | 33,558                |       | 33,490            |       |
|                                                                                                                                                          |       |                  |       |              |       |
| Total long-term assets                                                                                                                                        |       | 42,105                |       | 44,299            |       |
|                                                                                                                                                          |       |                  |       |              |       |
| PROPERTY AND EQUIPMENT, NET                                                                                                                                   |       | 18,879                |       | 21,258            |       |
|                                                                                                                                                          |       |                  |       |              |       |
| OTHER INTANGIBLE ASSETS, NET                                                                                                                                  |       | 4,265                 |       | 5,959             |       |
|                                                                                                                                                          |       |                  |       |              |       |
| GOODWILL                                                                                                                                                      |       | 149,090               |       | 149,876           |       |
|                                                                                                                                                          |       |                  |       |              |       |
| Total assets                                                                                                                                                  |       | $                     | 424,756    |              | $          | 433,881 |   |
|                                                                                                                                                               |            |                       |            |                   |            |  |  |  |  |

 

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

 

3

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Interim Condensed Consolidated Balance Sheets** |
|---------------------------------------------------|

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

 
| ** **                                                                                                                                                                                                                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                    | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | **(Unaudited)**   | ** ** |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                     |       |                  |       |              |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                          |       |                  |       |              |       |
| Short-term bank credit                                                                                                                                                                                                        |       | $                     | 1,275      |              | $          | 1,214 |   |
| Current maturities of long-term debt                                                                                                                                                                                          |       | 13,364                |       | 17,681            |       |
| Trade payables                                                                                                                                                                                                                |       | 31,280                |       | 27,638            |       |
| Advances from customers                                                                                                                                                                                                       |       | 7,679                 |       | 8,381             |       |
| Other accounts payable and accrued expenses                                                                                                                                                                                   |       | 64,271                |       | 66,465            |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| Total current liabilities                                                                                                                                                                                                     |       | 117,869               |       | 121,379           |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                        |       |                  |       |              |       |
| Long-term debt, net of current maturities                                                                                                                                                                                     |       | 36,918                |       | 31,939            |       |
| Excess of losses over investment in  affiliates                                                                                                                                                                               |       | 306                   |       | 237               |       |
| Accrued severance pay                                                                                                                                                                                                         |       | 36,888                |       | 37,119            |       |
| Minority interests                                                                                                                                                                                                            |       | 295                   |       | —            |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| Total long-term liabilities                                                                                                                                                                                                   |       | 74,407                |       | 69,295            |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                                                        |       |                  |       |              |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                    |       |                  |       |              |       |
| Common stock of $0.01 par value -                                                                                                                                                                                             |       |                  |       |              |       |
| Authorized: 76,500,000 shares at  December 31, 2004 and at June 30, 2005 (unaudited);  issued and outstanding: 32,772,578 shares at December 31, 2004 and  34,607,396 shares at June 30, 2005 (unaudited) |       | 328                   |       | 346               |       |
| Additional paid-in capital                                                                                                                                                                                                    |       | 270,967               |       | 281,819           |       |
| Deferred stock compensation                                                                                                                                                                                                   |       | (152                  | )          | (51               | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                          |       | (2,045                | )          | (11,198           | )          |
| Accumulated deficit                                                                                                                                                                                                           |       | (36,618               | )          | (27,709           | )          |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| Total stockholders’ equity                                                                                                                                                                                               |       | 232,480               |       | 243,207           |       |
|                                                                                                                                                                                                                          |       |                  |       |              |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                               |       | $                     | 424,756    |              | $          | 433,881 |   |
|                                                                                                                                                                                                                               |            |                       |            |                   |            |  |  |  |  |

 

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

 

4

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Interim Condensed  Consolidated Statements of Income** |
|----------------------------------------------------------|

**U.S. dollars in thousands (except per sharedata)**

 
| ** **                                                                        | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | **(Unaudited)**                       | ** ** | **(Unaudited)**                     | ** ** |
| ** **                                                                        | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                                          |       | $                                     | 73,879     |                                | $          | 94,218 |   | $ | 145,025 |   | $ | 182,623 |   |
| Cost of revenues (*)                                                              |       | 51,785                                |       | 68,033                              |       | 100,633 |   | 130,428 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts                |       | (43                                   | )          | 13                                  |       | (485 | ) | 98 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                                                                      |       | 22,137                                |       | 26,172                              |       | 44,877 |   | 52,097 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Operating expenses:                                                               |       |                                  |       |                                |       |   |   |   |   |
| Selling and marketing                                                             |       | 6,044                                 |       | 7,002                               |       | 12,130 |   | 14,033 |   |
| General and administrative (*)                                                    |       | 11,698                                |       | 12,966                              |       | 23,095 |   | 25,394 |   |
| Stock-based compensation                                                          |       | 51                                    |       | 1,286                               |       | 102 |   | 1,897 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Total operating expenses                                                          |       | 17,793                                |       | 21,254                              |       | 35,327 |   | 41,324 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Operating income                                                                  |       | 4,344                                 |       | 4,917                               |       | 9,550 |   | 10,772 |   |
| Financial expenses, net                                                           |       | (781                                  | )          | (494                                | )          | (3,150 | ) | (914 | ) |
| Other income, net                                                                 |       | 11                                    |       | 10                                  |       | 95 |   | 4 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Income before taxes on income                                                     |       | 3,574                                 |       | 4,433                               |       | 6,495 |   | 9,862 |   |
| Taxes on income                                                                   |       | 596                                   |       | 423                                 |       | 485 |   | 1,025 |   |
| Equity in net losses of affiliates                                                |       | (33                                   | )          | (27                                 | )          | (648 | ) | (29 | ) |
| Minority interests in losses (earnings) of  a subsidiary                          |       | (35                                   | )          | 0                                   |       | (35 | ) | 101 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net income                                                                        |       | $                                     | 2,910      |                                | $          | 3,983 |   | $ | 5,327 |   | $ | 8,909 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Allocation of undistributed earnings on  Class B Convertible Preferred stock |       | $                                     | (436       | )                                   | $          | — |   | $ | (802 | ) | $ | — |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net income after allocation of  undistributed earnings                            |       | $                                     | 2,474      |                                | $          | 3,983 |   | $ | 4,525 |   | $ | 8,909 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Basic net earnings per share                                                      |       | $                                     | 0.13       |                                | $          | 0.12 |   | $ | 0.24 |   | $ | 0.26 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Diluted net earnings per share                                                    |       | $                                     | 0.12       |                                | $          | 0.11 |   | $ | 0.21 |   | $ | 0.25 |   |
|                                                                                   |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |

 

----

(*)     Expenses excluding stock-based compensation areas follows:

 
| ** **                 | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                 | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **(Unaudited)**                       | ** ** | **(Unaudited)**                     | ** ** |
| ** **                 | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenues           |       | $                                     | —     |                                | $          | — |   | $ | — |   | $ | 98 |   |
| General and administrative |       | 51                                    |       | 1,286                               |       | 102 |   | 1,799 |   |
|                            |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

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

 

5

----

 

**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Interim Condensed  Consolidated Statements of Cash Flows** |
|--------------------------------------------------------------|

**U.S. dollars in thousands**

 
| ** **                                                                                                                     | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2004**                            | ** ** | **2005** | ** ** |
| ** **                                                                                                                     | ** ** | **(Unaudited)**                     | ** ** |
| Cash flows from operating activities:                                                                                          |       |                                |       |   |   |
| Net income                                                                                                                     |       | $                                   | 5,327      |   | $ | 8,909 |   |
| Adjustments required to reconcile net  income to net cash provided by (used in) operating activities:                          |       |                                |       |   |   |
| Amortization of deferred stock compensation  related to Ness GSG acquisition                                                   |       | 105                                 |       | 101 |   |
| Stock-based compensation related to  warrants granted to banks                                                                 |       | 21                                  |       | 11 |   |
| Stock-based compensation related to  redeemable options                                                                        |       | —                              |       | 1,897 |   |
| Equity in net losses of affiliates                                                                                             |       | 648                                 |       | 29 |   |
| Minority interests in losses (earnings) of  a subsidiary                                                                       |       | 35                                  |       | (101 | ) |
| Currency fluctuation of long-term debt                                                                                         |       | 2,732                               |       | 1,670 |   |
| Accrued interest on long-term debt                                                                                             |       | (546                                | )          | (892 | ) |
| Depreciation and amortization                                                                                                  |       | 2,503                               |       | 3,809 |   |
| Deferred income taxes, net                                                                                                     |       | (827                                | )          | (2,078 | ) |
| Loss (gain) on sale of property and  equipment                                                                                 |       | 5                                   |       | (409 | ) |
| Trading marketable securities, net                                                                                             |       | 11                                  |       | (27 | ) |
| Increase in trade receivables                                                                                                  |       | (10,205                             | )          | (10,923 | ) |
| Increase in unbilled receivables                                                                                               |       | (2,226                              | )          | (6,172 | ) |
| Increase in other accounts receivable and  prepaid expenses                                                                    |       | (253                                | )          | (205 | ) |
| Increase in inventories and work in  progress                                                                                  |       | (269                                | )          | (762 | ) |
| Increase in long-term prepaid expenses                                                                                         |       | (632                                | )          | (1,748 | ) |
| Increase (decrease) in trade payables                                                                                          |       | 1,079                               |       | (3,752 | ) |
| Increase in advances from customers                                                                                            |       | 2,193                               |       | 1,191 |   |
| Increase in other accounts payable and  accrued expenses                                                                       |       | 8,459                               |       | 1,618 |   |
| Increase in accrued severance pay, net                                                                                         |       | 595                                 |       | 511 |   |
|                                                                                                                           |       |                                |       |   |   |
| Net cash provided by (used in) operating  activities                                                                           |       | 8,755                               |       | (7,523 | ) |
|                                                                                                                           |       |                                |       |   |   |
| Cash flows from investing activities:                                                                                          |       |                                |       |   |   |
| Net cash paid for acquisition of  consolidated subsidiaries (a)                                                                |       | —                              |       | (3,187 | ) |
| Proceeds from decrease in investment in a  subsidiary, net of cash in the subsidiary at the time it ceased being  consolidated |       | (168                                | )          | — |   |
| Acquisition of minority interest in a  subsidiary (b)                                                                          |       | —                              |       | — |   |
| Proceeds from sale of short-term bank  deposits                                                                                |       | 3,157                               |       | — |   |
| Proceeds from sale of property and  equipment                                                                                  |       | 424                                 |       | 600 |   |
| Purchase of property and equipment and  capitalization of software developed for internal use                                  |       | (3,587                              | )          | (4,587 | ) |
| Capitalization of software development  costs                                                                                  |       | (1,580                              | )          | (1,483 | ) |
| Other                                                                                                                          |       | (61                                 | )          | — |   |
|                                                                                                                           |       |                                |       |   |   |
| Net cash used in investing activities                                                                                          |       | (1,815                              | )          | (8,657 | ) |
|                                                                                                                                |            |                                     |            |  |  |  |  |

 

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

 

6

----

 

**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Interim Condensed Consolidated Statements of Cash Flows** |
|-------------------------------------------------------------|

