**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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** **

**FORM 10-Q**

**(Mark One)**
| **ý**                                               | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **                                               | ** ** | ** **                                                                                    |
| **For the  quarterly period ended March 31, 2007**       |
| ** **                                               |
| ** ̈**                                               | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                               | ** ** | ** **                                                                                    |
| **For the  transition period from ________ to ________** |
|                                                     |
| **Commission  File Number 000-50954**                    |

** **

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** **

**NESS TECHNOLOGIES, 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 TowerAtidim High-Tech Industrial ParkBuilding 4Tel Aviv 61580, IsraelTelephone: +972 (3) 766-6800**

**(Address of registrant’s principalexecutive offices and registrant’s telephone number, including area code)**

** **

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** **

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

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

Large accelerated filer o         Acceleratedfiler x          Non-acceleratedfiler o

 

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

As of April 30, 2007, 39,024,000 shares of commonstock, $0.01 par value per share, were outstanding.

 

 

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**NESS TECHNOLOGIES, INC. AND SUBSIDIARIES**

**INDEX**
| PART I — FINANCIAL  INFORMATION                                                                           |   | 3      |
|----------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                           |   |   |
| Item  1. Financial Statements                                                                                  |   | 3      |
| Condensed Consolidated Balance Sheets — December 31,  2006 and March 31, 2007 (Unaudited)                 |   | 3      |
| Condensed Consolidated Statements of Income — Three  months ended March 31, 2006 and 2007 (Unaudited)     |   | 5      |
| Condensed Consolidated Statements of Cash Flows —  Three months ended March 31, 2006 and 2007 (Unaudited) |   | 6      |
| Notes to Interim Condensed Consolidated Financial  Statements — March 31, 2007 (Unaudited)                |   | 8      |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations            |   | 18     |
| Overview                                                                                                       |   | 18     |
| Recent  Developments                                                                                           |   | 19     |
| Consolidated Results of Operations                                                                             |   | 19     |
| Three Months Ended March 31, 2007 Compared to the Three  Months Ended March 31, 2006                           |   | 19     |
| Results  by Business Segment                                                                                   |   | 21     |
| Liquidity and Capital Resources                                                                                |   | 23     |
| Forward-Looking Statements and Risk Factors                                                                    |   | 25     |
| Item 3. Quantitative and Qualitative Disclosure about  Market Risk                                             |   | 25     |
| Item 4. Controls and Procedures                                                                                |   | 25     |
| Evaluation of Disclosure Controls and Procedures                                                               |   | 25     |
| Changes  in Internal Control                                                                                   |   | 26     |
|                                                                                                           |   |   |
| PART  II — OTHER INFORMATION                                                                              |   | 27     |
|                                                                                                           |   |   |
| Item  1. Legal Proceedings                                                                                     |   | 27     |
| Item  1A. Risk Factors                                                                                         |   | 27     |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                           |   | 27     |
| Item 3. Defaults upon Senior Securities                                                                        |   | 27     |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                   |   | 27     |
| Item  5. Other Information                                                                                     |   | 27     |
| Item 6. Exhibits                                                                                               |   | 27     |
|                                                                                                           |   |   |
| SIGNATURES                                                                                                     |   | 29     |
|                                                                                                           |   |   |
| EXHIBIT INDEX                                                                                                  |   | 30     |

 

2

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# **PART I —FINANCIAL INFORMATION**

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

**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIES**

**InterimCondensed Consolidated Balance Sheets**

**U.S. dollars in thousands**

** **
| ** **                                                                                                                                        | ** ** | **December 31,**                                                                                    | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                        | ** ** | **        2006        ** | ** ** | **2007**           | ** ** |
| ** **                                                                                                                                        | ** ** | ** **                                                                                               | ** ** | **(Unaudited)**    | ** ** |
| ASSETS                                                                                                                                            |       |                                                                                                     |       |               |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| CURRENT ASSETS:                                                                                                                                   |       |                                                                                                     |       |               |       |
| Cash and cash  equivalents                                                                                                                        |       | $                                                                                                        | 46,675     |               | $          | 42,504 |   |
| Short-term bank  deposits                                                                                                                         |       | 2,027                                                                                                    |       | 3,669              |       |
| Trade  receivables (net of allowance for doubtful accounts of $2,812 and $2,928 at  December 31, 2006 and March 31, 2007, respectively) |       | 137,755                                                                                                  |       | 138,137            |       |
| Unbilled  receivables                                                                                                                             |       | 30,109                                                                                                   |       | 48,401             |       |
| Other accounts  receivable and prepaid expenses                                                                                                   |       | 14,033                                                                                                   |       | 14,927             |       |
| Inventories                                                                                                                                       |       | 177                                                                                                      |       | 228                |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| Total current assets                                                                                                                              |       | 230,776                                                                                                  |       | 247,866            |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| LONG-TERM ASSETS:                                                                                                                                 |       |                                                                                                     |       |               |       |
| Long-term  prepaid expenses and other assets                                                                                                      |       | 6,480                                                                                                    |       | 7,586              |       |
| Investments at  cost                                                                                                                              |       | 1,193                                                                                                    |       | 1,167              |       |
| Unbilled  receivables                                                                                                                             |       | 14,985                                                                                                   |       | 7,763              |       |
| Deferred income  taxes, net                                                                                                                       |       | 7,529                                                                                                    |       | 6,868              |       |
| Severance pay  fund                                                                                                                               |       | 42,321                                                                                                   |       | 42,732             |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| Total long-term assets                                                                                                                            |       | 72,508                                                                                                   |       | 66,116             |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| PROPERTY AND EQUIPMENT,  NET                                                                                                                      |       | 28,279                                                                                                   |       | 28,905             |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| INTANGIBLE ASSETS, NET                                                                                                                            |       | 8,336                                                                                                    |       | 7,564              |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| GOODWILL                                                                                                                                          |       | 201,718                                                                                                  |       | 203,709            |       |
|                                                                                                                                              |       |                                                                                                     |       |               |       |
| Total assets                                                                                                                                      |       | $                                                                                                        | 541,617    |               | $          | 554,160 |   |

