**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 

**(Mark One)**

 

**ý****     ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2005**

 

** ̈****     ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from              to              **

 

**Commission File Number 000-50954**

 

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**NESSTECHNOLOGIES, INC.**

(Exact name 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-Tech Industrial Park  Building 4  Tel Aviv 61580, Israel  Telephone: +972 (3) 766-6800**          |
| **(Address of registrant’s principal executive offices and  registrant’s telephone number, including area code)** |

 

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

 

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

 

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

 

Indicated below is the number of shares outstanding of the registrant’sstock at November 7, 2005:

 
| **Title of Class**             | ** ** | **Number of Shares Outstanding** | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| Common  Stock, $0.01 par value |       | 34,690,447                       |       |

 

 

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**NESS TECHNOLOGIES, INC. AND SUBSIDIARIES**

 

**INDEX**

 
| PART I – FINANCIAL INFORMATION                                                                           |   |
|---------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                          |   |
| Item 1. Financial Statements                                                                                  |   |
| Consolidated Balance Sheets – December 31,  2004 and September 30, 2005 (Unaudited)                      |   |
| Consolidated Statements of Income – Three  and nine months ended September 30, 2004 and 2005 (Unaudited) |   |
| Consolidated Statements of Cash Flows –  Nine months ended September 30, 2004 and 2005 (Unaudited)       |   |
| Notes to Interim Condensed Consolidated  Financial Statements – September 30, 2005 (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 September 30, 2005  Compared to the Three Months Ended September 30, 2004                  |   |
| Nine Months Ended September 30, 2005  Compared to the Nine Months Ended September 30, 2004                    |   |
| 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 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***

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

**InterimCondensed Consolidated Balance Sheets**

**U.S. dollars inthousands**

 
| ** **                                                                                                                                              | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                                                                                                                              | ** ** | **2004**         | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                              | ** ** | ** **       | ** ** | **(Unaudited)**   | ** ** |
| ASSETS                                                                                                                                                  |       |             |       |              |       |
|                                                                                                                                                    |       |             |       |              |       |
| CURRENT ASSETS:                                                                                                                                         |       |             |       |              |       |
| Cash and cash equivalents                                                                                                                               |       | $                | 104,229    |              | $          | 74,303 |   |
| Marketable securities                                                                                                                                   |       | 383              |       | 5,212             |       |
| Trade receivables (net of allowance for  doubtful accounts of $2,154 and $2,111 at December 31, 2004 and September 30,  2005 (unaudited), respectively) |       | 75,183           |       | 87,059            |       |
| Unbilled receivables                                                                                                                                    |       | 20,327           |       | 28,956            |       |
| Other accounts receivable and prepaid  expenses                                                                                                         |       | 9,127            |       | 10,117            |       |
| Inventories and work in progress                                                                                                                        |       | 1,168            |       | 2,446             |       |
|                                                                                                                                                    |       |             |       |              |       |
| Total current assets                                                                                                                                    |       | 210,417          |       | 208,093           |       |
|                                                                                                                                                    |       |             |       |              |       |
| LONG-TERM ASSETS:                                                                                                                                       |       |             |       |              |       |
| Long-term prepaid expenses                                                                                                                              |       | 3,655            |       | 5,032             |       |
| Marketable securities                                                                                                                                   |       | 69               |       | 34                |       |
| Deferred income taxes                                                                                                                                   |       | 4,823            |       | 6,112             |       |
| Severance pay fund                                                                                                                                      |       | 33,558           |       | 34,575            |       |
|                                                                                                                                                    |       |             |       |              |       |
| Total long-term assets                                                                                                                                  |       | 42,105           |       | 45,753            |       |
|                                                                                                                                                    |       |             |       |              |       |
| PROPERTY AND EQUIPMENT, NET                                                                                                                             |       | 18,879           |       | 20,874            |       |
|                                                                                                                                                    |       |             |       |              |       |
| OTHER INTANGIBLE ASSETS, NET                                                                                                                            |       | 4,265            |       | 6,365             |       |
|                                                                                                                                                    |       |             |       |              |       |
| GOODWILL                                                                                                                                                |       | 149,090          |       | 150,083           |       |
|                                                                                                                                                    |       |             |       |              |       |
| Total assets                                                                                                                                            |       | $                | 424,756    |              | $          | 431,168 |   |

 

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

 

3

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

**Interim Condensed Consolidated Balance Sheets**

**U.S. dollars inthousands (except share and par value data)**

 
| ** **                                                                                                                                                                                                                                             | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                             | ** ** | **2004**         | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                                                                                                                             | ** ** | ** **       | ** ** | **(Unaudited)**   | ** ** |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                              |       |             |       |              |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                   |       |             |       |              |       |
| Short-term bank credit                                                                                                                                                                                                                                 |       | $                | 1,275      |              | $          | 7,096 |   |
| Current maturities of long-term debt                                                                                                                                                                                                                   |       | 13,364           |       | 28,550            |       |
| Trade payables                                                                                                                                                                                                                                         |       | 31,280           |       | 22,122            |       |
| Advances from customers                                                                                                                                                                                                                                |       | 7,679            |       | 3,713             |       |
| Other accounts payable and accrued expenses                                                                                                                                                                                                            |       | 64,271           |       | 72,511            |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| Total current liabilities                                                                                                                                                                                                                              |       | 117,869          |       | 133,992           |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                 |       |             |       |              |       |
| Long-term debt, net of current maturities                                                                                                                                                                                                              |       | 36,918           |       | 9,027             |       |
| Excess of losses over investment in  affiliates                                                                                                                                                                                                        |       | 306              |       | 304               |       |
| Accrued severance pay                                                                                                                                                                                                                                  |       | 36,888           |       | 38,272            |       |
| Minority interests                                                                                                                                                                                                                                     |       | 295              |       | —            |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| Total long-term liabilities                                                                                                                                                                                                                            |       | 74,407           |       | 47,603            |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| COMMITMENTS  AND CONTINGENT LIABILITIES                                                                                                                                                                                                                |       |             |       |              |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                             |       |             |       |              |       |
| Common stock of $0.01 par value -  Authorized: 76,500,000 shares at December 31, 2004 and at September 30, 2005  (unaudited); issued and  outstanding: 32,772,578 shares at December 31, 2004 and 34,675,942 shares at  September 30, 2005 (unaudited) |       | 328              |       | 347               |       |
| Additional paid-in capital                                                                                                                                                                                                                             |       | 270,967          |       | 282,005           |       |
| Deferred stock compensation                                                                                                                                                                                                                            |       | (152             | )          | (25               | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                   |       | (2,045           | )          | (11,067           | )          |
| Accumulated deficit                                                                                                                                                                                                                                    |       | (36,618          | )          | (21,692           | )          |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| Total stockholders’ equity                                                                                                                                                                                                                        |       | 232,480          |       | 249,573           |       |
|                                                                                                                                                                                                                                                   |       |             |       |              |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                        |       | $                | 424,756    |              | $          | 431,168 |   |

 

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

 

4

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**InterimCondensed Consolidated Statements of Income**

**U.S. dollars inthousands (except per share data)**

 
| ** **                                                                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                              | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **(Unaudited)**                       | ** ** | **(Unaudited)**                            | ** ** |
| ** **                                                                   | ** ** | ** **                            | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                                     |       | $                                     | 77,152     |                                       | $          | 97,719 |   | $ | 222,177 |   | $ | 280,342 |   |
| Cost of revenues (*)                                                         |       | 53,969                                |       | 69,882                                     |       | 154,602 |   | 200,310 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts           |       | 26                                    |       | (254                                       | )          | (459 | ) | (156 | ) |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Gross profit                                                                 |       | 23,157                                |       | 28,091                                     |       | 68,034 |   | 80,188 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Operating expenses:                                                          |       |                                  |       |                                       |       |   |   |   |   |
| Selling and marketing                                                        |       | 6,822                                 |       | 7,081                                      |       | 18,952 |   | 21,114 |   |
| General and administrative (*)                                               |       | 10,888                                |       | 13,268                                     |       | 33,951 |   | 38,663 |   |
| Stock-based compensation                                                     |       | 57                                    |       | 76                                         |       | 191 |   | 1,973 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Total operating expenses                                                     |       | 17,767                                |       | 20,425                                     |       | 53,094 |   | 61,750 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Operating income                                                             |       | 5,390                                 |       | 7,666                                      |       | 14,940 |   | 18,438 |   |
| Financial expenses, net                                                      |       | (1,177                                | )          | (383                                       | )          | (4,327 | ) | (1,297 | ) |
| Other income (expenses), net                                                 |       | (16                                   | )          | (14                                        | )          | 79 |   | (10 | ) |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Income before taxes on income                                                |       | 4,197                                 |       | 7,269                                      |       | 10,692 |   | 17,131 |   |
| Taxes on income                                                              |       | 473                                   |       | 1,252                                      |       | 958 |   | 2,277 |   |
| Equity in net losses of affiliates                                           |       | (3                                    | )          | —                                     |       | (651 | ) | (29 | ) |
| Minority interests in losses (earnings) of  a subsidiary                     |       | (30                                   | )          | —                                     |       | (65 | ) | 101 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Net income                                                                   |       | $                                     | 3,691      |                                       | $          | 6,017 |   | $ | 9,018 |   | $ | 14,926 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Allocation of undistributed earnings on  Class B Convertible Preferred stock |       | $                                     | (554       | )                                          | $          | — |   | $ | (1,356 | ) | $ | — |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Net income after allocation of  undistributed earnings                       |       | $                                     | 3,137      |                                       | $          | 6,017 |   | $ | 7,662 |   | $ | 14,926 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Basic net earnings per share                                                 |       | $                                     | 0.16       |                                       | $          | 0.17 |   | $ | 0.40 |   | $ | 0.43 |   |
|                                                                         |       |                                  |       |                                       |       |   |   |   |   |
| Diluted net earnings per share                                               |       | $                                     | 0.14       |                                       | $          | 0.17 |   | $ | 0.36 |   | $ | 0.42 |   |

 

----

(*)   Expenses excluding stock-based compensation are as follows:

 
| ** **                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2004**                              | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                  | ** ** | **(Unaudited)**                       | ** ** | **(Unaudited)**                      | ** ** |
|                        |       |                                  |       |                                 |       |   |   |   |   |
| Cost of  revenues           |       | $                                     | —     |                                 | $          | — |   | $ | — |   | $ | 98 |   |
| General and  administrative |       | 57                                    |       | 76                                   |       | 191 |   | 1,875 |   |
|                             |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |

