** **

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

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**FORM 10-Q**

**(Mark One)**

**ý****                ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended March 31, 2006**

** ̈****                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For thetransition period from ________ to ________**

**CommissionFile Number 000-50954**

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

** **

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

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

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

Large acceleratedfiler  ̈          Acceleratedfiler ý          Non-acceleratedfiler o

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

As of May 5,2006, 35,531,697 shares of common stock, $0.01 par value per share, wereoutstanding.

 

 

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**NESS TECHNOLOGIES, INC. ANDSUBSIDIARIES**

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

 

2

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# **PART I— FINANCIAL INFORMATION**

# ***Item 1. Financial Statements***

# **NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES****Interim Condensed Consolidated Balance SheetsU.S.dollars in thousands**

| ** **                                                                                                                                                    | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| ** **                                                                                                                                                    | ** ** | ** **            | ** ** | **(Unaudited)**    | ** ** |
| ASSETS                                                                                                                                                        |       |                  |       |               |       |
|                                                                                                                                                          |       |                  |       |               |       |
| CURRENT ASSETS:                                                                                                                                               |       |                  |       |               |       |
| Cash and cash equivalents                                                                                                                                     |       | $                     | 33,579     |               | $          | 31,238 |   |
| Short-term bank deposits                                                                                                                                      |       | 39,561                |       | 26,573             |       |
| Marketable securities                                                                                                                                         |       | 2,651                 |       | 2,659              |       |
| Trade receivables (net of allowance for doubtful  accounts of $2,320 and $2,977 at December 31, 2005 and March 31,  2006 (unaudited), respectively) |       | 99,097                |       | 99,517             |       |
| Unbilled receivables                                                                                                                                          |       | 28,545                |       | 37,345             |       |
| Other accounts receivable and prepaid expenses                                                                                                                |       | 13,664                |       | 15,290             |       |
| Inventories and work in progress                                                                                                                              |       | 2,506                 |       | 1,126              |       |
|                                                                                                                                                          |       |                  |       |               |       |
| Total current  assets                                                                                                                                         |       | 219,603               |       | 213,748            |       |
|                                                                                                                                                          |       |                  |       |               |       |
| LONG-TERM ASSETS:                                                                                                                                             |       |                  |       |               |       |
| Long-term prepaid expenses                                                                                                                                    |       | 4,816                 |       | 5,377              |       |
| Marketable securities                                                                                                                                         |       | 32                    |       | 115                |       |
| Deferred income taxes                                                                                                                                         |       | 5,271                 |       | 2,292              |       |
| Severance pay fund                                                                                                                                            |       | 35,845                |       | 35,605             |       |
|                                                                                                                                                          |       |                  |       |               |       |
| Total long-term  assets                                                                                                                                       |       | 45,964                |       | 43,389             |       |
|                                                                                                                                                          |       |                  |       |               |       |
| PROPERTY AND  EQUIPMENT, NET                                                                                                                                  |       | 21,308                |       | 24,316             |       |
|                                                                                                                                                          |       |                  |       |               |       |
| INTANGIBLE  ASSETS, NET                                                                                                                                       |       | 7,938                 |       | 11,282             |       |
|                                                                                                                                                          |       |                  |       |               |       |
| GOODWILL                                                                                                                                                      |       | 159,421               |       | 169,232            |       |
|                                                                                                                                                          |       |                  |       |               |       |
| Total assets                                                                                                                                                  |       | $                     | 454,234    |               | $          | 461,967 |   |

 

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

3

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIESInterim Condensed Consolidated Balance Sheets****U.S. dollars in thousands (except share and par valuedata)**
| ** **                                                                                                                                                                                                                                                         | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                                         | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| ** **                                                                                                                                                                                                                                                         | ** ** | ** **            | ** ** | **(Unaudited)**    | ** ** |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                         |       |                  |       |               |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                               |       |                  |       |               |       |
| Short-term bank credit                                                                                                                                                                                                                                             |       | $                     | 21,011     |               | $          | 36,442 |   |
| Current maturities of long-term debt                                                                                                                                                                                                                               |       | 6,862                 |       | 6,433              |       |
| Trade payables                                                                                                                                                                                                                                                     |       | 35,259                |       | 30,607             |       |
| Advances from customers                                                                                                                                                                                                                                            |       | 7,670                 |       | 8,593              |       |
| Other accounts payable and accrued expenses                                                                                                                                                                                                                        |       | 82,657                |       | 73,409             |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| Total current  liabilities                                                                                                                                                                                                                                         |       | 153,459               |       | 155,484            |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                             |       |                  |       |               |       |
| Long-term debt, net of current maturities                                                                                                                                                                                                                          |       | 6,294                 |       | 5,288              |       |
| Excess of losses over investment in affiliates                                                                                                                                                                                                                     |       | 257                   |       | 342                |       |
| Accrued severance pay                                                                                                                                                                                                                                              |       | 39,722                |       | 39,658             |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| Total long-term  liabilities                                                                                                                                                                                                                                       |       | 46,273                |       | 45,288             |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| COMMITMENTS AND  CONTINGENT LIABILITIES                                                                                                                                                                                                                            |       |                  |       |               |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                         |       |                  |       |               |       |
| Common stock of $0.01 par value - Authorized:  76,500,000 shares at December 31, 2005 and at March 31, 2006  (unaudited); Issued and  outstanding: 34,771,837 shares at December 31, 2005 and 35,329,137  shares at March 31, 2006 (unaudited) |       | 348                   |       | 353                |       |
| Additional paid-in capital                                                                                                                                                                                                                                         |       | 282,669               |       | 285,879            |       |
| Deferred stock compensation                                                                                                                                                                                                                                        |       | (27                   | )          | —             |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                                               |       | (13,559               | )          | (16,445            | )          |
| Accumulated deficit                                                                                                                                                                                                                                                |       | (14,929               | )          | (8,592             | )          |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                   |       | 254,502               |       | 261,195            |       |
|                                                                                                                                                                                                                                                               |       |                  |       |               |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                                                   |       | $                     | 454,234    |               | $          | 461,967 |   |

 

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

4

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESInterim Condensed Consolidated Statements of Income****U.S. dollars in thousands (except per share data)**
| ** **                                                         | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                                         | ** ** | **(Unaudited)**                                  | ** ** |
|                                                               |       |                                             |       |   |   |
| Revenues                                                           |       | $                                                | 88,405     |   | $ | 107,042 |   |
| Cost of revenues  (*)                                              |       | 62,492                                           |       | 75,668 |   |
| Provision for  losses (reverse of losses) on uncompleted contracts |       | 85                                               |       | 48 |   |
|                                                               |       |                                             |       |   |   |
| Gross profit                                                       |       | 25,828                                           |       | 31,326 |   |
|                                                               |       |                                             |       |   |   |
| Operating expenses:                                                |       |                                             |       |   |   |
| Selling and marketing                                              |       | 7,031                                            |       | 8,491 |   |
| General and administrative (*)                                     |       | 12,942                                           |       | 14,930 |   |
|                                                               |       |                                             |       |   |   |
| Total operating  expenses                                          |       | 19,973                                           |       | 23,421 |   |
|                                                               |       |                                             |       |   |   |
| Operating income                                                   |       | 5,855                                            |       | 7,905 |   |
| Financial  expenses, net                                           |       | (426                                             | )          | (61 | ) |
| Other expenses,  net                                               |       | —                                           |       | (39 | ) |
|                                                               |       |                                             |       |   |   |
| Income before  taxes on income                                     |       | 5,429                                            |       | 7,805 |   |
| Taxes on income                                                    |       | 602                                              |       | 1,468 |   |
| Equity in net  losses of affiliates                                |       | (2                                               | )          | — |   |
| Minority  interests in losses of a subsidiary                      |       | 101                                              |       | — |   |
|                                                               |       |                                             |       |   |   |
| Net income                                                         |       | $                                                | 4,926      |   | $ | 6,337 |   |
|                                                               |       |                                             |       |   |   |
| Basic net earnings  per share                                      |       | $                                                | 0.15       |   | $ | 0.18 |   |
|                                                               |       |                                             |       |   |   |
| Diluted net earnings  per share                                    |       | $                                                | 0.14       |   | $ | 0.18 |   |