 

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

3

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**InterimCondensed Consolidated Balance Sheets**

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

** **
| ** **                                                                                                                                                                                                                                 | ** ** | **December 31,**                                                                                    | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                 | ** ** | **        2006        ** | ** ** | **2007**           | ** ** |
| ** **                                                                                                                                                                                                                                 | ** ** | ** **                                                                                               | ** ** | **(Unaudited)**    | ** ** |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                  |       |                                                                                                     |       |               |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| CURRENT  LIABILITIES:                                                                                                                                                                                                                      |       |                                                                                                     |       |               |       |
| Short-term bank credit                                                                                                                                                                                                                     |       | $                                                                                                        | 4,869      |               | $          | 3,521 |   |
| Current maturities of long-term debt                                                                                                                                                                                                       |       | 4,420                                                                                                    |       | 3,837              |       |
| Trade payables                                                                                                                                                                                                                             |       | 42,839                                                                                                   |       | 38,251             |       |
| Advances from customers and deferred revenues                                                                                                                                                                                              |       | 30,364                                                                                                   |       | 38,604             |       |
| Other accounts payable and accrued expenses                                                                                                                                                                                                |       | 76,128                                                                                                   |       | 76,482             |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| Total current  liabilities                                                                                                                                                                                                                 |       | 158,620                                                                                                  |       | 160,695            |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| LONG-TERM  LIABILITIES:                                                                                                                                                                                                                    |       |                                                                                                     |       |               |       |
| Long-term debt and other liabilities, net of current  maturities                                                                                                                                                                           |       | 3,311                                                                                                    |       | 3,893              |       |
| Accrued severance pay                                                                                                                                                                                                                      |       | 47,031                                                                                                   |       | 48,174             |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| Total long-term  liabilities                                                                                                                                                                                                               |       | 50,342                                                                                                   |       | 52,067             |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| COMMITMENTS AND  CONTINGENT LIABILITIES                                                                                                                                                                                                    |       |                                                                                                     |       |               |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                                                                |       |                                                                                                     |       |               |       |
| Common Stock of $0.01 par value - Authorized:  76,500,000 shares at December 31, 2006 and at March 31, 2007 ;  Issued and outstanding: 38,638,682 shares at December 31, 2006 and  39,018,301 shares at March 31, 2007 |       | 387                                                                                                      |       | 391                |       |
| Additional paid-in capital                                                                                                                                                                                                                 |       | 317,799                                                                                                  |       | 319,470            |       |
| Accumulated other comprehensive income (loss)                                                                                                                                                                                              |       | (415                                                                                                     | )          | 2,438              |       |
| Retained earnings                                                                                                                                                                                                                          |       | 14,884                                                                                                   |       | 19,099             |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| Total  stockholders’ equity                                                                                                                                                                                                           |       | 332,655                                                                                                  |       | 341,398            |       |
|                                                                                                                                                                                                                                       |       |                                                                                                     |       |               |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                           |       | $                                                                                                        | 541,617    |               | $          | 554,160 |   |

 

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

4

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

**InterimCondensed Consolidated Statements of Income**

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

 
| ** **                        | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                        | ** ** | **(Unaudited)**                                  | ** ** |
|                              |       |                                             |       |   |   |
| Revenues                          |       | $                                                | 107,042    |   | $ | 125,778 |   |
| Cost of revenues  (*)             |       | 75,716                                           |       | 89,676 |   |
|                              |       |                                             |       |   |   |
| Gross profit                      |       | 31,326                                           |       | 36,102 |   |
|                              |       |                                             |       |   |   |
| Operating  expenses:              |       |                                             |       |   |   |
| Selling and marketing (*)         |       | 8,491                                            |       | 9,472 |   |
| General and administrative (*)    |       | 14,930                                           |       | 19,914 |   |
|                              |       |                                             |       |   |   |
| Total operating  expenses         |       | 23,421                                           |       | 29,386 |   |
|                              |       |                                             |       |   |   |
| Operating income                  |       | 7,905                                            |       | 6,716 |   |
| Financial income  (expenses), net |       | (61                                              | )          | 389 |   |
| Other income  (expenses), net     |       | (39                                              | )          | 6 |   |
|                              |       |                                             |       |   |   |
| Income before  taxes on income    |       | 7,805                                            |       | 7,111 |   |
| Taxes on income                   |       | 1,468                                            |       | 1,396 |   |
|                              |       |                                             |       |   |   |
| Net income                        |       | $                                                | 6,337      |   | $ | 5,715 |   |
|                              |       |                                             |       |   |   |
| Basic net  earnings per share     |       | $                                                | 0.18       |   | $ | 0.15 |   |
|                              |       |                                             |       |   |   |
| Diluted net earnings  per share   |       | $                                                | 0.18       |   | $ | 0.15 |   |