 

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

 

5

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**InterimCondensed Consolidated Statements of Cash Flows**

**U.S. dollars in thousands**

 
| ** **                                                                                            | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                            | ** ** | **2004**                             | ** ** | **2005** | ** ** |
| ** **                                                                                            | ** ** | **(Unaudited)**                      | ** ** |
| Cash flows  from operating activities:                                                                |       |                                 |       |   |   |
| Net income                                                                                            |       | $                                    | 9,018      |   | $ | 14,926 |   |
| Adjustments required to reconcile net  income to net cash provided by (used in) operating activities: |       |                                 |       |   |   |
| Amortization of deferred stock compensation  related to Ness GSG acquisition                          |       | 159                                  |       | 118 |   |
| Stock-based compensation related to  warrants granted to banks                                        |       | 32                                   |       | 11 |   |
| Stock-based compensation related to  redeemable options                                               |       | —                               |       | 1,956 |   |
| Equity in net losses of affiliates                                                                    |       | 651                                  |       | 29 |   |
| Minority interests in losses (earnings) of  a subsidiary                                              |       | 65                                   |       | (101 | ) |
| Currency fluctuation of long-term debt                                                                |       | 1,882                                |       | 2,281 |   |
| Accrued interest on long-term debt                                                                    |       | (542                                 | )          | (634 | ) |
| Depreciation and amortization                                                                         |       | 3,691                                |       | 6,448 |   |
| Deferred income taxes, net                                                                            |       | (784                                 | )          | (1,412 | ) |
| Loss on sale of property and equipment                                                                |       | 31                                   |       | 21 |   |
| Trading marketable securities, net                                                                    |       | 19                                   |       | (214 | ) |
| Increase in trade receivables                                                                         |       | (11,590                              | )          | (15,561 | ) |
| Increase in unbilled receivables                                                                      |       | (4,589                               | )          | (10,271 | ) |
| Decrease (increase) in other accounts  receivable and prepaid expenses                                |       | (770                                 | )          | 23 |   |
| Decrease (increase) in inventories and work  in progress                                              |       | 370                                  |       | (1,231 | ) |
| Increase in long-term prepaid expenses                                                                |       | (1,337                               | )          | (1,666 | ) |
| Increase (decrease) in trade payables                                                                 |       | 1,174                                |       | (9,308 | ) |
| Decrease in advances from customers                                                                   |       | (428                                 | )          | (3,608 | ) |
| Increase in other accounts payable and  accrued expenses                                              |       | 7,126                                |       | 8,212 |   |
| Increase in accrued severance pay, net                                                                |       | 742                                  |       | 598 |   |
|                                                                                                  |       |                                 |       |   |   |
| Net cash provided by (used in) operating  activities                                                  |       | 4,920                                |       | (9,383 | ) |
|                                                                                                  |       |                                 |       |   |   |
| Cash flows from investing activities:                                                                 |       |                                 |       |   |   |
| Net cash paid for acquisition of  consolidated subsidiaries (a)                                       |       | —                               |       | (4,364 | ) |
| Cash in a subsidiary at the time it ceased  being consolidated                                        |       | (168                                 | )          | — |   |
| Acquisition of minority interest in a  subsidiary (b)                                                 |       | —                               |       | — |   |
| Proceeds from sale of short-term bank  deposits                                                       |       | 2,920                                |       | — |   |
| Proceeds from sale of marketable  securities                                                          |       | —                               |       | 387 |   |
| Acquisition of available-for-sale  marketable securities                                              |       | —                               |       | (5,202 | ) |
| Proceeds from sale of property and  equipment                                                         |       | 540                                  |       | 149 |   |
| Purchase of property and equipment and  capitalization of software developed for internal use         |       | (8,491                               | )          | (6,012 | ) |
| Capitalization of software development  costs                                                         |       | (2,030                               | )          | (1,633 | ) |
| Other                                                                                                 |       | (61                                  | )          | — |   |
|                                                                                                  |       |                                 |       |   |   |
| Net cash used in investing activities                                                                 |       | (7,290                               | )          | (16,675 | ) |
|                                                                                                       |            |                                      |            |  |  |  |  |

 

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

 

6

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Interim Condensed Consolidated Statements of Cash Flows**

**U.S. dollars in thousands**

 
| ** **                                                    | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                             | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(Unaudited)**                      | ** ** |
| Cash flows from financing activities:                         |       |                                 |       |   |   |
| Exercise of options and warrants                              |       | $                                    | 43         |   | $ | 9,132 |   |
| Short-term bank loans and credit, net                         |       | 10,214                               |       | 5,116 |   |
| Proceeds from long-term debt                                  |       | 10,765                               |       | 21,216 |   |
| Principal payments of long-term debt                          |       | (23,158                              | )          | (34,345 | ) |
|                                                          |       |                                 |       |   |   |
| Net cash provided by (used in) financing  activities          |       | (2,136                               | )          | 1,119 |   |
|                                                          |       |                                 |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents |       | (791                                 | )          | (4,987 | ) |
|                                                          |       |                                 |       |   |   |
| Decrease in cash and cash equivalents                         |       | (5,297                               | )          | (29,926 | ) |
| Cash and cash equivalents at the beginning  of the period     |       | 46,004                               |       | 104,229 |   |
|                                                          |       |                                 |       |   |   |
| Cash and cash equivalents at the end of the  period           |       | $                                    | 40,707     |   | $ | 74,303 |   |
|                                                          |       |                                 |       |   |   |
| Supplemental disclosures of cash flows  information:          |       |                                 |       |   |   |
|                                                          |       |                                 |       |   |   |
| Cash paid during the period for:                              |       |                                 |       |   |   |
| Interest                                                      |       | $                                    | 2,573      |   | $ | 895 |   |
|                                                          |       |                                 |       |   |   |
| Taxes                                                         |       | $                                    | 661        |   | $ | 897 |   |

 

----

(a)        Inconjunction with the acquisitions, the fair values of the assets acquired andliabilities assumed at the dates of related acquisitions were as follows:

 
| Capital  deficiency, net (excluding cash and cash equivalents) |   | $      | (1,859 | )      |
|----------------------------------------------------------------|--------|--------|--------|--------|
| Property and  equipment                                        |   | 2,353  |   |
| Long-term  loans and convertible loan                          |   | (1,601 | )      |
| Other assets                                                   |   | 48     |   |
| Goodwill                                                       |   | 3,744  |   |
| Work force                                                     |   | 1,069  |   |
| Accrued  severance pay, net                                    |   | (70    | )      |
| Customer  related intangible assets                            |   | 680    |   |
| Net cash  paid for acquisitions of consolidated subsidiaries   |   | $      | 4,364  |   |

 

(b)        Inconjunction with the acquisition of the minority interest in a subsidiary in2005, the fair values of the assets acquired and liabilities assumed at thedate of acquisition were as follows:

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

 

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

 

7

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

**Notesto Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

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

 

Ness Technologies, Inc. was incorporated under the laws of the State ofDelaware, in March 1999.  We operatethrough our subsidiaries in Israel, the United States, Europe and Asia.

 

We are a global provider of information technology (“IT”) services andsolutions designed to help clients improve their competitiveness andeffectiveness. Our portfolio of solutions and services includes systemintegration and application development, outsourcing, software and consulting,and quality assurance and training. Offshore services and development are asignificant component of each of these categories. We and our subsidiariesprimarily serve the following vertical markets: government and defense,financial services, life sciences and healthcare, telecommunications andutilities, and independent software vendors.

 

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

 

a.     Unaudited InterimFinancial Information

 

The accompanying condensed consolidatedbalance sheet as of September 30, 2005, the condensed consolidated statementsof income for the three and nine months ended September 30, 2004 and 2005, andthe condensed consolidated statements of cash flows for the nine months endedSeptember 30, 2004 and 2005 are unaudited. These unaudited interim condensedconsolidated financial statements have been prepared in accordance with UnitedStates generally accepted accounting principles for interim financialinformation. In the opinion of management, the unaudited interim condensedconsolidated financial statements include all adjustments of a normal recurringnature necessary for a fair presentation of our consolidated financial positionas of September 30, 2005, our consolidated results of operations for the threeand nine months ended September 30, 2004 and 2005, and our consolidated cashflows for the nine months ended September 30, 2004 and 2005.

 

The balance sheet at December 31, 2004 hasbeen derived from the audited consolidated financial statements at that datebut does not include all of the information and footnotes required by U. S. generallyaccepted accounting principles for complete financial statements.

 

These consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and accompanying notes for the year ended December 31, 2004 includedin our Annual Report on Form 10-K filed with the U.S. Securities and ExchangeCommission (“SEC”) on March 31, 2005.

 

Results for the three and nine months endedSeptember 30, 2005 are not necessarily indicative of results that may beexpected for the year ending December 31, 2005.

 

Unless otherwise noted, (1) all references to“dollars” or “$” are to United States dollars and all references to “NIS” areto New Israeli Shekels and (2) all references to shares of our common stock andper share information 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 inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Actual results could differ fromthose estimates.

 

8

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

c.     Financial statements inU.S. dollars

 

Our subsidiaries’ transactions are recordedin local currencies. We have designated the U.S. dollar as the primaryfunctional currency of our operations in the United States, the NIS as theprimary functional currency of our subsidiaries’ operations in Israel, andlocal currencies as the primary functional currencies of our operationselsewhere. Accordingly, for all subsidiaries of which the dollar is thefunctional currency, monetary accounts maintained in other currencies arere-measured into U.S. dollars, in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 52 “Foreign Currency Translation.” Alltransaction gains and losses of the re-measured monetary balance sheet itemsare reflected in the statements of income as financial income or expenses, asappropriate.

 

For those foreign subsidiaries whosefunctional currency has been determined to be their local currency, assets andliabilities are translated at period-end exchange rates and statements of incomeitems are translated at average exchange rates prevailing during that period.Such translation adjustments are recorded as a separate component ofaccumulated other comprehensive income (loss) in stockholders’ equity.

 

The financial statements of affiliatesreported using the equity method of accounting, whose functional currency hasbeen determined to be their local currency, have been translated into dollars.All balance sheet accounts have been translated using the exchange rates ineffect at the balance sheet date. Statements of income amounts have beentranslated using the average exchange rate for the period. The resultingaggregate translation adjustments are reported as a separate component ofaccumulated other comprehensive income (loss) in stockholders’ equity.

 

d.     Principles ofconsolidation

 

Our consolidated financial statements includethe accounts of the company and its wholly and majority owned subsidiaries, orthe group. Inter-company transactions and balances, including profit frominter-company sales not yet realized outside the group, have been eliminated inconsolidation.