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(*)   Expenses include stock-basedcompensation, as follows:
| ** **                  | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                  | ** ** | **(Unaudited)**                                  | ** ** |
|                        |       |                                             |       |   |   |
| Cost of revenues            |       | $                                                | 98         |   | $ | — |   |
| General and  administrative |       | 513                                              |       | 127 |   |
|                             |            |                                                  |            |  |  |  |  |

 

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

5

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES****Interim Condensed Consolidated Statements of Cash Flows****U.S. dollars in thousands**
| ** **                                                                                             | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                                                                             | ** ** | **(Unaudited)**                                  | ** ** |
| Cash flows from  operating activities:                                                                 |       |                                             |       |   |   |
| Net income                                                                                             |       | $                                                | 4,926      |   | $ | 6,337 |   |
| Adjustments required to  reconcile net income to net cash provided by (used in) operating activities:  |       |                                             |       |   |   |
| Stock-based  compensation-related expenses                                                             |       | 592                                              |       | 95 |   |
| Equity in net losses of  affiliates                                                                    |       | 2                                                |       | — |   |
| Minority interests in  losses of a subsidiary                                                          |       | (101                                             | )          | — |   |
| Currency fluctuation of  long-term debt                                                                |       | 1,096                                            |       | 196 |   |
| Accrued interest on  long-term debt                                                                    |       | (1,251                                           | )          | (512 | ) |
| Depreciation and  amortization                                                                         |       | 1,495                                            |       | 2,773 |   |
| Deferred income taxes,  net                                                                            |       | (1,432                                           | )          | (648 | ) |
| Loss (gain) on sale of  property and equipment                                                         |       | 6                                                |       | (33 | ) |
| Decrease (increase) in  trade receivables                                                              |       | (3,536                                           | )          | 2,599 |   |
| Increase in unbilled  receivables                                                                      |       | (4,810                                           | )          | (8,645 | ) |
| Increase in other  accounts receivable and prepaid expenses                                            |       | (156                                             | )          | (1,274 | ) |
| Decrease in inventories  and work in progress                                                          |       | 486                                              |       | 1,480 |   |
| Increase in long-term  prepaid expenses                                                                |       | (1,781                                           | )          | (154 | ) |
| Increase (decrease) in  trade payables                                                                 |       | 2,043                                            |       | (6,237 | ) |
| Increase in advances  from customers                                                                   |       | 103                                              |       | 969 |   |
| Increase (decrease) in  other accounts payable and accrued expenses                                    |       | 4,223                                            |       | (11,999 | ) |
| Increase in accrued  severance pay, net                                                                |       | 590                                              |       | 222 |   |
|                                                                                                   |       |                                             |       |   |   |
| Net cash provided by  (used in) operating activities                                                   |       | 2,495                                            |       | (14,831 | ) |
|                                                                                                   |       |                                             |       |   |   |
| Cash flows from  investing activities:                                                                 |       |                                             |       |   |   |
| Net cash paid for  acquisition of a consolidated subsidiary (a)                                        |       | —                                           |       | (13,611 | ) |
| Acquisition of minority  interest in a subsidiary (b)                                                  |       | (114                                             | )          | — |   |
| Proceeds from maturity  of short-term bank deposits                                                    |       | —                                           |       | 12,645 |   |
| Proceeds from sale of  property and equipment                                                          |       | 137                                              |       | 599 |   |
| Purchase of property  and equipment and capitalization of software development costs for internal  use |       | (1,564                                           | )          | (2,621 | ) |
| Capitalization of  software development costs                                                          |       | (924                                             | )          | (167 | ) |
|                                                                                                   |       |                                             |       |   |   |
| Net cash used in  investing activities                                                                 |       | (2,465                                           | )          | (3,155 | ) |
|                                                                                                        |            |                                                  |            |  |  |  |  |

 

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

6

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIESInterim Condensed Consolidated Statements of Cash Flows****U.S. dollars in thousands**
| ** **                                                    | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                                    | ** ** | **(Unaudited)**                                  | ** ** |
| Cash flows from  financing activities:                        |       |                                             |       |   |   |
| Exercise of options and warrants                              |       | $                                                | 7,659      |   | $ | 3,088 |   |
| Short-term bank loans and credit, net                         |       | 76                                               |       | 13,717 |   |
| Principal payments of long-term debt                          |       | (1,253                                           | )          | (1,186 | ) |
|                                                          |       |                                             |       |   |   |
| Net cash provided by (used in) financing activities           |       | 6,482                                            |       | 15,619 |   |
|                                                          |       |                                             |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | (2,018                                           | )          | 26 |   |
|                                                          |       |                                             |       |   |   |
| Increase  (decrease) in cash and cash equivalents             |       | 4,494                                            |       | (2,341 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 104,229                                          |       | 33,579 |   |
|                                                          |       |                                             |       |   |   |
| Cash and cash  equivalents at the end of the period           |       | $                                                | 108,723    |   | $ | 31,238 |   |
|                                                          |       |                                             |       |   |   |
| Supplemental  disclosures of cash flows information:          |       |                                             |       |   |   |
|                                                          |       |                                             |       |   |   |
| Cash paid during the period for:                              |       |                                             |       |   |   |
| Interest                                                      |       | $                                                | 435        |   | $ | 529 |   |
| Taxes                                                         |       | $                                                | 174        |   | $ | 7,335 |   |

 

(a)             *In conjunction with the acquisition, the fair values of the assetsacquired and liabilities assumed at the date of the related acquisition were asfollows:*

 
| Working capital (capital deficiency), net (excluding  cash and cash equivalents) |   | $      | — |   | $      | (1,364 | )      |
|----------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Property and equipment                                                           |   | — |   | 3,063  |   |
| Long-term loans                                                                  |   | — |   | (214   | )      |
| Deferred tax liability                                                           |   | — |   | (1,020 | )      |
| Goodwill                                                                         |   | — |   | 10,146 |   |
| Customer relations and backlog                                                   |   | — |   | 3,000  |   |
| Net cash used in acquisition of a consolidated  subsidiary                       |   | $      | — |   | $      | 13,611 |   |

 

(b)            *Inconjunction with the acquisition of the minority interest in a subsidiaryduring the three months ended March 31, 2005, the fair values of theassets acquired and liabilities assumed at the date of acquisition were asfollows:*

 
| Minority interest                                           |   | $      | 197    |   | $      | — |   |
|-------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Goodwill                                                    |   | 3,196  |   | — |   |
| Customer-related intangible assets                          |   | 139    |   | — |   |
|                                                        |   | 3,532  |   | — |   |
| Less issuance of share                                      |   | (3,418 | )      | — |   |
| Net cash used in acquisitions of consolidated  subsidiaries |   | $      | 114    |   | $      | — |   |

 

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

7

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**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

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

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

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

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

##### a.               UnauditedInterim Financial Information

The accompanying condensed consolidated balance sheet as of March 31,2006, the condensed consolidated statements of income for the three monthsended March 31, 2005 and 2006, and the condensed consolidated statementsof cash flows for the three months ended March 31, 2005 and 2006 areunaudited. These unaudited interim condensed consolidated financial statementshave been prepared in accordance with U.S. generally accepted accountingprinciples for interim financial information. In the opinion of management, theunaudited interim condensed consolidated financial statements include alladjustments of a normal recurring nature necessary for a fair presentation ofour consolidated financial position as of March 31, 2006, our consolidatedresults of operations for the three months ended March 31, 2005 and 2006,and our consolidated cash flows for the three months ended March 31, 2005and 2006.