----

(*)   Includes stock-basedcompensation to employees, as follows:
| ** **                  | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                  | ** ** | **(Unaudited)**                                  | ** ** |
| Cost of revenues            |       | $                                                | —     |   | $ | 85 |   |
| Selling and  marketing      |       | —                                           |       | 22 |   |
| General and  administrative |       | 146                                              |       | 269 |   |
|                             |            |                                                  |            |  |  |  |  |

 

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

 

5

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**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIES**

**InterimCondensed Consolidated Statements of Cash Flows**

**U.S. dollars in thousands**

** **
| ** **                                                                                             | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                                                                                             | ** ** | **(Unaudited)**                                  | ** ** |
| Cash flows from  operating activities:                                                                 |       |                                             |       |   |   |
| Net income                                                                                             |       | $                                                | 6,337      |   | $ | 5,715 |   |
| Adjustments  required to reconcile net income to net cash used in operating activities:                |       |                                             |       |   |   |
| Stock-based  compensation-related expenses                                                             |       | 146                                              |       | 376 |   |
| Currency  fluctuation of long-term debt                                                                |       | 70                                               |       | 19 |   |
| Depreciation and  amortization                                                                         |       | 2,773                                            |       | 2,942 |   |
| Deferred income  taxes, net                                                                            |       | (648                                             | )          | 621 |   |
| Loss (gain) on  sale of property and equipment                                                         |       | (33                                              | )          | 21 |   |
| Decrease in  trade receivables, net                                                                    |       | 2,599                                            |       | 1,082 |   |
| Increase in  unbilled receivables                                                                      |       | (8,645                                           | )          | (10,229 | ) |
| Increase in  other accounts receivable and prepaid expenses                                            |       | (1,274                                           | )          | (3,257 | ) |
| Decrease  (increase) in inventories and work in progress                                               |       | 1,480                                            |       | (49 | ) |
| Increase in  long-term prepaid expenses                                                                |       | (154                                             | )          | (973 | ) |
| Decrease in  trade payables                                                                            |       | (6,237                                           | )          | (4,984 | ) |
| Increase in  advances from customers and deferred revenues                                             |       | 969                                              |       | 7,736 |   |
| Decrease in  other accounts payable and accrued expenses                                               |       | (12,436                                          | )          | (309 | ) |
| Increase in  accrued severance pay, net                                                                |       | 222                                              |       | 643 |   |
|                                                                                                   |       |                                             |       |   |   |
| Net cash used in  operating activities                                                                 |       | (14,831                                          | )          | (646 | ) |
|                                                                                                   |       |                                             |       |   |   |
| Cash flows from  investing activities:                                                                 |       |                                             |       |   |   |
| Net cash paid  for acquisition of a consolidated subsidiary (a)                                        |       | (13,611                                          | )          | — |   |
| Proceeds from  sale of cost investment, net                                                            |       | —                                           |       | 1,866 |   |
| Proceeds from  maturity of (investment in) short-term bank deposits                                    |       | 12,645                                           |       | (1,587 | ) |
| Proceeds from  sale of property and equipment                                                          |       | 599                                              |       | 54 |   |
| Purchase of  property and equipment and capitalization of software development costs for  internal use |       | (2,621                                           | )          | (2,564 | ) |
| Capitalization  of software development costs                                                          |       | (167                                             | )          | — |   |
|                                                                                                   |       |                                             |       |   |   |
| Net cash used in investing activities                                                                  |       | (3,155                                           | )          | (2,231 | ) |
|                                                                                                        |            |                                                  |            |  |  |  |  |

 

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

6

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**NESSTECHNOLOGIES, INC. AND ITS SUBSIDIARIES**

**Interim Condensed Consolidated Statements of CashFlows**

**U.S. dollars in thousands**

** **
| ** **                                                    | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                                                    | ** ** | **(Unaudited)**                                  | ** ** |
| Cash flows from  financing activities:                        |       |                                             |       |   |   |
| Exercise of options                                           |       | $                                                | 3,088      |   | $ | 1,299 |   |
| Short-term bank loans and credit, net                         |       | 13,717                                           |       | (1,341 | ) |
| Principal payments of long-term debt                          |       | (1,186                                           | )          | (1,601 | ) |
|                                                          |       |                                             |       |   |   |
| Net cash provided by (used in) financing activities           |       | 15,619                                           |       | (1,643 | ) |
|                                                          |       |                                             |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents |       | 26                                               |       | 349 |   |
|                                                          |       |                                             |       |   |   |
| Decrease in cash  and cash equivalents                        |       | (2,341                                           | )          | (4,171 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 33,579                                           |       | 46,675 |   |
|                                                          |       |                                             |       |   |   |
| Cash and cash  equivalents at the end of the period           |       | $                                                | 31,238     |   | $ | 42,504 |   |
|                                                          |       |                                             |       |   |   |

----

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

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

 

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

 

7

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**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIES**

**Notes toInterim Condensed Consolidated Financial Statements**

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

***Note 1: General***

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

We are a global provider of information technology (“IT”)services and solutions designed to help clients improve their competitivenessand effectiveness. Our portfolio of solutions and services includes systemintegration and application development, outsourcing, software and consulting,and quality assurance and training. 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.               UnauditedInterim Financial Information

The accompanying condensed consolidated balance sheet as of March 31,2007, the condensed consolidated statements of income for the three monthsended March 31, 2006 and 2007, and the condensed consolidated statementsof cash flows for the three months ended March 31, 2006 and 2007 areunaudited. These unaudited interim condensed consolidated financial statementshave been prepared in accordance with U. S. generally accepted accountingprinciples for interim financial information. In the opinion of management, theunaudited interim condensed consolidated financial statements include alladjustments of a normal recurring nature necessary for a fair presentation ofour consolidated financial position as of March 31, 2007, our consolidatedresults of operations for the three months ended March 31, 2006 and 2007,and our consolidated cash flows for the three months ended March 31, 2006and 2007.

