UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549







FORM
10-Q





(Mark
One)


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




For
the quarterly period ended March 31, 2010




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
transition period from ________ to ________





Commission
File Number 000-50954










NESS
TECHNOLOGIES, INC.


(Exact
name of registrant as specified in its charter)





Delaware
                    98-0346908(State
      or other jurisdiction of
                    (I.R.S.
      Employerincorporation
      or organization)
                    Identification
      Number)





Ness
Tower


Atidim
High-Tech Industrial Park


Building
4


Tel
Aviv 61580, Israel


Telephone:
+972 (3) 766-6800


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







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




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).   ̈ Yes   ̈ No




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.


Large
accelerated filer  ̈Accelerated filer xNon-accelerated
filer  ̈Smaller reporting company  ̈




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




As of
April 30, 2010, 38,263,067 shares of the issuer’s common stock, $0.01 par value
per share, were outstanding.










NESS
TECHNOLOGIES, INC. AND SUBSIDIARIES





INDEX





PART
      I – FINANCIAL INFORMATION
                                                                                                                3Item
      1. Financial Statements
                                                                                                                3Consolidated
      Balance Sheets – December 31, 2009 and March 31, 2010
      (Unaudited)
                                                                                                                3Consolidated
      Statements of Income – Three months ended March 31, 2009 and 2010
      (Unaudited)
                                                                                                                5Consolidated
      Statements of Cash Flows – Three months ended March 31, 2009 and 2010
      (Unaudited)
                                                                                                                6Notes
      to Interim Consolidated Financial Statements – March 31, 2010
      (Unaudited)
                                                                                                                8Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                                                                                                                23Forward-Looking
      Statements
                                                                                                                23Overview
                                                                                                                23Recent
      Developments
                                                                                                                24Consolidated
      Results of Operations
                                                                                                                25Three
      Months Ended March 31, 2010 Compared to the Three Months Ended March 31,
      2009
                                                                                                                25Quarterly
      Results of Operations
                                                                                                                28Results
      by Business Segment
                                                                                                                29Liquidity
      and Capital Resources
                                                                                                                30Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                                                                                                                33Item
      4. Controls and Procedures
                                                                                                                33Evaluation
      of Disclosure Controls and Procedures
                                                                                                                33Changes
      in Internal Control Over Financial Reporting
                                                                                                                34PART
      II – OTHER INFORMATION
                                                                                                                35Item
      1. Legal Proceedings
                                                                                                                35Item
      1A. Risk Factors
                                                                                                                35Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                                                                                                                35Item 3. Defaults upon Senior
      Securities
                                                                                                                35Item
      4. (Removed and Reserved)
                                                                                                                36Item
      5. Other Information
                                                                                                                36Item
      6. Exhibits
                                                                                                                36SIGNATURES
                                                                                                                37EXHIBIT
      INDEX
                                                                                                                38





PART
I – FINANCIAL INFORMATION




Item
1. Financial Statements




NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Interim
Consolidated Balance Sheets


U.S.
dollars in thousands





December
                  31, 2009
              
              
              March 31,
                  2010(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              40,218
              
              
              $
              41,194Restricted
      cash
              
              
              2,470
              
              
              
              2,925Short-term
      bank deposits
              
              
              25,939
              
              
              
              20,776Trade
      receivables, net of allowance for doubtful accounts of $2,789 at December
      31, 2009 and $2,356 at March 31, 2010
              
              
              131,452
              
              
              
              124,130Unbilled
      receivables
              
              
              28,012
              
              
              
              29,847Other
      accounts receivable and prepaid expenses
              
              
              27,832
              
              
              
              27,187Work
      in progress
              
              
              9,690
              
              
              
              8,168Total
      assets attributed to discontinued operations
              
              
              43,212
              
              
              
              36,639Total
      current assets
              
              
              308,825
              
              
              
              290,866LONG-TERM
      ASSETS:Long-term
      prepaid expenses and other assets
              
              
              6,083
              
              
              
              6,151Unbilled
      receivables
              
              
              4,654
              
              
              
              4,904Deferred
      income taxes, net
              
              
              3,608
              
              
              
              3,293Severance
      pay fund
              
              
              53,145
              
              
              
              54,919Property
      and equipment, net
              
              
              35,739
              
              
              
              34,699Intangible
      assets, net
              
              
              10,016
              
              
              
              8,494Goodwill
              
              
              263,541
              
              
              
              261,421Total
      long-term assets
              
              
              376,786
              
              
              
              373,881Total
      assets
              
              $
              685,611
              
              
              $
              664,747





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


– 3
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Interim
Consolidated Balance Sheets


U.S.
dollars in thousands (except share and par value data)





December
                  31, 2009
              
              
              March 31,
                  2010(Unaudited)LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIES:Short-term
      bank credit
              
              $
              500
              
              
              $
              —Current
      maturities of long-term debt
              
              
              21,332
              
              
              
              23,194Trade
      payables
              
              
              30,914
              
              
              
              28,955Advances
      from customers and deferred revenues
              
              
              40,639
              
              
              
              36,734Other
      accounts payable and accrued expenses
              
              
              99,464
              
              
              
              95,276Total
      liabilities attributed to discontinued operations
              
              
              25,461
              
              
              
              24,121Total
      current liabilities
              
              
              218,310
              
              
              
              208,280LONG-TERM
      LIABILITIES:Long-term
      debt, net of current maturities
              
              
              50,836
              
              
              
              43,071Other
      long-term liabilities
              
              
              6,689
              
              
              
              7,070Deferred
      income taxes
              
              
              2,045
              
              
              
              1,849Accrued
      severance pay
              
              
              56,443
              
              
              
              58,348Total
      long-term liabilities
              
              
              116,013
              
              
              
              110,338COMMITMENTS
      AND CONTINGENT LIABILITIESSTOCKHOLDERS’
      EQUITY:Preferred
      stock of $0.01 par value – Authorized: 8,500,000 shares at December 31,
      2009 and at March 31, 2010; Issued and outstanding: none at December 31,
      2009 and March 31, 2010
              
              
              —
              
              
              
              —Common
      stock of $0.01 par value – Authorized: 76,500,000 shares at December 31,
      2009 and at March 31, 2010; Issued: 39,628,994 at December 31, 2009 and at
      March 31, 2010; Outstanding: 38,399,290 at December 31, 2009 and
      38,282,590 at March 31, 2010
              
              
              396
              
              
              
              396Additional
      paid-in capital
              
              
              332,928
              
              
              
              333,757Accumulated
      other comprehensive income
              
              
              16,176
              
              
              
              15,488Retained
      earnings
              
              
              6,476
              
              
              
              1,787Treasury
      stock, at cost (1,229,704 shares at December 31, 2009 and 1,346,404 at
      March 31, 2010)
              
              
              (4,688
              )
              
              
              (5,299
              )Total
      stockholders’ equity
              
              
              351,288
              
              
              
              346,129Total
      liabilities and stockholders’ equity
              
              $
              685,611
              
              
              $
              664,747





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


– 4
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Interim
Consolidated Statements of Income


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





Three
      months ended
                  March
      31,2009
              
              
              2010(Unaudited)
              
              
              (Unaudited)Revenues
              
              $
              126,281
              
              
              $
              133,333Cost
      of revenues
              
              
              94,359
              
              
              
              96,521Gross
      profit
              
              
              31,922
              
              
              
              36,812Selling
      and marketing
              
              
              9,212
              
              
              
              10,053General
      and administrative
              
              
              23,585
              
              
              
              24,342Insurance
      settlement related to 2007 arbitration expense, net of related
      expenses
              
              
              (2,610
              )
              
              
              —Commissions
      related to the sale of Israeli SAP sales and distribution
      operations
              
              
              (2,534
              )
              
              
              —Total
      operating expenses
              
              
              27,653
              
              
              
              34,395Operating
      income
              
              
              4,269
              
              
              
              2,417Financial
      expenses, net
              
              
              (1,156
              )
              
              
              (209
              )Income
      before taxes on income
              
              
              3,113
              
              
              
              2,208Taxes
      on income
              
              
              642
              
              
              
              1,510Net
      income from continuing operations
              
              $
              2,471
              
              
              $
              698Net
      loss from discontinued operations
              
              
              (943
              )
              
              
              (5,387
              )Net
      income (loss)
              
              $
              1,528
              
              
              $
              (4,689
              )Basic
      net earnings per share from continuing operations
              
              $
              0.06
              
              
              $
              0.02Diluted
      net earnings per share from continuing operations
              
              $
              0.06
              
              
              $
              0.02Basic
      net loss per share from discontinued operations
              
              $
              (0.02
              )
              
              $
              (0.14
              )Diluted
      net loss per share from discontinued operations
              
              $
              (0.02
              )
              
              $
              (0.14
              )Basic
      net earnings (loss) per share
              
              $
              0.04
              
              
              $
              (0.12
              )Diluted
      net earnings (loss) per share
              
              $
              0.04
              
              
              $
              (0.12
              )





(*)
            Includes
      stock-based compensation, as
follows:




Three
      months ended
                  March
      31,2009
              
              
              2010(Unaudited)
              
              
              (Unaudited)Cost
      of revenues
              
              $
              63
              
              
              $
              53Selling
      and marketing
              
              
              57
              
              
              
              44General
      and administrative
              
              
              808
              
              
              
              732





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


– 5
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Interim
Consolidated Statements of Cash Flows


U.S.
dollars in thousands





Three
      months ended
                  March
      31,2009
              
              
              2010(Unaudited)
              
              
              (Unaudited)Cash flows from
      operating activities:Net
      income (loss)
              
              $
              1,528
              
              
              $
              (4,689
              )Adjustments
      required to reconcile net income (loss) to net cash provided by operating
      activities:Net
      loss from discontinued operations
              
              
              943
              
              
              
              5,387Stock-based
      compensation-related expenses
              
              
              928
              
              
              
              829Currency
      fluctuation of restricted cash and short-term bank
deposits
              
              
              —
              
              
              
              (957
              )Depreciation
      and amortization
              
              
              4,203
              
              
              
              4,169Loss
      on sale of property and equipment and impairment and sale of cost
      investments
              
              
              248
              
              
              
              66Commissions
      related to the sale of Israeli SAP sales and distribution
      operations
              
              
              (2,534
              )
              
              
              —Decrease
      in trade receivables, net
              
              
              22,906
              
              
              
              7,163Decrease
      (increase) in unbilled receivables
              
              
              105
              
              
              
              (2,460
              )Decrease
      in other accounts receivable and prepaid expenses
              
              
              1,376
              
              
              
              964Decrease
      in work-in-progress
              
              
              18
              
              
              
              1,265Increase
      in long-term prepaid expenses
              
              
              (274
              )
              
              
              (41
              )Deferred
      income taxes, net
              
              
              (945
              )
              
              
              456Decrease
      in trade payables
              
              
              (5,432
              )
              
              
              (1,568
              )Decrease
      in advances from customers and deferred revenues
              
              
              (420
              )
              
              
              (3,747
              )Increase
      in other long-term liabilities
              
              
              332
              
              
              
              420Decrease
      in other accounts payable and accrued expenses
              
              
              (13,847
              )
              
              
              (4,204
              )Increase
      (decrease) in accrued severance pay, net
              
              
              (23
              )
              
              
              104Net
      cash provided by (used in) discontinued operations
              
              
              (518
              )
              