**U.S. dollars in thousands**

 
| ** **                                                    | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                            | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(Unaudited)**                     | ** ** |
| Cash flows from financing activities:                         |       |                                |       |   |   |
| Exercise of options and warrants                              |       | $                                   | 43         |   | $ | 8,848 |   |
| Short-term bank credit, net                                   |       | 2,890                               |       | (986 | ) |
| Proceeds from long-term debt                                  |       | 6,193                               |       | — |   |
| Principal payment of long-term debt                           |       | (17,880                             | )          | (1,493 | ) |
|                                                          |       |                                |       |   |   |
| Net cash provided by (used in) financing  activities          |       | (8,754                              | )          | 6,369 |   |
|                                                          |       |                                |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents |       | (679                                | )          | (2,511 | ) |
|                                                          |       |                                |       |   |   |
| Increase (decrease) in cash and cash  equivalents             |       | (2,493                              | )          | (12,322 | ) |
| Cash and cash equivalents at the beginning  of the period     |       | 46,004                              |       | 104,229 |   |
|                                                          |       |                                |       |   |   |
| Cash and cash equivalents at the end of the  period           |       | $                                   | 43,511     |   | $ | 91,907 |   |
|                                                          |       |                                |       |   |   |
| Supplemental disclosures of cash flows  information:          |       |                                |       |   |   |
|                                                          |       |                                |       |   |   |
| Cash paid during the period for:                              |       |                                |       |   |   |
| Interest                                                      |       | $                                   | 1,563      |   | $ | 656 |   |
|                                                          |       |                                |       |   |   |
| Taxes                                                         |       | $                                   | 461        |   | $ | 374 |   |

 

(a)     In conjunction with the acquisitions, the fairvalues of the assets acquired and liabilities assumed at the dates of relatedacquisitions were as follows:

 
| Working capital (capital deficiency), net  (excluding cash and cash equivalents) |   | $      | (1,995 | )      |
|----------------------------------------------------------------------------------|--------|--------|--------|--------|
| Property and equipment                                                           |   | 2,306  |   |
| Long-term loans and convertible loan                                             |   | (1,601 | )      |
| Other assets                                                                     |   | 48     |   |
| Goodwill                                                                         |   | 2,680  |   |
| Work force                                                                       |   | 1,069  |   |
| Customer related intangible assets                                               |   | 680    |   |
| Net cash paid from acquisitions of  consolidated subsidiaries                    |   | $      | 3,187  |   |

 

(b)     In conjunction with the acquisition of the minorityinterest in a subsidiary, the fair values of the assets acquired andliabilities assumed at the date of acquisition were as follows:

 
| Capital deficiency, net (excluding cash and  cash equivalents) |   | $      | (82    | )      |
|----------------------------------------------------------------|--------|--------|--------|--------|
| Other long-term tangible assets                                |   | 20     |   |
| Property and equipment                                         |   | 18     |   |
| Goodwill                                                       |   | 3,323  |   |
| Customer related intangible assets                             |   | 139    |   |
|                                                           |   | 3,418  |   |
| Less issuance of shares                                        |   | (3,418 | )      |
| Net cash provided from acquisition of  minority interest       |   | $      | — |   |

 

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

 

7

----

 

**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the three andsix month periods ended June 30, 2004 and 2005 is unaudited)**

 

#### ***Note 1: General***

#### *** ***

Ness Technologies, Inc.was incorporated under the laws of the State of Delaware, in March 1999.  We operate through our subsidiaries inIsrael, the United States, Europe and Asia.

 

We are a global provider ofinformation technology (“IT”) services and solutions designed to help clientsimprove their competitiveness and effectiveness. Our portfolio of solutions andservices includes system integration and application development, outsourcing,software and consulting, and quality assurance and training. Offshore servicesand development are a significant component of each of these categories. We andour subsidiaries primarily serve the following vertical markets: government anddefense, financial services, life sciences and healthcare, telecommunicationsand utilities, and independent software vendors.

 

#### ***Note 2: SignificantAccounting Policies***

 

a.     Unaudited InterimFinancial Information

 

The accompanying condensedconsolidated balance sheet as of June 30, 2005, the condensed consolidatedstatements of income for the three and six months ended June 30, 2004 and2005, and the condensed consolidated statements of cash flows for the sixmonths ended June 30, 2004 and 2005 are unaudited. These unaudited interimcondensed consolidated financial statements have been prepared in accordancewith United States generally accepted accounting principles for interimfinancial information. In the opinion of management, the unaudited interimcondensed consolidated financial statements include all adjustments of a normalrecurring nature necessary for a fair presentation of our consolidatedfinancial position as of June 30, 2005, our consolidated results ofoperations for the three and six months ended June 30, 2004 and 2005, andour consolidated cash flows for the six months ended June 30, 2004 and2005.

 

The balance sheet at December 31,2004 has been derived from the audited consolidated financial statements atthat date but does not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements.

 

These consolidated financialstatements should be read in conjunction with the audited consolidated financialstatements and accompanying notes for the year ended December 31, 2004included in our Annual Report on Form 10-K filed with the U.S. Securitiesand Exchange Commission (“SEC”) on March 31, 2005.

 

Results for the three andsix months ended June 30, 2005 are not necessarily indicative of resultsthat may be expected for the year ending December 31, 2005.

 

Unless otherwise noted, (1) allreferences to “dollars” or “$” are to United States dollars and all referencesto “NIS” are to New Israeli Shekels and (2) all references to shares ofour common stock and per share information have been adjusted to reflect the0.7193-for-one reverse stock split effected on September 20, 2004.

 

b.     Use of estimates

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes. Actual results could differfrom those estimates.

 

8

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

c.     Financial statements inU.S. dollars

 

Our subsidiaries’transactions are recorded in local currencies. We have designated the U.S.dollar as the primary functional currency of our operations in the UnitedStates, the NIS as the primary functional currency of our subsidiaries’operations in Israel, and local currencies as the primary functional currenciesof our operations elsewhere. Accordingly, for all subsidiaries of which thedollar is the functional currency, monetary accounts maintained in othercurrencies are re-measured into U.S. dollars, in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 52 “Foreign CurrencyTranslation.” All transaction gains and losses of the re-measured monetarybalance sheet items are reflected in the statement of income as financialincome or expenses, as appropriate.

 

For those foreignsubsidiaries whose functional currency has been determined to be their localcurrency, assets and liabilities are translated at period-end exchange ratesand statement of operations items are translated at average exchange ratesprevailing during that period. Such translation adjustments are recorded as aseparate component of accumulated other comprehensive income (loss) instockholders’ equity.

 

The financial statements ofaffiliates reported using the equity method of accounting, whose functionalcurrency has been determined to be their local currency, have been translatedinto dollars. All balance sheet accounts have been translated using the exchangerates in effect at the balance sheet date. Statement of operations amounts havebeen translated using the average exchange rate for the period. The resultingaggregate translation adjustments are reported as a separate component ofaccumulated other comprehensive income (loss) in stockholders’ equity.

 

d.     Principles ofconsolidation

 

Our consolidated financialstatements include the accounts of the company and its wholly and majorityowned subsidiaries, or the group. Inter-company transactions and balances,including profit from inter-company sales not yet realized outside the group,have been eliminated in consolidation.

 

e.     Acquisition of subsidiaries

 

1.    Ness U.S.A.Inc. (“Ness U.S.A.”)

 

On October 25, 2001, weand other investors incorporated Ness U.S.A., a corporation incorporated underthe laws of the State of Delaware, for the purpose of acquiring certain assetsand assuming certain liabilities of Blueflame Inc. (“Blueflame”) out ofBlueflame’s chapter 11 bankruptcy proceeding. On the date of incorporation, weheld 68% of the outstanding common stock of Ness U.S.A. and other investorsheld the remaining 32% of the outstanding common stock of Ness U.S.A. On November 1,2001, Ness U.S.A. acquired these assets with a fair market value ofapproximately $6,656 for cash consideration and related purchase costs totalingapproximately $5,140. The transaction was accounted for by the purchase methodof accounting according to SFAS No. 141 “Business Combinations.”

 

Ness U.S.A. is afull-service business and advanced technology solutions provider to the lifesciences, financial services, telecommunications and other industries. NessU.S.A. offers technical and management consulting services intended to createbusiness improvements by building integrated business process and technologysolutions to strategic problems.

 

9

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

In addition to theconsideration paid at closing, we agreed to the following contingent payments:

 

a)     An amount equalto 50% of the pre-closing accounts receivable actually collected by us inexcess of $6,000 net of prepayments.

 

b)    Payment of acontingent promissory note in the amount of $750, following the occurrence ofthe earlier of the following two events:

 

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

 

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

 

(i)       if thequalifying transaction occurred period to December 31, 2003, thecontingent payment would have been equal to the aggregate consideration inexcess of $4,500, but not more than $750.

 

(ii)      if thequalifying transaction occurs after December 31, 2003 but prior to January 1,2005, the contingent payment will be equal to $650, unless the considerationfor such qualifying transaction is in excess of $6,600, in which case the contingentpayment will be equal to $750.

 

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

 

As the purchase price waslower than the fair market value of the net assets acquired, but is subject tocontingent payment, we recorded at the date of acquisition, the lesser of themaximum amount of contingent consideration or the excess over cost as if itwere a liability, until the consideration contingency is resolved.

 

In respect of the contingentpromissory note, a liability in the amount of $750 was recorded among long-termliabilities and as of December 31, 2004 and June 30, 2005, theliability was classified in current liabilities.

 

On December 27, 2002,we acquired additional stock of Ness U.S.A. from certain of the employees andother private investors so that, as of December 31, 2003, we held 86% ofNess U.S.A.’s common stock. The acquisition was accounted for under thepurchase method of accounting according to SFAS No. 141. The totalconsideration of $5,001 (including $323 in transaction costs) for the sharespurchased consisted of the issuance of 647,170 shares of our common stock,valued at a fair value of $4,678.

 

Under the securitiesexchange agreement, we agreed to offer the remaining stockholders of NessU.S.A. shares of common stock in exchange for their shares of Ness U.S.A. atthe same exchange ratio used in the December 2002 exchange on the earliestdate practicable after receiving a no-

 

10

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

action letter from theSecurities and Exchange Commission or completing an initial public offering ofour common stock.

 

On November 12, 2004, wefiled a Form S-4 Registration Statement in respect of an exchange offerfor the remaining shares Ness U.S.A. The offer commenced on January 31,2005 and ended on February 28, 2005. 96 of 98 offerees accepted the offerbringing our holdings in Ness U.S.A. following the offer to 99.9%. On March 1,2005, we issued 260,316 shares to the offerees, for the consideration of $3,532(including $113 in transaction costs). The acquisition was accounted for underthe purchase method of accounting according to SFAS No. 141.

 

Basedupon a preliminary valuation of tangible and intangible assets acquired, we haveallocated the total cost of the acquisition to Ness U.S.A.’s assets andliabilities as follows:

 
| ** **                                                  | ** ** | **March 1,  2005** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|
|                                                        |       |                    |       |
| Cash and cash equivalents                                   |       | $                       | 426        |   |
| Trade receivables                                           |       | 277                     |       |
| Unbilled receivable                                         |       | 185                     |       |
| Other accounts receivable                                   |       | 64                      |       |
| Other long-term tangible assets                             |       | 20                      |       |
| Property and equipment                                      |       | 18                      |       |
| Total tangible assets acquired                              |       | 990                     |       |
|                                                        |       |                    |       |
| Customer related intangible asset (five  years useful life) |       | 139                     |       |
| Goodwill                                                    |       | 3,323                   |       |
| Total intangible assets acquired                            |       | 3,462                   |       |
|                                                        |       |                    |       |
| Total tangible and intangible assets  acquired              |       | 4,452                   |       |
|                                                        |       |                    |       |
| Accounts payable                                            |       | (148                    | )          |
| Other accounts payable                                      |       | (280                    | )          |
| Related parties, net                                        |       | (492                    | )          |
|                                                        |       |                    |       |
| Total liabilities assumed                                   |       | (920                    | )          |
|                                                        |       |                    |       |
| Net assets acquired                                         |       | $                       | 3,532      |   |

 

The allocation of thepurchase price reflected in the June 30, 2005 condensed consolidatedbalance sheet is preliminary. We have arranged to obtain a valuation of Ness U.S.A.’scurrent assets, current liabilities, property and equipment and intangibleassets. Management expects to obtain such completed report during the thirdquarter of 2005.