The balance sheet at December 31, 2006 has been derived from theaudited consolidated financial statements at that date but does not include allof the information and footnotes required by U. S. generally acceptedaccounting principles for complete financial statements.

These consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements and accompanying notes forthe year ended December 31, 2006 included in our Annual Report onForm 10-K filed with the U.S. Securities and Exchange Commission (“SEC”)on March 14, 2007.

Results for the three months ended March 31, 2007 are notnecessarily indicative of results that may be expected for the year endingDecember 31, 2007.

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

##### b.              Reclassification

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

##### c.               Use of estimates

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

8

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

**Notes to Interim CondensedConsolidated Financial Statements**

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

##### d.              Principles ofconsolidation

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

##### e.               Acquisition ofsubsidiaries

| 1. |   | Ness IBS |
|----|--------|----------|

 

On February 28, 2006, we acquired all of the outstanding shares ofOlas Software Solutions, Inc., d/b/a Innova Solutions (“Innova”), a provider ofIT services and solutions based in the United States and India. We acquired theoutstanding shares for cash consideration of $15,000 and related purchase costsof $249. Additional payment of $8,225, provided for in 2006, was made in April2007 based on achievement of certain agreed milestones for the year 2006.Additional payment of up to $1,775 is required to be made in April 2008 basedon achievement of certain agreed milestones for the year 2007. Innova became awholly-owned subsidiary of Ness Technologies, Inc. and, accordingly, itsresults of operations are included in our consolidated financial statementssince the acquisition date. Upon completion of the acquisition, Innova changedits name to Ness Innovative Business Services, Inc., or Ness IBS.

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their relative fair values (as of theacquisition date, except for goodwill, which was updated to include theadditional payments) as follows:

| Cash and cash equivalents                                                             |   | $  1,566 |   |
|---------------------------------------------------------------------------------------|--------|--------------------|--------|
| Trade  receivables                                                                    |   | 3,527              |   |
| Other accounts  receivable                                                            |   | 1,310              |   |
| Property and  equipment                                                               |   | 1,233              |   |
| Other long-term  assets                                                               |   | 519                |   |
| Intangible  assets:                                                                   |   |               |   |
| Customer  relations                                                                   |   | 1,848              |   |
| Backlog                                                                               |   | 640                |   |
| Workforce.                                                                            |   | 4,773              |   |
| Goodwill                                                                              |   | 14,886             |   |
| Total assets  acquired                                                                |   | 30,302             |   |
| Liabilities  assumed:                                                                 |   |               |   |
| Accounts payable  and other accrued expenses                                          |   | 4,606              |   |
| Other current  liabilities                                                            |   | 2,008              |   |
| Accrual for  additional consideration to be paid subsequent to the balance sheet date |   | 8,225              |   |
| Long-term  liabilities                                                                |   | 214                |   |
| Total  liabilities assumed                                                            |   | 15,053             |   |
| Net assets acquired                                                                   |   | $ 15,249      |   |

 

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

9

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

**Notes to Interim CondensedConsolidated Financial Statements**

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

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

b.              The value assigned to the customer-related intangiblesamounted to $2,488. The fair value of Innova’s customer-related intangibles wasdetermined using the Income Approach. Customer relations is amortized over its usefullife, estimated as 4.83 years. Backlog is amortized according to its expectedrevenue recognition schedule.

c.               This acquisition was treated as an asset purchase fortax purposes and, as such, the goodwill related to this acquisition isdeductible for tax purposes.

On March 31, 2007, Ness IBS was merged into Ness USA, Inc.

Pro forma information in accordance with SFAS No. 141 is providedin Note 2e(3).
| 2. |   | NessPro Spain |
|----|--------|---------------|

 

On December 14, 2006, we acquired all of the outstanding shares ofSelesta España (“Selesta”), an IT software distribution and systems integrationcompany based in Spain, for a purchase price of €8 million, or $10,579,and related purchase costs of $125. The purchase price consisted of €6.25 millionpaid in cash at the closing and €1.75 million placed in escrow for sixmonths contingent on the verification of the accuracy of certainrepresentations made by the sellers. Additional payment of €0.8 million,or $1,066, will be made during 2007 based on achievement of certain revenue andoperating income milestones in 2006. The additional payment was accrued for andrecorded as goodwill in the December 31, 2006 consolidated balance sheet,as the milestones were met. An additional payment of €1 million or $1,332may be made during 2008 based on achievement of certain revenue and operatingincome milestones for 2007. Selesta became a wholly-owned subsidiary of ourDutch subsidiary, Ness Technologies, B.V., and, accordingly, its results ofoperations have been included in our consolidated financial statements sincethe acquisition date. Upon completion of the acquisition, Selesta changed itsname to NessPro Spain s.a.

This acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their related fair values (as of theacquisition date, except for goodwill, which was updated to include theadditional payments), using the exchange rate prevailing on the date ofacquisition, as follows:

10

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

**Notes to Interim CondensedConsolidated Financial Statements**

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

| Cash and cash equivalents                                                             |   | $     986 |   |
|---------------------------------------------------------------------------------------|--------|------------------------------------|--------|
| Trade receivables                                                                     |   | 3,168                              |   |
| Property and equipment                                                                |   | 140                                |   |
| Other accounts receivable                                                             |   | 984                                |   |
| Intangible assets:                                                                    |   |                               |   |
| Customer relations                                                                    |   | 758                                |   |
| Distribution agreements                                                               |   | 279                                |   |
| Workforce.                                                                            |   | 435                                |   |
| Goodwill                                                                              |   | 10,561                             |   |
| Total assets acquired                                                                 |   | 17,311                             |   |
| Liabilities assumed:                                                                  |   |                               |   |
| Accounts payable and other accrued expenses                                           |   | 3,125                              |   |
| Accrual for additional consideration to be paid  subsequent to the balance sheet date |   | 1,070                              |   |
| Deferred tax liability                                                                |   | 321                                |   |
| Other current liabilities                                                             |   | 2,091                              |   |
| Total liabilities assumed                                                             |   | 6,607                              |   |
| Net assets  acquired                                                                  |   | $ 10,704                      |   |

 

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

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

b.              The value assigned to the customer-related intangiblesamounted to $1,037. The fair value of Selesta’s customer-related intangibleswas determined using the Income Approach.

c.               We recorded a deferred tax liability of $321 for thedifference between the assigned values and the tax bases of thecustomer-related intangibles acquired.

Pro forma information in accordance with SFAS No. 141 is providedin Note 2e(3).

3.               The following tablepresents certain combined unaudited statements of income data for the threemonths ended March 31, 2006 as if the acquisitions of Ness IBS and NessProSpain had occurred on January 1, 2006, after giving effect to purchaseaccounting adjustments, including amortization of identifiable intangibleassets:

11

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

**Notes to Interim CondensedConsolidated Financial Statements**

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

|                     | ** ** | **Three months ended**March 31, 2006 | ** ** |
|---------------------|------------|----------------------------------------------------------|------------|
| ** **          | ** ** | **(unaudited)**                                          | ** ** |
|                |       |                                                     |       |
| Revenues            |       | $113,989                                                 |       |
| Net income          |       | $5,849                                                   |       |
|                |       |                                                     |       |
| Earnings per share: |       |                                                     |       |
| Basic               |       | $0.17                                                    |       |
| Diluted             |       | $0.16                                                    |       |

 

##### f.                 Goodwill

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

On January 1, 2007 we realigned our segments slightly (see Note 6).There was no significant effect on the allocation of goodwill between thesegments.

In the three months ended March 31, 2007, we recorded additionalgoodwill of $1,991, mainly resulting from translation adjustments.

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

During the three months ended March 31, 2007, we granted optionsto purchase 691,200 shares of our Common Stock to executive officers, selectedemployees and directors. Out of the 691,200 options granted, we granted certainof our senior management a total of 666,000 options. These options vest inaccordance with certain performance conditions through April 1, 2010. FromApril 1, 2010 to April 30, 2010, the grantees have the right toredeem the vested unexercised options outstanding on April 1, 2010 at the priceof $4.50 per each outstanding option. Given the specific characteristics of theoptions, we used a Monte Carlo simulation in order to estimate their fairvalue. Management believes this valuation technique produces a better estimateof fair values than the closed form option pricing model, considering theguidance provided in FASB 123(R). Options for the remaining 25,200 shareswere fully vested on the date of grant. The options on all 691,200 shares weregranted on January 4, 2007 before the stock market opened at an exercise priceequal to the closing price on the Nasdaq Stock Market the prior business day,or $14.27.

We estimate the fair value of stock options granted using theBlack-Scholes-Merton option pricing model for service options and the MonteCarlo option pricing model for performance condition options. Theoption-pricing models require a number of assumptions, of which the mostsignificant are the expected stock price volatility and the expected optionterm. Expected volatility was calculated based upon actual historical stockprice movements. The expected term of options granted is based upon historicalexperience and represents the period of time that options granted are expectedto be outstanding. The risk-free interest rate is based on the yield from U.S.treasury bonds with an equivalent term. We have historically not paid dividendsand have no foreseeable plans to pay dividends. The fair value was estimated atthe date of grant using the following assumptions:

12

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

**Notes to Interim CondensedConsolidated Financial Statements**

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

|                           | ** ** | **Black-Scholes  Three months ended  March 31, 2007** | ** ** | **Monte Carlo  Three months ended  March 31, 2007** | ** ** |
|---------------------------|------------|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                | ** ** | **(Unaudited)**                                                           | ** ** | **(Unaudited)**                                                              | ** ** |
| Dividend yield            |       | 0%                                                                        |       | 0%                                                                           |       |
| Expected volatility       |       | 31%                                                                       |       | 29%-31%                                                                      |       |
| Risk-free  interest       |       | 4.63%                                                                     |       | 4.61%-4.95%                                                                  |       |
| Expected life (in  years) |       | 2                                                                         |       | N/A                                                                          |       |

 

As of March 31, 2007, approximately $1,693 of total unrecognizedcompensation cost related to stock-based compensation is expected to berecognized over a period of 4 years. The total unrecognized stock-basedcompensation cost to be recognized in future periods as of March 31, 2007 doesnot consider the effect of stock options that may be issued in subsequentperiods.