              
              1,578Net
      cash provided by operating activities
              
              
              8,594
              
              
              
              4,735Cash flows from
      investing activities:Consideration
      from sale of a consolidated subsidiary, net of
cash-in-hand
              
              
              —
              
              
              
              1,384Proceeds
      from maturity of (investment in) short-term bank deposits,
    net
              
              
              (11,082
              )
              
              
              5,662Proceeds
      from sale of property and equipment
              
              
              171
              
              
              
              —Purchase
      of property and equipment and capitalization of software developed for
      internal use
              
              
              (3,076
              )
              
              
              (1,744
              )Net
      cash used in discontinued operations
              
              
              (3,114
              )
              
              
              (2,655
              )Net
      cash provided by (used in) investing activities
              
              
              (17,101
              )
              
              
              2,647Cash flows from
      financing activities:Repurchase
      of shares
              
              
              (1,217
              )
              
              
              (611
              )Short-term
      bank loans and credit, net
              
              
              207
              
              
              
              (500
              )Principal
      payments of long-term debt
              
              
              (1,731
              )
              
              
              (3,121
              )Net
      cash used in discontinued operations
              
              
              (242
              )
              
              
              —Net
      cash used in financing activities
              
              
              (2,983
              )
              
              
              (4,232
              )





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


– 6
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Interim
Consolidated Statements of Cash Flows


U.S.
dollars in thousands





Three
      months ended
                  March
      31,2009
              
              
              2010(Unaudited)
              
              
              (Unaudited)Effect
      of exchange rate changes on cash and cash equivalents
              
              
              (1,273
              )
              
              
              (2,174
              )Increase
      (decrease) in cash and cash equivalents
              
              
              (12,763
              )
              
              
              976Cash
      and cash equivalents at the beginning of the period
              
              
              44,585
              
              
              
              40,218Cash
      and cash equivalents at the end of the period
              
              $
              31,822
              
              
              $
              41,194





Non-cash
      activityAccrual
      for additional consideration for acquisitions
                
                $
                2,984
                
                
                $
                —Loss
      from mark-to-market of foreign exchange forward contracts and interest
      rate swap
                
                $
                232
                
                
                $
                69





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


– 7
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements


U.S.
dollars in thousands (except share and per share data) (Unaudited)




Note
1: General




Ness
Technologies, Inc. (“we,” “our,” “us” or “the Company”) was incorporated under
the laws of the State of Delaware in March 1999. We operate through our
subsidiaries in North America, Europe, Israel and Asia Pacific.




We are a
global provider of IT and business services and solutions with specialized
expertise in software product engineering; and system integration, application
development, consulting and software distribution. We deliver our portfolio of
solutions and services using a global delivery model combining offshore,
near-shore and local teams. The primary verticals we serve include high-tech
companies and independent software vendors; utilities and government; financial
services; defense and homeland security; and life sciences and
healthcare.




Note
2: Significant Accounting Policies




a.
            Unaudited Interim
      Financial Information




The
accompanying consolidated balance sheet as of March 31, 2010, the consolidated
statements of income for the three months ended March 31, 2009 and 2010 and the
consolidated statements of cash flows for the three months ended March 31, 2009
and 2010 are unaudited. These unaudited interim consolidated financial
statements have been prepared in accordance with U.S. generally accepted
accounting principles for interim financial information. In the opinion of
management, the unaudited interim consolidated financial statements include all
adjustments of a normal recurring nature necessary for a fair presentation of
our consolidated financial position as of March 31, 2010, our consolidated
results of operations for the three months ended March 31, 2009 and 2010 and our
consolidated cash flows for the three months ended March 31, 2009 and
2010.




The
balance sheet at December 31, 2009 has been derived from the audited
consolidated financial statements at that date but does not include all of the
information and footnotes required by U.S. generally accepted accounting
principles for complete financial statements.




These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and accompanying notes for the year ended
December 31, 2009 included in our Annual Report on Form 10-K filed with the U.S.
Securities and Exchange Commission (“SEC”) on March 15, 2010.




Results
for the three months ended March 31, 2010 are not necessarily indicative of
results that may be expected for the year ending December 31, 2010.




Unless
otherwise noted, all references to “dollars” or “$” are to United States dollars
and all references to “NIS” are to New Israeli Shekels.




b.
            Reclassification




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


c.
              Use of
      estimates
  The
preparation of financial statements in conformity with United States generally
accepted accounting principles requires our management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Our management believes that the estimates, judgments and
assumptions used are reasonable based upon information available at the time
they are made. These estimates, judgments and assumptions can affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the financial statements, and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.


– 8
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements


U.S.
dollars in thousands (except share and per share data) (Unaudited)






d.
            Principles of
      consolidation




Our
consolidated financial statements include the accounts of the company and its
wholly and majority owned subsidiaries, referred to herein as 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.
            Fair value
      measurements




We
categorize the fair value of our financial assets and liabilities according to
the hierarchy established by the Financial Standards Accounting Board (“FASB”),
which prioritizes the inputs to valuation techniques used to measure fair value.
The hierarchy gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements) and the
lowest priority to unobservable inputs (Level 3 measurements). The three levels
of the fair value hierarchy are described as follows:




Level
      1
                      Valuations
      based on quoted prices in active markets for identical assets or
      liabilities that we have the ability to directly
access.Level
      2
                      Valuations
      based on quoted prices for similar assets or liabilities; valuations for
      interest-bearing securities based on non-daily quoted prices in active
      markets; quoted prices in markets that are not active; or other inputs
      that are observable or can be corroborated by observable data for
      substantially the full term of the assets or
  liabilities.Level
      3
                      Valuations
      based on inputs that are supported by little or no market activity and
      that are significant to the fair value of the assets or
      liabilities.




A
financial instrument’s level within the fair value hierarchy is based on the
lowest level of any input that is significant to the fair value
measurement.




In
circumstances in which a quoted price in an active market for the identical
liability is not available, we are required to use the quoted price of the
identical liability when traded as an asset, quoted prices for similar
liabilities, or quoted prices for similar liabilities when traded as assets. If
these quoted prices are not available, then we are required to use another
valuation technique, such as an income approach or a market
approach.




Assets
and liabilities measured at fair value under Accounting Standards Codification
(“ASC”) Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”), as of
March 31, 2010 were presented on our Consolidated Balance Sheet as
follows:


– 9
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements


U.S.
dollars in thousands (except share and per share data)
(Unaudited)




Total
                  
                  
                  Quoted
                      Prices in
                      Active
                      Markets
                      for
                      Identical
                      Assets
                      (Level 1)
                  
                  
                  Significant
                      Other
                      Observable
                      Inputs
                      (Level 2)
                  
                  
                  Significant
                      Unobservable
                      Inputs
                      (Level 3)Derivative
      instruments (recurring basis)
                  
                  $
                  1,694
                  
                  
                  $
                  —
                  
                  
                  $
                  1,694
                  
                  
                  $
                  —Goodwill
      and intangible assets, net (non-recurring basis)
                  
                  $
                  269,915
                  
                  
                  
                  
                  
                  
                  $
                  —
                  
                  
                  $
                  269,915Total
      assets
                  
                  $
                  271,609
                  
                  
                  $
                  —
                  
                  
                  $
                  1,694
                  
                  
                  $
                  269,915Derivative
      instruments (recurring basis)
                  
                  $
                  1,763
                  
                  
                  $
                  —
                  
                  
                  $
                  1,763
                  
                  
                  $
                  —Total
      liabilities
                  
                  $
                  1,763
                  
                  
                  $
                  —
                  
                  
                  $
                  1,763
                  
                  
                  $
                  —




Assets
and liabilities measured at fair value under ASC 820 as of December 31, 2009
were presented on our Consolidated Balance Sheet as follows:




Total
                
                
                Quoted
                    Prices in
                    Active
                    Markets
                    for
                    Identical
                    Assets
                    (Level 1)
                
                
                Significant
                    Other
                    Observable
                    Inputs
                    (Level 2)
                
                
                Significant
                    Unobservable
                    Inputs
                    (Level 3)Derivative
      instruments (recurring basis)
                
                $
                1,221
                
                
                $
                —
                
                
                $
                1,221
                
                
                $
                —Goodwill
      and intangible assets, net (non-recurring basis)
                
                $
                273,557
                
                
                $
                —
                
                
                $
                —
                
                
                $
                273,557Total
      assets
                
                $
                274,778
                
                
                $
                —
                
                
                $
                1,221
                
                
                $
                273,557Derivative
      instruments (recurring basis)
                
                $
                665
                
                
                $
                —
                
                
                $
                665
                
                
                $
                —Total
      liabilities
                
                $
                665
                
                
                $
                —
                
                
                $
                665
                
                
                $
                —




The fair
value of long-term debt is estimated by discounting the future cash flows using
current interest rates for loans of similar terms and maturities. The carrying
amount of the long-term debt approximates its fair value.




In
addition to the assets and liabilities described above, our financial
instruments also include cash, trade receivables, other accounts receivable,
related party receivables, trade payables, accrued expenses and other payables.
The fair value of these financial instruments was not materially different from
their carrying value at March 31, 2010 and December 31, 2009 due to the
short-term maturity of these instruments.


– 10
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements


U.S.
dollars in thousands (except share and per share data) (Unaudited)




f.
            Impact of recently
      issued and adopted accounting
  pronouncements




In
October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue
Arrangements (amendments to FASB ASC Topic 605, Revenue Recognition)” (“ASU
2009-13”), and ASU No. 2009-14, “Certain Arrangements That Include Software
Elements (amendments to FASB ASC Topic 985, Software)” (“ASU 2009-14”). ASU
2009-13 requires entities to allocate revenue in an arrangement using estimated
selling prices of the delivered goods and services based on a selling price
hierarchy. The amendments eliminate the residual method of revenue allocation
and require revenue to be allocated using the relative selling price method. ASU
2009-14 removes tangible products from the scope of software revenue guidance
and provides guidance on determining whether software deliverables in an
arrangement that includes a tangible product are covered by the scope of the
software revenue guidance. As a result of the amendments included in ASU No.
2009-14, many tangible products and services that rely on software will be
accounted for under the multiple-element arrangements revenue recognition
guidance rather than under the software revenue recognition guidance. ASU No.
2009-14 also provides guidance on how to allocate transaction consideration when
an arrangement contains both deliverables within the scope of software revenue
guidance (software deliverables) and deliverables not within the scope of that
guidance (non-software deliverables). ASU 2009-13 and ASU 2009-14 are to be
applied on a prospective basis for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010, with
early adoption permitted. We are currently evaluating the impact of this
standard on our consolidated results of operations and financial
condition.




In 2010,
the FASB issued ASU No. 2010-06 which amends ASC Topic 820-10, “Fair Value
Measurements and Disclosures – Overall” (“ASC 820-10”). The update requires a
gross presentation of activities within the Level 3 roll-forward and adds a new
requirement to disclose transfers in and out of Level 1 and 2 measurements. The
update further clarifies the existing disclosure requirements in ASC 820-10
regarding: i) the level of disaggregation of fair value measurements; and ii)
the disclosures regarding inputs and valuation techniques. The update was
effective for our fiscal year beginning January 1, 2010 except for the gross
presentation of the Level 3 roll-forward information, which is effective for our
fiscal year beginning January 1, 2011. The principal impact from this update
will be expanded disclosures regarding our fair value measurements.