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

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

Results for the three months ended March 31, 2006 are notnecessarily indicative of results that may be expected for the year ending December 31,2006.

Unless otherwise noted, (1) all references to “dollars” or “$” areto United States dollars and all references to “NIS” are to New Israeli Shekelsand (2) all references to shares of our common stock and per shareinformation have been adjusted to reflect the 0.7193-for-one reversestock split effected on September 20, 2004.

##### b.              Use of estimates

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

8

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

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

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

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

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

##### d.              Principles ofconsolidation

Our consolidated financial statements include the accounts of the companyand its wholly and majority owned subsidiaries, or the group. Inter-companytransactions and balances, including profit from inter-company sales not yetrealized outside the group, have been eliminated in consolidation.

##### e.               Acquisition ofsubsidiaries

1.  Ness U.S.A. Inc. (“Ness U.S.A.”)

On November 12, 2004, we filed a Form S-4 RegistrationStatement in respect of an exchange offer for the remaining shares of NessU.S.A. which we did not already own. The offer commenced on January 31,2005 and ended on February 28, 2005. 96 of 98 offerees accepted the offerbringing our holdings in Ness U.S.A. following the offer to 99.9%. On March 1,2005, we issued 260,316 shares to the offerees, for the consideration of$3,532. The acquisition was accounted for under the purchase method ofaccounting according to SFAS No. 141, “Business Combinations.”

In September 2005, Ness U.S.A. purchased the outstanding shares ofNess U.S.A.’s common stock from the remaining two offerees in a privatetransaction, and it immediately thereafter retired the shares, since which timewe have held 100% of the shares of common stock of Ness U.S.A.

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

9

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

Based upon a valuation of tangible andintangible assets acquired and liabilities assumed, we have allocated the totalcost of the acquisition to Ness U.S.A.’s assets and liabilities (as of theacquisition date) as follows:

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

 

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

2.    Ness Romania

On April 1, 2005, we acquired all of the outstanding shares ofRadix Company SA (“Radix”), a provider of IT services and solutions based inRomania. The purchase price was €4 million, or $5,385, consisting of €2 millionpaid in cash at the closing and €2 million placed in escrow for six monthscontingent on the verification of the accuracy of certain representations madeby the sellers. Additional payments of $1,775, or €1.5 million, were made in April 2006because of an achievement of certain revenue and operating income milestones in2005. The additional payments were accrued for and recorded as goodwill in the December 31,2005 consolidated balance sheet. An additional payment of up to €1.5 millionwill be required to be made in April 2007 based on achievement of certainrevenue and operating income milestones for 2006. Currently, we cannot estimatethe probability of achieving these milestones. Radix became a wholly-ownedsubsidiary of our Dutch subsidiary, Ness Technologies, B.V., and, accordingly,its results of operations have been included in our consolidated financialstatements since the acquisition date. Upon completion of the acquisition,Radix Company SA changed its name to Ness Romania.

10

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

This acquisition was accounted for under the purchase method of accountingand, accordingly, the purchase price was allocated to the assets acquired andliabilities assumed based on their related fair values. We have allocated thetotal cost of the acquisition to Ness Romania’s assets and liabilities (as ofthe acquisition date, except for goodwill, which was updated to include theadditional payments) as follows: 

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

 

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

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

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

b.              The value assigned to the customer-related intangiblesamounted to $420. The fair value of Radix’s customer base was determined usingthe Income Approach.

3.    Ness DM a.s.

On June 1, 2005, we acquired all of the outstanding shares ofEfcon a.s. (“Efcon”), a provider of IT services and solutions based in theCzech Republic. The purchase price was €0.6 million, or $738, consisting of €350,000paid at closing and €250,000 payable within 55 days contingent on theverification of the accuracy of certain representations made by the sellers. Anadditional payment of $237, or €0.2 million was made in February 2006based on achievement of certain

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

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

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

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

 

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

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

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

b.              The value assigned to the customer-related intangiblesamounted to $64. The fair value of Ness DM’s customer base was determined usingthe Income Approach.

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

4.    NTR

On September 12, 2005, we acquired all of the outstanding sharesof N.T.R. Holding Ltd. (“NTR”), a provider of IT services and solutions basedin Israel. The purchase price was $1,350. An additional payment of $150 will bemade based on achievement of certain 2005 performance goals, which wereachieved. The additional required payment was accrued for and recorded asgoodwill in the December 31, 2005 consolidated balance sheet. NTR became awholly-owned subsidiary of Ness A.T., a part of our Ness Israel group, and,accordingly, its results of operations have been included in the consolidatedfinancial statements since September 12, 2005.

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

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

 

The allocation of thepurchase price reflected in the consolidated balance sheet is preliminary. Wehave arranged to obtain a valuation of NTR's current assets, currentliabilities, long-term tangible assets, property and equipment and intangibleassets and liabilities. Management expects to obtain such completed reportduring 2006.

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

5.    Delta

On October 3, 2005, we acquired all the outstanding shares ofDelta Electronic Services a.s. (“Delta”), a provider of IT services andsolutions in Slovakia. Ness acquired the outstanding shares for cashconsideration of $8,000 and related purchase costs of approximately $115. Inaddition, as Delta achieved certain business goals by the end of 2005, Nesspaid an additional amount of $3,000 during 2006. Upon completion of theacquisition, Delta changed its name to Ness Slovakia, and it operates as a partof Ness Europe. Delta became a wholly-owned subsidiary of Ness B.V., a part ofNess European group, and, accordingly, its results of operations have beenincluded in the consolidated financial statements since October 3, 2005.

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

| Cash and cash equivalents                   |   | $      | 2,158  |   |
|---------------------------------------------|--------|--------|--------|--------|
| Trade receivables                           |   | 1,476  |   |
| Property and equipment                      |   | 575    |   |
| Other accounts receivable                   |   | 1,176  |   |
| Deferred tax liabilities                    |   | (555   | )      |
| Intangible assets:                          |   |   |   |
| Customer  relations                         |   | 1,593  |   |
| Backlog                                     |   | 256    |   |
| Capitalized software development costs      |   | 621    |   |
| Workforce                                   |   | 1,290  |   |
| Goodwill                                    |   | 5,810  |   |
| Total assets  acquired                      |   | 14,400 |   |
| Liabilities assumed:                        |   |   |   |
| Accounts payable and other accrued expenses |   | 1,235  |   |
| Other current liabilities                   |   | 1,925  |   |
| Long-term liabilities                       |   | 125    |   |
| Total  liabilities assumed                  |   | 3,285  |   |
| Net assets acquired                         |   | $      | 11,115 |   |

 

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

6.    Innova

On February 28, 2006, we acquired all of the outstanding shares ofInnova Solutions (“Innova”), a provider of IT services and solutions based inthe United States and India. Ness acquired the outstanding shares for cashconsideration of $15,000 and related purchase costs of approximately $177.Additional payments of up to $10,000 are required to be made in April 2007and April

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIESNotes to Interim Condensed Consolidated Financial StatementsU.S. dollars in thousands (except share and per share data) (Unaudited)**

2008 based on achievement of certain revenue and operating incomemilestones for the years 2006 and 2007, respectively. Innova became awholly-owned subsidiary of Ness Technologies, Inc. and, accordingly, itsresults of operations are included in our consolidated financial statementssince the acquisition date. Upon completion of the acquisition, Innova changedits name to Ness Innovative Business Services.