 

e.     Acquisition ofsubsidiaries

 

1.    NessU.S.A. Inc. (“Ness U.S.A.”)

 

On October 25, 2001, we and other investorsincorporated Ness U.S.A., a corporation incorporated under the laws of theState of Delaware, for the purpose of acquiring certain assets and assumingcertain liabilities of Blueflame Inc. (“Blueflame”) out of Blueflame’s chapter11 bankruptcy proceeding. On the date of incorporation, we held 68% of theoutstanding common stock of Ness U.S.A. and other investors held the remaining32% of the outstanding common stock of Ness U.S.A. On November 1, 2001, NessU.S.A. acquired these assets with a fair market value of approximately $6,656 forcash consideration and related purchase costs totaling approximately $5,140.The transaction was accounted for by the purchase method of accountingaccording to SFAS No. 141, “Business Combinations.”

 

Ness U.S.A. is a full-service business andadvanced technology solutions provider to the life sciences, financialservices, telecommunications and other industries. Ness U.S.A. offers technicaland management consulting services intended to create business improvements bybuilding integrated business process and technology solutions to strategicproblems.

 

9

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

In addition to the consideration paid atclosing, we agreed to the following contingent payments:

 

a)     An amount equal to 50% of thepre-closing accounts receivable actually collected by us in excess of $6,000net of prepayments.

 

b)    Payment of a contingentpromissory note in the amount of $750, following the occurrence of the earlierof the following two events:

 

(1)   The sum of $750, if Ness U.S.A.’sannual EBITDA, as defined in the asset purchase agreement relating to theacquisition, in each of any two calendar years during the period commencing onJanuary 1, 2002 and ending December 31, 2005 exceeds $5,000; or

 

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

 

(i)       ifthe qualifying transaction occurred prior to December 31, 2003, the contingentpayment would have been equal to the aggregate consideration in excess of $4,500,but not more than $750.

 

(ii)      ifthe qualifying transaction occurred after December 31, 2003 but prior toJanuary 1, 2005, the contingent payment would have been equal to $650, unlessthe consideration for such qualifying transaction was in excess of $6,600, inwhich case the contingent payment would have been equal to $750.

 

(iii)     ifthe qualifying transaction occurs after December 31, 2004 but prior to January1, 2006, the contingent payment will be equal to $550, unless the considerationfor such qualifying transaction is equal to or in excess of $7,500, in whichcase the contingent payment will be equal to $750.

 

As the purchase price was lower than the fairmarket value of the net assets acquired, but is subject to contingent payment,we recorded at the date of acquisition, the lesser of the maximum amount ofcontingent consideration or the excess over cost as if it were a liability,until the consideration contingency is resolved.

 

In respect of the contingent promissory note,a liability in the amount of $750 was recorded among long-term liabilities andas of December 31, 2004 and September 30, 2005, the liability was classified incurrent liabilities.

 

On December 27, 2002, we acquired additionalstock of Ness U.S.A. from certain of the employees and other private investorsso that, as of December 31, 2003, we held 86% of Ness U.S.A.’s common stock.The acquisition was accounted for under the purchase method of accountingaccording to SFAS No. 141. The total consideration of $5,001 (including $323 intransaction costs) for the shares purchased consisted of the issuance of647,170 shares of our common stock, valued at a fair value of $4,678.

 

Under the securities exchange agreement, weagreed to offer the remaining stockholders of Ness U.S.A. shares of commonstock in exchange for their shares of Ness U.S.A. at the same exchange ratioused in the December 2002 exchange on the earliest date practicable afterreceiving a no-action

 

10

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

letter from the Securities and ExchangeCommission or completing an initial public offering of our common stock.

 

On November 12, 2004, we filed a Form S-4Registration Statement in respect of an exchange offer for the remaining sharesof Ness U.S.A. The offer commenced on January 31, 2005 and ended on February28, 2005. 96 of 98 offerees accepted the offer bringing our holdings in NessU.S.A. following the offer to 99.9%. On March 1, 2005, we issued 260,316 sharesto the offerees, for the consideration of $3,532 (including $113 in transactioncosts). The acquisition was accounted for under the purchase method ofaccounting according to SFAS No. 141.

 

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

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

 

The allocation of the purchase pricereflected in the September 30, 2005 condensed consolidated balance sheet ispreliminary. We have arranged to obtain a valuation of Ness U.S.A.’s currentassets, current liabilities, long-term tangible assets, property and equipmentand intangible assets. Management expects to obtain such completed reportduring the fourth quarter of 2005.

 

2.     NessGSG Inc.

 

Effective June 30, 2003, we acquired throughmerger all of the outstanding stock of Ness GSG Inc. (formerly, Apar HoldingCorp.), or Ness GSG, for the purpose of expanding our IT services

 

11

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

capabilities. Ness GSG was incorporated underthe laws of the Commonwealth of Pennsylvania, with operations, through itssubsidiaries, in Asia, the United States and Europe. The Ness GSG subsidiariesspecialize in hardware and software consulting. Some of our principalstockholders, who owned approximately 53% of the outstanding common stock ofNess GSG prior to the acquisition, received 3,955,169 shares of our commonstock upon the closing of the merger.

 

Pursuant to the merger agreement, we agreedto issue additional shares of common stock to the stockholders of Ness GSG ifand when we issued shares of common stock in exchange for the remaining sharesof Ness U.S.A. We agreed to issue the number of shares of our common stocknecessary to preserve the ownership percentage of the former stockholders ofNess GSG at the same percentage ownership they held prior to the issuance ofsuch shares to the remaining stockholders of Ness U.S.A., in exchange for theirNess U.S.A. shares. Subsequent to the completion of the Ness U.S.A. exchangeoffer, on March 2, 2005, we issued to the former stockholders of Ness GSG89,305 additional shares of our common stock pursuant to the terms of themerger agreement. These shares were recorded at their aggregate par value andreduced additional paid in capital in the same amount, at the date issued.

 

3.     NessRomania

 

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

 

This acquisition was accounted for under thepurchase method of accounting and, accordingly, the purchase price wasallocated to the assets acquired and liabilities assumed based on their relatedfair values.  We have allocated the totalcost of the acquisition to Ness Romania’s assets and liabilities as follows:

 

12

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 
| ** **                                   | ** ** | **April 1, 2005** | ** ** |
|----------------------------------------------|------------|-------------------|------------|
|                                         |       |              |       |
| Cash and cash equivalents                    |       | $                 | 2,511      |   |
| Trade receivables                            |       | 933               |       |
| Inventories                                  |       | 137               |       |
| Property and equipment                       |       | 2,094             |       |
| Other accounts receivable                    |       | 97                |       |
| Intangible assets:                           |       |              |       |
| Customer relationships                       |       | 420               |       |
| Backlog                                      |       | 260               |       |
| Work force                                   |       | 730               |       |
| Goodwill                                     |       | 2,680             |       |
| Total assets acquired                        |       | 9,862             |       |
| Liabilities assumed:                         |       |              |       |
| Accounts payable and other  accrued expenses |       | 1,420             |       |
| Other current liabilities                    |       | 1,506             |       |
| Long-term liabilities                        |       | 1,551             |       |
| Total liabilities assumed                    |       | 4,477             |       |
| Net assets acquired                          |       | $                 | 5,385      |   |

 

The allocation of the purchase pricereflected in the September 30, 2005 condensed consolidated balance sheet ispreliminary. We have arranged to obtain a valuation of Ness Romania’s currentassets, current liabilities, long-term liabilities, property and equipment andintangible assets.  Management expects toobtain such completed report during the fourth quarter of 2005.

 

Pro forma information in accordance with SFASNo. 141 has not been provided, since the revenues and net income of NessRomania were not material in relation to our total consolidated revenues and netincome.

 

4.     NessDM a.s.

 

On June 1, 2005, we acquired all of theoutstanding shares of Efcon a.s. (“Efcon”), a provider of IT services andsolutions based in the Czech Republic. The purchase price was €0.6 million, or $0.8 million, consisting of€350,000 paid at closing and €250,000 payable within 55 days contingent on theverification of the accuracy of certain representations made by thesellers.  An additional payment of up to€1.2 million is required to be made in April 2006 based on achievement ofcertain 2005 performance goals.  Up to€400,000 of the April 2006 amount may be advanced if certain interimperformance goals are met.  Efcon becamea wholly-owned subsidiary of Ness Czech s.r.o., a part of our Ness Europegroup, and, accordingly, its results of operations have been included in ourconsolidated financial statements since the acquisition date.  Following the acquisition, Efcon changed itsname to Ness DM a.s.  In January 2006, weintend for it to be an integral division of Ness Czech s.r.o.

 

This acquisition was accounted for under thepurchase method of accounting and, accordingly, the purchase price wasallocated to the assets acquired and liabilities assumed based on their relatedfair values.  We have allocated the totalcost of the acquisition to Ness DM’s assets and liabilities as follows: 

 

13

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

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

 

The allocation of the purchase pricereflected in the September 30, 2005 condensed consolidated balance sheet ispreliminary. We have arranged to obtain a valuation of Ness DM’s currentassets, current liabilities, long-term liabilities, property and equipment andintangible assets. Management expects to obtain such completed report duringthe fourth quarter of 2005.

 

Pro forma information in accordance with SFASNo. 141 has not been provided, since the revenues and net income of Ness DMwere not material in relation to our total consolidated revenues and netincome.

 

5.     NTR

 

On September 13, 2005, we acquired all of theoutstanding shares of N.T.R. Holding Ltd. (“NTR”), a provider of IT servicesand solutions based in Israel.  Thepurchase price was $1.35 million.  Anadditional payment of up to $0.15 million is required to be made based on achievementof certain 2005 performance goals.  NTRbecame a wholly-owned subsidiary of Ness A.T., a part of our Ness Israel group,and, accordingly, its results of operations have been included in ourconsolidated financial statements since the acquisition date.