Note
3: Acquisitions




a.
            Gilon Business Insight
      Ltd.




On March
25, 2010, we signed a definitive agreement to acquire all of the outstanding
capital stock of Gilon Business Insight Ltd. (“Gilon”), a privately-held,
leading Israeli provider of business intelligence consulting and implementation
solutions and services, for cash consideration of NIS 65 million, or
approximately $17,500. An additional payment of up to NIS 9 million, or
approximately $2,400, may be made during the two-year period following the
closing of the agreement should Gilon achieve certain performance goals. The
purchase closed on May 4, 2010. The acquisition of Gilon increases our market
share in Israel and further positions us as a provider of enterprise solutions,
with a blend of enterprise resource planning (“ERP”), business intelligence
(“BI”) and customer relationship management (“CRM”) capabilities. We intend to
utilize Gilon’s capabilities to help fulfill the demand for business
intelligence applications, solutions and services around the world. Following
our acquisition of Gilon, it became part of Ness Israel under our System
Integration and Application Development segment.




b.
            Goodwill




In the
three months ended March 31, 2010, we decreased our goodwill by $2,120 on
account of translation adjustments.


– 11
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Goodwill
and intangible assets deemed to have indefinite lives are tested for impairment
annually, or between annual tests in certain circumstances, and written down
when impaired. Goodwill is tested for impairment at the reporting unit level by
comparing the fair value of the reporting unit with its carrying value. We
perform our annual impairment analysis of goodwill as of December 31 of each
year, or more often if there are indicators of impairment present. As of
December 31, 2009, we performed our annual impairment test and recorded goodwill
impairment of $28,531. As our market capitalization is lower than our
stockholders’ equity and in response to changes in our assumptions related to
future cash flows and market conditions during the three months ended March 31,
2010, we updated our analysis and performed an impairment test as of March 31,
2010. As a result of the analysis, we concluded that goodwill was not
impaired.




In
accordance with ASC Topic 350, “Intangibles – Goodwill and Other,” each time we
performed the test, we compared the fair value of each reporting unit to its
carrying value. In such a test, if the fair value exceeds the carrying value of
the net assets, goodwill is considered not impaired, and we are not required to
perform further testing. We determined the fair value of each reporting unit
using the Income Approach, which utilizes a discounted cash flow model, as this
approach best approximates the reporting unit’s fair value at this time.
Judgments and assumptions related to revenues, operating income, future
short-term and long-term growth rates, weighted average cost of capital,
interest, capital expenditures, cash flows, and market conditions are inherent
in developing the discounted cash flow model. We considered historical rates and
current market conditions when determining the discount and growth rates to use
in our analyses. We corroborated the fair values using the Market Approach. If
the carrying value of the net assets exceeds the fair value, then we must
perform the second step of the impairment test in order to determine the implied
fair value of goodwill. Determining the fair value of our net assets and our
off-balance sheet intangibles would require us to make judgments that involve
the use of significant estimates and assumptions. If these estimates or their
related assumptions change in the future, we may be required to record
impairment charges for our goodwill.




Note
4: Discontinued operations




On
January 15, 2010, we closed a share purchase agreement with a privately-held
Dutch company to sell the shares of our indirectly wholly-owned subsidiary Ness
Benelux for a total of €1.2 million, or $1,711. Prior to the sale, Ness Benelux
operated as part of Ness Europe under our System Integration and Application
Development segment and was engaged primarily in providing IT professional
services in the Netherlands.




On
February 1, 2010, our board of directors resolved to sell our operations in the
Asia Pacific region, and on April 24, 2010, we signed a definitive asset
transfer agreement with the buyer. Ness Asia Pacific operates as part of our
System Integration and Application Development segment and is engaged primarily
in providing IT professional services in Singapore, Thailand and
Malaysia.




On March
29, 2010, our board of directors resolved to sell our NessPRO operations in
Europe, and we are currently seeking a buyer for these operations. NessPRO
Europe operates as part of our former Software Distribution segment and is
engaged primarily in selling and distributing licenses to third-party enterprise
software products in Italy, Spain and Portugal.




The
results of operations for Ness Asia Pacific and NessPRO Europe for the three
months ended March 31, 2010, and the results of operations for Ness Benelux,
Ness Asia Pacific and NessPRO Europe for the three months ended March 31, 2009,
including revenues and operating expenses, have been reclassified in the
accompanying income statements as discontinued operations in accordance with ASC
Topic 205-20, “Presentation of Financial Statements – Discontinued Operations”
(“ASC 205-20”). In addition, our balance sheets at December 31, 2009 and March
31, 2010 have been reclassified to reflect the assets and liabilities of these
operations as assets and liabilities of discontinued operations within current
assets and current liabilities; and our statements of cash flows for the three
months ended March 31, 2009 and 2010 have been reclassified to reflect the cash
flows used in or provided by discontinued operations.


– 12
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




The
results of operations for Ness Asia Pacific for the three months ended March 31,
2009 and 2010, that were reported separately as discontinued operations in the
consolidated statements of income are summarized as follows:




Three
      months ended
                    March
      31,2009
                
                
                2010(Unaudited)
                
                
                (Unaudited)Revenues
                
                $
                3,602
                
                
                $
                4,783Operating
      loss
                
                $
                (661
                )
                
                $
                (2,286
                )Net
      loss from discontinued operations
                
                $
                (764
                )
                
                $
                (2,305
                )Basic
      net earnings per share from discontinued operations
                
                $
                (0.02
                )
                
                $
                (0.06
                )Diluted
      net earnings per share from discontinued operations
                
                $
                (0.02
                )
                
                $
                (0.06
                )







The
results of operations NessPRO Europe for the three months ended March 31, 2009
and 2010, that were reported separately as discontinued operations in the
consolidated statements of income are summarized as follows:




Three
      months ended
                    March
      31,2009
                
                
                2010(Unaudited)
                
                
                (Unaudited)Revenues
                
                $
                4,923
                
                
                $
                3,787Operating
      loss
                
                $
                (357
                )
                
                $
                (2,991
                )Net
      loss from discontinued operations
                
                $
                (277
                )
                
                $
                (3,082
                )Basic
      net earnings per share from discontinued operations
                
                $
                (0.01
                )
                
                $
                (0.08
                )Diluted
      net earnings per share from discontinued operations
                
                $
                (0.01
                )
                
                $
                (0.08
                )





The
results of operations Ness Benelux for the three months ended March 31, 2009,
that were reported separately as discontinued operations in the consolidated
statements of income are summarized as follows:


– 13
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Three months
                    endedMarch 31, 2009(Unaudited)Revenues
                
                $
                1,628Operating
      income
                
                $
                115Net
      income from discontinued operations
                
                $
                98Basic
      net earnings per share from discontinued operations
                
                $
                (0.00
                )Diluted
      net earnings per share from discontinued operations
                
                $
                (0.00
                )




Note
5: Insurance settlement related to 2007 arbitration expense, net of related
expenses




On March
31, 2009, we received a settlement payment of $2,610, net of related expenses,
from our liability insurance provider related to the arbitration settlement
which we recognized in the fourth quarter of 2007, using the exchange rate
prevailing on the payment date. No further payments from our insurance provider
are expected related to this matter.




Note
6: Commissions related to the sale of Israeli SAP sales and distribution
operations




In the
three months ended March 31, 2009, we recorded income of $2,534, representing
commissions related to the sale of our SAP sales and distribution operations in
Israel to SAP AG in August 2008, in connection with meeting certain performance
criteria for 2008.




Note
7: Derivative Instruments




ASC Topic
815, “Derivatives and Hedging,” requires companies to recognize all of their
derivative instruments as either assets or liabilities in the statement of
financial position at fair value. For derivative instruments that are designated
and qualify as a fair value hedge (i.e., they hedge the exposure to changes in
the fair value of an asset or a liability or an identified portion thereof that
is attributable to a particular risk), the gain or loss on the derivative
instrument as well as the offsetting loss or gain on the hedged item
attributable to the hedged risk are recognized in current earnings during the
period of the change in fair values. Derivatives that are designated and qualify
as hedges of forecasted transactions (i.e., cash flow hedges) are carried at
fair value with the effective portion of a derivative’s gain or loss recorded in
other comprehensive income and subsequently recognized in earnings in the same
period or periods in which the hedged forecasted transaction affects earnings.
For derivative instruments that are not designated and qualified as hedging
instruments, the gains or losses on the derivative instruments are recognized in
current earnings during the period of the change in fair values.




The
derivative instruments we use are designed to reduce the market risk associated
with the exposure of our underlying transactions, assets and liabilities to
fluctuations in currency exchange rates or interest rates. We believe that there
is no significant risk of nonperformance by these counterparties because we
monitor the credit ratings of counterparties with whom we have outstanding
contracts with a significant mark-to-market positive amount, and we limit our
financial exposure with any one financial institution.


– 14
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Cash
Flow Hedging Strategy:




At March
31, 2010, we held interest rate swap derivatives to convert certain
floating-rate debts to fixed-rate debts. The interest rate swap derivatives
involve an agreement to pay fixed-rate interest and receive floating-rate
interest, at specified intervals, calculated on agreed notional amounts that
match the amounts of the original loans and paid on the same installments and
maturity dates and as such there was no ineffectiveness related to these
derivatives for the three months ended March 31, 2010. At March 31, 2010, the
aggregate notional amount of the interest rate swaps was $22,341, with all
unrealized losses being deferred in accumulated other comprehensive income. The
liability is presented within other long-term liabilities on the balance sheet
at March 31, 2010, as the interest rate swap derivatives expire in November 2012
through April 2013.




We enter
into foreign exchange forward contracts to hedge against the effect of exchange
rate fluctuations on forecasted cash flows denominated in Indian Rupees. At
March 31, 2010, the notional amount of foreign exchange forward contracts we
entered into was $40,000 and there was no ineffectiveness related to these
foreign exchange forward contracts for the three months ended March 31, 2010,
with all unrealized gains being deferred in accumulated other comprehensive
income. The asset is presented within other accounts receivable and prepaid
expenses on the balance sheet at March 31, 2010, as foreign exchange forward
contracts expire through March 31, 2011.




Derivatives
Instruments Not Designated as Hedging Strategy:




We enter
into foreign exchange forward contracts to hedge a portion of our trade payables
and receivables for a period of one to three months. The purpose of the foreign
currency instruments is to protect the fair value of our trade payables and
receivables due to foreign exchange rates. All gains and losses related to such
derivative instrument are recorded in financial expenses, net.