On March 12, 2007, options to purchase an aggregate of 350,000 shareswere granted to two of our executive officers in connection with their hiring,at an exercise price equal to the closing price on the Nasdaq Stock Market theprior business day, or $13.00. The options were granted subject to stockholderapproval of our proposed 2007 Stock Option Plan, which is described in theproxy statement for our 2007 annual meeting of stockholders filed with the SECon April 30, 2007.

***Note 3: Commitments and Contingent Liabilities***

##### a.               Litigation

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 or results of operations.

One of our Israeli subsidiaries is currently in a dispute with one ofits clients, an Israeli insurance company, regarding the terms and conditionsof a software development contract (the “Contract”). The insurance companyclaims that we have materially breached the Contract by not timely deliveringthe required software. The insurance company issued a contract terminationnotice on September 21, 2006, collected autonomous guarantees provided byour subsidiary in the amount of about $2.1 million on November 23,2006, and is demanding payment of the amounts paid so far, as well as damages.Furthermore, this termination could affect our reputation and impair ourrelations with another client as well as with additional prospects for thesoftware. We believe that we have not materially breached the Contract and thatthe delays were caused by the insurance company’s actions. However, we do notcontest the insurance company’s right to terminate the contract forconvenience, subject to certain provisions including proper settlement ofpayments, as per the Contract. The Contract provides for mandatory arbitration,which commenced in January 2007, in which we intend to vigorously defend ourposition. The insurance company and our subsidiary have both issued theirrespective claims to the arbitrator, as well as responses to the other party’sclaims. The total scope of the project is approximately $9 million. Withrespect to this contract, approximately $3 million is included in ouraccounts receivable and approximately $2 million is included in otheraccounts receivable and prepaid expenses. We can give no assurance at thepresent time of the exposure, if any, for these claims. We believe that ourliability insurance policy, which has a cap of $5 million per claim,should cover such exposure. At this stage we can not estimate the result of thearbitration and we expect that the arbitration process may be protracted. Ifthe outcome of the dispute is not in our favor and not in line with our positiondescribed above, it may adversely affect our financial position, results ofoperations and cash flows.

13

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**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIES**

**Notesto Interim Condensed Consolidated Financial Statements**

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

#####  

##### b.              Guarantees

Guarantees are contingent commitments issued by us generally toguarantee our performance in different projects to our customers, such astenders. The term of a guarantee generally is equal to the term of the relatedprojects, which can be as short as 30 days or as long as 8 years. The maximumpotential amount of future payments we could be required to make under ourguarantees at December 31, 2006 and March 31, 2007, is $37,336 and $38,975,respectively. We do not hold collateral to support guarantees when deemednecessary.

##### c.               Liens andcharges

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

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

##### a.               Totalcomprehensive income:

|                                                                   | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                                                        | ** ** | **(Unaudited)**                                  | ** ** |
| Net income                                                        |       | $                                                | 6,337      |   | $ | 5,715 |   |
| Foreign currency  translation adjustments, net                    |       | (2,815                                           | )          | 2,852 |   |
| Net unrealized gains on  available-for-sale marketable securities |       | (60                                              | )          | — |   |
| Comprehensive income                                              |       | $                                                | 3,462      |   | $ | 8,567 |   |

 

##### b.              Option exercises:

In the three months ended March 31, 2007, a total of 379,619 optionswere exercised into common stock for aggregate consideration of $1,299.

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

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

On January 1, 2006, we completed the reorganization ofour operations into operating segments. Our chief operating decision-maker isour chief executive officer, who evaluates our performance and allocatesresources based on segment revenues and operating profit.

On January 1, 2007, we expanded our Managed StrategicServices (MSS) segment to include the non-financial services portions of NessIBS (formerly Innova), a component of our “Other” segment, and we changed thename of MSS to Ness North America; and we moved our Ness UK organization fromour “Other” segment to our Ness Europe segment. 2006 data for these threesegments is reclassified to reflect the current organization of the segments.

14

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**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIES**

**Notes to Interim CondensedConsolidated Financial Statements**

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

 

Our operating segments are:

1. **Ness North America (Ness NA)**, whichincludes India-based offshore services as well as system integration andapplication development and consulting services. Verticals served by thissegment are: independent software vendors, life sciences and healthcare andothers.

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

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

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

5. **Other**, which comprises operations representing,individually, less than 10% of our consolidated revenues and operating profit.These include our operations in Asia Pacific, the financial services componentof Ness IBS division (formerly Innova) as well as the recently acquired NessPROSpain (formerly Selesta España).

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

The table below presents financial information for ourfive reportable segments:
| ** **                        | ** ** | **Three months ended March 31, 2007** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                        | ** ** | **Ness  NA**                                                   | ** ** | **TSG** | ** ** | **Ness  Europe** | ** ** | **Ness  Israel** | ** ** | **Other** | ** ** | **Unallocated** | ** ** | **Total** | ** ** |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues from external  customers |       | $                                                              | 26,101     |   | $ | 14,153 |   | $ | 22,874 |   | $ | 50,600 |   | $ | 12,050 |   | — |   | $ | 125,778 |   |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income                  |       | $                                                              | 2,003      |   | $ | 2,370 |   | $ | 1,451 |   | $ | 3,089 |   | $ | 593 |   | $ | (2,790 | ) | $ | 6,716 |   |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Financial income, net             |       |                                                           |       |   |   |   |   |   |   |   |   |   |   | 389 |   |
| Other income, net                 |       |                                                           |       |   |   |   |   |   |   |   |   |   |   | 6 |   |
| Income before taxes on  income    |       |                                                           |       |   |   |   |   |   |   |   |   |   |   | $ | 7,111 |   |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                   |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