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

| Cash and cash equivalents                   |   | $      | 1,566  |   |
|---------------------------------------------|--------|--------|--------|--------|
| Trade receivables                           |   | 3,421  |   |
| Property and equipment                      |   | 3,063  |   |
| Deferred tax liability                      |   | (1,020 | )      |
| Other accounts receivable                   |   | 1,829  |   |
| Intangible assets:                          |   |   |   |
| Customer relations and backlog              |   | 3,000  |   |
| Goodwill and workforce                 |   | 10,146 |   |
| Total assets  acquired                      |   | 22,005 |   |
| Liabilities assumed:                        |   |   |   |
| Accounts payable and other accrued expenses |   | 4,606  |   |
| Other current liabilities                   |   | 2,008  |   |
| Long-term liabilities                       |   | 214    |   |
| Total  liabilities assumed                  |   | 6,828  |   |
| Net assets acquired                         |   | $      | 15,177 |   |

 

Customer relations and backlog are amortized over their useful lives,preliminarily estimated as five years.

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

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

##### f.                 Goodwill

On January 1, 2006, we began segment reporting, and therefore wehave allocated our goodwill balance as of January 1, 2006 to ourreportable segments based on their relative fair value as of that date.

We have elected to perform our annual goodwill impairment test duringthe fourth quarter of the year. No indications of impairment were identifiedduring the three months ended March 31, 2006.

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

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

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

Our results of operations for the three months ended March 31,2006 include expenses of $127 in operating expense related to the adoption ofSFAS 123(R). In accordance with the modified prospective method, ourconsolidated financial statements for prior periods have not been restated toreflect, and do not include, the impact of SFAS 123(R).

Adoption of SFAS 123(R) did not change our accounting forshare-based payments issued to non-employees.

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

SFAS 123(R) requires companies to estimate the fair value ofshare-based awards on the date of grant using an option-pricing model, whereapplicable. Share-based compensation expense recognized in our condensedconsolidated statement of income for the first quarter of fiscal 2006 includescompensation expense for share-based awards granted (i) prior to, but notyet vested as of, December 31, 2005, based on the grant date fair valueestimated in accordance with the original provisions of SFAS 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”), and (ii) subsequent to December 31,2005, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R). We recognize these compensation costs net of aforfeiture rate and recognize the compensation costs for only those sharesexpected to vest on a straight-line basis over the requisite service period ofthe award, which is generally the option vesting term of three to four years.SFAS 123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. In our pro forma information required under SFAS 123 forperiods prior to fiscal 2006, we accounted for forfeitures as they occurred.

As of March 31, 2006, approximately $393 of total unrecognizedcompensation cost related to stock based compensation is expected to berecognized over a weighted-average period of 3 years. The total unrecognizedstock-based compensation cost to be recognized in future periods as of March 31,2006 does not consider the effect of stock options that may be issued insubsequent periods.

The fair value of each option grant was estimated at the date of grantusing the Black-Scholes option pricing model. During the first quarter of 2006and 2005 no new options were granted.

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

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

|                                                                | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                                         | ** ** |
| ** **                                                     | ** ** | **(Unaudited)**                                  | ** ** |
| Net income  available to common stock, as reported             |       | $                                                | 4,926      |   |
| Add: Stock-based employee compensation — intrinsic  value |       | 611                                              |       |
| Deduct: Stock-based employee compensation — fair  value   |       | (2,565                                           | )          |
| Pro forma net income                                           |       | $                                                | 2,972      |   |
|                                                           |       |                                             |       |
| Basic net earnings  per share, as reported                     |       | $                                                | 0.15  |   |
| Diluted net  earnings per share, as reported                   |       | $                                                | 0.14  |   |
|                                                           |       |                                             |       |
| Pro forma basic  net earnings per share                        |       | $                                                | 0.09  |   |
| Pro forma diluted net  earnings per share                      |       | $                                                | 0.08  |   |

 

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

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

 In February 2006, the FASBissued FASB Statement No. 155, “Accounting for Hybrid FinancialInstruments — an amendment of FASB Statements No. 133 and 140.” Thisstatement amends FASB Statements No. 133, “Accounting for DerivativeInstruments and Hedging Activities” (“FAS 133”), and No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities” (“FAS 140”). This statement allows financial instruments that haveembedded derivatives to be accounted for as a whole (eliminating the need tobifurcate the derivative from its host) if the holder elects to account for thewhole instrument on a fair value basis. It also clarifies which interest-onlystrips and principal-only strips are not subject to the requirements of FAS133; establishes a requirement to evaluate interests in securitized financialassets to identify interest that are freestanding derivatives or that arehybrid financial instruments that contain an embedded derivative requiringbifurcation; clarifies that concentrations of credit risk in the form ofsubordination are not embedded derivatives; and, amends FAS

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

140 to eliminate theprohibition on a qualifying special-purpose entity from holding a derivativefinancial instrument that pertains to a beneficial interest other than anotherderivative financial instrument. This statement shall be effective for allfinancial instruments acquired or issued after the beginning of an entity’sfirst fiscal year beginning after September 15, 2006. Management believesthis statement will not have a material effect on our consolidated financialstatements.

##### i.                  Reclassification

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

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

##### a.               Composition

Our long-term debt is composed as follows:

|                          | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|--------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **               | ** ** | ** **                  | ** ** | **(Unaudited)**          | ** ** |
| Banks (1)                |       | $                           | 11,610     |                     | $          | 9,584 |   |
| Loans from  others       |       | 1,546                       |       | 2,137                    |       |
|                     |       | 13,156                      |       | 11,721                   |       |
| Less current  maturities |       | 6,862                       |       | 6,433                    |       |
|                     |       | $                           | 6,294      |                     | $          | 5,288 |   |

----

(1)          The long-term loans default upon the failure of any ofour subsidiaries named as borrowers under the loans to satisfy certainconditions and comply with covenants. As of December 31, 2005 and March 31,2006, management believes that the subsidiaries are in compliance withforegoing conditions. The weighted average interest rate on the bank loans asof December 31, 2005 was 6.75%.

##### b.              Classification

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

|                          | ** ** | **Interest rate (%)** | ** ** | **Amount**         | ** ** |
|--------------------------|------------|---------------------------------|------------|--------------------|------------|
| ** **               | ** ** | **December 31,**           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| ** **               | ** ** | **2005**                        | ** ** | **2006**           | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **               | ** ** | ** **                      | ** ** | **(Unaudited)**    | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| In, or linked to  dollar |       | 5-6                             |       | 5-6                |       | $ | 2,169 |   | $ | 2,137 |   |
| In NIS - linked  to CPI  |       | 6-8                             |       | 6-8                |       | 10,987 |   | 9,584 |   |
|                     |       |                            |       |               |       | $ | 13,156 |   | $ | 11,721 |   |

#####  

##### c.               Maturities

The liabilities mature as follows:

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

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

 

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

##### a.               Litigation

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

##### b.              Guarantees

Guarantees are contingent commitments issued by us generally toguarantee our performance in different projects to our customers, such astenders. The term of a guarantee generally is equal to the term of the relatedprojects, which can be as short as 30 days or as long as 5 years. The maximumpotential amount of future payments we could be required to make under ourguarantees at December 31, 2005 and March 31, 2006, is $36,168 and$34,845, respectively. We do not hold collateral to support guarantees whendeemed necessary.

##### c.               Liens andcharges

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

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

##### a.               Redeemableoptions:

Our Executive Committee approved and resolved on August 31, 2004to provide to certain optionees (specifically, those who exchanged theiroptions in two previously public entities acquired by us for options in Ness)the right to redeem their options for a cash payment. The grant date occurredduring the fourth quarter of 2004. The total number of redeemable options, allof which are currently vested, is 352,256, and the aggregate redemption valueas of March 31, 2006 is approximately $3,335.