The
following tables present fair value amounts and gains and losses of derivative
instruments and related hedged items:




Fair Values of Derivative InstrumentsAssets
                
                LiabilitiesBalance Sheet Item
                
                March 31,
                    2010
                
                Balance Sheet Item
                
                March 31,
                    2010(Unaudited)
                
                
                
                (Unaudited)Cash
      flow hedging:Foreign
      exchange forward contracts
                “Other
      accounts receivable and
                  prepaid
      expenses”
                
                $
                1,689
                
                “Other
      accounts payable and
                  accrued
      expenses”
                
                $
                —Interest
      rate swap
                
                
                
                —
                
                “Other
      long-term liabilities”
                
                
                501Total
      cash flow hedging
                
                
                $
                1,689
                
                
                
                $
                501Derivatives
      not designated as hedging:Foreign
      exchange forward contracts
                “Other
      accounts receivable andprepaid expenses”
                
                
                5
                
                “Other
      accounts payable and
                  accrued
      expenses”
                
                
                1,262Total
      derivatives
                
                
                $
                1,694
                
                
                
                $
                1,763


– 15
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)





Gain (loss) Recognized in Statements of IncomeGain (loss)
                      
                      
                      
                      Three
                      
                      
                      ThreeRecognized in Other
                      
                      
                      
                      months
                      
                      
                      monthsComprehensive
                      
                      
                      
                      Ended
                      
                      
                      endedIncome
                      
                      
                      
                      March 31,
                      
                      
                      March 31,March 31, 2010
                      
                      Statements of Income Item
                      
                      2009
                      
                      
                      2010(Unaudited)
                      
                      
                      
                      (Unaudited)
                      
                      
                      (Unaudited)Cash
      flow hedging:Foreign
      exchange forward contracts
                      
                      $
                      1,489
                      
                      “Cost
      of revenues” and
                        “Total
      operating expenses”
                      
                      $
                      (1,860
                      )
                      
                      $
                      753Interest
      rate swap
                      
                      
                      (246
                      )
                      “Financial
      expenses, net”
                      
                      
                      (37
                      )
                      
                      
                      (131
                      )Total
      cash flow hedging
                      
                      $
                      1,243
                      
                      
                      
                      $
                      (1,897
                      )
                      
                      $
                      622Derivatives
      not designated as hedging:Foreign
      exchange forward contracts
                      
                      
                      
                      
                      “Financial
      expenses, net”
                      
                      
                      (973
                      )
                      
                      
                      (980
                      )Total
      derivatives
                      
                      
                      
                      
                      
                      
                      $
                      (2,870
                      )
                      
                      $
                      (358
                      )




Note
8: Commitments and Contingent Liabilities




a.
            Litigation




We are
periodically a party to routine litigation incidental to our business. Other
than as disclosed below, we do not believe that we are a party to or our
property is subject to any pending legal proceeding that is likely to have a
material adverse effect on our business, financial condition or results of
operations.




One of
our Israeli subsidiaries is currently involved in legal proceedings with the
Israeli Ministry of Justice (the “MOJ”). The legal proceedings relate to a
contract for the provision of an information system for the MOJ, executed in
November 2005 (the “MOJ Contract”). Following continued disputes, correspondence
and discussions, on February 9, 2009 we filed a claim with the Israeli District
Court located in Jerusalem claiming, among other things, a breach of the MOJ
Contract by the MOJ, including in connection with the MOJ’s demands for
revisions and changes to the software that were not contemplated in the MOJ
Contract. Our claim is for damages in the amount of NIS 20.7 million, or
approximately $5,600, using the exchange rate prevailing at March 31, 2010. On
February 11, 2009, the MOJ filed a claim against our Israeli subsidiary in the
Israeli District Court located in Jerusalem claiming, among other things, that
our Israeli subsidiary breached the MOJ Contract and failed to fulfill its
undertakings and obligations set forth therein. The MOJ’s claim is for damages
in the amount of NIS 79.5 million, or approximately $21,400, using the exchange
rate prevailing at March 31, 2010. The MOJ and our subsidiary have filed answers
to the respective claims. Both claims were transferred to the Israeli District
Court located in Tel Aviv and the first pretrial hearing for both claims is set
for September 7, 2010. We believe that we have a substantial basis with respect
to our claim and valid defenses with respect to the MOJ’s claim. While we intend
to vigorously prosecute our claim and defend against the MOJ’s claim, we cannot
at this point predict the outcome of either claim. Adverse decisions on these
claims may materially adversely affect our financial condition.


– 16
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




b.
            Guarantees




Guarantees
are contingent commitments issued by us generally to guarantee our performance
in different projects to our customers, such as tenders. The term of a guarantee
generally is equal to the term of the related projects, which can be as short as
30 days or as long as 8 years. The maximum potential amount of future payments
we could be required to make under our guarantees at December 31, 2009 and March
31, 2010 is $36,650 and $35,240, respectively. We do not hold collateral to
support guarantees except when deemed necessary.




c.
            Liens and
      charges




In order
to obtain loans, credits or other banking services from certain commercial
banks, we signed a negative pledge agreement with these banks. With the consent
of the banks, we recorded a fixed charge on deposits in the amount of
approximately $2,554 held by our Indian subsidiary related to the mark-to-market
of foreign exchange forward contracts.




d.
            Covenants




Long-term
loans and bank guarantees contain customary restrictive covenants as further
discussed below. Failure to comply with the covenants could lead to an event of
default under the agreements governing some or all of the indebtedness,
permitting the applicable lender to accelerate all borrowings under the
applicable agreement.




1.
              Long-term
      loans denominated in dollars and euros contain covenants which, among
      other things, require us to maintain positive operating income in the last
      four quarters; require a certain ratio of total financial obligations to
      EBITDA and of total stockholders’ equity to total consolidated assets; and
      place limitations on our ability to merge or transfer assets to third
      parties. As of December 31, 2009, we were not in compliance with covenants
      under certain long-term loans requiring positive operating income and a
      certain ratio of total financial obligations to EBITDA. We received a
      waiver from the banks with respect to the covenants as of December 31,
      2009, and the banks agreed to provide, as substitutes, less stringent
      covenants to apply through September 30, 2010. As of March 31, 2010, we
      were in compliance and expect to remain in compliance with these
      covenants.




2.
              A
      long-term loan and bank guarantees denominated in NIS contain covenants
      which, among other things, require our Israeli subsidiary to maintain
      positive annual net income in a fiscal year; require a certain ratio of
      total stockholders’ equity to total consolidated assets and minimum
      stockholders’ equity; and place limitations on its ability to merge,
      transfer or pledge assets to third parties. As of March 31, 2010, we were
      in compliance with these
covenants.




– 17
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Note
9: Stockholders’ Equity




a.
            Total comprehensive
      income:




Three
      months ended
                      March
      31,2009
                  
                  
                  2010(Unaudited)
                  
                  
                  (Unaudited)Net
      income (loss)
                  
                  $
                  1,528
                  
                  
                  $
                  (4,689
                  )Foreign
      currency translation adjustments, net
                  
                  
                  (22,733
                  )
                  
                  
                  (1,482
                  )Unrealized
      income on foreign exchange forward contracts and interest rate
      swap
                  
                  
                  232
                  
                  
                  
                  794Comprehensive
      loss
                  
                  $
                  (20,973
                  )
                  
                  $
                  (5,377
                  )




b.
            Changes in accumulated
      other gain (loss) due to cash flow hedging
  strategy:




Three
      months ended
                    March
      31,2009
                
                
                2010(Unaudited)
                
                
                (Unaudited)Balance
      at the beginning of the period
                
                $
                (4,000
                )
                
                $
                449Mark
      to market of foreign exchange forward contracts and interest rate
      swap
                
                
                (1,492
                )
                
                
                1,416Loss
      (gain) recognized in earnings during the period
                
                
                1,872
                
                
                
                (622
                )Balance
      at the end of the period
                
                $
                (3,620
                )
                
                $
                1,243




c.
            Option
      exercises:




In the
three months ended March 31, 2009 and 2010, no options to purchase our common
stock were exercised.




d.
            Treasury
      stock:




During
the three months ended March 31, 2009 and 2010, we repurchased 388,722 and
116,700 shares of our common stock on the open market for an aggregate purchase
price of $1,217 and $611, respectively.




Note
10: Segment Reporting




Our
segment information has been prepared in accordance with ASC Topic 280, “Segment
Reporting.” Operating segments are defined as components of an enterprise
engaging in business activities about which separate financial information is
available that is evaluated regularly by our chief operating decision-maker in
deciding how to allocate resources and assess performance. Our chief operating
decision-maker is our chief executive officer, who evaluates our performance and
allocates resources based on segment revenues and operating profit.




We no
longer report a separate Software Distribution segment, as we reclassified our
European software distribution operations as discontinued operations and we
reclassified our Israeli software distribution operations to our System
Integration and Application Development segment, effective as of January 1,
2010, as a result of the resolution of our board of directors to sell our
European software distribution operations. Segment data for prior periods has
been restated to reflect the current organization of the
segments.


– 18
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Our
operating segments are:




1.
              Software Product
      Engineering, in which, through our Software Product Labs business
      unit, we offer software product research and development services. We set
      up these labs for clients and operate them on an ongoing basis, enabling
      us to collaborate with our clients’ engineering teams to extend their
      capacity and budgets throughout the software product life cycle. We locate
      our Software Product Labs predominantly in India and in Central and
      Eastern Europe and we operate them across multiple locations as needed to
      optimize global delivery. They primarily serve customers in North America
      and Europe, and may include team members local to the
    client.




2.
              System Integration and
      Application Development, in which we offer a broad set of IT
      services to our clients in the areas of system integration, application
      development, consulting and software distribution. We provide these
      services to customers in over 20 countries throughout North America,
      Europe, Israel and Asia Pacific. We deliver the services through a global
      delivery model that includes local teams as well as offshore and
      near-shore resources. We provide these services for a wide range of
      clients in many verticals, including utilities and government, financial
      services, defense and homeland security, life sciences and healthcare,
      manufacturing and transportation, retail, and
  others.




Segment
operating profit is defined as income from operations, excluding unallocated
headquarters costs. Expenses included in segment operating profit consist
principally of direct selling, general, administrative and delivery costs.
Certain general and administrative expenses, stock-based compensation and a
portion of depreciation are not allocated to specific segments as management
believes they are not directly attributable to any specific segment.
Accordingly, these expenses are categorized as “Unallocated Expenses” and
adjusted against our total income from operations. Additionally, our management
has determined that it is not practical to allocate certain identifiable assets
by segment when such assets are used interchangeably among the
segments.




The table
below presents financial information for our reportable segments:




Three months ended March 31, 2010Software
                    Product
                    Engineering
                
                
                System
                    Integration &
                    Application
                    Development
                
                
                Unallocated
                    Expenses
                
                
                Total(Unaudited)Revenues
      from external customers
                
                $
                26,397
                
                
                $
                106,936
                
                
                $
                —
                
                
                $
                133,333Operating
      income (loss)
                
                $
                3,853
                
                
                $
                3,227
                
                
                $
                (4,663
                )
                
                
                2,417Financial
      expenses, net
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (209
                )Income
      before taxes on income
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                2,208


– 19
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Three months ended March 31, 2009Software
                    Product
                    Engineering
                
                
                System
                    Integration &
                    Application
                    Development
                
                
                Unallocated
                    Expenses
                
                
                Total(Unaudited)Revenues
      from external customers
                
                $
                24,966
                
                
                $
                101,315
                
                
                $
                —
                
                
                $
                126,281Operating
      income (loss)
                
                $
                4,114
                
                
                $
                5,311
                
                
                $
                (5,156
                )
                
                
                4,269Financial
      expenses, net
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,156
                )Income
      before taxes on income
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                3,113




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




The
following tables present total revenues for the three months ended March 31,
2009 and 2010, and long-lived assets as of December 31, 2009 and March 31,
2010:




Three
      months ended
                    March
      31,2009
                
                
                2010(Unaudited)
                
                
                (Unaudited)Revenues
      from sales to unaffiliated customers:Israel
                
                $
                45,270
                
                
                $
                47,639North
      America
                
                
                42,479
                
                
                
                45,249Europe
      (excluding Czech Republic)
                
                
                20,035
                
                
                
                20,096Czech
      Republic
                
                
                16,438
                
                
                
                18,905Asia
      Pacific
                
                
                2,059
                
                
                
                1,444$
                126,281
                
                
                $
                133,333




December
                    31,
      2009
                
                
                March
      31,
                    2010(Unaudited)Long-lived
      assets:Israel
                
                $
                21,984
                
                
                $
                22,302India
                
                
                6,812
                
                
                
                6,311Europe
                
                
                4,183
                
                
                
                3,546North
      America
                
                
                2,760
                
                
                
                2,540$
                35,739
                
                
                $
                34,699




Other
than as disclosed in the tables above, the revenues and long-lived assets
attributable to individual foreign countries are not material.