15

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**NESS TECHNOLOGIES, INC. AND ITSSUBSIDIARIES**

**Notesto Interim Condensed Consolidated Financial Statements**

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

 
| ** **                        | ** ** | **Three months ended March 31, 2006** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                        | ** ** | **Ness  NA**                                                   | ** ** | **TSG** | ** ** | **Ness  Europe** | ** ** | **Ness  Israel** | ** ** | **Other** | ** ** | **Unallocated** | ** ** | **Total** | ** ** |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues from external  customers |       | $                                                              | 20,798     |   | $ | 14,784 |   | $ | 21,086 |   | $ | 44,059 |   | $ | 6,315 |   | — |   | $ | 107,042 |   |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income                  |       | $                                                              | 2,584      |   | $ | 1,861 |   | $ | 1,682 |   | $ | 3,136 |   | $ | 101 |   | $ | (1,459 | ) | $ | 7,905 |   |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Financial expenses, net           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   | (61 | ) |
| Other expenses, net               |       |                                                           |       |   |   |   |   |   |   |   |   |   |   | (39 | ) |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income before taxes on  income    |       |                                                           |       |   |   |   |   |   |   |   |   |   |   | $ | 7,805 |   |
|                              |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                   |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

The following presents total revenues for the threemonths ended March 31, 2006 and 2007, and long-lived assets as of December 31,2006 and March 31, 2007:

|                                                 | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                                      | ** ** | **(Unaudited)**                                  | ** ** |
| Revenues from sales to  unaffiliated customers: |       |                                             |       |   |   |
| Israel                                          |       | $                                                | 52,925     |   | $ | 60,633 |   |
| United States                                   |       | 27,317                                           |       | 33,189 |   |
| Europe                                          |       | 21,276                                           |       | 25,301 |   |
| Asia and the Far  East                          |       | 4,515                                            |       | 5,456 |   |
| Others                                          |       | 1,009                                            |       | 1,199 |   |
|                                            |       | $                                                | 107,042    |   | $ | 125,778 |   |

 

|                        | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **             | ** ** | **2006**              | ** ** | **2007**           | ** ** |
| ** **             | ** ** | ** **            | ** ** | **(Unaudited)**    | ** ** |
| Long-lived assets:     |       |                  |       |               |       |
| Israel                 |       | $                     | 111,634    |               | $          | 112,419 |   |
| United States          |       | 81,740                |       | 82,923             |       |
| Europe                 |       | 34,567                |       | 34,550             |       |
| Asia and the Far  East |       | 10,377                |       | 10,265             |       |
| Others                 |       | 15                    |       | 21                 |       |
|                   |       | $                     | 238,333    |               | $          | 240,178 |   |

####  

#### ***Note 7: Income taxes***

In June 2006, the Financial Accounting Standards Board(“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes” (“FIN 48”) — an interpretation of FASB Statement No. 109, “Accountingfor Income Taxes.” The Interpretation addresses the determination of whethertax benefits claimed or expected to be claimed on a tax return should berecorded in the financial statements. Under FIN 48, we may recognize the taxbenefit from an uncertain tax position only if it is more likely than not thatthe tax position will be sustained on examination by the taxing authorities,based on the technical merits of the position. The tax benefits recognized inthe financial statements from such a position should be measured based on thelargest benefit that has a greater than fifty percent likelihood of beingrealized upon ultimate settlement. FIN 48 also provides guidance on 

16

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

**Notes to InterimCondensed Consolidated Financial Statements**

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

 

derecognizing, classification, interest and penaltieson income taxes and accounting in interim periods, and requires increaseddisclosures. As a result of the adoption we recorded approximately $1.5 millionof reserve for uncertain tax positions which, if recognized, would affect theeffective tax rate. This amount includes accrued interest expense and penaltiesrelated to the unrecognized tax benefits. We recognize accrued interest relatedto unrecognized tax benefits in interest expenses. Penalties are recognized asa component of income tax expense.

The amount of income taxes we pay is subject toongoing audit by federal, state and foreign tax authorities, which oftenresults in proposed assessments. Management performs a comprehensive review ofits global tax positions on a quarterly basis and accrues amounts forcontingent tax liabilities. Based on these reviews, the result of discussionsand resolutions of matters with certain tax authorities and the closure of taxyears subject to tax audit, reserves are adjusted as necessary. However, futureresults may include favorable or unfavorable adjustments to our estimated taxliabilities in the period the assessments are determined or resolved.Additionally, the jurisdictions in which our earnings and/or deductions arerealized may differ from current estimates. We are no longer subject to U.S.federal, state and local, or non U.S. income tax examination for years before2001.

The effective tax rate used in computing the provisionfor income taxes is based on our projected fiscal year income before taxes,including estimated income by tax jurisdiction. The difference between theeffective tax rate and the statutory tax rate is due preliminary to foreign taxholidays, foreign subsidiaries with different tax rates, non-deductibleexpenses and deferred taxes on losses for which valuation allowance wasprovided.

#### ***Note 8: Basic and Diluted Net Earnings per Share***

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

The total weighted average number of shares related tothe outstanding options and warrants excluded from the calculations of dilutednet earnings per share, as they would have been anti-dilutive for all periodspresented, was 2,532,118 and 710,955 for the three months ended March 31, 2006and 2007, respectively.