The redemption right is exercisable from October 1, 2004 until May 31,2006. Each option subject to the redemption right may be transferred by theemployee to us for a cash payment that is linked, at the employee’s solediscretion, either to the Israeli CPI and shall bear a NIS interest at the rateof 5% per year, or to the U.S. dollar with a U.S. dollar interest at the rateof 6% per year, calculated from the original option grant date of September 23,1999 or October 3, 1999, up to the redemption date. Each of 272,976options may be exercised to acquire one share of our common stock at a price of$3.49 and are redeemable at the NIS equivalent amount of $10.02 per option asof March 31, 2006. Each of 79,280 options may be exercised to acquire oneshare of our common stock at a price of $7.45, and are redeemable at the NISequivalent amount of $7.55 per option as of March 31, 2006. The exerciseprices and redemption amounts are subject to adjustments for stock splits,dividends, recapitalizations and the like, as set forth in our share optionplan to which each option is subject.

19

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

We account for the rights following the guidance of FIN No. 28, “Accountingfor Stock Appreciation Rights and Other Variable Stock Option or Award Plans,”relating to tandem awards and EITF No. 00-23, “Issues Related to theAccounting for Stock Compensation under APB No. 25 and FIN No. 44.”Accordingly, once we believe it is likely that the rights would be exercised inthe future, a liability will be recorded at the then value of the redemptionrights, with a corresponding charge to compensation expense. The liability willbe accreted periodically to equal the amount that would be payable if theawards were redeemed at each balance sheet date. As of March 31, 2006, webelieved it was likely that the rights would be exercised, and accordingly, werecorded a liability in that respect in the total amount of $3,335, included inother accounts payable and accrued expenses, reflecting the value of theredemption rights at March 31, 2006.

##### b.              Totalcomprehensive income:

|                                                                            | ** ** | **Three months ended  March 31,** | ** **  |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|-------------|
| ** **                                                                 | ** ** | **2005**                                         | ** **  | **2006** | ** ** |
| ** **                                                                 | ** ** | **(Unaudited)**                                  | ** **  |
| Net income                                                                 |       | $                                                | 4,926  |   | $ | 6,337 |   |
| Foreign currency  translation adjustments, net                             |       | (3,791                                           | )           | (2,815 | ) |
| Net unrealized  losses (gains) on available-for-sale marketable securities |       | 67                                               |        | (60 | ) |
| Comprehensive income                                                       |       | $                                                | 1,202       |   | $ | 3,462 |   |

####  

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

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

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

Our operating segments are:

1. **Managed Strategic Services**, which includesIndia-based offshore services as well as system integration andapplication development and consulting services. Verticals served by thissegment are: independent software vendors, life sciences and healthcareand others.

2. **Technologies & Systems Group**,which includes system integration and application development, real-timesystems development, consulting and outsourcing services for the defense,government and homeland security vertical, as well as systems for thetelecommunications vertical.

3. **Ness Europe**, which includes systemintegration and application development, outsourcing and software andconsulting for Eastern European and Western European customers, includingnear-shore services from Eastern Europe for Western European customers.Verticals served by this segment are: telecommunications and utilities,financial services and others.

20

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

4. **Ness Israel**, which includes systemintegration and application development, outsourcing, software andconsulting and quality assurance and training for customers in Israelwithin the following verticals: financial services, government, life sciences andhealthcare, manufacturing, retail, transportation and others.

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

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

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

|                                              | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(unaudited)**                                  | ** ** |
| **Revenues:**                                |       |                                             |       |   |   |
| Managed  Strategic Services (MSS)            |       | $                                                | 19,623     |   | $ | 22,101 |   |
| Technologies &  Systems Group (TSG) |       | 11,647                                           |       | 12,296 |   |
| Ness Europe                                  |       | 7,652                                            |       | 18,439 |   |
| Ness Israel                                  |       | 42,678                                           |       | 44,009 |   |
| Other                                        |       | 6,805                                            |       | 10,197 |   |
|                                         |       | $                                                | 88,405     |   | $ | 107,042 |   |

 

|                                              | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(unaudited)**                                  | ** ** |
| **Operating income (loss):**                 |       |                                             |       |   |   |
| Managed  Strategic Services (MSS)            |       | $                                                | 1,883      |   | $ | 2,939 |   |
| Technologies &  Systems Group (TSG) |       | 1,640                                            |       | 1,861 |   |
| Ness Europe                                  |       | 797                                              |       | 1,513 |   |
| Ness Israel                                  |       | 3,217                                            |       | 2,621 |   |
| Other                                        |       | (321                                             | )          | 461 |   |
| Unallocated  Expenses                        |       | (1,361                                           | )          | (1,490 | ) |
|                                         |       | $                                                | 5,855      |   | $ | 7,905 |   |

 

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

The following presents total revenues for the threemonth periods ended March 31, 2005 and 2006, and long-lived assets as of March 31,2005 and 2006:

21

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

|                                                 | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | **(Unaudited)**                                  | ** ** |
| Revenues from sales to  unaffiliated customers: |       |                                             |       |   |   |
| Israel                                          |       | $                                                | 51,708     |   | $ | 52,925 |   |
| United States                                   |       | 20,752                                           |       | 27,317 |   |
| Europe                                          |       | 10,377                                           |       | 21,276 |   |
| Asia and the Far East                           |       | 4,356                                            |       | 4,515 |   |
| Others                                          |       | 1,212                                            |       | 1,009 |   |
|                                            |       | $                                                | 88,405     |   | $ | 107,042 |   |

 

|                       | ** ** | **March 31,** | ** ** |
|-----------------------|------------|--------------------|------------|
| ** **            | ** ** | **2005**           | ** ** | **2006** | ** ** |
| ** **            | ** ** | **(Unaudited)**    | ** ** |
| Long-lived assets:    |       |               |       |   |   |
| Israel                |       | $                  | 103,351    |   | $ | 100,558 |   |
| United States         |       | 60,283             |       | 76,867 |   |
| Europe                |       | 2,730              |       | 19,639 |   |
| Asia and the Far East |       | 8,222              |       | 7,751 |   |
| Others                |       | 8                  |       | 15 |   |
|                  |       | $                  | 174,594    |   | $ | 204,830 |   |

 

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

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

The total weighted average number of shares related tothe outstanding options and warrants excluded from the calculations of dilutednet earnings per share, as they would have been anti-dilutive for all periodspresented, was 1,521,226, 19,755 and 2,532,118 for the year ended December 31,2005 the three months ended March 31, 2005 and 2006, respectively.

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

22

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**NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Notes to InterimCondensed Consolidated Financial Statements**

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

 
| ** **                                                                                                     | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| ** **                                                                                                     | ** ** | **(Unaudited)**                                  | ** ** |
| Numerator:                                                                                                     |       |                                             |       |   |   |
| Net income, numerator for basic and diluted per  share                                                         |       | $                                                | 4,926      |   | $ | 6,337 |   |
|                                                                                                           |       |                                             |       |   |   |
| Denominator:                                                                                                   |       |                                             |       |   |   |
| Weighted average number of shares of common stock                                                              |       | 33,755                                           |       | 34,870 |   |
| Denominator for basic net earnings per share                                                                   |       | 33,755                                           |       | 34,870 |   |
| Effect of  dilutive securities:                                                                                |       |                                             |       |   |   |
| Employee stock options and warrants                                                                            |       | 1,790                                            |       | 1,310 |   |
| Denominator for  diluted net earnings per share — adjusted weighted average assuming exercise  of options |       | 35,545                                           |       | 36,180 |   |
|                                                                                                                |            |                                                  |            |  |  |  |  |

 

23

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

*You should read the followingdiscussion and analysis together with our unaudited consolidated financialstatements and the accompanying notes. This discussion contains forward-lookingstatements, within the meaning of Section 27A of Securities Act of 1933,as amended, Section 21E of the Securities Exchange Act of 1934, asamended, and the Private Securities Litigation Reform Act of 1995, includingstatements regarding our expected financial position, business and financingplans. These statements involve risks and uncertainties. Our actual resultscould differ materially from the results described in or implied by theseforward-looking statements as a result of various factors, including thosediscussed below and elsewhere in our Annual Report on Form 10-Kfiled with the SEC on March 15, 2006, particularly under the headings “DisclosureStatement” and “Risk Factors.”*

### **Overview**

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

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

Our revenues increased to $107.0 million for the threemonths ended March 31, 2006, from $88.4 million for the three months endedMarch 31, 2005. Net income increased to $6.3 million for the three monthsended March 31, 2006, from $4.9 million for the three months ended March 31,2005.