Note
11: Income Taxes




As of
March 31, 2010 the total of our unrecognized tax benefits was $4,250, which, if
recognized, would affect our effective tax rates in future periods. Included in
that amount are accrued interest and penalties resulting from such unrecognized
tax benefits of $701 at March 31, 2010. During the three months ended March 31,
2010, we recorded $63 for interest and penalties expenses with respect to
uncertain tax positions. A reconciliation of the beginning and ending amounts of
unrecognized tax benefits as of March 31, 2010 is as follows:


– 20
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements





U.S.
dollars in thousands (except share and per share data) (Unaudited)




Balance
      as of January 1, 2010
                    
                    $
                    3,892Reductions
      related to changes in interest rates and foreign currency exchange
      rates
                    
                    
                    (22
                    )Additions
      related to tax positions taken during the period
                    
                    
                    380Balance
      as of March 31, 2010
                    
                    $
                    4,250




The
amount of income taxes we pay is subject to ongoing audit by federal, state and
foreign tax authorities, which often results in proposed assessments. Management
performs a comprehensive review of our global tax positions on a quarterly basis
and accrues amounts for contingent tax liabilities. Based on these reviews, the
result of discussions and resolutions of matters with certain tax authorities
and the closure of tax years subject to tax audit, reserves are adjusted as
necessary. However, future results may include favorable or unfavorable
adjustments to estimated tax liabilities in the period the assessments are
determined or resolved. Additionally, the jurisdictions in which earnings and/or
deductions are realized may differ from current estimates. We are no longer
subject to U.S. federal, state and local, or non-U.S. income tax examination for
years before 2004 with respect to our primary locations.




The
effective tax rate used in computing the provision for income taxes is based on
our projected fiscal year income before taxes, including estimated income by tax
jurisdiction. The difference between the effective tax rate and the statutory
tax rate is due primarily to foreign tax holidays, foreign subsidiaries with
different tax rates and non-deductible expenses.




Note
12: Basic and Diluted Net Earnings per Share




Basic net
earnings per share are computed based on the weighted average number of shares
of common stock outstanding during each period. Diluted net earnings per share
are computed based on the weighted average number of shares of common stock
outstanding during each period, plus dilutive potential shares of common stock
considered outstanding during the period, in accordance with ASC Topic 260,
“Earnings per Share.”




The
following table sets forth the computation of basic and diluted net earnings per
share of common stock:




Three
      months ended
                    March
      31,2009
                
                
                2010(Unaudited)
                
                
                (Unaudited)Numerator:Net
      income (loss), numerator for basic and diluted per share
                
                $
                1,528
                
                
                $
                (4,689
                )Denominator:Weighted
      average number of shares of common stock, denominator for basic net
      earnings per share from continuing operations, denominator for basic net
      earnings (loss) per share, denominator for diluted net loss per
      share
                
                
                38,922
                
                
                
                38,299Effect
      of dilutive securities:Employee
      stock options and restricted stock units
                
                
                593
                
                
                
                423Denominator
      for diluted net earnings per share from continuing operations, denominator
      for diluted net earnings per share - weighted average assuming exercise of
      options and restricted stock units
                
                
                39,515
                
                
                
                38,722


– 21
–


NESS
TECHNOLOGIES, INC. AND ITS SUBSIDIARIES


Notes
to Interim Consolidated Financial Statements


U.S.
dollars in thousands (except share and per share data) (Unaudited)




The total
weighted average number of shares related to the outstanding options excluded
from the calculations of diluted net earnings per share from continuing
operations and diluted net earnings per share, as they would have been
anti-dilutive for all periods presented, was 5,028,064 for the three months
ended March 31, 2009 and 4,359,898 for the three months ended March 31,
2010.




Note
13: Subsequent Events




On April
24, 2010, we signed a definitive asset transfer agreement with the buyer of our
operations in the Asia Pacific region. The sale is expected to close during the
three months ended June 30, 2010. See Note 4.




On May 4,
2010, we closed our acquisition of Gilon Business Insight Ltd. See Note
3(a).


– 22
–




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




The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited consolidated
financial statements and related notes appearing elsewhere in this Quarterly
Report on Form 10-Q.




Forward-Looking
Statements




This
quarterly report on Form 10-Q contains “forward-looking statements” that involve
risks and uncertainties, as well as assumptions that, if they never materialize
or prove incorrect, could cause our results to differ materially from those
expressed or implied by such forward-looking statements. The statements
contained in this Quarterly Report on Form 10-Q that are not purely historical
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are
often identified by the use of words such as, but not limited to, “anticipate,”
“believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,”
“will,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would” and
similar expressions or variations intended to identify forward-looking
statements. These statements are based on the beliefs and assumptions of our
management based on information currently available to management. Such
forward-looking statements are subject to risks, uncertainties and other
important factors that could cause actual results and the timing of certain
events to differ materially from future results expressed or implied by such
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those identified below, and those
discussed in the section titled “Risk Factors” included in our Annual Report on
Form 10-K for the year ended December 31, 2009 filed with the Securities and
Exchange Commission (the “SEC”) on March 15, 2010. Furthermore, such
forward-looking statements speak only as of the date of this report. Except as
required by law, we undertake no obligation to update any forward-looking
statements to reflect events or circumstances after the date of such
statements.




Overview




We are a
global provider of information technology, or IT, and business services and
solutions with specialized expertise in software product engineering; system
integration, application development, consulting and software distribution. We
deliver our portfolio of services and solutions using a global delivery model
combining offshore, near-shore and local teams. The primary industries, or
verticals, we serve include high-tech companies and independent software
vendors, or ISVs; utilities and public sector; financial services; defense and
homeland security; and life sciences and healthcare.




We have
operations in North America, Europe, Israel and India, serving customers in over
20 countries. We combine our deep expertise in the verticals we serve and strong
technical capabilities to provide a complete range of high quality services on a
global scale. By integrating our local and international personnel in focused
business and project teams, we leverage our corporate knowledge and experience,
intellectual property and global infrastructure to develop innovative solutions
for clients across the geographic areas and verticals we serve. Through our
global delivery model, which includes lower-cost offshore and near-shore
delivery capabilities, we can achieve meaningful cost reductions or other
benefits for our clients.




Our
revenues increased to $133.3 million for the three months ended March 31, 2010,
from $126.3 million for the three months ended March 31, 2009. Net income from
continuing operations decreased to $0.7 million for the three months ended March
31, 2010 from $2.5 million for the three months ended March 31,
2009.




The
dollar weakened by an average of 8% against the NIS and by an average of 10%
against the euro and other relevant European currencies in the three months
ended March 31, 2010 compared to the three months ended March 31, 2009. Since
approximately 60% of our revenues and 80% of our expenses are denominated in
non-dollar currencies, we estimate that our revenues were $7.9 million higher,
and our operating income was $0.4 million lower, in the three months ended March
31, 2010 as a result of changes in foreign currency exchange rates versus their
average rates for the three months ended March 31, 2009.


– 23
–


Our
client base is diverse, and we are not dependent on any single client. In the
three months ended March 31, 2010, no client accounted for more than 7.5% of our
revenues and our largest twenty clients together accounted for approximately 43%
of our revenues. For the three months ended March 31, 2010, the percentage of
our revenues derived in aggregate from agencies of the government of Israel was
approximately 14%. Existing clients from prior years generated more than 85% of
our revenues in the three months ended March 31, 2010.




Our
backlog from continuing operations as of March 31, 2010 was $663 million,
compared to $639 million as of March 31, 2009. The difference represents a
year-over-year backlog decrease for continuing operations of $3 million and an
increase in the dollar value of our non-U.S. backlog due to the weaker dollar of
$27 million. We achieve backlog through new signings of IT services projects and
outsourcing contracts, including for new and repeat customers. We recognize
backlog as revenue when we perform the services related to the
backlog.




For the
three months ended March 31, 2010, the percentage of our revenues derived from
clients in Europe was 29%; in Israel, 36%; in North America, 34%; and in Asia
Pacific, 1%.




As of
March 31, 2010, we had approximately 7,470 employees related to continuing
operations, including approximately 6,495 IT professionals. Of the 7,470
employees, approximately 2,945 were in India, 2,530 were in Israel, 1,445 were
in Europe, 495 were in North America and 55 were in Asia Pacific.




Recent
Developments




On
January 15, 2010, we closed a share purchase agreement with a privately-held
Dutch company to sell the shares of our indirectly wholly-owned subsidiary Ness
Benelux for a total of €1.2 million, or $1.7 million. Prior to the sale, Ness
Benelux operated as part of Ness Europe under our System Integration and
Application Development segment and was engaged primarily in providing IT
professional services in the Netherlands.




On
February 1, 2010, our board of directors resolved to sell our operations in the
Asia Pacific region, which operate as part of our System Integration and
Application Development segment and are engaged primarily in providing IT
professional services in Singapore, Thailand and Malaysia; and on April 24,
2010, we signed a definitive asset transfer agreement with the
buyer.




On March
29, 2010, our board of directors resolved to sell our NessPRO operations in
Europe, and we are currently seeking a buyer for these operations, which operate
as part of our former Software Distribution segment and are engaged primarily in
selling and distributing licenses to third-party enterprise software products in
Italy, Spain and Portugal.




The
determination to offer these units for sale is part of our restructuring effort
with respect to selected smaller operations that are unprofitable or that we
determined are not strategic to our planned future operations and growth. The
operations have been classified as discontinued operations.




On March
25, 2010, we signed a definitive agreement to acquire all of the outstanding
capital stock of Gilon Business Insight Ltd. (“Gilon”), a privately-held,
leading Israeli provider of business intelligence consulting and implementation
solutions and services, for cash consideration of NIS 65 million, or
approximately $17.5 million. An additional payment of up to NIS 9 million, or
approximately $2.4 million, may be made during the two-year period following the
closing of the agreement should Gilon achieve certain performance goals. The
purchase was closed on May 4, 2010. The acquisition of Gilon increases our
market share in Israel and further positions us as a provider of enterprise
solutions, with a blend of ERP, BI and CRM capabilities. We intend to utilize
Gilon’s capabilities to help fulfill the demand for business intelligence
applications, solutions and services around the world. Following our acquisition
of Gilon, it became part of Ness Israel under our System Integration and
Application Development segment.


– 24
–




Consolidated
Results of Operations




The
following table sets forth the items in our consolidated statements of income as
a percentage of revenues for the periods presented.