 

This acquisition was accounted for under thepurchase method of accounting and, accordingly, the purchase price wasallocated to the assets acquired and liabilities assumed based on their relatedfair values.  We have allocated the totalcost of the acquisition to NTR’s assets and liabilities as follows: 

 

14

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 
| ** **                                   | ** ** | **September 13,  2005** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
|                                         |       |                    |       |
| Cash and cash equivalents                    |       | $                       | 173        |   |
| Trade receivables                            |       | 408                     |       |
| Property and equipment                       |       | 47                      |       |
| Other accounts receivable                    |       | 391                     |       |
| Intangible assets:                           |       |                    |       |
| Goodwill                                     |       | 1,064                   |       |
| Total assets acquired                        |       | 2,083                   |       |
| Liabilities assumed:                         |       |                    |       |
| Accounts payable and other  accrued expenses |       | 68                      |       |
| Other current liabilities                    |       | 400                     |       |
| Long-term liabilities                        |       | 265                     |       |
| Total liabilities assumed                    |       | 733                     |       |
| Net assets acquired                          |       | $                       | 1,350      |   |

 

The allocation of the purchase pricereflected in the September 30, 2005 condensed consolidated balance sheet ispreliminary. We have arranged to obtain a valuation of NTR’s current assets,current liabilities, long-term liabilities, property and equipment and intangibleassets. Management expects to obtain such completed report during the fourthquarter of 2005.

 

Pro forma information in accordance with SFASNo. 141 has not been provided, since the revenues and net income of NTR werenot material in relation to our total consolidated revenues and net income.

 

f.      Goodwill

 

We have elected to perform our analysis ofgoodwill during the fourth quarter of the year. No indications of impairmentwere identified during the three and nine months ended September 30, 2005.

 

g.     Accounting for stock-basedcompensation

 

We have elected to follow AccountingPrinciples Board Opinion (“APB”) No. 25, “Accounting for Stock Issued toEmployees” and Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”)No. 44, “Accounting for Certain Transactions Involving Stock Compensation” inaccounting for our employee stock option plans. Under APB No. 25, when theexercise price of our stock options is less than the market price of theunderlying shares on the date of grant, compensation expense is recognized.

 

We adopted the disclosure provisions of SFASNo. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,”which amended certain provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods of transition for an entity thatvoluntarily changes to the fair value based method of accounting forstock-based employee compensation, effective as of the beginning of the priorfiscal year. We continue to apply the provisions of APB No. 25 in accountingfor stock-based compensation.

 

15

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

Pro forma information regarding our netincome and net earnings per share is required by SFAS No. 123 and has beendetermined as if we had accounted for our employee stock options under the fairvalue method prescribed by SFAS No. 123.

 

The fair value for options granted in thethree and nine month periods ended September 30, 2004 and 2005 is amortizedover their vesting periods and estimated at the date of grant using theBlack-Scholes option pricing model with the following weighted averageassumptions:

 
| ** **                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **2004**                              | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                | ** ** | **(Unaudited)**                       | ** ** |
| Dividend  yield           |       | 0                                     | %          | 0                                    | %          | 0 | % | 0 | % |
| Expected  volatility      |       | 0.52                                  |       | 0.38                                 |       | 0.52 |   | 0.38 |   |
| Risk-free  interest       |       | 2.5                                   | %          | 4.25                                 | %          | 2.5 | % | 4.25 | % |
| Expected  life (in years) |       | 4                                     |       | 4                                    |       | 4 |   | 4 |   |

 

Pro forma information under SFAS No. 123 isas follows:

 
| ** **                                                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                     | ** ** | **2004**                              | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(Unaudited)**                       | ** ** |
| Net income available to common stock, as  reported                                             |       | $                                     | 3,137      |                                 | $          | 6,017 |   | $ | 7,662 |   | $ | 14,926 |   |
| Add: Allocation of undistributed earnings  on Class B Convertible Preferred Stock, as reported |       | 554                                   |       | —                               |       | 1,356 |   | — |   |
| Deduct: Pro forma allocation of  undistributed earnings on Class B Convertible Preferred Stock |       | (441                                  | )          | —                               |       | (1,022 | ) | — |   |
| Add: Stock-based employee compensation –  intrinsic value                                 |       | 54                                    |       | 76                                   |       | 159 |   | 1,973 |   |
| Deduct: Stock-based employee compensation –  fair value                                   |       | (805                                  | )          | (708                                 | )          | (2,362 | ) | (4,201 | ) |
| Pro forma net income                                                                           |       | $                                     | 2,499      |                                 | $          | 5,385 |   | $ | 5,793 |   | $ | 12,698 |   |
|                                                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Basic net earnings per share, as reported                                                      |       | $                                     | 0.16  |                                 | $          | 0.17 |   | $ | 0.40  |   | $ | 0.43 |   |
| Diluted net earnings per share, as reported                                                    |       | $                                     | 0.14  |                                 | $          | 0.17 |   | $ | 0.36  |   | $ | 0.42 |   |
|                                                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Pro forma basic net earnings per share                                                         |       | $                                     | 0.13  |                                 | $          | 0.16 |   | $ | 0.31  |   | $ | 0.37 |   |
| Pro forma diluted net earnings per share                                                       |       | $                                     | 0.11  |                                 | $          | 0.15 |   | $ | 0.27  |   | $ | 0.36 |   |

 

h.     Impact of recently issuedaccounting pronouncements

 

On December 16, 2004, the FASB issued SFASNo. 123R (revised 2004), “Share-Based Payment,” which is a revision of SFAS No.123, “Accounting for Stock-Based Compensation,” which requires companies torecognize in the statements of income, all share-based payments to employees,including grants of employee stock options, based on their fair values.Accounting for share-based compensation transactions using the intrinsic methodsupplemented by pro forma disclosures will no longer be permissible. The newstatement will be effective for public entities as of the beginning of thefirst interim or annual reporting period of the first fiscal year beginningafter June 15, 2005. We will adopt the new statement on January 1, 2006.

 

16

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

SFAS No. 123R permits public companies toadopt its requirements using one of two methods:

 

1.  A “modified prospective” methodin which compensation cost is recognized beginning with the effective date (a)based on the requirements of SFAS No. 123R for all share base payments grantedafter the effective date and (b) based on the requirements of SFAS No. 123 forall awards granted to employees prior to the effective date of SFAS No. 123Rthat remain unvested on the effective date.

 

2.  A “modified retrospective”method which includes the requirements of the modified prospective method,described above, which also permits entities to restate, based on the amountspreviously recognized under SFAS No. 123 for purposes of pro forma disclosures,either (a) all prior periods presented or (b) prior interim periods of the yearof adoption.

 

We plan to adopt SFAS No. 123R using themodified prospective method.

 

We have not yet completed our analysis of theimpact of adopting SFAS 123R and are therefore currently unable to quantify theeffect on our financial statements. However, we believe that the adoption of this new statement will have animpact on our results of operations and net earnings per share as we will berequired to expense the fair value of all share-based payments.

 

In March 2005, the SEC released StaffAccounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”).  SAB 107 provides the SEC staff position regardingthe application of SFAS No. 123R. SAB 107 contains interpretive guidance related to the interactionbetween SFAS No. 123R and certain SEC rules and regulations, as wellas provides the Staff’s views regarding the valuation of share-based paymentarrangements for public companies.  SAB107 also highlights the importance of disclosures made related to theaccounting for share-based payment transactions. We are currently reviewing theeffect of SAB 107 on our condensed consolidated financial statements as weprepare to adopt SFAS 123R.

 

In May 2005, the FASB issued FASB StatementNo. 154, “Accounting Changes and Error Corrections” (“SFAS  154”) which replaces APB Opinion No. 20, “AccountingChanges”, and FASB Statement No. 3, “Reporting Accounting Changes in InterimFinancial  Statements.”  Among other changes, SFAS 154 requires that avoluntary change in accounting principles or a change required by a newaccounting pronouncement that does not include specific transition provisionsbe applied retrospectively with all prior period financial statements presentedon the new accounting principle, unless it is impracticable to do so. SFAS 154also provides that (1) a change in method of depreciating or amortizing along-lived non-financial asset be accounted for as a change in estimate(prospectively) that was affected by a change in accounting principle, and (2)correction of errors in previously issued financial statements should be termeda “restatement”.  SFAS 154 is effectivefor accounting changes and correction of errors made in fiscal years beginningafter June 15, 2005.  Accordingly, we arerequired to adopt the provisions of SFAS 154 in the first quarter of fiscal2006, beginning on January 1, 2006.  Weare currently evaluating the effect that the adoption of SFAS 154 will have onour consolidated results of operations and financial condition but we do notexpect SFAS 154 to have a material impact.

 

i.      Reclassification

 

Certain prior period amounts have beenreclassified to conform to the current period presentation.

 

17

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

#### ***Note 3: Long-TermDebt***

 

a.     Composition

 

Our long-term debt is composed as follows:

 
| ** **               | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|--------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **               | ** ** | ** **             | ** ** | **(Unaudited)**         | ** ** |
| Banks (1)                |       | $                      | 48,292     |                    | $          | 34,199 |   |
| Loan from  stockholders  |       | 1,000                  |       | 1,143                   |       |
| Loans from  others       |       | 990                    |       | 2,745                   |       |
|                     |       | 50,282                 |       | 37,577                  |       |
| Less current  maturities |       | 13,364                 |       | 28,550                  |       |
|                     |       | $                      | 36,918     |                    | $          | 9,027 |   |

 

----

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

 

b.     Classification

 

Classified by currency, linkage terms andinterest rates, the total amount of the liabilities (before deduction ofcurrent maturities) is as follows:

 
| ** **               | ** ** | **Interest rate (%)** | ** ** | **Amount**        | ** ** |
|--------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **               | ** ** | **December 31,**      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
| ** **               | ** ** | **2004**              | ** ** | **2005**          | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **               | ** ** | ** **            | ** ** | **(Unaudited)**   | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| In, or  linked to dollar |       | 5-8                   |       | 4-5               |       | $ | 33,027 |   | $ | 23,721 |   |
| In NIS -  linked to CPI  |       | 6-8                   |       | 5-8               |       | 17,255 |   | 13,856 |   |
|                     |       |                  |       |              |       | $ | 50,282 |   | $ | 37,577 |   |

 

c.     Maturities

 

The liabilities mature as follows:

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

 

18

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

**Notesto Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

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

#### *** ***

a.     Litigation

 

In 2004 and the nine month period endedSeptember 30, 2005, several employees filed lawsuits against subsidiaries ofours claiming payments due to them.  Thetotal of such open claims is $36.  Ourmanagement and our legal advisor believe that the allowance provided for thiscontingency in our consolidated financial statements is adequate to coverprobable costs arising from these matters.

 

b.     Guarantees

 

Guarantees are contingent commitments issuedby us generally to guarantee our performance in different projects to ourcustomers, such as tenders. The term of a guarantee generally is equal to theterm of the related projects, which can be as short as 30 days or as long as 5years. The maximum potential amount of future payments we could be required tomake under our guarantees at December 31, 2004 and September 30, 2005, is$21,948 and $27,909, respectively.  We donot hold collateral to support guarantees when deemed necessary.