Our revenue growth is attributable to a number offactors, including acquisitions we made, increases in the number and size ofprojects for existing clients and the addition of new clients. Our client baseis diverse, and we are not dependent on any single client. In the three monthsended March 31, 2006, no client accounted for more than 4% of our revenuesand our largest twenty clients together accounted less than approximately 31%of our revenues. For the three months ended March 31, 2006, the percentageof our revenues generated by public and private clients in Israel was 49%, andthe percentage of our revenues derived, in aggregate, from agencies of the governmentof Israel for the same time periods was 9%. Existing clients from prior yearsgenerated more than 85% of our revenues in the three months ended March 31,2006.

Our backlog as of March 31, 2006 was $527 millioncompared to $412 million as of March 31, 2005. This $115 million increasein our backlog was due primarily to new bookings. We achieve backlog throughnew signings of IT services projects and outsourcing contracts, including fornew and repeat customers. We recognize backlog as revenue when we perform theservices related to backlog.

For the three months ended March 31, 2006, thepercentage of our revenues derived from clients in Israel was 49%; in theUnited States, 26%; in Europe, 20%; in Asia and the Far East, 4%; and in othercountries, 1%.

For the three months ended March 31, 2006, wederived 33% of our revenues from system integration and applicationdevelopment; 43% from outsourcing (including offshore development); 14% fromsoftware and consulting; 7% from quality assurance and training; and 2% fromour other offerings.

24

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As of March 31, 2006, we had approximately 7,000employees, including approximately 6,120 IT professionals. Of the 7,000employees, approximately 3,170 were in Israel, 2,155 were in India, 520 were inNorth America, 780 were in Europe and 375 were in the Asia Pacific region.

### **RecentDevelopments**

There have been no significant developments since March 31,2006.

### **ConsolidatedResults of Operations**

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

|                                                | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Revenues                                       |       | 100.0                                            | %          | 100.0 | % |
| Cost of revenues                               |       | 70.7                                             |       | 70.7 |   |
| Provision for  losses on uncompleted contracts |       | 0.1                                              |       | 0.0 |   |
| Gross profit                                   |       | 29.2                                             |       | 29.3 |   |
|                                           |       |                                             |       |   |   |
| Operating  expenses:                           |       |                                             |       |   |   |
| Selling and marketing                          |       | 8.0                                              |       | 7.9 |   |
| General and administrative                     |       | 14.6                                             |       | 13.9 |   |
| Total operating expenses                       |       | 22.6                                             |       | 21.9 |   |
|                                           |       |                                             |       |   |   |
| Operating income                               |       | 6.6                                              |       | 7.4 |   |
| Financial  expenses, net                       |       | (0.5                                             | )          | (0.1 | ) |
| Other expenses,  net                           |       | 0.0                                              |       | 0.0 |   |
| Income before  taxes on income                 |       | 6.1                                              |       | 7.3 |   |
|                                           |       |                                             |       |   |   |
| Taxes on income                                |       | 0.7                                              |       | 1.4 |   |
| Equity in net  losses of affiliates            |       | 0.0                                              |       | — |   |
| Minority  interests in losses of a subsidiary  |       | 0.1                                              |       | — |   |
| Net income                                     |       | 5.6                                              |       | 5.9 |   |

 

### **ThreeMonths Ended March 31, 2006 Compared to the Three Months Ended March 31,2005**

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

|                                                | ** ** | **Three months ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                     | ** ** | **2005**                                         | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                       |       | $                                                | 88,405     |                     | $          | 107,042 |   | 18,637 |   | 21.1 |   |
| Cost of revenues                               |       | 62,492                                           |       | 75,668                   |       | 13,176 |   | 21.1 |   |
| Provision for  losses on uncompleted contracts |       | 85                                               |       | 48                       |       | (37 | ) | (43.2 | ) |
| Gross profit                                   |       | $                                                | 25,828     |                     | $          | 31,326 |   | 5,498 |   | 21.3 |   |
| Gross margin                                   |       | 29.2                                             | %          | 29.3                     | %          |   |   |   |   |

####  

#### ***Revenues***

Our revenues increased from $88.4 million in the threemonths ended March 31, 2005 to $107.0 million in the three months ended March 31,2006, representing an increase of $18.6 million, or 21.1%. A significantportion of the $13.2 million of revenue growth attributable toacquisitions made in the last twelve months was due to post-acquisition growthresulting from synergies with Ness. Of the $18.6 million increase in revenues,$5.0 million represents growth in outsourcing and offshore engagements and$13.6 million represents growth in our other offerings, comprised of systemintegration and application development, software and consulting, and qualityassurance and training. Revenues from

25

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outsourcing and offshore services increased as aresult of volume growth due to our sales initiatives related to theseofferings, including the hiring of key personnel and aligning of ourorganizational structure, and expansion into geographical areas in which wecurrently do business but previously had not offered outsourcing and offshoreservices. There was no significant change in our billing rates, or prices, fromthe three months ended March 31, 2005 to the three months ended March 31,2006.

#### ***Cost of revenues and provision for losses on uncompleted contracts***

Our cost of revenues, including salaries, wages andother direct and indirect costs, increased from $62.5 million in the threemonths ended March 31, 2005 to $75.7 million in the three months ended March 31,2006, representing an increase of $13.2 million, or 21.1%. A significantportion of the $8.8 million of cost of revenues increase attributable toacquisitions made in the last twelve months was due to growth in our deliverystaff needed to support post-acquisition revenue growth resulting fromsynergies with Ness, and $4.4 million was due to normal growth in ourdelivery staff needed to support our increased revenues. The change in ourprovision for losses on uncompleted contracts changed from $85,000 in the threemonths ended March 31, 2005 to $48,000 in the three months ended March 31,2006, as a result of net updates to the estimated costs of completion of ourfixed price projects.

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

Our gross profit (revenues less cost of revenues andprovision for losses on uncompleted contracts) increased from $25.8 million inthe three months ended March 31, 2005 to $31.3 million in the three monthsended March 31, 2006, representing an increase of $5.5 million, or 21.3 %.The increase was primarily due to our increase in revenues. A significantportion of the $4.4 million of gross profit increase attributable toacquisitions made in the last twelve months was due to post-acquisition revenuegrowth resulting from synergies with Ness, and $1.1 million was related toour other revenue growth. Gross margin for the three months ended March 31,2006 was 29.3%, compared to 29.2% in the three months ended March 31,2005. This change in gross margin was not significant.