Three months ended
                    March 31,2009
                
                
                2010Revenues
                
                
                100.0
                %
                
                
                100.0
                %Cost
      of revenues
                
                
                74.7
                
                
                
                72.4Gross
      profit
                
                
                25.3
                
                
                
                27.6Operating
      expenses:Selling
      and marketing
                
                
                7.3
                
                
                
                7.5General
      and administrative
                
                
                18.7
                
                
                
                18.3Insurance
      settlement related to 2007 arbitration expense, net of related
      expenses
                
                
                (2.1
                )
                
                
                —Commissions
      related to the sale of Israeli SAP sales and distribution
      operations
                
                
                (2.0
                )
                
                
                —Total
      operating expenses
                
                
                21.9
                
                
                
                25.8Operating
      income
                
                
                3.4
                
                
                
                1.8Financial
      expenses, net
                
                
                (0.9
                )
                
                
                (0.2
                )Income
      before taxes on income
                
                
                2.5
                
                
                
                1.7Taxes
      on income
                
                
                0.5
                
                
                
                1.1Net
      income from continuing operations
                
                
                2.0
                
                
                
                0.5Net
      loss from discontinued operations
                
                
                (0.7
                )
                
                
                (4.0
                )Net
      income (loss)
                
                
                1.2
                
                
                
                (3.5
                )




Three
Months Ended March 31, 2010 Compared to the Three Months Ended March 31,
2009




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




Three months ended
                    March 31,
                
                
                Increase2009
                
                
                2010
                
                
                $
                
                
                %Revenues
                
                $
                126,281
                
                
                $
                133,333
                
                
                
                7,052
                
                
                
                5.6Cost
      of revenues
                
                
                94,359
                
                
                
                96,521
                
                
                
                2,162
                
                
                
                2.3Gross
      profit
                
                $
                31,922
                
                
                $
                36,812
                
                
                
                4,890
                
                
                
                15.3Gross
      margin
                
                
                25.3
                %
                
                
                27.6
                %




Revenues




Our
revenues increased from $126.3 million in the three months ended March 31, 2009
to $133.3 million in the three months ended March 31, 2010, representing an
increase of $7.1 million, or 5.6%. This increase was primarily due to the
similar revenues of our System Integration and Application Development segment
compared to the three months ended March 31, 2009 as it benefitted from the
initial stages of the economic recovery in North America and Israel, despite the
continued recessionary environment in Central and Eastern Europe, an increase in
revenues of our Software Product Engineering segment, representing $1.3 million,
and foreign currency translation effects on our non-dollar revenues attributable
to the weaker dollar, representing $7.9 million.


– 25
–




Cost
of revenues




Our cost
of revenues, including salaries, wages and other direct and indirect costs,
increased from $94.4 million in the three months ended March 31, 2009 to $96.5
million in the three months ended March 31, 2010, representing an increase of
$2.2 million, or 2.3%. The increase was due primarily to foreign currency
translation effects on non-dollar expenses attributable to the weaker dollar,
representing $6.1 million, offset by severance expenses in the three months
ended March 31, 2009, mainly in Europe, for which there was no corresponding
expense in the three months ended March 31, 2010, representing $1.0
million.




Gross
Profit




Our gross
profit (revenues less cost of revenues) increased from $31.9 million in the
three months ended March 31, 2009 to $36.8 million in the three months ended
March 31, 2010, representing an increase of $4.9 million, or 15.3%. The increase
was due primarily to the increase in our revenues, representing $7.1 million,
the absence of severance expenses, representing $1.0 million, and foreign
currency translation effects on our non-dollar gross profits attributable to the
weaker dollar, representing $1.8 million. Gross margin increased from 25.3% in
the three months ended March 31, 2009 to 27.6% in the three months ended March
31, 2010 as a result of these factors.




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




Three months ended
                    March 31,
                
                
                Increase
                    (Decrease)2009
                
                
                2010
                
                
                $
                
                
                %Selling
      and marketing
                
                $
                9,212
                
                
                $
                10,053
                
                
                
                841
                
                
                
                9.1General
      and administrative
                
                
                23,585
                
                
                
                24,342
                
                
                
                757
                
                
                
                3.2Insurance
      settlement related to 2007 arbitration expense, net of related
      expenses
                
                
                (2,610
                )
                
                
                —
                
                
                
                2,610
                
                
                
                (100.0
                )Commissions
      related to the sale of Israeli SAP sales and distribution
      operations
                
                
                (2,534
                )
                
                
                —
                
                
                
                2,534
                
                
                
                (100.0
                )Total
      operating expenses
                
                
                27,653
                
                
                
                34,395
                
                
                
                6,742
                
                
                
                24.4Operating
      income
                
                $
                4,269
                
                
                $
                2,417
                
                
                
                (1,852
                )
                
                
                (43.4
                )




Selling
and marketing




Selling
and marketing expenses increased from $9.2 million in the three months ended
March 31, 2009 to $10.1 million in the three months ended March 31, 2010,
representing an increase of $0.8 million, or 9.1%. This increase was due
primarily to foreign currency translation effects on our non-dollar expenses
attributable to the weaker dollar, representing $0.7 million.




General
and administrative




General
and administrative expenses increased from $23.6 million in the three months
ended March 31, 2009 to $24.3 million in the three months ended March 31, 2010,
representing an increase of $0.8 million, or 3.2%. This increase was due
primarily to foreign currency translation effects on non-dollar expenses
attributable to the weaker dollar, representing $1.5 million, offset by
severance expenses in the three months ended March 31, 2009 for which there was
no corresponding expense in the three months ended March 31, 2010, representing
$1.7 million.




Insurance
settlement related to 2007 arbitration expense, net of related
expenses




In the
three months ended March 31, 2009, we recorded income of $2.6 million, net of
related expenses, representing an insurance settlement we received from our
liability insurance provider related to the arbitration settlement we recognized
in the fourth quarter of 2007. There was no corresponding income in the three
months ended March 31, 2010.


– 26
–




Commissions
related to the sale of Israeli SAP sales and distribution
operations




In the
three months ended March 31, 2009, we recorded income of $2.5 million,
representing commissions earned from SAP AG in connection with meeting certain
performance criteria for 2008. There was no corresponding income in the three
months ended March 31, 2010.




Operating
Income




Operating
income decreased from $4.3 million in the three months ended March 31, 2009 to
$2.4 million in the three months ended March 31, 2010, representing a decrease
of $1.9 million, or 43.4%. The major factors contributing to this decrease were
income in the three months ended March 31, 2009 from an insurance settlement,
net of related expenses, recognized by our System Integration and Application
Development segment related to our 2007 arbitration expense, representing $2.6
million, commissions recognized in the three months ended March 31, 2009 by
NessPRO Israel (at the time a part of our former Software Distribution segment
and now part of our System Integration and Application Development segment)
related to the August 2008 sale of our SAP sales and distribution operations,
representing $2.5 million, and foreign currency translation effects on
non-dollar operating income attributable to the weaker dollar, representing $0.4
million, offset by an increase in operating income of our System Integration and
Application Development segment, representing $2.9 million, and a decrease in
unallocated expenses, representing $0.9 million. See also “—Results by Business
Segment.”




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




Three months ended
                    March 31,
                
                
                Increase
                    (Decrease)2009
                
                
                2010
                
                
                $
                
                
                %Operating
      income
                
                $
                4,269
                
                
                $
                2,417
                
                
                
                (1,852
                )
                
                
                (43.4
                )Financial
      expenses, net
                
                
                (1,156
                )
                
                
                (209
                )
                
                
                947
                
                
                
                (81.9
                )Income
      before taxes on income
                
                
                3,113
                
                
                
                2,208
                
                
                
                (905
                )
                
                
                (29.1
                )Taxes
      on income
                
                
                642
                
                
                
                1,510
                
                
                
                868
                
                
                
                135.2Net
      income from continuing operations
                
                
                2,471
                
                
                
                698
                
                
                
                (1,773
                )
                
                
                (71.8
                )Net
      loss from discontinued operations
                
                
                (943
                )
                
                
                (5,387
                )
                
                
                (4,444
                )
                
                
                471.3Net
      income (loss)
                
                $
                1,528
                
                
                $
                (4,689
                )
                
                
                (6,217
                )
                
                
                N/A




Financial
expenses, net




Financial
expenses, net, decreased from $1.2 million in the three months ended March 31,
2009 to $0.2 million in the three months ended March 31, 2010, representing a
decrease of $0.9 million, or 81.9%. This decrease was due primarily to a
reduction in our average net debt, representing $0.2 million, lower interest
rates on our long-term debt, representing $0.1 million, and the favorable impact
of exchange rate differences, representing $0.6 million. Our average net debt
changed from $34.5 million in the three months ended March 31, 2009 to $5.0
million in the three months ended March 31, 2010.




Taxes
on income




Our taxes
on income increased from $0.6 million in the three months ended March 31, 2009
to $1.5 million in the three months ended March 31, 2010, representing an
increase of $0.9 million, or 135.2%. This increase was due primarily to our
inability to utilize existing deferred tax assets or create new deferred tax
assets in certain jurisdictions where we are still experiencing losses,
representing $1.4 million, offset by a decrease of $0.5 million resulting from
our lower taxable income. Our effective tax rate in the three months ended March
31, 2010 was 68.4%, compared to 20.6% in the three months ended March 31, 2009
as a result of these factors.


– 27
–




Net
income from continuing operations




Net
income from continuing operations decreased from $2.5 million in the three
months ended March 31, 2009 to $0.7 million in the three months ended March 31,
2010, representing a decrease of $1.8 million, or 71.8%. The decrease was due
primarily to our decrease in operating income of $1.9 million, and our increase
in taxes on income, representing $0.9 million, partially offset by our decrease
in financial expenses, net, representing $0.9 million.




Net
loss from discontinued operations




Our net
loss from discontinued operations increased from $0.9 million in the three
months ended March 31, 2009 to $5.4 million in the three months ended March 31,
2009, representing an increase of $4.4 million, or 471.3%. The increase was due
primarily to additional restructuring expenses in our NessPRO Europe and Asia
Pacific operations, representing $3.2 million. The results of NessPRO Europe
were reclassified as discontinued operations, and its long-term assets written
off, following our March 29, 2010 resolution to seek a buyer for the operations.
Also included in discontinued operations are our Ness Asia Pacific operations,
which our board of directors resolved on February 1, 2010 to sell and in respect
of which we signed a definitive asset transfer agreement with the buyer on April
24, 2010, and our Ness Benelux subsidiary, which we sold to a third party on
January 15, 2010.




Net
income (loss)




Net
income changed from $1.5 million in the three months ended March 31, 2009 to a
net loss of $4.7 million in the three months ended March 31, 2010, representing
a change of $6.2 million. The change was due primarily to our larger net loss
from discontinued operations, representing $4.4 million, our decrease in
operating income, representing $1.9 million, and our increase in taxes on
income, representing $0.9 million, partially offset by our decrease in financial
expenses, representing $0.9 million.




Quarterly
Results of Operations




The
following table presents our unaudited quarterly results of operations for the
eight quarters in the period ended December 31, 2009, which were reclassified in
accordance with the changes to our discontinued operations described in Note 4
of the accompanying financial notes. You should read the following table
together with the consolidated financial statements and related notes contained
elsewhere in this report. We have prepared the unaudited information on the same
basis as our audited consolidated financial statements. This table includes
normal recurring adjustments that we consider necessary for fair presentation of
our financial position and operating results for the quarters presented.
Operating results for any quarter are not necessarily indicative of results for
any future quarters or for a full year.