 

2.     Ness GSG Inc.

 

Effective June 30,2003, we acquired through merger all of the outstanding stock of Ness GSG Inc.(formerly, Apar Holding Corp.), or Ness GSG, for the purpose of expanding our ITservices

 

11

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

capabilities. Ness GSG wasincorporated under the laws of the Commonwealth of Pennsylvania, withoperations, through its subsidiaries, in Asia, the United States and Europe.The Ness GSG subsidiaries specialize in hardware and software consulting. Someof our principal stockholders, who owned approximately 53% of the outstandingcommon stock of Ness GSG prior to the acquisition, received 3,955,169 shares ofour common stock upon the closing of the merger.

 

Pursuant to the mergeragreement, we agreed to issue additional shares of common stock to thestockholders of Ness GSG if and when we issued shares of common stock inexchange for the remaining shares of Ness U.S.A. We agreed to issue the numberof shares of our common stock necessary to preserve the ownership percentage ofthe former stockholders of Ness GSG at the same percentage ownership they heldprior to the issuance of such shares to the Ness U.S.A. remaining stockholders,in exchange for their Ness U.S.A. shares. Subsequent to the completion of NessU.S.A. exchange offer, on March 2, 2005, we issued to the formerstockholders of Ness GSG 89,305 additional shares of our common stock pursuantto the terms of the merger agreement. These shares were recorded at theiraggregate par value and reduced additional paid in capital in the same amount,at the date issued.

 

3.     Ness Romania

 

On April 1, 2005, we acquiredall of the outstanding shares of Radix Company SA (“Radix”), a provider of ITservices and solutions based in Romania. The purchase price was €4 million, or$5.2 million, consisting of €2 million paid in cash at the closing and €2million placed in escrow for six months contingent on the verification of the accuracyof certain representations made by the sellers. Additional payments of up to €1.5 million each are required to be madein April 2006 and April 2007 based on achievement of certain revenueand operating income milestones.  Radixbecame a wholly-owned subsidiary of our Dutch subsidiary, Ness Technologies,B.V. and, accordingly, its results of operations have been included in ourconsolidated financial statements since the acquisition date.  Upon completion of the acquisition, RadixCompany SA changed its name to Ness Romania.

 

This acquisition wasaccounted for under the purchase method of accounting and, accordingly, thepurchase price was allocated to the assets and liabilities acquired based ontheir related fair values.  We haveallocated the total cost of the acquisition to Ness Romania’s assets andliabilities as follows:

 

12

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 
| ** **                                   | ** ** | **April 1, 2005** | ** ** |
|----------------------------------------------|------------|------------------------|------------|
|                                         |       |                   |       |
| Cash and cash equivalents                    |       | $                      | 2,511      |   |
| Trade receivables                            |       | 933                    |       |
| Inventory                                    |       | 137                    |       |
| Property and equipment                       |       | 2,094                  |       |
| Other accounts receivable                    |       | 97                     |       |
| Intangible assets:                           |       |                   |       |
| Customer relationships                       |       | 420                    |       |
| Backlog                                      |       | 260                    |       |
| Work force                                   |       | 730                    |       |
| Goodwill                                     |       | 2,680                  |       |
| Total assets acquired                        |       | 9,862                  |       |
| 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                          |       | $                      | 5,385      |   |

 

The allocation of thepurchase price reflected in the June 30, 2005 condensed consolidatedbalance sheet is preliminary. We have arranged to obtain a valuation of NessRomania’s current assets, current liabilities, long-term liabilities, propertyand equipment and intangible assets.

 

Pro forma information inaccordance with SFAS No. 141 has not been provided, since the revenues andnet income of Ness Romania were not material in relation to our totalconsolidated revenues and net income.

 

4.     Ness DM a.s.

 

On June 1, 2005, weacquired all of the outstanding shares of Efcon a.s. (“Efcon”), a provider ofIT services and solutions based in the Czech Republic.  The purchase price was €0.6 million, or $0.8million, consisting of €350,000 paid at closing and €250,000 payable within 55days contingent on the verification of the accuracy of certain representationsmade by the sellers.  An additionalpayment of up to €1.2 million is required to be made in April 2006 based onachievement of certain 2005 performance goals. Up to €400,000 of the April 2006 amount may be advanced if certaininterim performance goals are met.  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 the acquisition, Efcon changed itsname to Ness DM a.s.  In January, 2006,it will become an integral division of Ness Czech s.r.o.

 

Thisacquisition was accounted for under the purchase method of accounting and,accordingly, the purchase price was allocated to the assets and liabilitiesacquired based on their related fair values. We have allocated the total cost of the acquisition to Ness DM’s assetsand liabilities as follows:

 

13

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 
| ** **                                   | ** ** | **June 1, 2005** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
|                                         |       |                  |       |
| Cash and cash equivalents                    |       | $                     | 426        |   |
| Trade receivables                            |       | 314                   |       |
| Inventory                                    |       | 33                    |       |
| Property and equipment                       |       | 260                   |       |
| Other accounts receivable                    |       | 446                   |       |
| Intangible assets:                           |       |                  |       |
| Work force                                   |       | 339                   |       |
| Total assets acquired                        |       | 1,818                 |       |
| Liabilities assumed:                         |       |                  |       |
| Accounts payable and other  accrued expenses |       | 533                   |       |
| Other current liabilities                    |       | 498                   |       |
| Long term liabilities                        |       | 51                    |       |
| Total liabilities assumed                    |       | 1,082                 |       |
| Net assets acquired                          |       | $                     | 736        |   |

 

The allocation of thepurchase price reflected in the June 30, 2005 condensed consolidatedbalance sheet is preliminary. We have arranged to obtain a valuation of Ness DM’scurrent assets, current liabilities, long-term liabilities, property andequipment and intangible assets. Management expects to obtain such completedreport during the third quarter of 2005.

 

Pro forma information inaccordance with SFAS No. 141 has not been provided, since the revenues andnet income of Ness DM were not material in relation to our total consolidatedrevenues and net income.

 

f.      Goodwill

 

We have elected to performour analysis of goodwill during the fourth quarter of the year. No indicationsof impairment were identified during the three and six months ended June 30,2005.

 

g.     Accounting for stock-basedcompensation

 

We have elected to followAccounting Principles Board Opinion (“APB”) No. 25 “Accounting for StockIssued to Employees” and Financial Accounting Standards Board (“FASB”) Interpretation(“FIN”) No. 44 “Accounting for Certain Transactions Involving StockCompensation” in accounting for our employee stock option plans. Under APB No. 25,when the exercise price of our stock options is less than the market price ofthe underlying shares on the date of grant, compensation expense is recognized.

 

We adopted the disclosureprovisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transitionand Disclosure,” which amended certain provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation,” to provide alternative methods of transition foran entity that voluntarily changes to the fair value based method of accountingfor stock-based employee compensation, effective as of the beginning of the priorfiscal year. We continue to apply the provisions of APB No. 25 inaccounting for stock-based compensation.

 

14

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

Pro forma informationregarding our net income and net earnings per share is required by SFAS No. 123and has been determined as if we had accounted for our employee stock optionsunder the fair value method prescribed by SFAS No. 123.

 

The fair value for optionsgranted in the three and six month periods ended June 30, 2004 and 2005 isamortized over their vesting periods and estimated at the date of grant usingthe Black-Scholes option pricing model with the following weighted average assumptions:

 
| ** **                        | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                        | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(Unaudited)**                       | ** ** |
| Dividend yield                    |       | 0                                     | %          | 0                                   | %          | 0 | % | 0 | % |
| Expected volatility               |       | 0.52                                  |       | 0.39                                |       | 0.52 |   | 0.39 |   |
| Risk-free interest                |       | 2.5                                   | %          | 2.5                                 | %          | 2.5 | % | 2.5 | % |
| Expected life of up to (in years) |       | 4                                     |       | 4                                   |       | 4 |   | 4 |   |

 

Pro forma information underSFAS No. 123 is as follows:

 
| ** **                                                                                          | ** ** | **Three months ended  June 30,** | ** **       | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------------|-------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                              | ** **       | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                          | ** ** | **(Unaudited)**                       | ** **       |
| Net income available to common stock, as  reported                                                  |       | $                                     |  2,474      |                                | $          | 3,983 |   | $ |  4,525 |   | $ | 8,909 |   |
| Add: Allocation of undistributed earnings  on Class B Convertible Preferred Stock, as reported |       | 436                                   |             | —                              |       | 802 |   | — |   |
| Deduct: Pro forma allocation of  undistributed earnings on Class B Convertible Preferred Stock |       | (322                                  | )                | —                              |       | (581 | ) | — |   |
| Add: Stock-based employee compensation –  intrinsic value                                      |       | 54                                    |             | 1,286                               |       | 105 |   | 1,897 |   |
| Deduct: Stock-based employee compensation –  fair value                                        |       | (805                                  | )                | (2,093                              | )          | (1,557 | ) | (3,492 | ) |
| Pro forma net income                                                                                |       | $                                     |  1,837      |                                | $          | 3,176 |   | $ |  3,294 |   | $ | 7,314 |   |
|                                                                                                |       |                                  |             |                                |       |   |   |   |   |
| Basic net earnings per share, as reported                                                           |       | $                                     |  0.13  |                                | $          | 0.12 |   | $ |  0.24  |   | $ | 0.26 |   |
| Diluted net earnings per share, as reported                                                         |       | $                                     |  0.12  |                                | $          | 0.11 |   | $ |  0.21  |   | $ | 0.25 |   |
|                                                                                                |       |                                  |             |                                |       |   |   |   |   |
| Pro forma basic net earnings per share                                                              |       | $                                     |  0.10  |                                | $          | 0.09 |   | $ |  0.17  |   | $ | 0.21 |   |
| Pro forma diluted net earnings per share                                                            |       | $                                     |  0.09  |                                | $          | 0.09 |   | $ |  0.16  |   | $ | 0.21 |   |

 

h.     Impact of recently issued accountingpronouncements

 

On December 16, 2004,the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment,” whichis a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,”which requires companies to recognize in the statement of income, allshare-based payments to employees, including grants of employee stock options,based on their fair values. Accounting for share-based compensationtransactions using the intrinsic method supplemented by pro forma disclosureswill no longer be permissible. The new statement will be effective for publicentities as of the beginning of the first interim or annual reporting period ofthe first fiscal year beginning after June 15, 2005. We will adopt the newstatement on January 1, 2006. We have not yet completed our analysis ofthe impact of adopting SFAS 123R and are therefore currently unable to quantifythe effect on our financial statements. However, the

 

15

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

adoption of this newstatement will have an impact on our results of operations and net earnings pershare as we will be required to expense the fair value of all share-basedpayments.