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

|                             | ** ** | **Three months ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **2005**                                         | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                                | 7,031      |                     | $          | 8,491 |   | 1,460 |   | 20.8 |   |
| General and  administrative |       | 12,942                                           |       | 14,930                   |       | 1,988 |   | 15.4 |   |
| Total operating  expenses   |       | 19,973                                           |       | 23,421                   |       | 3,448 |   | 17.3 |   |
| Operating income            |       | $                                                | 5,855      |                     | $          | 7,905 |   | 2,050 |   | 35.0 |   |

 

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

Selling and marketing expenses increased from $7.0million in the three months ended March 31, 2005 to $8.5 million in thethree months ended March 31, 2006, representing an increase of $1.5million, or 20.8%. This increase was due primarily to the inclusion ofmarketing and sales expenses from our acquisitions in the last three quartersof 2005 and the first quarter of 2006, representing $1.1 million, and anincrease in marketing expenses, sales commissions and sales expenses needed tosupport our other revenue growth, representing $0.4 million.

#### ***General and administrative***

General and administrative expenses increased from$12.9 million in the three months ended March 31, 2005 to $14.9 million inthe three months ended March 31, 2006, representing an increase of $2.0million, or 15.4%. This increase was due primarily to the acquisitions by ourNess Europe segment in the last three quarters of 2005, representing $0.8million, general and administrative expenses associated with the reorganizationof our Ness Israel segment, representing $0.4 million, and an increase inallowance for doubtful debts in our Ness Israel segment, representing $0.6million, offset by lower stock-based compensation expenses, representing $0.5million.

26

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#### ***Operating Income***

Operating income increased from $5.9 million in thethree months ended March 31, 2005 to $7.9 million in the three monthsended March 31, 2006, representing an increase of $2.0 million, or 35.0%.The major factors contributing to this increase were acquisitions made in thelast twelve months by our Ness Europe, Ness Israel and Other segments,including operating income growth attributable to the post-acquisition revenuegrowth resulting from synergies with Ness, together representing $2.3 million,and growth in operating margin of our Managed Strategic Services andTechnologies & Systems Group segments, representing $1.5 million,offset by reorganization expenses in our Ness Israel segment, representing $0.4million, and acquisition integration expenses in our Ness Europe, Ness Israeland Other segments, representing $0.9 million.

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

|                                               | ** ** | **Three months ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                    | ** ** | **2005**                                         | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                              |       | $                                                | 5,855      |                     | $          | 7,905 |   | 2,050 |   | 35.0 |   |
| Financial  expenses, net                      |       | (426                                             | )          | (61                      | )          | 365 |   | (85.7 | ) |
| Other expenses,  net                          |       | —                                           |       | (39                      | )          | (39 | ) | N/A |   |
| Income before  taxes on income                |       | 5,429                                            |       | 7,805                    |       | 2,376 |   | 43.8 |   |
| Taxes on income                               |       | 602                                              |       | 1,468                    |       | 866 |   | 143.8 |   |
| Equity in net  losses of affiliates           |       | (2                                               | )          | —                   |       | 2 |   | (100.0 | ) |
| Minority  interests in losses of a subsidiary |       | 101                                              |       | —                   |       | (101 | ) | (100.0 | ) |
| Net income                                    |       | $                                                | 4,926      |                     | $          | 6,337 |   | 1,411 |   | 28.6 |   |

####  

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

Financial expenses, net, decreased from $0.4 millionin the three months ended March 31, 2005 to $0.1 million in the threemonths ended March 31, 2006, representing a decrease of $0.4 million, or85.7%. The decrease was due primarily to an increase in interest income ondeposits, representing $0.3 million, lower interest expenses on loans,representing $0.1 million, partially offset by the effects of foreign exchangerate changes as moderated by our hedging of foreign currencies, representing($49,000). We use certain forward foreign currency exchange contracts to hedgeour exposure against foreign currencies which differ from the local functionalcurrencies.

#### ***Other expenses, net***

Other expenses, net, increased from no expenses in thethree months ended March 31, 2005 to $39,000 in the three months ended March 31,2006. This change was not significant.

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

Our taxes on income increased from $0.6 million in thethree months ended March 31, 2005 to $1.5 million in the three monthsended March 31, 2006, representing an increase of $0.9 million, or 143.8%.This increase was primarily attributable to the increase in our income beforetaxes, representing $0.4 million, and a lower utilization of tax loss carryforwards compared to the year-ago period, representing $0.5.

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

Equity in net losses of affiliates decreased from$2,000 for the three months ended March 31, 2005 to zero in the threemonths ended March 31, 2006. This change was not significant.

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

Minority interests in losses of a subsidiary changedfrom losses of $0.1 million in the three months ended March 31, 2005 to noearnings in the three months ended March 31, 2006. This change was notsignificant.

27

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

Net income increased from $4.9 million in the threemonths ended March 31, 2005 to $6.3 million in the three months ended March 31,2006, representing an increase of $1.4 million, or 28.6%. The increase in net incomewas due primarily to our increase in operating income of $2.0 million and ourdecrease in financial expenses of $0.4 million, partially offset by ourincrease in taxes on income of $0.9 million.

### **Resultsby Business Segment**

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

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

Our operating segments are:

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

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

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

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

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

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

The table below presents financial information for ourfive reportable segments (dollars in thousands). Prior period data is presentedon a pro forma basis, as we were not organized into SFAS No. 131 operatingsegments at that time.

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| ** **                                   | ** ** | **Revenues**                                     | ** ** | **Operating Income**                        | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **Three months ended  March 31,** | ** ** | **Three months ended  March 31,** | ** ** |
| ** **                                   | ** ** | **2005**                                         | ** ** | **2006**                                         | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(unaudited)**                                  | ** ** | **(unaudited)**                                  | ** ** |
| ** **                                   | ** ** | ** **                                       | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Managed  Strategic Services (MSS)            |       | $                                                | 19,623     |                                             | $          | 22,101 |   | $ | 1,883 |   | $ | 2,939 |   |
| Technologies &  Systems Group (TSG) |       | 11,647                                           |       | 12,296                                           |       | 1,640 |   | 1,861 |   |
| Ness Europe                                  |       | 7,652                                            |       | 18,439                                           |       | 797 |   | 1,513 |   |
| Ness Israel                                  |       | 42,678                                           |       | 44,009                                           |       | 3,217 |   | 2,621 |   |
| Other                                        |       | 6,805                                            |       | 10,197                                           |       | (321 | ) | 461 |   |
| Unallocated  Expenses                        |       | —                                           |       | —                                           |       | (1,361 | ) | (1,490 | ) |
|                                         |       | $                                                | 88,405     |                                             | $          | 107,042 |   | $ | 5,855 |   | $ | 7,905 |   |

 

### **Liquidityand Capital Resources**

#### ***Overview***

As of March 31, 2006, we had cash, cashequivalents and short-term bank deposits of $57.8 million compared to $73.1million as of December 31, 2005. The funds held at locations outside ofthe United States are for future operating expenses, and we have no intentionof repatriating those funds. We are not, however, restricted in repatriatingthose funds back to the United States, if necessary. While we expect that cashgenerated by our non-U.S. subsidiaries will be reinvested in their respectivecountries to support expansion of our business, to the extent that funds wereremitted to the United States in the form of dividend payments, those paymentsmay be subject to withholding taxes in their respective countries, and would besubject to tax in the United States.