– 28
–





Three months endedMar 31,
                    2008
                
                
                Jun 30,
                    2008
                
                
                Sep 30,
                    2008
                
                
                Dec 31,
                    2008
                
                
                Mar 31,
                    2009
                
                
                Jun 30,
                    2009
                
                
                Sep 30,
                    2009
                
                
                Dec 31,
                    2009(unaudited) (dollars in thousands)Revenues
                
                $
                145,990
                
                
                $
                153,810
                
                
                $
                150,487
                
                
                $
                154,325
                
                
                $
                126,281
                
                
                $
                126,887
                
                
                $
                123,202
                
                
                $
                135,577Cost
      of revenues
                
                
                104,868
                
                
                
                108,332
                
                
                
                112,451
                
                
                
                114,725
                
                
                
                94,359
                
                
                
                92,542
                
                
                
                89,780
                
                
                
                109,380Gross
      profit
                
                
                41,122
                
                
                
                45,478
                
                
                
                38,036
                
                
                
                39,600
                
                
                
                31,922
                
                
                
                34,345
                
                
                
                33,422
                
                
                
                26,197Operating
      expenses:Selling
      and marketing
                
                
                10,561
                
                
                
                11,713
                
                
                
                10,939
                
                
                
                11,843
                
                
                
                9,212
                
                
                
                9,681
                
                
                
                10,033
                
                
                
                12,242General
      and administrative
                
                
                20,509
                
                
                
                24,350
                
                
                
                22,875
                
                
                
                24,694
                
                
                
                23,585
                
                
                
                21,233
                
                
                
                19,521
                
                
                
                25,253Gain
      from sale of SAP sales and distribution operations, net
                
                
                —
                
                
                
                —
                
                
                
                (18,366
                )
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Insurance
      settlement related to 2007 arbitration expense, net of related
      expenses
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (2,610
                )
                
                
                —
                
                
                
                —
                
                
                
                —Commissions
      related to the sale of Israeli SAP sales and distribution
      operations
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (2,534
                )
                
                
                —
                
                
                
                —
                
                
                
                —Total
      operating expenses
                
                
                31,070
                
                
                
                36,063
                
                
                
                15,448
                
                
                
                36,537
                
                
                
                27,653
                
                
                
                30,914
                
                
                
                29,554
                
                
                
                37,495Operating
      income (loss)
                
                
                10,052
                
                
                
                9,415
                
                
                
                22,588
                
                
                
                3,063
                
                
                
                4,269
                
                
                
                3,431
                
                
                
                3,868
                
                
                
                (11,298
                )Financial
      expenses, net
                
                
                (1,360
                )
                
                
                (896
                )
                
                
                (967
                )
                
                
                (1,875
                )
                
                
                (1,156
                )
                
                
                (666
                )
                
                
                (388
                )
                
                
                (788
                )Other
      income (expenses), net
                
                
                —
                
                
                
                —
                
                
                
                (392
                )
                
                
                2
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Income
      (loss) before taxes on income
                
                
                8,692
                
                
                
                8,519
                
                
                
                21,229
                
                
                
                1,190
                
                
                
                3,113
                
                
                
                2,765
                
                
                
                3,480
                
                
                
                (12,086
                )Taxes
      on income
                
                
                1,748
                
                
                
                1,671
                
                
                
                5,422
                
                
                
                295
                
                
                
                642
                
                
                
                537
                
                
                
                826
                
                
                
                5,266Net
      income (loss) from continuing operations
                
                $
                6,944
                
                
                $
                6,848
                
                
                $
                15,807
                
                
                $
                895
                
                
                $
                2,471
                
                
                $
                2,228
                
                
                $
                2,654
                
                
                $
                (17,352
                )Net
      income (loss) from discontinued operations
                
                
                (50
                )
                
                
                1,242
                
                
                
                340
                
                
                
                3,433
                
                
                
                (943
                )
                
                
                (1,186
                )
                
                
                (1,812
                )
                
                
                (38,514
                )Net
      income (loss)
                
                $
                6,894
                
                
                $
                8,090
                
                
                $
                16,147
                
                
                $
                4,328
                
                
                $
                1,528
                
                
                $
                1,042
                
                
                $
                842
                
                
                $
                (55,866
                )




Results
by Business Segment




Operating
segments are defined as components of an enterprise engaging in business
activities about which separate financial information is available that is
evaluated regularly by our chief operating decision-maker in deciding how to
allocate resources and assess performance. Our chief operating decision-maker is
our chief executive officer, who evaluates our performance and allocates
resources based on segment revenues and operating profit.




We no
longer report a separate Software Distribution segment, as we reclassified our
European software distribution operations as discontinued operations and we
reclassified our Israeli software distribution operations to our System
Integration and Application Development segment, effective as of January 1,
2010, as a result of the resolution of our board of directors to sell our
European software distribution operations. Segment data for prior periods has
been restated to reflect the current organization of the segments.




Our
operating segments are:




1.
              Software Product
      Engineering, in which, through our Software Product Labs business
      unit, we offer software product research and development services. We set
      up these labs for clients and operate them on an ongoing basis, enabling
      us to collaborate with our clients’ engineering teams to extend their
      capacity and budgets throughout the software product life cycle. We locate
      our Software Product Labs predominantly in India and in Central and
      Eastern Europe and we operate them across multiple locations as needed to
      optimize global delivery. They primarily serve customers in North America
      and Europe, and may include team members local to the
    client.




– 29
–


2.
              System Integration and
      Application Development, in which we offer a broad set of IT
      services to our clients in the areas of system integration, application
      development, consulting and software distribution. We provide these
      services to customers in over 20 countries throughout North America,
      Europe, Israel and Asia Pacific. We deliver the services through a global
      delivery model that includes local teams as well as offshore and
      near-shore resources. We provide these services for a wide range of
      clients in many verticals, including utilities and government, financial
      services, defense and homeland security, life sciences and healthcare,
      manufacturing and transportation, retail, and
  others.




Segment
operating profit is defined as income from operations, excluding unallocated
headquarters costs. Expenses included in segment operating profit consist
principally of direct selling, general, administrative and delivery costs.
Certain general and administrative expenses, stock-based compensation and a
portion of depreciation are not allocated to specific segments as management
believes they are not directly attributable to any specific segment.
Accordingly, these expenses are categorized as “Unallocated Expenses” and
adjusted against our total income from operations. Additionally, our management
has determined that it is not practical to allocate certain identifiable assets
by segment when such assets are used interchangeably among the
segments.




The table
below presents financial information for our reportable segments (dollars in
thousands):




Three months ended
                      March 31,Segment
      Data:
                  
                  2009
                  
                  
                  2010Revenues:Software
      Product Engineering
                  
                  $
                  24,966
                  
                  
                  $
                  26,397System
      Integration and Application Development
                  
                  
                  101,315
                  
                  
                  
                  106,936$
                  126,281
                  
                  
                  $
                  133,333Operating
      Income (Loss):Software
      Product Engineering
                  
                  $
                  4,114
                  
                  
                  $
                  3,853System
      Integration and Application Development
                  
                  
                  5,311
                  
                  
                  
                  3,227Unallocated
      Expenses
                  
                  
                  (5,156
                  )
                  
                  
                  (4,663
                  )$
                  4,269
                  
                  
                  $
                  2,417




Liquidity
and Capital Resources




Overview




As of
March 31, 2010, we had cash and cash equivalents, restricted cash and short-term
bank deposits of $64.9 million compared to $68.6 million as of December 31,
2009. The funds held at locations outside of the United States are for future
operating expenses and capital expenditures, and we have no intention of
repatriating those funds. We are not, however, restricted in repatriating those
funds back to the United States, if necessary. While we expect that cash
generated by our non-U.S. subsidiaries will be reinvested in their respective
geographic areas to support expansion of our business, to the extent that funds
were repatriated to the United States in the form of dividend payments, those
payments may be subject to withholding taxes in their respective countries, and
would be subject to tax in the United States.


– 30
–




Cash
Flows




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




Three months ended
                    March 31,2009
                
                
                2010Net
      cash provided by operating activities
                
                $
                8,594
                
                
                $
                4,735Net
      cash provided by (used in) investing activities
                
                
                (17,101
                )
                
                
                2,647Net
      cash used in financing activities
                
                
                (2,983
                )
                
                
                (4,232
                )Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (1,273
                )
                
                
                (2,174
                )Increase
      (decrease) in cash and cash equivalents
                
                
                (12,763
                )
                
                
                976Cash
      and cash equivalents at the beginning of the period
                
                
                44,585
                
                
                
                40,218Cash
      and cash equivalents at the end of the period
                
                $
                31,822
                
                
                $
                41,194




Three
months ended March 31, 2010 compared to the three months ended March 31,
2009




Net cash
provided by operating activities was $4.7 million in the three months ended
March 31, 2010, compared to $8.6 million in the three months ended March 31,
2009. The major factors contributing to the decrease were a smaller decrease in
our trade receivables and unbilled receivables together, representing $18.3
million, and lower net income from continuing operations, representing $1.8
million, offset by a smaller decrease in other accounts payable and accrued
expenses, representing $9.6 million, a small decrease in trade payables,
representing $3.9 million, and commissions in the three months ended March 31,
2009 related to the 2008 sale of our Israeli SAP sales and distribution
operations, representing $2.5 million.




Net cash
provided by investing activities was $2.6 million in the three months ended
March 31, 2010, compared to net cash used of $17.1 million in the three months
ended March 31, 2009. The major factor contributing to the change was proceeds
from maturity of short-term bank deposits in the three months ended March 31,
2010 compared to investment in short-term bank deposits in the three months
ended March 31, 2009, representing $16.7 million.




Net cash
used in financing activities was $4.2 million in the three months ended March
31, 2010, compared to $3.0 million in the three months ended March 31, 2009. The
major factors contributing to the increase were greater principal payments of
long-term debt, representing $1.4 million, and repayments of short-term bank
credit in the three months ended March 31, 2010 compared to proceeds from
short-term bank credit in the three months ended March 31, 2009, representing
$0.7 million, offset by lower repurchase of share as part of our share
repurchase plan, representing $0.6 million.




The
effect of exchange rate changes on cash and cash equivalents was ($2.2) million
in the three months ended March 31, 2010, compared to ($1.3) million in the
three months ended March 31, 2009. The change was primarily due to the effect of
translation adjustments on our net current assets.