 

c.     Liens and charges

 

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

 

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

 

a.     Redeemable options:

 

Our Executive Committee approved and resolvedon August 31, 2004 to provide to certain optionees (specifically, those whoexchanged their options in two previously public entities acquired by us foroptions in Ness) the right to redeem 391,499 of their options, all of whichwere vested at the time of grant, for a cash payment. The grant date occurredin the fourth quarter of 2004. During the first nine months of 2005, certainoptionees exercised their options and one optionee exercised his redemptionrights and had his options redeemed. Accordingly, as of September 30, 2005, the total number of shares ofcommon stock for which these redeemable options are exercisable is 368,972, andthe aggregate redemption value is $3.4 million. The redemption right isexercisable from October 1, 2004 until May 31, 2006. Each option subject to theredemption right may be transferred by the employee to us for a cash paymentthat is linked, at the employee’s sole discretion, either to the Israeli CPIand shall bear an NIS interest at the rate of 5% per year, or to the dollarwith interest at the rate of 6% per year, calculated from the original optiongrant date of September 23, 1999 or October 3, 1999, up to the redemption date.Each of 278,932 options (“Group A”) may be exercised to acquire one share ofour common stock at a price of $3.49 and are redeemable at the NIS equivalentof $9.74 per option as of September 30, 2005. Each of 90,040 options (“Group B”)may be exercised to acquire one share of our common stock at a price of $7.45,and are redeemable at the NIS equivalent of $7.33 per option as of September30, 2005. The exercise prices and redemption amounts are subject to adjustmentsfor stock splits, dividends, recapitalizations and the like, as set forth inour share option plan to which each option is subject. We account for therights following the guidance of FIN No. 28, “Accounting for Stock AppreciationRights and Other Variable Stock Option or Award Plans,” relating to tandemawards and Emerging Issues Task Force (“EITF”) No. 00-23, “Issues Related tothe Accounting 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 is recorded at the then value of the redemption rights,with a corresponding charge to

 

19

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 

compensation expense. The liability will beaccreted periodically to equal the amount that would be payable if the awardswere redeemed at each balance sheet date.

 

As of September 30, 2005, we believed it waslikely that the rights would be exercised, and accordingly, we recorded aliability in that respect in the total amount of $3.4 million, included inother accounts payable and accrued expenses, reflecting the value of theredemption rights at September 30, 2005. Related stock-based compensationexpense was recorded in the statements of income for the nine months endedSeptember 30, 2005 in the total amount of $2.0 million.

 

b.     Total comprehensive income:

 
| ** **                                                         | ** ** | **Three months ended  September 30,** | ** **  | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|-------------|--------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                              | ** **  | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | **(Unaudited)**                       | ** **  |
| Net income                                                         |       | $                                     | 3,691  |                                 | $          | 6,017 |   | $ | 9,018  |   | $ | 14,926 |   |
| Foreign currency translation adjustment,  net                      |       | 533                                   |        | 255                                  |       | (2,354 | ) | (8,956 | ) |
| Net unrealized losses on available-for-sale  marketable securities |       | (3                                    | )           | (86                                  | )          | (35 | ) | (28 | ) |
| Comprehensive income                                               |       | $                                     | 4,221       |                                 | $          | 6,186 |   | $ | 6,629 |   | $ | 5,942 |   |

 

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

 

We adopted SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information.”  We operate inone reportable segment. Our total revenues are attributed to geographic areasbased on the location of the end customer.

 

The following present total revenues for the three and nine monthperiods ended September 30, 2004 and 2005, and long-lived assets as ofSeptember 30, 2004 and 2005:

 
| ** **                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                      | ** ** | **2004**                              | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(Unaudited)**                       | ** ** |
| Revenues from sales to unaffiliated  customers: |       |                                  |       |                                 |       |   |   |   |   |
| Israel                                          |       | $                                     | 43,175     |                                 | $          | 52,842 |   | $ | 127,636 |   | $ | 153,014 |   |
| United States                                   |       | 19,486                                |       | 21,222                               |       | 53,697 |   | 65,376 |   |
| Europe                                          |       | 9,671                                 |       | 17,535                               |       | 28,188 |   | 44,384 |   |
| Asia and the Far East                           |       | 4,105                                 |       | 4,697                                |       | 10,720 |   | 13,513 |   |
| Others                                          |       | 715                                   |       | 1,423                                |       | 1,936 |   | 4,055 |   |
|                                            |       | $                                     | 77,152     |                                 | $          | 97,719 |   | $ | 222,177 |   | $ | 280,342 |   |

 

20

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 
| ** **            | ** ** | **September 30,** | ** ** |
|-----------------------|------------|-------------------|------------|
| ** **            | ** ** | **2004**          | ** ** | **2005** | ** ** |
| ** **            | ** ** | **(Unaudited)**   | ** ** |
| Long-lived  assets:   |       |              |       |   |   |
| Israel                |       | $                 | 98,888     |   | $ | 100,636 |   |
| United States         |       | 56,397            |       | 60,140 |   |
| Europe                |       | 2,633             |       | 7,945 |   |
| Asia and the Far East |       | 8,203             |       | 8,587 |   |
| Others                |       | 6                 |       | 15 |   |
|                  |       | $                 | 166,127    |   | $ | 177,323 |   |

 

#### ***Note 7: Basic andDiluted Net Earnings per Share***

 

Basic net earnings per share are computed based on the weighted averagenumber of shares of common stock outstanding during each period, plus dilutiveConvertible Preferred stock considered outstanding during each period, in accordancewith the guidance of EITF No. D-95 “Effect of Participating ConvertibleSecurities on the Computation of Basic Earnings per Share.” Diluted netearnings per share are computed based on the weighted average number of sharesof common stock outstanding during each period, plus dilutive potential sharesof common stock considered outstanding during the period, in accordance withSFAS No. 128, “Earnings per Share.”

 

The total weighted average number of shares related to the outstandingoptions, warrants, Convertible Preferred stock and convertible loan fromstockholders excluded from the calculations of diluted net earnings per share,as they would have been anti-dilutive for all periods presented, was186,401,  104,386,  1,183,597, 116,053 and 782,223 for the year ended December 31, 2004 the threemonths ended September 30, 2004 and 2005, respectively, and the nine monthsended September 30, 2004 and 2005, respectively.

 

The following table sets forth the computation of basic and diluted netearnings per share of common stock (in thousands):

 

21

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

**Notes to Interim Condensed Consolidated Financial Statements**

**U.S. dollars in thousands (except share and per share data)(information as of September 30, 2005 and for the three and nine month periodsended September 30, 2004 and 2005 is unaudited)**

 
| ** **                                                                                                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2004**                              | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                     | ** ** | **(Unaudited)**                       | ** ** |
| Numerator:                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                                                                                                                     |       | $                                     | 3,691      |                                 | $          | 6,017 |   | $ | 9,018 |   | $ | 14,926 |   |
| Allocation of undistributed earnings on  Class B Convertible Preferred Stock                                                                   |       | (554                                  | )          | —                               |       | (1,356 | ) | — |   |
| Numerator for basic and diluted per share  data: Net income after allocation of undistributed earnings on Class B  Convertible Preferred Stock |       | $                                     | 3,137      |                                 | $          | 6,017 |   | $ | 7,662 |   | $ | 14,926 |   |
|                                                                                                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Denominator:                                                                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average number of shares of common  stock                                                                                             |       | 16,654                                |       | 34,648                               |       | 16,537 |   | 34,314 |   |
| Weighted average number of shares of  preferred stock                                                                                          |       | 2,412                                 |       | —                               |       | 2,412 |   | — |   |
| Denominator for basic net earnings per  share                                                                                                  |       | 19,066                                |       | 34,648                               |       | 18,949 |   | 34,314 |   |
| Effect of dilutive securities:                                                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Employee stock options and warrants                                                                                                            |       | 2,936                                 |       | 851                                  |       | 2,550 |   | 1,248 |   |
| Denominator for diluted net earnings per  share – adjusted weighted average assuming conversions and exercise of  options and warrants    |       | 22,002                                |       | 35,499                               |       | 21,499 |   | 35,562 |   |

 

#### ***Note 8: SubsequentEvents***

 

On October 3, 2005, we acquired all the outstandingshares of Delta Electronic Services a.s., a provider of IT services andsolutions in Slovakia. The purchase price was $7.75 million. In addition,should Delta achieve certain business goals by the end of 2005 and during thefirst quarter of 2006, Ness will pay an additional amount of up to $3.25million.  Upon completion of theacquisition, Delta changed its name to Ness Slovakia, and it operates as a partof Ness Europe.

 

22

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## ***Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations***

 

*You should read the following discussion and analysistogether with our unaudited consolidated financial statements and theaccompanying notes.  This discussioncontains forward-looking statements, within the meaning of Section 27A ofSecurities Act of 1933, as amended, Section 21E of the Securities Exchange Actof 1934, as amended, and the Private Securities Litigation Reform Act of 1995,including statements regarding our expected financial position, business andfinancing plans.  These statementsinvolve risks and uncertainties. Our actual results could differ materiallyfrom the results described in or implied by these forward-looking statements asa result of various factors, including those discussed below and elsewhere inour Annual Report on Form 10-K  filedwith the SEC on March 31, 2005, particularly under the headings “DisclosureStatement” and “Risk Factors.”*

 

### **Overview**

 

We are a global provider of information technology, or IT, services andend-to-end business solutions designed to help clients improve theircompetitiveness and effectiveness. End-to-end business solutions encompass allstages of a client’s business process and incorporate all technologies and ITservices related to that process. Our portfolio of solutions and servicesincludes outsourcing, system integration and application development, softwareand consulting, and quality assurance and training. The primary industries, orverticals, we serve include government and defense, financial services, lifesciences and healthcare, telecommunications and utilities, and independentsoftware vendors, or ISVs.

 

We have operations in 15 countries across North America, Europe andAsia. We combine our deep vertical expertise and strong technical capabilitiesto provide a complete range of high quality services on a global scale. Byintegrating our local and international personnel in focused business andproject teams, this global delivery model leverages our corporate knowledge andexperience, intellectual property and global infrastructure to developinnovative solutions for clients across the geographies and verticals we 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 $97.7 million and $280.3 million for thethree and nine months ended September 30, 2005, respectively, from $77.2million and $222.2 million for the three and nine months ended September 30,2004, respectively.  Net income increasedto $6.0 million and $14.9 million for the three and nine months ended September30, 2005, respectively, from $3.7 million and $9.0 million for the three andnine months ended September 30, 2004, respectively.