 

In March 2005, the SECreleased Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB107”).  SAB 107 provides the SEC staffposition regarding the application of SFAS No. 123R.  SAB 107 contains interpretive guidance relatedto the interaction between SFAS No. 123R and certain SEC rules andregulations, as well as provides the Staff’s views regarding the valuation ofshare-based payment arrangements for public companies.  SAB 107 also highlights the importance ofdisclosures made related to the accounting for share-based paymenttransactions. We are currently reviewing the effect of SAB 107 on our condensedconsolidated financial statements as we prepare to adopt SFAS 123R.

 

i.      Reclassification

 

Certain prior period amountshave been reclassified to conform to the current period presentation.

 

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

#### *** ***

a.     Composition

 

Our long-term debt iscomposed as follows:

 
| ** **              | ** ** | **December  31, 2004** | ** ** | **June 30,  2005** | ** ** |
|-------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **              | ** ** | ** **             | ** ** | **(Unaudited)**         | ** ** |
| Banks (1)               |       | $                      | 48,292     |                    | $          | 45,298 |   |
| Loan from stockholders  |       | 1,000                  |       | 1,000                   |       |
| Loans from others       |       | 990                    |       | 3,322                   |       |
|                    |       | 50,282                 |       | 49,620                  |       |
| Less current maturities |       | 13,364                 |       | 17,681                  |       |
|                    |       | $                      | 36,918     |                    | $          | 31,939 |   |

 

----

(1) The long-term loans default upon thefailure of any of our subsidiaries named as borrowers under the loans tosatisfy certain conditions and comply with covenants. As of December 31,2004 and June 30, 2005, management believes that the subsidiaries are incompliance with foregoing conditions. The weighted average interest rate on thebank loans as of December 31, 2004 was 6%.

 

b.     Classification

 

Classified by currency,linkage terms and interest rates, the total amount of the liabilities (beforededuction of current maturities) is as follows:

 

16

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to  Interim Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 
| ** **                  | ** ** | **Interest rate (%)** | ** ** | **Amount**        | ** ** |
|-----------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                  | ** ** | **December 31,** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                  | ** ** | **2004**              | ** ** | **2005**          | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                  | ** ** | ** **            | ** ** | **(Unaudited)**   | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| In, or linked to dollar     |       | 5-8                   |       | 5-6               |       | $ | 33,027 |   | $ | 33,772 |   |
| In NIS – linked to CPI |       | 6-8                   |       | 6-8               |       | 17,255 |   | 15,848 |   |
|                        |       |                  |       |              |       | $ | 50,282 |   | $ | 49,620 |   |

 

c.     Maturities

 

The liabilities mature asfollows:

 
| **As of December 31,** | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------|------------|
| 2005 (current maturity)     |       | $          | 13,364     |   |
| 2006                        |       | 16,438     |       |
| 2007                        |       | 13,700     |       |
| 2008                        |       | 5,243      |       |
| 2009                        |       | 1,537      |       |
|                        |       | $          | 50,282     |   |
|                             |            |            |            |  |  |

 

#### ***Note 4: Commitments andContingent Liabilities***

 

a.     Litigation

 

In 2004 and the six-monthperiod ended June 30, 2005, several employees filed lawsuits againstsubsidiaries of ours claiming payments due to them in the total amount of $79.

 

Our Israeli subsidiarycurrently has a dispute in respect of an outsourcing contract in which it hasprovided services as a subcontractor to the Israeli Ministry of Environment.The Israeli Ministry of Environment submitted a claim for approximately $1,100and our subsidiary submitted two counterclaims amounting aggregately to $660.The dispute is currently discussed through arbitration.

 

Our management and our legaladvisor believe that the allowance provided for these contingencies in ourconsolidated financial statements is adequate to cover probable costs arisingfrom these matters.

 

b.     Guarantees

 

Guarantees are contingentcommitments issued by us generally to guarantee our performance in differentprojects to our customers, such as tenders. The term of a guarantee generallyis equal to the term of the related projects, which can be as short as 30 daysor as long as 5 years. The maximum potential amount of future payments we couldbe required to make under our guarantees at December 31, 2004 and June 30,2005, is $21,948 and $23,294, respectively. We do not hold collateral to support guarantees when deemed necessary.

 

c.     Liens and charges

 

To secure our liabilities,we and our subsidiaries recorded fixed and floating charges on our holdings insubsidiaries, and on our and our subsidiaries’ property and equipment, sharecapital and goodwill.

 

17

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

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

#### *** ***

a.     Redeemable options:

 

Our Executive Committeeapproved and resolved on August 31, 2004 to provide to certain optionees(specifically, those who exchanged their options in two previously publicentities acquired by us for options in Ness) the right to redeem 391,499 oftheir options, all of which were vested at the time of grant, for a cashpayment. The grant date occurred in the fourth quarter of 2004. During thefirst six months of 2005, certain optionees exercised their options and oneoptionee exercised his redemption rights and had his options redeemed.  Accordingly, as of June 30, 2005, thetotal number of shares of common stock for which these redeemable options areexercisable is 368,972, and the aggregate redemption value is $3.3 million. Theredemption right is exercisable from October 1, 2004 until May 31,2006. Each option subject to the redemption right may be transferred by theemployee to us for a cash payment that is linked, at the employee’s solediscretion, either to the Israeli CPI and shall bear an NIS interest at therate of 5% per year, or to the dollar with interest at the rate of 6% per year,calculated from the original option grant date of September 23, 1999 or October 3,1999, up to the redemption date. Each of 278,932 options (“Group A”) may beexercised to acquire one share of our common stock at a price of $3.49 and areredeemable at the NIS equivalent of $9.59 per option as of June 30, 2005.Each of 90,040 options (“Group B”) may be exercised to acquire one share of ourcommon stock at a price of $7.45, and are redeemable at the NIS equivalent of $7.23per option as of June 30, 2005. The exercise prices and redemption amountsare subject to adjustments for stock splits, dividends, recapitalizations andthe like, as set forth in our share option plan to which each option issubject. We account 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 Emerging Issues Task Force (“EITF”) No. 00-23“Issues Related to the Accounting for Stock Compensation under APB No. 25and FIN No. 44.” Accordingly, once we believe it is likely that the rightswould be exercised in the future, a liability is recorded at the then value ofthe redemption rights, with a corresponding charge to compensation expense. Theliability will be accreted periodically to equal the amount that would bepayable if the awards were redeemed at each balance sheet date.

 

As of June 30, 2005, we believed it was likelythat the rights would be exercised, and accordingly, we recorded a liability inthat respect in the total amount of $3.3 million, included in other accountspayable and accrued expenses, reflecting the value of the redemption rights at June 30,2005. Related stock based compensation expense was recorded in the statement ofincome in the total amount of $1.8 million for the six months ended June 30,2005.

 

b.     Total comprehensive income(loss):

 
| ** **                                                         | ** ** | **Three months ended  June 30,** | ** **  | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|-------------|-------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                              | ** **  | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | **(Unaudited)**                       | ** **  |
| Net income                                                         |       | $                                     | 2,910  |                                | $          | 3,983 |   | $ | 5,327  |   | $ | 8,909 |   |
| Foreign currency translation adjustment,  net                      |       | 434                                   |        | (5,420                              | )          | (2,887 | ) | (9,211 | ) |
| Net unrealized losses on available-for-sale  marketable securities |       | 11                                    |        | 9                                   |       | (32 | ) | (58 | ) |
| Comprehensive income (loss)                                        |       | $                                     | 3,355       |                                | $          | (1,428 | ) | $ | 2,408 |   | $ | (360 | ) |

 

18

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to Interim  Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

#### ***Note 6: GeographicInformation***

#### *** ***

We adopted SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information.”  We operate in one reportable segment. Ourtotal revenues are attributed to geographic areas based on the location of theend customer.

 

The following present totalrevenues for the three and six month periods ended June 30, 2004 and 2005,and long-lived assets as of June 30, 2004 and 2005:

 
| ** **                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                      | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(Unaudited)**                       | ** ** |
| Revenues from sales to unaffiliated  customers: |       |                                  |       |                                |       |   |   |   |   |
| Israel                                          |       | $                                     | 42,876     |                                | $          | 48,464 |   | $ | 84,464 |   | $ | 100,172 |   |
| United States                                   |       | 17,975                                |       | 23,402                              |       | 34,210 |   | 44,154 |   |
| Europe                                          |       | 8,645                                 |       | 16,472                              |       | 18,516 |   | 26,849 |   |
| Asia and the Far East                           |       | 3,726                                 |       | 4,460                               |       | 6,614 |   | 8,816 |   |
| Others                                          |       | 657                                   |       | 1,420                               |       | 1,221 |   | 2,632 |   |
|                                            |       | $                                     | 73,879     |                                | $          | 94,218 |   | $ | 145,025 |   | $ | 182,623 |   |
|                                                 |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **            | ** ** | **June 30,** | ** ** |
|-----------------------|------------|-------------------|------------|
| ** **            | ** ** | **2004**          | ** ** | **2005** | ** ** |
| ** **            | ** ** | **(Unaudited)**   | ** ** |
| Long-lived assets:    |       |              |       |   |   |
| Israel                |       | $                 | 98,047     |   | $ | 99,503 |   |
| United States         |       | 56,303            |       | 60,243 |   |
| Europe                |       | 2,428             |       | 8,738 |   |
| Asia and the Far East |       | 4,810             |       | 8,602 |   |
| Others                |       | 7                 |       | 7 |   |
|                  |       | $                 | 161,595    |   | $ | 177,093 |   |
|                       |            |                   |            |  |  |  |  |  |  |

 

#### ***Note 7: Basic and DilutedNet Earnings per Share***

 

Basic net earnings per shareare computed based on the weighted average number of shares of common stockoutstanding during each period, plus dilutive Convertible Preferred stockconsidered outstanding during each period, in accordance with the guidance of EITFNo. D-95 “Effect of Participating Convertible Securities on theComputation of Basic Earnings per Share.” Diluted net earnings per share arecomputed based on the weighted average number of shares of common stockoutstanding during each period, plus dilutive potential shares of common stockconsidered outstanding during the period, in accordance with SFAS No. 128,“Earnings per Share.”

 

The total weighted averagenumber of shares related to the outstanding options, warrants, ConvertiblePreferred stock and convertible loan from stockholders excluded from thecalculations of diluted net earnings per share, as they would have beenanti-dilutive for all periods presented, was 186,401, 104,386, 1,143,316, 121,886and 581,536 for the year ended December 31, 2004 the three months ended June 30,2004 and 2005, respectively, and the six months ended June 30, 2004 and2005, respectively.