– 31
–




Long-term
and Short-term Debt




At March
31, 2010, we had three long-term loans taken in 2007 to fund acquisitions: a
long-term loan from a commercial bank in the amount of €6.9 million, or $9.3
million, to fund the acquisition of NessPRO Italy S.p.A., taken originally in
September 2007; a long-term loan from a commercial bank in the amount of €11.8
million, or $15.9 million, to fund the acquisition of FMC Consulting and
Informatics Ltd., taken in November 2007; and a long-term loan from a commercial
bank in the amount of $10.2 million to fund the acquisition of MS9 Consulting
LLC, taken in November 2007. In addition, we had a long-term loan from a
commercial bank in the amount of €11.1 million, or $14.9 million, taken in March
2008 and a long-term loan from a commercial bank in the amount of $12.2 million,
taken originally in April 2009. The $12.2 million loan matures over four years
with principal payments commencing in the first year. Each other long-term loan
matures over five years from the inception of the loan with principal payments
commencing in the third year. Each long-term loan bears interest at fixed or
variable rates, and is paid quarterly. The long-term loans contain covenants
which, among other things, require positive operating income in the last four
quarters; require a certain ratio of total financial obligations to consolidated
EBITDA and of total stockholders’ equity to total consolidated assets; and place
limitations on our ability to merge or transfer assets to third parties. Our
failure to comply with the covenants could lead to an event of default under the
agreements governing some or all of this indebtedness, permitting the applicable
lender to accelerate all borrowings under the applicable agreement. As of
December 31, 2009, we were not in compliance with covenants under certain
long-term loans requiring positive operating income and a certain ratio of total
financial obligations to EBITDA. We received a waiver from the banks with
respect to the covenants as of December 31, 2009, and the banks agreed to
provide, as substitutes, less stringent covenants to apply
through September 30, 2010. As of March 31, 2010, we were in compliance and
expect to remain in compliance with these covenants. In connection with the
above-mentioned covenants, we received the consent of the commercial banks
during 2008 to record a fixed charge on deposits in the amount of $2.6 million
held by our Indian subsidiary related primarily to the mark-to-market of foreign
exchange forward contracts into which we entered to hedge against the effect of
exchange rate fluctuations on cash flows denominated in Indian
Rupees.




In
addition, at March 31, 2010, one of our Israeli subsidiaries had a long-term
loan of NIS 12.6 million, or $3.4 million, from a commercial bank, taken
originally in March 2008, bearing interest at a fixed rate and maturing over
five years, with principal and interest paid quarterly. This loan and bank
guarantees obtained by this Israeli subsidiary contain covenants which, among
other things, require positive annual net income in a fiscal year; require a
certain ratio of total stockholders’ equity to total consolidated assets and a
minimum stockholders’ equity of this Israeli subsidiary; and place limitations
on its ability to merge, transfer or pledge assets to third parties. Our failure
to comply with the covenants could lead to an event of default under the
agreements governing some or all of this indebtedness, permitting the applicable
lender to accelerate all borrowings under the applicable agreement and to
foreclose on any collateral. As of March 31, 2010, we were in compliance and
expect to remain in compliance with these covenants.




We
anticipate funding a portion of our global growth through financing from
commercial banks.




Anticipated
Needs




We intend
to fund future growth through future cash flow from operations and available
bank borrowings. We believe the borrowings and future cash flow from operations
will be sufficient to fund continuing operations for the foreseeable
future.




In order
to achieve our strategic business objectives, we may be required to seek
additional financing. For example, future acquisitions may require additional
equity and/or debt financing. In addition, we may require further capital to
continue to enhance our infrastructure and for working capital purposes. These
financings may not be available on acceptable terms, or at all.




Critical
Accounting Estimates




Preparation
of our financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. We believe the most complex and sensitive judgments, because of
their significance to our consolidated financial statements, result primarily
from the need to make estimates about the effects of matters that are inherently
uncertain. Management’s Discussion and Analysis and Note 2 to the consolidated
financial statements presented in our 2009 Annual Report on Form 10-K, filed
with the SEC on March 15, 2010, describe the significant accounting estimates
and policies used in preparation of our consolidated financial statements.
Actual results in these areas could differ from management’s estimates. There
were no significant changes in our critical accounting estimates during the
three months ended March 31, 2010.




Contractual
Obligations




As of
March 31, 2010, except for the short-term and long-term loans obtained through
March 31, 2010, as described in the long-term and short-term debt section above,
there have been no material changes to the contractual obligations we disclosed
in our 2009 Annual Report on Form 10-K, filed with the SEC on March 15,
2010.


– 32
–




Item
3. Quantitative and Qualitative Disclosures About Market Risk




We have
operations in 18 different countries and commercial relationships in many other
parts of the world. Our foreign operations contract with clients using
applicable local currencies, euros or dollars. As a result, we are subject to
adverse movements in foreign currency exchange rates in countries in which we
conduct business. Our earnings are predominantly affected by fluctuations in the
value of the dollar as compared to the New Israeli Shekel, the Indian Rupee, the
euro and the Czech Crown; and to some extent by fluctuations in intra-European
currency rates.




As an
example, a decrease of 10% in the value of the euro relative to the U.S. dollar
in the three months ended March 31, 2010 would have resulted in an increase in
the U.S. dollar reporting value of our operating income of $0.2 million for that
period, while an increase of 10% in the value of the euro relative to the U.S.
dollar in the three months ended March 31, 2010 would have resulted in a
decrease in the U.S. dollar reporting value of our operating income of $0.2
million for that period.




In order
to reduce the effect of such movements on our earnings, we utilize certain
foreign exchange forward contracts to hedge our exposure against the Indian
Rupee. In the future, we may enter into additional forward foreign currency
exchange or other derivatives contracts to further hedge our exposure to foreign
currency exchange rates.




We
utilize interest rate swap derivatives to convert certain floating-rate debt to
fixed-rate debt. Our interest rate swap derivatives involve an agreement to pay
a fixed-rate interest and receive a floating-rate interest, at specified
intervals, calculated on an agreed notional amount that matches the amount of
the original loan and paid on the same installments and maturity
dates.




Other
than as described above, we do not engage in trading market risk sensitive
instruments or purchase hedging or “other than trading” instruments that are
likely to expose us to market risk, whether interest rate, commodity price or
equity price risk, nor have we purchased options or entered into swaps or
forward or futures contracts, nor do we use derivative financial instruments for
speculative trading purposes.




In the
future, we may be subject to interest rate risk on our investments and loans,
which would affect their carrying value.




Item
4. Controls and Procedures




Evaluation
of Disclosure Controls and Procedures




As of the
end of the period covered by this report, our principal executive officer and
principal financial officer evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act). Based on their evaluation of our disclosure controls and
procedures, our principal executive officer and principal financial officer,
with the participation of our management, have concluded that our disclosure
controls and procedures were effective as of March 31, 2010 to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is (a) recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and forms and (b)
accumulated and communicated to management, including our principal executive
officer and principal financial officer, as appropriate to allow for timely
decisions regarding required disclosure.




It should
be noted that any system of controls, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the
system are met. In addition, the design of any control system is based in part
upon certain assumptions about the likelihood of future events. Given these and
other inherent limitations of control systems, there is only reasonable
assurance that our controls will succeed in achieving their stated goals under
all potential future conditions. Our principal executive officer and principal
financial officer have concluded that our disclosure controls and procedures
were effective at the reasonable assurance level as of March 31,
2010.


– 33
–




Changes
in Internal Control Over Financial Reporting




As of the
end of the period covered by this report, there were no changes in our internal
controls over financial reporting, or in other factors that could significantly
affect these controls, that materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.


– 34
–


PART
II – OTHER INFORMATION




Item
1. Legal Proceedings




We are
periodically a party to routine litigation incidental to our business. Other
than as disclosed below, we do not believe that we are a party to or our
property is subject to any pending legal proceeding that is likely to have a
material adverse effect on our business, financial condition or results of
operations.




One of
our Israeli subsidiaries is currently involved in legal proceedings with the
Israeli Ministry of Justice (the “MOJ”). The legal proceedings relate to a
contract for the provision of an information system for the MOJ, executed in
November 2005 (the “MOJ Contract”). Following continued disputes, correspondence
and discussions, on February 9, 2009 we filed a claim with the Israeli District
Court located in Jerusalem claiming, among other things, a breach of the MOJ
Contract by the MOJ, including in connection with the MOJ’s demands for
revisions and changes to the software that were not contemplated in the MOJ
Contract. Our claim is for damages in the amount of NIS 20.7 million, or
approximately $5.6 million, using the exchange rate prevailing at March 31,
2010. On February 11, 2009, the MOJ filed a claim against our Israeli subsidiary
in the Israeli District Court located in Jerusalem claiming, among other things,
that our Israeli subsidiary breached the MOJ Contract and failed to fulfill its
undertakings and obligations set forth therein. The MOJ’s claim is for damages
in the amount of NIS 79.5 million, or approximately $21.4 million, using the
exchange rate prevailing at March 31, 2010. The MOJ and our subsidiary have
filed answers to the respective claims. Both claims were transferred to the
Israeli District Court located in Tel Aviv and the first pretrial hearing for
both claims is set for September 7, 2010. We believe that we have a substantial
basis with respect to our claim and valid defenses with respect to the MOJ’s
claim. While we intend to vigorously prosecute our claim and defend against the
MOJ’s claim, we cannot at this point predict the outcome of either claim.
Adverse decisions on these claims may materially adversely affect our financial
condition.




Item
1A. Risk Factors




There are
no material changes from the risk factors previously disclosed in our Annual
Report on Form 10-K filed with the SEC on March 15, 2010.




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




On
October 30, 2008, our board of directors authorized a stock repurchase program,
under which we could repurchase up to 4,000,000 shares of our common stock, or
approximately 10% of the outstanding shares, in the succeeding twelve months. On
November 1, 2009, our board of directors approved a 12-month extension of the
stock repurchase plan.




During
the three months ended March 31, 2010, we purchased a total of 116,700 shares at
an average price of $5.24 per share, for an aggregate purchase price of
$610,944. The remaining authorized number of shares that may be repurchased
under the plan is 2,653,596.




Period
                
                Total
                    Number of
                    Shares
                    Repurchased
                
                
                Average
                    Price Paid
                    per Share
                
                
                Total Number of Shares
                    Purchased as Part of
                    Publicly Announced
                    Plans or Programs
                
                
                Maximum Number of
                    Shares that May Yet Be
                    Purchased Under the
                    Plans or ProgramsJanuary
      1-31, 2010
                
                
                104,900
                
                
                $
                5.21
                
                
                
                104,900
                
                
                
                2,665,396February
      1-28, 2010
                
                
                11,800
                
                
                $
                5.48
                
                
                
                11,800
                
                
                
                2,653,596March
      1-31, 2010
                
                
                —
                
                
                $
                —
                
                
                
                —
                
                
                
                2,653,596Total
                
                
                116,700
                
                
                $
                5.24
                
                
                
                116,700
                
                
                
                2,653,596




Item
3. Defaults upon Senior Securities




None.


– 35
–




Item
4. (Removed and Reserved)




Item
5. Other Information




None.




Item
6. Exhibits




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




Exhibit Number
                  
                  Description31.1
                  
                  Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                  
                  Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                  
                  Certification
      of Principal Executive Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32.2
                  
                  Certification
      of Principal Financial Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.


– 36
–


SIGNATURES




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




NESS
      TECHNOLOGIES, INC.(Registrant)Date:
      May 6,
      2010
              By:
              /s/Issachar
      GerlitzIssachar
      GerlitzChief
      Executive Officer, President and Director(principal
      executive officer)Date:
      May 6,
      2010
              By:
              /s/Ofer
      SegevOfer
      SegevExecutive
      Vice President and Chief Financial Officer(principal
      financial and accounting
officer)


– 37
–


EXHIBIT
INDEX




Exhibit Number
              
              Description31.1
              
              Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
              
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
              
              Certification
      of Principal Executive Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32.2
              
              Certification
      of Principal Financial Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.




– 38
–