 

Our revenue growth is attributable to a number of factors, includingacquisitions we made, increases in the number and size of projects for existingclients and the addition of new clients. Our client base is diverse, and we arenot dependent on any single client. In the three and nine months endedSeptember 30, 2005, no client accounted for more than 5% of our revenues andour largest twenty clients together accounted less than approximately 35% ofour revenues. For the three and nine months ended September 30, 2005, thepercentage of our revenues generated by public and private clients in Israelwas 54% and 55%, respectively, and the percentage of our revenues derived, inaggregate, from agencies of the government of Israel for the same time periodswas 10.4% and 10.8%, respectively. Existing clients from prior years generatedmore than 85% of our revenues in the three and nine months ended September 30,2005.

 

Our backlog as of September 30, 2005 was $439 million compared to $354million as of September 30, 2004. This $85 million increase in our backlog wasdue primarily to new bookings. We achieve backlog through new signings of ITservices projects and outsourcing contracts for new and repeat customers. Werecognize backlog as revenue when we perform the services related to backlog.

 

For the three and nine months ended September 30, 2005, the percentageof our revenues derived from clients in Israel was 54% and 55%, respectively;in the United States, 22% and 23%, respectively; in Europe, 18% and

 

23

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16%, respectively; in Asia andthe Far East, 5% and 5%, respectively; and in other countries, 1% and 1%, respectively.

 

For the three and nine months ended September 30, 2005, we derived 31%and 31%, respectively, of our revenues from system integration and applicationdevelopment; 46% and 46%, respectively, from outsourcing (including offshoredevelopment); 15% and 15%, respectively, from software and consulting; 6% and6%, respectively, from quality assurance and training; and 2% and 2%,respectively, from our other offerings.

 

As of September 30, 2005, we had approximately 5,725 employees,including approximately 5,020 IT professionals. Of the 5,725 employees, approximately 3,030 were in Israel, 1,390 werein India, 345 were in North America, 550 were in Europe and 405 were in theAsia Pacific region.

 

**RecentDevelopments**

 

On October 3, 2005, we acquired all the outstanding shares of DeltaElectronic Services a.s., a provider of IT services and solutions in Slovakia.The purchase price was $7.75 million. In addition, should Delta achieve certainbusiness goals by the end of 2005 and during the first quarter of 2006, Nesswill pay an additional amount of up to $3.25 million. For the full year 2004,Delta generated revenues of more than $18 million and was profitable.  Delta, which specializes in enterpriseresource planning systems and custom enterprise applications, has been one ofthe fastest growing IT services and solutions providers in Slovakia in recentyears serving mainly the public and utilities sector. Delta has additionaloperations in the Czech Republic and Germany. We expect our expansion inSlovakia to provide greater opportunities for Ness and to better position us tooffer near-shore outsourcing services for European markets. Upon completion ofthe acquisition, Delta changed its name to Ness Slovakia, and it operates as apart of Ness Europe.

 

**Consolidated Results of Operations**

 

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

 
| ** **                                                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                              | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues                                                           |       | 100.0                                 | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                                   |       | 70.0                                  |       | 71.5                                 |       | 69.6 |   | 71.5 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts |       | 0.0                                   |       | (0.3                                 | )          | (0.2 | ) | (0.1 | ) |
| Gross profit                                                       |       | 30.0                                  |       | 28.7                                 |       | 30.6 |   | 28.6 |   |
|                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Operating expenses:                                                |       |                                  |       |                                 |       |   |   |   |   |
| Selling and marketing                                              |       | 8.8                                   |       | 7.2                                  |       | 8.5 |   | 7.5 |   |
| General and administrative                                         |       | 14.1                                  |       | 13.6                                 |       | 15.3 |   | 13.8 |   |
| Stock-based compensation                                           |       | 0.1                                   |       | 0.1                                  |       | 0.1 |   | 0.7 |   |
| Total operating expenses                                           |       | 23.0                                  |       | 20.9                                 |       | 23.9 |   | 22.0 |   |
|                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Operating income                                                   |       | 7.0                                   |       | 7.8                                  |       | 6.7 |   | 6.6 |   |
| Financial expenses, net                                            |       | (1.5                                  | )          | (0.4                                 | )          | (1.9 | ) | (0.5 | ) |
| Other income (expenses), net                                       |       | 0.0                                   |       | 0.0                                  |       | 0.0 |   | 0.0 |   |
| Income before taxes on income                                      |       | 5.4                                   |       | 7.4                                  |       | 4.8 |   | 6.1 |   |
|                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Taxes on income                                                    |       | 0.6                                   |       | 1.3                                  |       | 0.4 |   | 0.8 |   |
| Equity in net losses of affiliates                                 |       | 0.0                                   |       | 0.0                                  |       | (0.3 | ) | 0.0 |   |
| Minority interests in losses (earnings) of  a subsidiary           |       | 0.0                                   |       | 0.0                                  |       | 0.0 |   | 0.0 |   |
| Net income                                                         |       | 4.8                                   |       | 6.2                                  |       | 4.1 |   | 5.3 |   |

 

24

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**Three Months Ended September 30, 2005 Compared to the Three MonthsEnded September 30, 2004**

 

The following table summarizes certain line items from our consolidatedstatement of operations (dollars in thousands):

 
| ** **                                                         | ** ** | **Three months ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | **2004**                              | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                                           |       | $                                     | 77,152     |                     | $          | 97,719 |   | 20,567 |   | 26.7 |   |
| Cost of revenues                                                   |       | 53,969                                |       | 69,882                   |       | 15,913 |   | 29.5 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts |       | 26                                    |       | (254                     | )          | (280 | ) | N/A |   |
| Gross profit                                                       |       | $                                     | 23,157     |                     | $          | 28,091 |   | 4,934 |   | 21.3 |   |
| Gross margin                                                       |       | 30.0                                  | %          | 28.7                     | %          |   |   |   |   |

 

#### ***Revenues***

 

Our revenues increased from $77.2 million in the three months endedSeptember 30, 2004 to $97.7 million in the three months ended September 30,2005, representing an increase of $20.6 million, or 26.7%.  The increase was primarily due to growth inoutsourcing and offshore engagements, representing $5.8 million, and growth inour other offerings, comprised of system integration and applicationdevelopment, software and consulting, and quality assurance and training,representing $14.8 million.  Revenuesfrom outsourcing and offshore services increased as a result of volume growthdue to our sales initiatives related to these offerings, including the hiringof key personnel and aligning of our organizational structure, and expansioninto geographical areas in which we currently do business but previously had notoffered outsourcing and offshore services. There was no significant change inour billing rates, or prices, from the three months ended September 30, 2004 tothe three months ended September 30, 2005.

 

#### ***Cost of revenuesand provision for losses (reverse of losses) on uncompleted contracts***

 

Our cost of revenues, including salaries, wages and other direct andindirect costs, increased from $54.0 million in the three months endedSeptember 30, 2004 to $69.9 million in the three months ended September 30,2005, representing an increase of $15.9 million, or 29.5 %. The increase wasattributable to growth in our delivery staff needed to support our increasedrevenues.  The change in our provisionfor losses (reverse of losses) on uncompleted contracts changed from $26,000 inthe three months ended September 30, 2004 to ($0.3) million in the three monthsended September 30, 2005, as a result of net updates to the estimated costs ofcompletion of our fixed price projects.

 

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

 

Our gross profit (revenues less cost of revenues and provision forlosses (reverse of losses) on uncompleted contracts) increased from $23.2million in the three months ended September 30, 2004 to $28.1 million in thethree months ended September 30, 2005, representing an increase of $4.9 million,or 21.3 %. The increase was primarily related to our increase in revenues,representing $6.2 million, offset by a decrease in our gross margin,representing approximately ($1.2) million. Gross margin for the three monthsended September 30, 2005 was 28.7%, compared to 30.0% in the three months endedSeptember 30, 2004. The decrease in gross margin resulted primarily from highercontract setup costs associated with new outsourcing and offshore engagementsattributable to our greater than anticipated revenue growth in the quarter.

 

The following table summarizes certain line items from our consolidatedstatement of operations (dollars in thousands):

 

25

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| ** **                  | ** ** | **Three months ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **2004**                              | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                     | 6,822      |                     | $          | 7,081 |   | 259 |   | 3.8 |   |
| General and  administrative |       | 10,888                                |       | 13,268                   |       | 2,380 |   | 21.9 |   |
| Stock-based  compensation   |       | 57                                    |       | 76                       |       | 19 |   | 33.3 |   |
| Total  operating expenses   |       | 17,767                                |       | 20,425                   |       | 2,658 |   | 15.0 |   |
| Operating  income           |       | $                                     | 5,390      |                     | $          | 7,666 |   | 2,276 |   | 42.2 |   |

 

#### ***Selling andmarketing***

 

Selling and marketing expenses increased from $6.8 million in the threemonths ended September 30, 2004 to $7.1 million in the three months endedSeptember 30, 2005, representing an increase of $0.3 million, or 3.8%. This increasewas due primarily to an increase in marketing expenses, sales commissions andother sales expenses attributable to our revenue growth in the period.

 

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

 

General and administrative expenses increased from $10.9 million in thethree months ended September 30, 2004 to $13.3 million in the three monthsended September 30, 2005, representing an increase of $2.4 million, or 21.9%.This increase was due primarily to increased general and administrativeexpenses necessary to support our revenue growth, including the general andadministrative expenses of our second quarter acquisitions, together representing$1.7 million, and certain additional expenses associated with being a public companyincluding implementation of compliance measures required by the Sarbanes-OxleyAct, representing $0.7 million.

 

#### ***Stock-basedcompensation***

 

Stock-based compensation expenses increased from $57,000 in the threemonths ended September 30, 2004 to $0.1 million in the three months endedSeptember 30, 2005.  This increase wasnot significant.