 

19

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**
| **Notes to  Interim Condensed Consolidated Financial Statements** |
|-------------------------------------------------------------------|

**U.S.dollars in thousands (information as of June 30, 2005 and for the threeand six month periods ended June 30, 2004 and 2005 is unaudited)**

 

The following table setsforth the computation of basic and diluted net earnings per share of commonstock (in thousands):

 
| ** **                                                                                                                                          | ** ** | **Three months ended  June 30,** | ** **  | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|-------------|-------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2004**                              | ** **  | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                          | ** ** | **(Unaudited)**                       | ** **  |
| Numerator:                                                                                                                                          |       |                                  |        |                                |       |   |   |   |   |
| Net income                                                                                                                                          |       | $                                     |  2,910 |                                | $          | 3,983 |   | $ |  5,327 |   | $ | 8,909 |   |
| Allocation of undistributed earnings on  Class B Convertible Preferred Stock                                                                   |       | (436                                  | )           | —                              |       | (802 | ) | — |   |
| Numerator for basic and diluted per share  data: Net income after allocation of undistributed earnings on Class B  Convertible Preferred Stock |       | $                                     |  2,474 |                                | $          | 3,983 |   | $ |  4,525 |   | $ | 8,909 |   |
|                                                                                                                                                |       |                                  |        |                                |       |   |   |   |   |
| Denominator:                                                                                                                                        |       |                                  |        |                                |       |   |   |   |   |
| Weighted average number of shares of common  stock                                                                                                  |       | 16,478                                |        | 34,541                              |       | 16,478 |   | 34,147 |   |
| Weighted average number of shares of  preferred stock                                                                                               |       | 2,412                                 |        | —                              |       | 2,412 |   | — |   |
| Denominator for basic net earnings per  share                                                                                                       |       | 18,890                                |        | 34,541                              |       | 18,890 |   | 34,147 |   |
| Effect of dilutive securities:                                                                                                                      |       |                                  |        |                                |       |   |   |   |   |
| Employee stock options and warrants                                                                                                                 |       | 2,312                                 |        | 1,103                               |       | 2,357 |   | 1,447 |   |
| Denominator for diluted net earnings per  share – adjusted weighted average assuming conversions and exercise of  options and warrants         |       | 21,202                                |        | 35,644                              |       | 21,247 |   | 35,594 |   |

 

#### ***Note 8: Subsequent Events***

 

On June 29,2005, we signed a definitive agreement to acquire Delta Electronic Servicesa.s., a provider of IT services and solutions in Slovakia. The purchase priceis $7.75 million. In addition, should Delta achieve certain business goals bythe end of 2005 and during the first quarter of 2006, Ness will pay anadditional amount of up to $3.25 million. The acquisition is expected to closeduring the third quarter of 2005 and is subject to customary closingconditions.

 

20

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***Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations***

*** ***

*You shouldread the following discussion and analysis together with our unaudited consolidatedfinancial statements and the accompanying notes.  This discussion contains forward-lookingstatements, within the meaning of Section 27A of Securities Act of 1933,as amended, Section 21E of the Securities Exchange Act of 1934, asamended, and the Private Securities Litigation Reform Act of 1995, includingstatements regarding our expected financial position, business and financingplans.  These statements involve risksand uncertainties. Our actual results could differ materially from the resultsdescribed in or implied by these forward-looking statements as a result ofvarious factors, including those discussed below and elsewhere in our AnnualReport on Form 10-K filed with the SEC on March 31, 2005,particularly under the headings “Disclosure Statement” and “Risk Factors.”*

 

### **Overview**

 

We are a global provider ofinformation technology, or IT, services and end-to-end business solutionsdesigned to help clients improve their competitiveness and effectiveness.End-to-end business solutions encompass all stages of a client’s businessprocess and incorporate all technologies and IT services related to thatprocess. Our portfolio of solutions and services includes outsourcing, systemintegration and application development, software and consulting, and qualityassurance and training. The primary industries, or verticals, we serve includegovernment and defense, financial services, life sciences and healthcare,telecommunications and utilities, and independent software vendors, or ISVs.

 

We have operations in 15countries across North America, Europe and Asia. We combine our deep verticalexpertise and strong technical capabilities to provide a complete range of highquality services on a global scale. By integrating our local and internationalpersonnel in focused business and project teams, this global delivery modelleverages our corporate knowledge and experience, intellectual property andglobal infrastructure to develop innovative solutions for clients across thegeographies and verticals we serve. We complement this global delivery modelwith our offshore delivery capabilities to achieve meaningful cost reductionsor other benefits for our clients.

 

Our revenues increased to $94.2million and $182.6 million for the three and six months ended June 30, 2005,respectively, from $73.9 million and $145.0 million for the three and six monthsended June 30, 2004, respectively. Net income increased to $4.0 million and $8.9 million for the three andsix months ended June 30, 2005, respectively, from $2.9 million and $5.3million for the three and six months ended June 30, 2004, respectively.

 

Our revenue growth isattributable to a number of factors, including acquisitions we made, increasesin the number and size of projects for existing clients and the addition of newclients. Our client base is diverse, and we are not dependent on any singleclient. In the three and six months ended June 30, 2005, no clientaccounted for more than 5% of our revenues and our largest twenty clientstogether accounted less than approximately 35% of our revenues. For the three andsix months ended June 30, 2005, the percentage of our revenues generatedby public and private clients in Israel was 51% and 55%, respectively, and thepercentage of our revenues derived, in aggregate, from agencies of thegovernment of Israel for the same time periods was 10% and 11%, respectively.Existing clients from prior years generated more than 85% of our revenues inthe three and six months ended June 30, 2005.

 

Our backlog as of June 30,2005 was $418 million compared to $342 million as of June 30, 2004. This $76million increase in our backlog was due primarily to new bookings. We achievebacklog through new signings of IT services projects and outsourcing contracts,including for new and repeat customers. We recognize backlog as revenue when weperform the services related to backlog.

 

For the three and six monthsended June 30, 2005, the percentage of our revenues derived from clientsin Israel was 51% and 55%, respectively; in the United States, 25% and 24%,respectively; in Europe, 17% and

 

21

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15%, respectively; in Asia and the Far East, 5% and 5%,respectively; and in other countries, 2% and 1%, respectively.

 

For the three and six monthsended June 30, 2005, we derived 32% and 31%, respectively, of our revenuesfrom system integration and application development; 46% and 47%, respectively,from outsourcing (including offshore development); 15% and 14%, respectively, fromsoftware and consulting; 5% and 5%, respectively, from quality assurance and training;and 2% and 3%, respectively, from our other offerings.

 

As of June 30, 2005, wehad approximately 5,430 employees, including approximately 4,735 ITprofessionals.  Of the 5,430 employees,approximately 2,850 were in Israel, 1,380 were in India, 350 were in NorthAmerica, 500 were in Europe and 355 were in the Asia Pacific region.

 

### **RecentDevelopments**

 

On April 1, 2005, wecompleted the acquisition of Radix Company SA, a privately held leading providerof IT services and solutions based in Romania. The purchase price was €4million, or $5.2 million. In addition, should Radix achieve certain performancegoals over the next two years, we will pay an additional amount of up to €3million, or approximately $3.9 million. For the full year 2004, Radix Company SA generated revenues in excess of$12 million and was profitable.  RadixCompany SA is one of the leading Romanian IT services and solutions providersand is expected to provide synergies with Ness’ current operations in Centraland Eastern Europe. Upon completion of the acquisition, Radix Company SAchanged its name to Ness Romania and it now operates as a wholly-ownedsubsidiary of our Dutch subsidiary, Ness Technologies, B.V.

 

On June 1, 2005, we acquiredEfcon a.s., a privately held provider of IT services and solutions based in theCzech Republic.  The aggregate purchaseprice will be up to €1.8 million, or $2.3 million, depending on achievement ofcertain performance goals over the next year. The acquisition of Efcon, which specializes in enterprise resourceplanning systems, document management systems, enterprise content managementsystems and workflow applications, is expected to leverage our market positionand extend our portfolio of solutions and services in Central and EasternEurope.  Following the acquisition, Efconchanged its name to Ness DM a.s. and began operating as a wholly-ownedsubsidiary of Ness Czech s.r.o., a part of our Ness Europe group.  In January, 2006, it will become an integraldivision of Ness Czech s.r.o.

 

On June 29, 2005, wesigned a definitive agreement to acquire Delta Electronic Services a.s., aprivately held leading provider of IT services and solutions in Slovakia. Thepurchase price is $7.75 million. In addition, should Delta achieve certainbusiness goals by the end of 2005 and during the first quarter of 2006, Nesswill pay an additional amount of up to $3.25 million. The acquisition isexpected to close during the third quarter of 2005 and is subject to customaryclosing conditions. For the full year 2004, Delta generated revenues of morethan $18 million and was profitable.  Delta, which specializes in enterpriseresource planning systems and custom enterprise applications, has been one ofthe fastest growing IT services and solutions providers in Slovakia in recentyears serving mainly the public and utilities sector. Delta has additionaloperations in the Czech Republic and Germany. We expect our expansion inSlovakia to provide greater opportunities for Ness and to better position us tooffer near-shore outsourcing services for European markets. Upon completion ofthe acquisition, Delta will change its name to Ness Slovakia and will operateas a part of Ness Europe.

 

On June 26, 2005,dbMotion, Inc. an affiliate of Ness (formerly Ness ISI) in which we retaina non-controlling interest, completed a second round of private financing.  In connection with this private investmentround, we sold a portion of our holdings in dbMotion, reducing our stake indbMotion from 33.3% to 19.9%, and resulting in a capital gain of $0.2 million.

 

### **ConsolidatedResults of Operations**

 

The following table setsforth the items in our consolidated statement of operations as a percentage ofrevenues for the periods presented.

 

22

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| ** **                                                         | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues                                                           |       | 100.0                                 | %          | 100.0                               | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                                   |       | 70.1                                  |       | 72.2                                |       | 69.4 |   | 71.4 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts |       | (0.1                                  | )          | 0.0                                 |       | (0.3 | ) | 0.1 |   |
| Gross profit                                                       |       | 30.0                                  |       | 27.8                                |       | 30.9 |   | 28.5 |   |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| Operating expenses:                                                |       |                                  |       |                                |       |   |   |   |   |
| Selling and marketing                                              |       | 8.2                                   |       | 7.4                                 |       | 8.4 |   | 7.7 |   |
| General and administrative                                         |       | 15.8                                  |       | 13.8                                |       | 15.9 |   | 13.9 |   |
| Stock-based compensation                                           |       | 0.1                                   |       | 1.4                                 |       | 0.1 |   | 1.0 |   |
| Total operating expenses                                           |       | 24.1                                  |       | 22.6                                |       | 24.4 |   | 22.6 |   |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| Operating income                                                   |       | 5.9                                   |       | 5.2                                 |       | 6.6 |   | 5.9 |   |
| Financial expenses, net                                            |       | (1.1                                  | )          | (0.5                                | )          | (2.2 | ) | (0.5 | ) |
| Other income, net                                                  |       | 0.0                                   |       | 0.0                                 |       | 0.1 |   | 0.0 |   |
| Income before taxes on income                                      |       | 4.8                                   |       | 4.7                                 |       | 4.5 |   | 5.4 |   |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| Taxes on income                                                    |       | 0.8                                   |       | 0.4                                 |       | 0.3 |   | 0.6 |   |
| Equity in net losses of affiliates                                 |       | 0.0                                   |       | 0.0                                 |       | (0.4 | ) | 0.0 |   |
| Minority interests in losses (earnings) of  a subsidiary           |       | 0.0                                   |       | 0.0                                 |       | 0.0 |   | 0.1 |   |
| Net income                                                         |       | 3.9                                   |       | 4.2                                 |       | 3.7 |   | 4.9 |   |

 

### **Three Months EndedJune 30, 2005 Compared to the Three Months Ended June 30, 2004**

 

The following tablesummarizes certain line items from our consolidated statement of operations(dollars in thousands):

 
| ** **                                                         | ** ** | **Three months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | **2004**                              | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                                           |       | $                                     | 73,879     |                     | $          | 94,218 |   | 20,339 |   | 27.5 |   |
| Cost of revenues                                                   |       | 51,785                                |       | 68,033                   |       | 16,248 |   | 31.4 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts |       | (43                                   | )          | 13                       |       | 56 |   | N/A |   |
| Gross profit                                                       |       | $                                     | 22,137     |                     | $          | 26,172 |   | 4,035 |   | 18.2 |   |
| Gross margin                                                       |       | 30.0                                  | %          | 27.8                     | %          |   |   |   |   |

 

#### ***Revenues***

 

Our revenues increased from$73.9 million in the three months ended June 30, 2004 to $94.2 million inthe three months ended June 30, 2005, representing an increase of $20.3million, or 27.5%.  The increase wasprimarily due to growth in outsourcing and offshore engagements, representing $8.8million, growth in our other offerings, comprised of system integration andapplication development, software and consulting, and quality assurance andtraining, representing $7.0 million, and the inclusion of revenue fromacquisitions made in the second quarter, representing $4.5 million. Revenuesfrom outsourcing and offshore services increased as a result of volume growthdue to our sales initiatives related to these offerings, including the hiringof key personnel and aligning of our organizational structure, and expansioninto geographical areas in which we currently do business but previously hadnot offered outsourcing and offshore services. There was no significant changein our billing rates, or prices, from the three months ended June 30, 2004to the three months ended June 30, 2005.