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

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

 

|                                                               | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Net cash  provided by (used in) operating activities          |       | $                                                | 2,495      |   | $ | (14,831 | ) |
| Net cash used in  investing activities                        |       | (2,465                                           | )          | (3,155 | ) |
| Net cash provided  by financing activities                    |       | 6,482                                            |       | 15,619 |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | (2,018                                           | )          | 26 |   |
| Increase  (decrease) in cash and cash equivalents             |       | 4,494                                            |       | (2,341 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 104,229                                          |       | 33,579 |   |
| Cash and cash  equivalents at the end of the period           |       | $                                                | 108,723    |   | $ | 31,238 |   |

* *

*Three months ended March 31,2006 compared to the three months ended March 31, 2005*

Net cash used in operating activities was $14.8million in the three months ended March 31, 2006, compared to net cashprovided by operating activities of $2.5 million in the three months ended March 31,2005. The major factors contributing to the change were an increase in taxpayments to the Israeli Tax Authority, representing $7.2 million, a decrease intrade payables in our Ness Europe segment associated with the entities itacquired in 2005, representing $6.8 million, and an increase in our unbilledreceivables due to large fixed price government and defense projects currentlybeing executed, representing $3.8 million, offset by a decrease in tradereceivables of $6.1 million and our increase in net income of $1.4 million. Thedecrease in trade receivables would have been approximately $6.0 millionlarger, if not for the pre-election delay in the Israeli government’s approvalof its 2006 budget.

Net cash used in investing activities was $3.2 millionin the three months ended March 31, 2006, compared with $2.5 million inthe three months ended March 31, 2005. The major factors contributing to theincrease were

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payments in respect of the acquisitions we made duringthe first quarter, representing $13.6 million, net of cash acquired, andcapital expenditures associated with our acquisitions in Eastern Europe,representing $0.8 million, offset by the sale of short-term bank deposits,representing $12.6 million.

Net cash provided by financing activities was $15.6million in the three months ended March 31, 2006, compared with $6.5million in the three months ended March 31, 2005. The change was primarilydue to an increase in short-term bank loans and credit, representing $13.7million, offset by lower proceeds from employee exercises of stock options,representing $4.5 million.

The effect of exchange rate changes on cash and cashequivalents was $26,000 in the three months ended March 31, 2006, comparedto ($2.0) million in the three months ended March 31, 2005. The change wasprimarily due to long-term inter-company balances, representing $2.2 million.

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

At March 31, 2006, we had aggregate short-termand long-term bank and other borrowings of $47.1 million, consisting of variousnotes denominated in dollars and NIS (linked to index) with interest ratesranging from approximately 4.5% to 7.5% and a weighted average interest rate ofapproximately 6.75%, with maturities of one to four years. These aggregate bankborrowings included $21.1 million from Bank Hapoalim, with an interest rate ofapproximately 4.5% and maturity of one year; $7.1 million from Israel DiscountBank, with interest rates of approximately 5.9% to 7.5% and maturities of oneto three years; $5.8 million from Bank Leumi, with an interest rate ofapproximately 5.9% and maturity of one year; and $11.2 million from four otherlenders, in amounts ranging from $1.0 million to $8.1 million, with interestrates of approximately 5.8% to 7.0% and maturities of up to four years. Themaximum interest rate for our dollar-linked borrowings was approximately 4.5%,and for NIS index linked borrowings was approximately 7.5%.

At March 31, 2006, we had net cash position of$12.3 million, compared to $41.6 as of December 31, 2005. Despite thisreduction in net cash, we have been able to reduce our financial expensessequentially.

Our only materialindebtedness is amounts owed by Ness Technologies Holdings Ltd., one of oursubsidiaries, to Bank Hapoalim and Israel Discount Bank. The shares of two ofour Israeli subsidiaries are pledged to these banks as security for borrowingsunder the agreements. We are currently the process of canceling the pledges onthese shares. The relevant debt instruments contain customary restrictivecovenants relating to the borrower and our wholly-owned subsidiary Ness A.T.Ltd., including the following:

·                  limitations on incurring debt;

·                  prohibition on pledging assets;

·                  prohibition on distributing dividends;

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

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

·                  limitations on merging or transferring assets.

In addition, the Israel Discount Bank agreementrequires that the net cash and liquid assets of the borrower must not be lowerthan $18.0 million. As of March 31, 2006, we are in compliance and expectto remain in compliance with all of our covenants. Our failure to comply withthese covenants could lead to an event of default under the agreementsgoverning some or all of the indebtedness, permitting the applicable lender toaccelerate all borrowings under the applicable agreement, and to foreclose onany collateral.

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

We intend to fund future growth through cash flow fromoperations, available bank borrowings and the remaining net proceeds of ourinitial public offering. We believe the remaining balance of the proceeds ofour initial public offering, together with borrowings and cash flow fromoperations, will be sufficient to fund

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continuing operations for the foreseeable future. Inorder to achieve our strategic business objectives, we may be required to seekadditional financing. For example, future acquisitions may require additionalequity and/or debt financing. In addition, we may require further capital tocontinue to develop our technology and infrastructure and for working capitalpurposes. These financings may not be available on acceptable terms, or at all.

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

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

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

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

We have direct operations in 15 different countriesand relationships in many other parts of the world. Our foreign operationscontract with clients in their applicable local currencies or dollars. As aresult, we are subject to adverse movements in foreign currency exchange ratesin those countries where we conduct business. Beginning in the second quarterof 2005, we entered into certain forward foreign currency exchange contracts tohedge our exposure against foreign currencies which differ from the localfunctional currencies. In the future, we may enter into additional forwardforeign currency exchange or other derivatives contracts to further hedge ourexposure to foreign currency exchange rates.

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

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

### **Evaluationof Disclosure Controls and Procedures**

As of the end of the period covered by this report,our chief executive officer and chief financial officer evaluated theeffectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended).Based on their evaluation of our disclosure controls and procedures, our chiefexecutive officer and chief financial officer, with the participation of ourmanagement, have concluded that our disclosure controls and procedures areeffectively designed to ensure that information required to be disclosed by usin the reports that we file or submit under the Securities Exchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and are operating in an effective manner.

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

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### **Changes in Internal Control**

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

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# **PART II— OTHER INFORMATION**

## ***Item 1. Legal Proceedings***

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

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

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

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

Not applicable.

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

None.

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

None.

## ***Item 5. Other Information***

On May 8, 2006, we amended our employmentagreement with Aharon Fogel, the chairman of our board of directors. Effective May 8,2006, Mr. Fogel is entitled to receive twelve months’ prior notice if weterminate or choose not to renew his employment agreement, and he must providetwelve months’ prior notice if he terminates or chooses not to renew theagreement.

## ***Item 6. Exhibits***

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

| Exhibit Number | ** ** | **Description**                                                                                                                                                |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | Amendment to Employment Agreement, effective as of  May 8, 2006, between the Registrant and Aharon Fogel.                                                 |
|                |       |                                                                                                                                                           |
| 31.1                |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|                |       |                                                                                                                                                           |
| 31.2                |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|                |       |                                                                                                                                                           |
| 32.1                |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                           |
| 32.2                |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

#  

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# **SIGNATURES**

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

NESS TECHNOLOGIES, INC.(Registrant)
| Date: May 9, 2006  | By:    | /s/ RAVIV ZOLLER                               |
|-------------------------|--------|------------------------------------------------|
|                    |   | Raviv Zoller                                   |
|                    |   | Chief Executive  Officer, President, Director  |
|                    |   | (Principal  executive officer)                 |
|                    |   |                                           |
|                    |   |                                           |
| Date: May 9,  2006 | By:    | /s/ YTZHAK EDELMAN                             |
|                    |   | Ytzhak Edelman                                 |
|                    |   | Chief Financial  Officer and deputy to the CEO |
|                    |   | (Principal  financial and accounting officer)  |

#  

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# **EXHIBITINDEX**

| Exhibit Number | ** ** | **Description**                                                                                                                                                |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | Amendment to Employment Agreement, effective as of  May 8, 2006, between the Registrant and Aharon Fogel.                                                 |
|                |       |                                                                                                                                                           |
| 31.1                |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|                |       |                                                                                                                                                           |
| 31.2                |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|                |       |                                                                                                                                                           |
| 32.1                |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                           |
| 32.2                |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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