 

The following table summarizes certain line items from our consolidatedstatement of operations (dollars in thousands):

 
| ** **                                               | ** ** | **Three months ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **2004**                              | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating  income                                        |       | $                                     | 5,390      |                     | $          | 7,666 |   | 2,276 |   | 42.2 |   |
| Financial  expenses, net                                 |       | (1,177                                | )          | (383                     | )          | 794 |   | (67.5 | ) |
| Other  expenses, net                                     |       | (16                                   | )          | (14                      | )          | 2 |   | (12.5 | ) |
| Income  before taxes on income                           |       | 4,197                                 |       | 7,269                    |       | 3,072 |   | 73.2 |   |
| Taxes on  income                                         |       | 473                                   |       | 1,252                    |       | 779 |   | 164.7 |   |
| Equity in  net losses of affiliates                      |       | (3                                    | )          | —                   |       | 3 |   | (100.0 | ) |
| Minority  interests in losses (earnings) of a subsidiary |       | (30                                   | )          | —                   |       | 30 |   | (100.0 | ) |
| Net income                                               |       | $                                     | 3,691      |                     | $          | 6,017 |   | 2,326 |   | 63.0 |   |

 

#### ***Financialexpenses, net***

 

Financial expenses, net, decreased from $1.2 million in the threemonths ended September 30, 2004 to $0.4 million in the three months endedSeptember 30, 2005, representing a decrease of $0.8 million, or 67.5%. Thedecrease was due primarily to investment income from the proceeds of ourinitial public offering and reduced debt service expenses following ourreduction of net long-term debt in the fourth quarter of 2004 and subsequently.In the three months ended September 30, 2005, we replaced high rate loans, increasedthe return on our deposits and entered into certain forward foreign currencyexchange contracts to hedge our exposure against foreign currencies whichdiffer from the local functional currencies.

 

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

 

Other expenses, net, decreased from $16,000 in the three months endedSeptember 30, 2004 to $14,000 in the three months ended September 30, 2005.This change was not significant.

 

26

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

 

Our taxes on income increased from $0.5 million in the three monthsended September 30, 2004 to $1.3 million in the three months ended September30, 2005, representing an increase of $0.8 million, or 165%. This increase wasprimarily attributable to the increase in our income before taxes, representing$0.7 million.

 

#### ***Equity in netlosses of affiliates***

 

Equity in net losses of affiliates decreased from $3,000 for the threemonths ended September 30, 2004 to zero in the three months ended September 30,2005.  This change was not significant.

 

#### ***Minority interestsin losses (earnings) of a subsidiary***

 

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

 

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

 

Net income increased from $3.7 million in the three months endedSeptember 30, 2004 to $6.0 million in the three months ended September 30,2005, representing an increase of $2.3 million, or 63.0%. The increase in netincome was due primarily to our increase in operating income of $2.3 millionand our decrease in financial expenses of $0.8 million, partially offset by ourincrease in taxes on income of $0.8 million.

 

### **NineMonths Ended September 30, 2005 Compared to the Nine Months Ended September 30,2004**

 

The following table summarizes certain line items from our consolidatedstatement of operations (dollars in thousands):

 
| ** **                                                         | ** ** | **Nine months ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | **2004**                             | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues                                                           |       | $                                    | 222,177    |                     | $          | 280,342 |   | 58,165 |   | 26.2 |   |
| Cost of revenues                                                   |       | 154,602                              |       | 200,310                  |       | 45,708 |   | 29.6 |   |
| Provision for losses (reverse of losses) on  uncompleted contracts |       | (459                                 | )          | (156                     | )          | 303 |   | (66.0 | ) |
| Gross profit                                                       |       | $                                    | 68,034     |                     | $          | 80,188 |   | 12,154 |   | 17.9 |   |
| Gross margin                                                       |       | 30.6                                 | %          | 28.6                     | %          |   |   |   |   |

 

#### ***Revenues***

 

Our revenues increased from $222.2 million in the nine months endedSeptember 30, 2004 to $280.3 million in the nine months ended September 30,2005, representing an increase of $58.2 million, or 26.2%.  The increase was primarily due to growth inoutsourcing and offshore engagements, representing $24.8 million, and growth inour other offerings, comprised of system integration and applicationdevelopment, software and consulting, and quality assurance and training, representing$33.4 million.  Revenues from outsourcingand offshore services increased as a result of volume growth due to our salesinitiatives related to these offerings, including the hiring of key personneland aligning of our organizational structure, and expansion into geographicalareas in which we currently do business but previously had not offeredoutsourcing and offshore services. There was no significant change in ourbilling rates, or prices, from the nine months ended September 30, 2004 to thenine months ended September 30, 2005.

 

#### ***Cost of revenuesand provision for losses (reverse of losses) on uncompleted contracts***

 

Our cost of revenues, including salaries, wages and other direct andindirect costs, increased from $154.6 million in the nine months endedSeptember 30, 2004 to $200.3 million in the nine months ended September 30,2005, representing an increase of $45.7 million, or 29.6 %. The increase wasattributable to growth in our delivery staff needed to support our increasedrevenues.  The change in our provisionfor losses (reverse of losses) on uncompleted contracts changed from ($0.5)million in the nine months ended September 30, 2004 to ($0.2)

 

27

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million in the nine monthsended September 30, 2005, as a result of net updates to our estimated costs ofcompletion of our fixed price projects.

 

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

 

Our gross profit (revenues less cost of revenues and provision forlosses (reverse of losses) on uncompleted contracts) increased from $68.0million in the nine months ended September 30, 2004 to $80.2 million in thenine months ended September 30, 2005, representing an increase of $12.2 million,or 17.9 %. The increase was primarily related to our increase in revenues,representing $17.8 million, offset by a decrease in our gross margin,representing approximately ($5.6) million. Gross margin for the nine monthsended September 30, 2005 was 28.6%, compared to 30.6% in the nine months endedSeptember 30, 2004. The decrease in gross margin resulted primarily from highercontract setup costs associated with new outsourcing and offshore engagementsattributable to our greater than anticipated revenue growth in the first threequarters of 2005 and from an increase in our use of subcontractors and vendorsin the first quarter in order to meet certain delivery commitments.

 

The following table summarizes certain line items from our consolidatedstatement of operations (dollars in thousands):

 
| ** **                  | ** ** | **Nine months ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **2004**                             | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and  marketing      |       | $                                    | 18,952     |                     | $          | 21,114 |   | 2,162 |   | 11.4 |   |
| General and  administrative |       | 33,951                               |       | 38,663                   |       | 4,712 |   | 13.9 |   |
| Stock-based  compensation   |       | 191                                  |       | 1,973                    |       | 1,782 |   | 933.0 |   |
| Total  operating expenses   |       | 53,094                               |       | 61,750                   |       | 8,656 |   | 16.3 |   |
| Operating  income           |       | $                                    | 14,940     |                     | $          | 18,438 |   | 3,498 |   | 23.4 |   |

 

#### ***Selling andmarketing***

 

Selling and marketing expenses increased from $19.0 million in the ninemonths ended September 30, 2004 to $21.1 million in the nine months endedSeptember 30, 2005, representing an increase of $2.2 million, or 11.4%. Thisincrease was due primarily to a $1.6 million increase in marketing expenses,especially in Europe, and increases in our sales commissions and other salesexpenses of $0.6 million. These additional marketing expenses are relatedprimarily to our efforts to enhance our brand recognition.

 

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

 

General and administrative expenses increased from $34.0 million in thenine months ended September 30, 2004 to $38.7 million in the nine months endedSeptember 30, 2005, representing an increase of $4.7 million, or 13.9%. Thisincrease was due primarily to increased general and administrative expensesnecessary to support our revenue growth, including the general andadministrative expenses of our second quarter acquisitions, together representing$3.0 million, and certain additional expenses associated with being a publiccompany including implementation of compliance measures required by theSarbanes-Oxley Act, representing $1.7 million.

 

#### ***Stock-basedcompensation***

 

Stock-based compensation expenses increased from $0.2 million in thenine months ended September 30, 2004 to $2.0 million in the nine months endedSeptember 30, 2005, representing an increase of $1.8 million. This increase wasdue primarily to a charge to compensation expense in respect of redeemableoptions, representing $1.8 million, described in note 5(a) to our interimcondensed consolidated financial statements – September 30, 2005.  We expect no further significant compensationexpense related to these redeemable options.

 

The following table summarizes certain line items from our consolidatedstatement of operations (dollars in thousands):

 

28

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| ** **                                               | ** ** | **Nine months ended  September 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **2004**                             | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating  income                                        |       | $                                    | 14,940     |                     | $          | 18,438 |   | 3,498 |   | 23.4 |   |
| Financial  expenses, net                                 |       | (4,327                               | )          | (1,297                   | )          | 3,030 |   | (70.0 | ) |
| Other income  (expenses), net                            |       | 79                                   |       | (10                      | )          | (89 | ) | N/A |   |
| Income  before taxes on income                           |       | 10,692                               |       | 17,131                   |       | 6,439 |   | 60.2 |   |
| Taxes on  income                                         |       | 958                                  |       | 2,277                    |       | 1,319 |   | 137.7 |   |
| Equity in  net losses of affiliates                      |       | (651                                 | )          | (29                      | )          | 622 |   | (95.6 | ) |
| Minority  interests in losses (earnings) of a subsidiary |       | (65                                  | )          | 101                      |       | 166 |   | N/A |   |
| Net income                                               |       | $                                    | 9,018      |                     | $          | 14,926 |   | 5,908 |   | 65.5 |   |

 

#### ***Financialexpenses, net***

#### *** ***

Financial expenses, net, decreased from $4.3 million in the nine monthsended September 30, 2004 to $1.3 million in the nine months ended September 30,2005, representing a decrease of $3.0 million, or 70.0%. The decrease was dueprimarily to investment income from the proceeds of our initial public offeringand reduced debt service expenses following our reduction of net long-term debtin the fourth quarter of 2004 and subsequently. In the three months endedSeptember 30, 2005, we replaced high rate loans, increased the return on our depositsand entered into certain forward foreign currency exchange contracts to hedgeour exposure against foreign currencies which differ from the local functionalcurrencies.

 

#### ***Other income(expenses), net***

#### *** ***

Other income (expenses), net, changed from income of $79,000 in thenine months ended September 30, 2004 to expenses of $10,000 in the nine monthsended September 30, 2005. This change was not significant.

 

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

#### *** ***

Our taxes on income increased from $1.0 million in the nine monthsended September 30, 2004 to $2.3 million in the nine months ended September 30,2005, representing an increase of $1.3 million, or 138%. This increase wasattributable to the increase in our income before taxes, representing $2.0 million,offset by the tax reduction attributable to our stock-based compensationexpense, representing ($0.7) million.

 

#### ***Equity in netlosses of affiliates***

#### *** ***

Equity in net losses of affiliates decreased from $0.7 million for thenine months ended September 30, 2004 to $29,000 in the nine months endedSeptember 30, 2005. This decrease was due to a capital loss related to ourreduced ownership of our affiliate, Ness ISI (now known as dbMotion Ltd.), in2004. Following the January 1, 2004 issuance of preferred shares by Ness ISIthat reduced our share ownership to a non-controlling interest, we no longerconsolidate Ness ISI’s results in our financial statements.