 

#### ***Cost of revenues andprovision for losses (reverse of losses) on uncompleted contracts***

#### *** ***

Our cost of revenues,including salaries, wages and other direct costs, increased from $51.8 millionin the three months ended June 30, 2004 to $68.0 million in the threemonths ended June 30, 2005, representing an increase of $16.2 million, or 31.4%. The increase was attributable to growth in our delivery staff needed tosupport our increased revenues.  Thechange in our provision for losses (reverse of losses) on uncompleted contractschanged from ($43,000) in the three months ended June 30, 2004 to $13,000in the three months ended June 30, 2005, as a result of net changes in ourfixed price project loss provisions.

 

23

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#### ***Gross Profit***

#### *** ***

Our gross profit (revenuesless cost of revenues and provision for losses (reverse of losses) onuncompleted contracts) increased from $22.1 million in the three months ended June 30,2004 to $26.2 million in the three months ended June 30, 2005,representing an increase of $4.0 million, or 18.2 %. The increase was primarilyrelated to our increase in revenues, representing $6.1 million, offset by a decreasein our gross margin, representing approximately ($2.1) million. Gross marginfor the three months ended June 30, 2005 was 27.8%, compared to 30.0% inthe three months ended June 30, 2004. The decrease in gross marginresulted primarily from higher contract setup costs associated with newoutsourcing and offshore engagements attributable to our greater thananticipated revenue growth in the quarter.

 

The following tablesummarizes certain line items from our consolidated statement of operations (dollarsin thousands):

 
| ** **                 | ** ** | **Three months ended  June 30,** | ** **  | **Increase  (Decrease)** | ** ** |
|----------------------------|------------|---------------------------------------|-------------|--------------------------|------------|
| ** **                 | ** ** | **2004**                              | ** **  | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and marketing      |       | $                                     |  6,044 |                     | $          |  7,002 |   | 958 |   | 15.9 |   |
| General and administrative |       | 11,698                                |        | 12,966                   |       | 1,268 |   | 10.8 |   |
| Stock-based compensation   |       | 51                                    |        | 1,286                    |       | 1,235 |   | 2,422 |   |
| Total operating expenses   |       | 17,793                                |        | 21,254                   |       | 3,461 |   | 19.4 |   |
| Operating income           |       | $                                     |  4,344 |                     | $          |  4,917 |   | 573 |   | 13.2 |   |

 

#### ***Selling and marketing***

 

Selling and marketingexpenses increased from $6.0 million in the three months ended June 30,2004 to $7.0 million in the three months ended June 30, 2005, representingan increase of $1.0 million, or 15.9%. This increase was due primarily to a $0.8million increase in marketing expenses, especially in Europe, and increases inour sales commissions and other sales expenses of $0.2 million. These additionalmarketing expenses are related primarily to our efforts to enhance our brandrecognition.

 

#### ***General andadministrative***

#### *** ***

General and administrativeexpenses increased from $11.7 million in the three months ended June 30,2004 to $13.0 million in the three months ended June 30, 2005,representing an increase of $1.3 million, or 10.8%. This increase was dueprimarily to increased general and administrative expenses necessary to supportour revenue growth, representing $0.5 million, and certain additional expensesassociated with being a public company, including implementation of compliancemeasures required by the Sarbanes-Oxley Act, representing $0.8 million.

 

#### ***Stock-based compensation***

#### *** ***

Non-cash stock-basedcompensation expenses increased from $0.1 million in the three months ended June 30,2004 to $1.3 million in the three months ended June 30, 2005, representingan increase of $1.2 million. This increase was due primarily to a charge to non-cashstock compensation expense in respect of redeemable options, representing $1.2 million,described in note 5(a) to our interim condensed consolidated financialstatements — June 30, 2005.  Weexpect no further significant compensation expense related to these redeemableoptions.

 

The following tablesummarizes certain line items from our consolidated statement of operations (dollarsin thousands):

 

24

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| ** **                                               | ** ** | **Three months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **2004**                              | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                                         |       | $                                     | 4,344      |                     | $          | 4,917 |   | 573 |   | 13.2 |   |
| Financial expenses, net                                  |       | (781                                  | )          | (494                     | )          | 287 |   | (36.7 | ) |
| Other income, net                                        |       | 11                                    |       | 10                       |       | (1 | ) | (9.1 | ) |
| Income before taxes on income                            |       | 3,574                                 |       | 4,433                    |       | 859 |   | 24.1 |   |
| Taxes on income                                          |       | 596                                   |       | 423                      |       | (173 | ) | (29.0 | ) |
| Equity in net losses of affiliates                       |       | (33                                   | )          | (27                      | )          | 6 |   | (19.4 | ) |
| Minority interests in losses (earnings) of  a subsidiary |       | (35                                   | )          | 0                        |       | 35 |   | (100.2 | ) |
| Net income                                               |       | $                                     | 2,910      |                     | $          | 3,983 |   | 1,073 |   | 36.9 |   |

 

#### ***Financial expenses, net***

 

Financial expenses, net,decreased from $0.8 million in the three months ended June 30, 2004 to $0.5million in the three months ended June 30, 2005, representing a decreaseof $0.3 million, or 36.7%. The decrease was due primarily to investment incomefrom the proceeds of our initial public offering and reduced debt serviceexpenses following our reduction of net long-term debt in the fourth quarter of2004.

 

#### ***Other income, net***

#### *** ***

Other income, net, decreasedfrom $11,000 in the three months ended June 30, 2004 to $10,000 in thethree months ended June 30, 2005. This change was not significant.

 

#### ***Taxes on income***

#### *** ***

Our taxes on income decreasedfrom $0.6 million in the three months ended June 30, 2004 to $0.4 millionin the three months ended June 30, 2005, representing a decrease of $0.2million, or 29.0%. This decrease was attributable to the increase in our incomebefore taxes, representing $0.3 million, offset by the tax reductionattributable to our non-cash stock-based compensation expense, representing($0.5) million.

 

#### ***Equity in net losses ofaffiliates***

#### *** ***

Equity in net losses ofaffiliates decreased from $33,000 for the three months ended June 30, 2004to $27,000 in the three months ended June 30, 2005.  This change was not significant.

 

#### ***Minority interests inlosses (earnings) of a subsidiary***

#### *** ***

Minority interests in losses(earnings) of a subsidiary changed from earnings of $35,000 in the three monthsended June 30, 2004 to no earnings in the three months ended June 30,2005. This change was not significant.

 

#### ***Net Income***

#### *** ***

Net income increased from $2.9million in the three months ended June 30, 2004 to $4.0 million in thethree months ended June 30, 2005, representing an increase of $1.1 million,or 36.9%. The increase in net income was due primarily to our increase inoperating income of $0.6 million, our decrease in financial expenses of $0.3 millionand our decrease in taxes on income of $0.2 million.  The increase in our operating income was itselfoffset by an increase in non-cash stock-based compensation of $1.2 million.

 

### **Six Months Ended June 30,2005 Compared to the Six Months Ended June 30, 2004**

 

The following tablesummarizes certain line items from our consolidated statement of operations(dollars in thousands):

 

25

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| ** **                                                         | ** ** | **Six months ended  June 30,** | ** **   | **Increase  (Decrease)** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------|--------------|--------------------------|------------|
| ** **                                                         | ** ** | **2004**                            | ** **   | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                                           |       | $                                   | 145,025      |                     | $          | 182,623 |   | 37,598 |   | 25.9 |   |
| Cost of revenues                                                   |       | 100,633                             |         | 130,428                  |       | 29,795 |   | 29.6 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts |       | (485                                | )            | 98                       |       | 583 |   | N/A |   |
| Gross profit                                                       |       | $                                   |  44,877 |                     | $          |  52,097 |   | 7,220 |   | 16.1 |   |
| Gross margin                                                       |       | 30.9                                | %            | 28.5                     | %          |   |   |   |   |

 

#### ***Revenues***

 

Our revenues increased from$145.0 million in the six months ended June 30, 2004 to $182.6 million inthe six months ended June 30, 2005, representing an increase of $37.6 million,or 25.9%.  The increase was primarily dueto growth in outsourcing and offshore engagements, representing $19.9 million, growthin our other offerings, comprised of system integration and applicationdevelopment, software and consulting, and quality assurance and training,representing $13.2 million, and the inclusion of revenue from acquisitions madein the second quarter, representing $4.5 million. Revenues from outsourcing andoffshore services increased as a result of volume growth due to our salesinitiatives related to these offerings, including the hiring of key personneland aligning of our organizational structure, and expansion into geographicalareas in which we currently do business but previously had not offeredoutsourcing and offshore services. There was no significant change in ourbilling rates, or prices, from the six months ended June 30, 2004 to thesix months ended June 30, 2005.

 

#### ***Cost of revenues andprovision for losses (reverse of losses) on uncompleted contracts***

#### *** ***

Our cost of revenues,including salaries, wages and other direct costs, increased from $100.6 millionin the six months ended June 30, 2004 to $130.4 million in the six monthsended June 30, 2005, representing an increase of $29.8 million, or 29.6 %.The increase was attributable to growth in our delivery staff needed to supportour increased revenues.  The change inour provision for losses (reverse of losses) on uncompleted contracts changedfrom ($0.5) million in the six months ended June 30, 2004 to $0.1 millionin the six months ended June 30, 2005, as a result of net changes in ourfixed price project loss provisions.

 

#### ***Gross Profit***

#### *** ***

Our gross profit (revenuesless cost of revenues and provision for losses (reverse of losses) onuncompleted contracts) increased from $44.9 million in the six months ended June 30,2004 to $52.1 million in the six months ended June 30, 2005, representingan increase of $7.2 million, or 16.1 %. The increase was primarily related toour increase in revenues, representing $11.6 million, offset by a decrease inour gross margin, representing approximately ($4.3) million. Gross margin forthe six months ended June 30, 2005 was 28.5%, compared to 30.9% in the sixmonths ended June 30, 2004. The decrease in gross margin resultedprimarily from higher contract setup costs associated with new outsourcing andoffshore engagements attributable to our greater than anticipated revenuegrowth in the first half and from an increase in our use of subcontractors andvendors in the first quarter in order to meet certain delivery commitments.

 

The following tablesummarizes certain line items from our consolidated statement of operations(dollars in thousands):

 
| ** **                 | ** ** | **Six months ended  June 30,** | ** **  | **Increase  (Decrease)** | ** ** |
|----------------------------|------------|-------------------------------------|-------------|--------------------------|------------|
| ** **                 | ** ** | **2004**                            | ** **  | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and marketing      |       | $                                   | 12,130      |                     | $          | 14,033 |   | 1,903 |   | 15.7 |   |
| General and administrative |       | 23,095                              |        | 25,394                   |       | 2,299 |   | 10.0 |   |
| Stock-based compensation   |       | 102                                 |        | 1,897                    |       | 1,795 |   | 1,760 |   |
| Total operating expenses   |       | 35,327                              |        | 41,324                   |       | 5,997 |   | 17.0 |   |
| Operating income           |       | $                                   |  9,550 |                     | $          |  10,772 |   | 1,222 |   | 12.8 |   |

 

#### ***Selling and marketing***

 

Selling and marketingexpenses increased from $12.1 million in the six months ended June 30,2004 to $14.0 million in the six months ended June 30, 2005, representingan increase of $1.9 million, or 15.7%. This increase

 

26

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was due primarily to a $1.6 million increase inmarketing expenses, especially in Europe, and increases in our salescommissions and other sales expenses of $0.3 million. These additionalmarketing expenses are related primarily to our efforts to enhance our brandrecognition.

 

#### ***General andadministrative***

#### *** ***

General and administrativeexpenses increased from $23.1 million in the six months ended June 30,2004 to $25.4 million in the six months ended June 30, 2005, representingan increase of $2.3 million, or 10.0%. This increase was due primarily toincreased general and administrative expenses necessary to support our revenuegrowth, representing $0.9 million, and certain additional expenses associatedwith being a public company, including implementation of compliance measuresrequired by the Sarbanes-Oxley Act, representing $1.4 million.

 

#### ***Stock-based compensation***

#### *** ***

Non-cash stock-basedcompensation expenses increased from $0.1 million in the six months ended June 30,2004 to $1.9 million in the six months ended June 30, 2005, representingan increase of $1.8 million. This increase was due primarily to a charge tonon-cash compensation expense in respect of redeemable options, representing $1.8million, described in note 5(a) to our interim condensed consolidatedfinancial statements – June 30, 2005. We expect no further significant compensation expense related to theseredeemable options.

 

The following tablesummarizes certain line items from our consolidated statement of operations(dollars in thousands):

 
| ** **                                               | ** ** | **Six months ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **2004**                            | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                                         |       | $                                   | 9,550      |                     | $          | 10,772 |   | 1,222 |   | 12.8 |   |
| Financial expenses, net                                  |       | (3,150                              | )          | (914                     | )          | 2,236 |   | (71.0 | ) |
| Other income, net                                        |       | 95                                  |       | 4                        |       | (91 | ) | (95.8 | ) |
| Income before taxes on income                            |       | 6,495                               |       | 9,862                    |       | 3,367 |   | 51.8 |   |
| Taxes on income                                          |       | 485                                 |       | 1,025                    |       | 540 |   | 111.4 |   |
| Equity in net losses of affiliates                       |       | (648                                | )          | (29                      | )          | 619 |   | (95.6 | ) |
| Minority interests in losses (earnings) of  a subsidiary |       | (35                                 | )          | 101                      |       | 136 |   | N/A |   |
| Net income                                               |       | $                                   | 5,327      |                     | $          | 8,909 |   | 3,582 |   | 67.2 |   |

 

#### ***Financial expenses, net***

 

Financial expenses, net,decreased from $3.2 million in the six months ended June 30, 2004 to $0.9million in the six months ended June 30, 2005, representing a decrease of$2.2 million, or 71.0%. The decrease was due primarily to investment incomefrom the proceeds of our initial public offering and reduced debt serviceexpenses following our reduction of net long-term debt in the fourth quarter of2004.

 

#### ***Other income, net***

#### *** ***

Other income, net, decreasedfrom $0.1 million in the six months ended June 30, 2004 to $4,000 in thesix months ended June 30, 2005. This change was not significant.

 

#### ***Taxes on income***

#### *** ***

Our taxes on income increasedfrom $0.5 million in the six months ended June 30, 2004 to $1.0 million inthe six months ended June 30, 2005. This increase was attributable to theincrease in our income before taxes and the depletion of our net operating losscarry forwards in Israel and the United States, together representing $1.2million, offset by the tax reduction attributable to our non-cash stock-basedcompensation expense, representing ($0.7) million.

 

#### ***Equity in net losses ofaffiliates***

#### *** ***

Equity in net losses ofaffiliates decreased from $0.6 million for the six months ended June 30,2004 to $29,000 in the six months ended June 30, 2005. This change was dueto a capital loss related to our reduced

 

27

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ownership of our affiliate, Ness ISI (now known asdbMotion Ltd.), in 2004. Following the January 1, 2004 issuance ofpreferred shares by Ness ISI that reduced our share ownership to anon-controlling interest, we no longer consolidate Ness ISI’s results in ourfinancial statements.

 

#### ***Minority interests inlosses (earnings) of a subsidiary***

#### *** ***

Minority interests in losses(earnings) of a subsidiary changed from earnings of $35,000 in the six monthsended June 30, 2004 to losses of $0.1 million in the six months ended June 30,2005. This change was not significant.

 

#### ***Net Income***

#### *** ***

Net income increased from $5.3million in the six months ended June 30, 2004 to $8.9 million in the sixmonths ended June 30, 2005, representing an increase of $3.6 million, or 67.2%.The increase in net income was due primarily to our increase in operatingincome of $1.2 million, our decrease in financial expenses of $2.2 million andour decrease in equity in net losses of affiliates of $0.6 million, partiallyoffset by the increase in our income taxes of $0.5 million.  The increase in our operating income wasitself offset by an increase in non-cash stock-based compensation of $1.8million.

 

### **Liquidity andCapital Resources**

 

#### ***Overview***

#### *** ***

As of June 30, 2005, wehad cash and cash equivalents amounting to $91.9 million compared to $104.2 millionas of December 31, 2004. The funds held at locations outside of the UnitedStates are for future operating expenses. We have no intention of repatriatingthose funds. We are not, however, restricted in repatriating those funds backto the United States, if necessary. While we expect that cash generated by ournon-U.S. subsidiaries will be reinvested in their respective countries tosupport expansion of our business, to the extent that funds were remitted tothe United States in the form of dividend payments, those payments would besubject to a withholding tax.

 

#### ***Cash Flows***

#### *** ***

The following tablesummarizes our cash flows for the periods presented (dollars in thousands):

 
| ** **                                                    | ** ** | **Six months ended  June 30,** | ** **        |
|---------------------------------------------------------------|------------|-------------------------------------|-------------------|
| ** **                                                    | ** ** | **2004**                            | ** **        | **2005** | ** ** |
| Net cash provided by (used in) operating  activities          |       | $                                   |   8,755 |   | $ |  (7,523 | ) |
| Net cash used in investing activities                         |       | (1,815                              | )                 | (8,657 | ) |
| Net cash provided by (used in) financing  activities          |       | (8,754                              | )                 | 6,369 |   |
| Effect of exchange rate changes on cash and  cash equivalents |       | (679                                | )                 | (2,511 | ) |
| Increase (decrease) in cash and cash  equivalents             |       | (2,493                              | )                 | (12,322 | ) |
| Cash and cash equivalents at the beginning  of the period     |       | 46,004                              |              | 104,229 |   |
| Cash and cash equivalents at the end of the  period           |       | $                                   |  43,511      |   | 91,907 |   |
|                                                               |            |                                     |                   |  |  |  |  |

 

Six months ended June 30,2005 compared to the six months ended June 30, 2004

 

Net cash used in operatingactivities was $7.5 million in the six months ended June 30, 2005,compared to net cash provided of $8.8 million in the six months ended June 30,2004. The major factors contributing to the change in net cash provided byoperating activities were a large annual payment to one of our suppliers,representing $8.2 million, and the payment of accumulated 2004 bonuses,representing $2.3 million, offset by our increase in net income, representing$3.6 million.

 

Net cash used in investingactivities was $8.7 million in the six months ended June 30, 2005,compared with $1.8 million in the six months ended June 30, 2004. Themajor factors contributing to the increase were payments in respect of theacquisitions we made during the second quarter, representing $3.2 million, netof cash acquired,

 

28

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and a reduction in the sale of short-term bankdeposits compared to the six months ended June 30, 2004, representing $3.2million.

 

Net cash provided byfinancing activities was $6.4 million in the six months ended June 30,2005, compared with net cash used of $8.8 million in the six months ended June 30,2004. The change was primarily due to the proceeds from employee exercises ofstock options, representing $8.8 million, and a reduction of $10.2 million inthe payment of long term loans, net.

 

The effect of exchange ratechanges on cash and cash equivalents was ($2.5) million in the six months endedJune 30, 2005, compared to ($0.7) million in the six months ended June 30,2004. The change was primarily due to long-term inter-company balances,representing $1.2 million.

 

#### ***Long-term and Short-termDebt***

#### *** ***

At June 30, 2005, wehad aggregate short-term and long-term bank and other borrowings of $50.8million, consisting of various notes denominated in dollars and NIS withinterest rates (in various currencies and linked to various indices) rangingfrom approximately 5% to 8% and a weighted average interest rate ofapproximately 6%, with maturities of two to five years. These aggregate bankborrowings included $25.6 million from Bank Hapoalim, with an interest rate ofapproximately 5.5% and maturity of three years; $14.3 million from IsraelDiscount Bank, with interest rates of approximately 5% to 8% and maturities oftwo to four years; and $10.9 million from six other lenders, in amounts rangingfrom $0.7 million to $3.0 million, with interest rates of approximately 5% to7% and maturities of up to three years. The maximum interest rate for ourdollar-linked borrowings is approximately 5.5%, and for NIS-linked borrowingsis approximately 8%.

 

#### ***Anticipated CapitalExpenditures***

#### *** ***

In the second quarter of2005, we used $0.2 million of the proceeds of our initial public offering to furtherreduce net debt beyond the net debt reduction of $37.1 million accomplished inthe fourth quarter of 2004 and the first quarter of 2005, in line with ourpreviously announced $40 million debt reduction plan. Following the use ofproceeds, our only material indebtedness is amounts owed by Ness TechnologiesHoldings Ltd., one of our subsidiaries, to Bank Hapoalim and Israel DiscountBank. The shares of two of our Israeli subsidiaries are pledged to these banksas security for borrowings under the agreements. The relevant debt instrumentscontain customary restrictive covenants relating to the borrower and ourwholly-owned subsidiary Ness A.T. Ltd., including the following:

 

•      limitations on incurringdebt;

•      prohibition on pledgingassets;

•      prohibition on distributingdividends;

•      stockholders’ equity mustnot be less than 30% of its total assets;

•      EBITDA must not be less than9.5% of revenues and not less than NIS 34 million; and

•      limitations on merging ortransferring assets.

 

In addition, the IsraelDiscount Bank agreement requires that the net cash and liquid assets of theborrower must not be lower than $18.0 million. As of June 30, 2005, we arein compliance and expect to remain in compliance with all of our covenants. Ourfailure to comply with these covenants could lead to an event of default underthe agreements governing some or all of the indebtedness, permitting theapplicable lender to accelerate all borrowings under the applicable agreement,and to foreclose on any collateral.