 

#### ***Minority interestsin losses (earnings) of a subsidiary***

#### *** ***

Minority interests in losses (earnings) of a subsidiary changed fromearnings of $0.1 million in the nine months ended September 30, 2004 to lossesof $0.1 million in the nine months ended September 30, 2005. This change wasnot significant.

 

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

#### *** ***

Net income increased from $9.0 million in the nine months endedSeptember 30, 2004 to $14.9 million in the nine months ended September 30,2005, representing an increase of $5.9 million, or 65.5%. The increase in netincome was due primarily to our increase in operating income of $3.5 million,our decrease in financial expenses of $3.0 million and our decrease in equityin net losses of affiliates of $0.6 million, partially offset by the increasein our income taxes of $1.3 million.  Theincrease in our operating income was itself offset by an increase instock-based compensation of $1.8 million.

 

29

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**Liquidity and Capital Resources**

 

#### ***Overview***

 

As of September 30, 2005, we had cash and cash equivalents amounting to$74.3 million compared to $104.2 million as of December 31, 2004. The fundsheld at locations outside of the United States are reserved for futureoperating expenses. While we expect that cash generated by our non-U.S.subsidiaries will be reinvested in their respective countries to supportexpansion of our business, to the extent that funds were remitted to the UnitedStates in the form of dividend payments, those payments would be subject to awithholding tax.

 

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

 

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

 
| ** **                                                    | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                             | ** ** | **2005** | ** ** |
| Net cash  provided by (used in) operating activities          |       | $                                    | 4,920      |   | $ | (9,383 | ) |
| Net cash  used in investing activities                        |       | (7,290                               | )          | (16,675 | ) |
| Net cash  provided by (used in) financing activities          |       | (2,136                               | )          | 1,119 |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | (793                                 | )          | (4,987 | ) |
| Decrease in  cash and cash equivalents                        |       | (5,297                               | )          | (29,926 | ) |
| Cash and  cash equivalents at the beginning of the period     |       | 46,004                               |       | 104,229 |   |
| Cash and  cash equivalents at the end of the period           |       | $                                    | 40,707     |   | $ | 74,303 |   |

 

Nine months ended September 30, 2005 compared to the nine months endedSeptember 30, 2004

 

Net cash used in operating activities was $9.4 million in the ninemonths ended September 30, 2005, compared to net cash provided by operatingactivities of $4.9 million in the nine months ended September 30, 2004. Themajor factors contributing to the change were a large annual payment to one ofour suppliers, representing $8.2 million, and an increase in our unbilledreceivables due to large fixed price government and defense projects currentlybeing executed, representing $8.6 million, offset by our increase in netincome, representing $5.9 million.

 

Net cash used in investing activities was $16.7 million in the ninemonths ended September 30, 2005, compared with $7.3 million in the nine monthsended September 30, 2004. The major factors contributing to the increase werepayments in respect of the acquisitions we made during the second and third quarters,representing $4.4 million, net of cash acquired, and investment in available-for-salemarketable securities, representing $4.8 million.

 

Net cash provided by financing activities was $1.1 million in the ninemonths ended September 30, 2005, compared with net cash used of $2.1 million inthe nine months ended September 30, 2004. The change was primarily due to theproceeds from employee exercises of stock options, representing $9.1 million, partiallyoffset by a reduction of $5.1 million in short-term bank loans and credit.

 

The effect of exchange rate changes on cash and cash equivalents was ($5.0)million in the nine months ended September 30, 2005, compared to ($0.8) millionin the nine months ended September 30, 2004. The change was primarily due tolong-term inter-company balances, representing $3.8 million.

 

#### ***Long-term andShort-term Debt***

#### *** ***

At September 30, 2005, we had aggregate short-term and long-term bankand other borrowings of $44.7 million, consisting of various notes denominatedin dollars and NIS (linked to index) with interest rates ranging fromapproximately 4.5% to 7.5% and a weighted average interest rate ofapproximately 5%, with maturities of two to five 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

 

30

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of approximately 6.5% to 7.5%and maturities of two to three years; and $16.5 million from six other lenders,in amounts ranging from $0.1 million to $4.0 million, with interest rates ofapproximately 5% to 7% and maturities of up to three years. The maximuminterest rate for our dollar-linked borrowings is approximately 4.5%, and forNIS index linked borrowings is approximately 7.5%.

 

At September 30, 2005, we had net cash position of $29.6 million,compared to $41.1 as of June 30, 2005. Despite this reduction in net cash, we have been able to reduce ourfinancial expenses sequentially.

 

#### ***AnticipatedCapital Expenditures***

 

In the third quarter of 2005, we used $11.3 million of the proceeds ofour initial public offering to further reduce net debt beyond the net debtreduction of $37.3 million accomplished from the fourth quarter of 2004 throughthe second quarter of 2005, exceeding our previously announced $40 million debtreduction plan. Following the use of proceeds, our only material indebtednessis amounts owed by Ness Technologies Holdings Ltd., one of our subsidiaries, toBank Hapoalim and Israel Discount Bank. The shares of two of our Israelisubsidiaries are pledged to these banks as security for borrowings under theagreements. The relevant debt instruments contain customary restrictivecovenants relating to the borrower and our wholly-owned subsidiary Ness A.T.Ltd., including the following:

 

•      limitations onincurring debt;

•      prohibition onpledging assets;

•      prohibition ondistributing dividends;

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

•      EBITDA must notbe less than 9.5% of revenues and not less than NIS 34 million; and

•      limitations onmerging or transferring assets.

 

In addition, the Israel Discount Bank agreement requires that the netcash and liquid assets of the borrower must not be lower than $18.0 million. Asof September 30, 2005, we are in compliance and expect to remain in compliancewith all of our covenants. Our failure to comply with these covenants couldlead to an event of default under the agreements governing some or all of theindebtedness, permitting the applicable lender to accelerate all borrowingsunder the applicable agreement, and to foreclose on any collateral.

 

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

 

We intend to fund future growth through cash flow from operations,available bank borrowings and the remaining net proceeds of our initial publicoffering. We believe the remaining balance of the proceeds of our initialpublic offering, together with borrowings and cash flow from operations, willbe sufficient to fund continuing operations for the foreseeable future. Inorder to achieve our strategic business objectives, we may be required to seekadditional financing. For example, future acquisitions may require additionalequity and/or debt financing. In addition, we may require 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-Looking Statements and Risk Factors**

 

This Quarterly Report on Form 10-Q, including Management’s Discussionand Analysis of Financial Condition and Results of Operations, containsforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Forward-looking statements often are proceeded by words such as “believes,”“expects,” “may,” “anticipates,” “plans,” “intends,” “assumes,” “will” orsimilar expressions. Forward-looking statements reflect management’s currentexpectations, as of the date of this report, and involve certain risks and uncertainties.Our actual results could differ materially from those anticipated in theseforward looking statements as a result of various factors. Some of the factorsthat could cause future results to materially differ from the recent results orthose projected in forward-looking statements include the “Risk Factors”described in our 2004 Annual Report on Form 10-K filed with the SEC on March31, 2005.

 

31

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## ***Item3. Quantitative and Qualitative Disclosure about Market Risk***

 

We do not engage in trading market-risk instruments or purchase hedgingor “other than trading” instruments that are likely to expose us to marketrisk, whether interest rate, commodity price or equity price risk. We have notpurchased options or entered into swaps or forward or futures contracts and donot use derivative financial instruments for speculative trading purposes.

 

We have direct operations in 15 different countries and relationshipsin many other parts of the world. Our foreign operations contract with clientsin their applicable local currencies or dollars. As a result, we are subject toadverse movements in foreign currency exchange rates in those countries wherewe conduct business.    Beginning inthe second quarter and continuing into the third quarter, we entered intocertain forward foreign currency exchange contracts to hedge our exposure againstforeign currencies which differ from the local functional currencies.  In the future, we may enter into additionalforward foreign currency exchange or other derivatives contracts to furtherhedge our exposure to foreign currency exchange rates.

 

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

 

## ***Item4. Controls and Procedures***

 

**Evaluation of Disclosure Controls and Procedures**

 

As of the end of the period covered by this report, our chief executiveofficer and chief financial officer evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended). Based on theirevaluation of our disclosure controls and procedures, our chief executiveofficer and chief financial officer, with the participation of our management,have concluded that our disclosure controls and procedures are effectivelydesigned to ensure that information required to be disclosed by us in thereports that we file or submit under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules and formsand are operating in an effective manner.

 

It should be noted that any system of controls, however well designedand operated, can provide only reasonable, and not absolute, assurance that theobjectives of the system are met. In addition, the design of any control systemis based in part upon certain assumptions about the likelihood of futureevents. Given these and other inherent limitations of control systems, there isonly reasonable assurance that our controls will succeed in achieving theirstated goals under all potential future conditions.

 

**Changes inInternal Control**

 

As of the end of the period covered by this report, there were nosignificant changes in our internal controls over financial reporting or inother factors that could significantly affect these controls.

 

32

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**PART II – OTHER INFORMATION**

 

***Item 1. Legal Proceedings***

 

We are periodically a party to routine litigation incidental to ourbusiness. We do not believe that we are a party to any pending legal proceedingthat is likely to have a material adverse effect on our business, financialcondition, results of operations or cash flows.

 

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

 

In the third quarter of 2005, we used $11.3 million of the proceeds ofour initial public offering, which closed on October 4, 2004, to further reducenet debt beyond the net debt reduction of $37.3 million accomplished from thefourth quarter of 2004 through the second quarter of 2005, exceeding ourpreviously announced $40 million debt reduction plan.  We intend to apply the balance of theproceeds to fund business growth and expansion and for working capital andgeneral corporate purposes.  We may alsouse a portion of the net proceeds for acquisitions of additional businesses,assets and technologies or the establishment of joint ventures.  As of the date of this report, we have noagreements to enter into any material acquisition, investment, partnership,alliance or other joint venture transaction.

 

## ***Item3. Defaults upon Senior Securities.***

 

None.

 

## ***Item4. Submission of Matters to a Vote of Security Holders***

 

None.

 

## ***Item5. Other Information***

 

None.

 

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

 

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

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

 

33

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**SIGNATURES**

 

 

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

 

 

NESS TECHNOLOGIES, INC.

(Registrant)

 

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

 

34

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**EXHIBITINDEX**

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

 

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