 

#### ***Anticipated Needs***

#### *** ***

We intend to fund futuregrowth through cash flow from operations, available bank borrowings and the netproceeds of our initial public offering. We believe the proceeds of our initialpublic offering, together with borrowings and cash flow from operations, willbe sufficient to fund continuing operations for the foreseeable future. Inorder to achieve our strategic business objectives, we may be required to seekadditional financing. For example, future acquisitions may require additionalequity and/or debt financing. In addition, we may require

 

29

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further capital to continue to develop ourtechnology and infrastructure and for working capital purposes. Thesefinancings may not be available on acceptable terms, or at all.

 

### **Forward-LookingStatements and Risk Factors**

 

This Quarterly Report on Form 10-Q,including Management’s Discussion and Analysis of Financial Condition andResults of Operations, contains forward-looking statements within the meaningof the Private Securities Litigation Reform Act of 1995.  Forward-looking statements often areproceeded by words such as “believes,” “expects,” “may,” “anticipates,” “plans,”“intends,” “assumes,” “will” or similar expressions. Forward-looking statementsreflect management’s current expectations, as of the date of this report, andinvolve certain risks and uncertainties. Our actual results could differmaterially from those anticipated in these forward looking statements as aresult of various factors. Some of the factors that could cause future resultsto materially differ from the recent results or those projected inforward-looking statements include the “Risk Factors” described in our AnnualReport on Form 10-K filed with the SEC on March 31, 2005.

 

***Item 3. Quantitative and QualitativeDisclosure about Market Risk***

*** ***

We do not engage in tradingmarket-risk instruments or purchase hedging or “other than trading” instrumentsthat are likely to expose us to market risk, whether interest rate, commodityprice or equity price risk. We have not purchased options or entered into swapsor forward or futures contracts. We do not use derivative financial instrumentsfor speculative trading purposes.

 

We have direct operations in15 different countries and relationships in many other parts of the world. Ourforeign operations contract with clients in their applicable local currenciesor dollars. As a result, we are subject to adverse movements in foreigncurrency exchange rates in those countries where we conduct business.  In the second quarter, we entered intocertain forward foreign currency exchange contracts to hedge our exposure to theIndian Rupee.  In the future, we mayenter into additional forward foreign currency exchange or other derivatives contractsto further hedge our exposure to foreign currency exchange rates.

 

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

 

***Item 4. Controls and Procedures***

*** ***

### **Evaluation ofDisclosure Controls and Procedures**

 

As of the end of the periodcovered by this report, our chief executive officer and chief financial officerevaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended). Based on their evaluation of our disclosurecontrols and procedures, our chief executive officer and chief financialofficer, with the participation of our management, have concluded that ourdisclosure controls and procedures are effectively designed to ensure thatinformation required to be disclosed by us in the reports that we file orsubmit under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and are operating inan effective manner.

 

It should be noted that anysystem of controls, however well designed and operated, can provide onlyreasonable, and not absolute, assurance that the objectives of the system aremet. In addition, the design of any control system is based in part uponcertain assumptions about the likelihood of future events. Given these andother inherent limitations of control systems, there is only reasonableassurance that our controls will succeed in achieving their stated goals underall potential future conditions.

 

### **Changes inInternal Control**

 

As of the end of the periodcovered by this report, there were no significant changes in our internalcontrols over financial reporting or in other factors that could significantlyaffect these controls.

 

30

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# **PART II – OTHERINFORMATION**

# ** **

***Item 1. Legal Proceedings***

*** ***

We are periodically a partyto routine litigation incidental to our business. We do not believe that we area party to any pending legal proceeding that is likely to have a materialadverse effect on our business, financial condition or results of operations.

 

***Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds***

*** ***

In the second quarter of2005, we used $0.2 million of the proceeds of our initial public offering,which closed on October 4, 2004, to further reduce net debt beyond the netdebt reduction of $37.1 million accomplished in the fourth quarter of 2004 andthe first quarter of 2005, in line with our previously announced $40 milliondebt reduction plan.  We intend to applythe balance of the proceeds to fund business growth and expansion and forworking capital and general corporate purposes. We may also use a portion of the net proceeds for acquisitions ofadditional businesses, assets and technologies or the establishment of jointventures.  As of the date of this report,we have no agreements to enter into any material acquisition, investment,partnership, alliance or other joint venture transaction; other than ourannounced acquisition of Delta Electronic Services a.s. (see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Recent Developments”).

 

***Item 3. Defaults upon Senior Securities.***

*** ***

None.

 

***Item 4. Submission of Matters to a Vote ofSecurity Holders***

*** ***

The following matters weresubmitted to a vote of the stockholders at our 2005 Annual Meeting ofStockholders held on June 3, 2005 (the “Annual Meeting”): (1) electionof directors, and (2) ratification of the appointment of Kost Forer Gabbay &Kasierer, a member of Ernst & Young Global, as our independent auditorsfor the year ending December 31, 2005. The number of shares of common stock outstanding and eligible to vote asof the record date of April 20, 2005 was 34,532,770.

 

Each of these matters wasapproved by the requisite vote of our stockholders.  Set forth below is the number of votes castfor, against or withheld, as well as the number of abstentions and brokernon-votes as to the respective matters, including a separate tabulation withrespect to each nominee for director:

 
| **Nominee**                          | ** ** | **For**    | ** ** | **Withheld** | ** ** | ** **  | ** ** | ** **           | ** ** |
|--------------------------------------|------------|------------|------------|--------------|------------|-------------|------------|----------------------|------------|
| Aharon Fogel                         |       | 25,631,374 |       | 2,145,864    |       |        |       |                 |       |
| Raviv Zoller                         |       | 25,631,374 |       | 2,145,864    |       |        |       |                 |       |
| Rajeev Srivastava                    |       | 25,572,029 |       | 2,205,209    |       |        |       |                 |       |
| Dr. Henry Kressel               |       | 27,084,307 |       | 692,931      |       |        |       |                 |       |
| Morris Wolfson                       |       | 25,738,213 |       | 2,039,025    |       |        |       |                 |       |
| Dr. Satyam C. Cherukuri         |       | 27,092,978 |       | 684,260      |       |        |       |                 |       |
| Dan S. Suesskind                     |       | 26,898,547 |       | 878,691      |       |        |       |                 |       |
|                                 |       |       |       |         |       |        |       |                 |       |
| **Proposal**                         | ** ** | **For**    | ** ** | **Against**  | ** ** | **Abstain** | ** ** | **Broker  Non-Vote** | ** ** |
| Proposal 2: Ratification of Auditors |       | 27,548,331 |       | 217,446      |       | 11,461      |       | 0                    |       |

 

***Item 5. Other Information***

*** ***

On August 9, 2005, Dr. KennethA. Pickar was elected to our board of directors.  Dr. Pickar was also appointed to our auditcommittee, effective August 15, 2005, replacing Dr. Henry Kressel,who resigned from the audit committee effective the same date.  Dr. Pickar satisfies the independencerequirements of SEC Rule 10A-3, and as such our audit committee will becomprised solely of directors who satisfy the NASDAQ National Market and SECaudit committee membership requirements.

 

31

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Dr. Pickar has servedas a board member of Neustar Corporation since 1999 and of H2Scan LLC, since January 2005.  He has served on the executive committee ofTech Coast Angels (LA) since 2001 and of the operating committee of Idealabsince 2004.  From 1997 to 1999, Dr. Pickarserved on the board of directors of Level One Corporation, which was traded onNASDAQ prior to the company’s sale to Intel Corporation.  From 1986 to 1987, he served on the board ofdirectors of the Microelectronics and Computer Consortium.  From 1983 to 1986, he served on the board ofdirectors of the Semiconductor Research Corporation, where he held the positionof vice chairman in 1986. From 1993 to 1998, Dr. Pickar served as seniorvice president, research and development for AlliedSignal Aerospace.  Previously, Dr. Pickar held executive,research and development and technology positions with corporations includingGeneral Electric Corporate Research and Development, Signetics Corporation,Bell Northern Research and Bell Laboratories. In addition to his extensivebusiness experience, Dr. Pickar has been, since 1998, a visiting professorof Mechanical Engineering at the California Institute of Technology, where heserved as the J. Stanley Johnson Professor from 1999 to 2003. He is also avisiting lecturer at University of California, Los Angeles (UCLA) AndersonSchool of Management.  Dr. Pickarholds a bachelor of science degree, cum laude, Phi Beta Kappa, in physics andmathematics from City University of New York, and a master’s degree anddoctorate of Physics from the University of Pennsylvania.

 

On August 9, 2005,Rajeev Srivastava voluntarily resigned his position on our board ofdirectors.  Mr. Srivastava willcontinue his role as President of Ness Global Services.

 

On August 10, 2005, weentered into a new employment agreement with Shachar Efal, oneof our executive officers, effective as of July 1, 2005.  The agreement is for a term of two years andshall be extended for successive one year periods unless terminated asdescribed below.  Mr. Efal’s initialannual base salary, which is denominated in NIS, is approximately $188,292based on the dollar to NIS exchange rate of July 1, 2005. He is alsoentitled to an annual bonus determined 50% in proportion to the share that ourchief executive officer receives of his maximum annual bonus and 50% based onthe business results of Mr. Efal’s area of responsibility, subject to anaggregate maximum of $200,000.  We mayterminate Mr. Efal’s’ employment by providing three months prior noticeand Mr. Efal may terminate his employment by providing us with threemonths prior notice.  If we terminate Mr. Efal’semployment other than for cause, Mr. Efal will be entitled to his basesalary through the date of termination and for six months thereafter and to allamounts deposited in his favor in pension funds, including payments made forseverance pay.  If Mr. Efalterminates his employment other than for cause, Mr. Efal will be entitledto his base salary through the date of termination and, at the discretion ofour chief executive officer, for up to three months thereafter and to allamounts deposited in his favor in pension funds, including payments made forseverance pay.  However, if Mr. Efalis terminated for cause or resigns in such situation, Mr. Efal will not beentitled to receive any base salary after the date his employment ceases or anyamount deposited on his behalf in any pension fund. The agreement also containscustomary confidentiality and non-competition provisions.  The non-competition provisions apply during Mr. Efal’semployment and for one year thereafter.

 

***Item 6. Exhibits***

*** ***

The following is a list ofexhibits filed as part of this Form 10-Q:

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                    |       | Personal  Employment Agreement, dated as of August 10, 2005, between Ness  Technologies Holdings Ltd. and Shachar Efal (English translation).             |
| 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. |

 

32

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# **SIGNATURES**

# ** **

Pursuant to the requirementsof the Securities Exchange Act of 1934, as amended, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

NESS TECHNOLOGIES, INC.

(Registrant)

 

 
| Date:  | August 11, 2005 | By:    | /s/ Raviv  Zoller                                     |   |
|--------|----------------------|--------|-------------------------------------------------------|--------|
|   |                 |   | Raviv Zoller                                          |
|   |                 |   | Chief Executive Officer, President, Director          |
|   |                 |   | (Principal executive officer)                         |
|   |                 |   |                                                  |
|   |                 |   |                                                  |
| Date:  | August 11, 2005 | By:    | /s/ Ytzhak  Edelman                                   |   |
|   |                 |   | Ytzhak Edelman                                        |
|   |                 |   | Executive Vice President and Chief  Financial Officer |
|   |                 |   | (Principal financial and accounting  officer)         |

 

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# **EXHIBIT INDEX**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                    |       | Personal  Employment Agreement, dated as of August 10, 2005, between Ness  Technologies Holdings Ltd. and Shachar Efal (English translation).             |
| 31.1                    |       | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                     |
| 31.2                    |       | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                     |
| 32.1                    |       | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2                    |       | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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