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

|                                                                                                      | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                                                                                           | ** ** | **(Unaudited)**                                  | ** ** |
| Numerator:                                                                                           |       |                                             |       |   |   |
| Net income, numerator  for basic and diluted per share                                               |       | $                                                | 6,337      |   | $ | 5,715 |   |
|                                                                                                 |       |                                             |       |   |   |
| Denominator:                                                                                         |       |                                             |       |   |   |
| Weighted average  number of shares of common stock                                                   |       | 34,870                                           |       | 38,872 |   |
| Effect of  dilutive securities:                                                                      |       |                                             |       |   |   |
| Employee stock  options and warrants                                                                 |       | 1,310                                            |       | 463 |   |
| Denominator for diluted net earnings per share — weighted average  assuming exercise of options |       | 36,180                                           |       | 39,335 |   |
|                                                                                                      |            |                                                  |            |  |  |  |  |

 

17

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

*You should read the followingdiscussion and analysis together with our unaudited consolidated financialstatements and the accompanying notes. This discussion contains forward-lookingstatements, within the meaning of Section 27A of Securities Act of 1933, asamended, Section 21E of the Securities Exchange Act of 1934, as amended, andthe Private Securities Litigation Reform Act of 1995, including statementsregarding our expected financial position, business and financing plans. Thesestatements involve risks and uncertainties. Our actual results could differ materiallyfrom the results described in or implied by these forward-looking statements asa result of various factors, including those discussed below and elsewhere inour Annual Report on Form 10-K filed with the SEC on March 14, 2007,particularly under the headings “Disclosure Statement” and “Risk Factors.”*

### **Overview**

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

We have operations in 16 countries across NorthAmerica, Europe and Asia. We combine our deep vertical expertise and strongtechnical capabilities to provide a complete range of high quality services ona global scale. By integrating our local and international personnel in focusedbusiness and project teams, this global delivery model leverages our corporateknowledge and experience, intellectual property and global infrastructure todevelop innovative solutions for clients across the geographies and verticalswe serve. We complement this global delivery model with our offshore deliverycapabilities to achieve meaningful cost reductions or other benefits for ourclients.

Our revenues increased to $125.8 million for the threemonths ended March 31, 2007, from $107.0 million for the three months endedMarch 31, 2006. Net income decreased to $5.7 million for the three months endedMarch 31, 2007, from $6.3 million for the three months ended March 31, 2006primarily as a result of exceptional expenses related to our managementtransition of $1.8 million, losses from our United Kingdom operations of $0.8million and other expenses aggregating to $0.4 million.

Our revenue growth is attributable to a number offactors, including acquisitions we made, increases in the number and size ofprojects for existing clients, and the addition of new clients. Our client baseis diverse, and we are not dependent on any single client. In the three monthsended March 31, 2007, no client accounted for more than 5% of our revenues andour largest twenty clients together accounted for approximately 31% of ourrevenues. For the three months ended March 31, 2007, the percentage of ourrevenues derived in aggregate from agencies of the government of Israel was 9%.Existing clients from prior years generated more than 85% of our revenues inthe three months ended March 31, 2007.

Our backlog as of March 31, 2007 was $631 millioncompared to $527 million as of March 31, 2006. This $104 million increase inour backlog was due primarily to new bookings. We achieve backlog through newsignings of IT services projects and outsourcing contracts, including for newand repeat customers. We recognize backlog as revenue when we perform theservices related to backlog.

For the three months ended March 31, 2007, thepercentage of our revenues derived from clients in Israel was 48%; in theUnited States, 26%; in Europe, 20%; in Asia and the Far East, 4%; and in othercountries, 1%.

For the three months ended March 31, 2007, we derived43% of our revenues from outsourcing (including offshore development); 30% fromsystem integration and application development; 17% from software andconsulting; 8% from quality assurance and training; and 2% from our otherofferings.

 

18

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As of March 31, 2007, we had approximately 7,500employees, including approximately 6,555 IT professionals. Of the 7,500employees, approximately 3,355 were in Israel, 2,295 were in India, 585 were inNorth America, 895 were in Europe and 370 were in the Asia Pacific region.

### **RecentDevelopments**

On April 17, 2007,we signed a definitive agreement to acquire Advanced Industrial ManagementCompany Limited (“AIM”), a privately-held leading software distributor inThailand. The purchase price is $2.4 million in cash. In addition, should AIMachieve certain business goals by the end of the years 2007 and 2008, we willpay an additional amount of up to $1.35 million. The acquisition is expected toclose during May 2007 and is subject to customary closing conditions. AIMemploys 35 people and for the year 2006 was profitable. AIM will become part ofNessPRO, our software product distribution business, currently operating inIsrael, Spain, Portugal, Singapore and Thailand. AIM will strengthen ourcurrent operations in Asia Pacific. Upon closing of the acquisition, AIM willchange its name to NessPRO Thailand Ltd.

### **ConsolidatedResults of Operations**

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

|                                   | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| Revenues                          |       | 100.0                                            | %          | 100.0 | % |
| Cost of revenues                  |       | 70.7                                             |       | 71.3 |   |
| Gross profit                      |       | 29.3                                             |       | 28.7 |   |
|                              |       |                                             |       |   |   |
| Operating expenses:               |       |                                             |       |   |   |
| Selling and  marketing            |       | 7.9                                              |       | 7.5 |   |
| General and administrative        |       | 13.9                                             |       | 15.8 |   |
| Total operating  expenses         |       | 21.9                                             |       | 23.4 |   |
|                              |       |                                             |       |   |   |
| Operating income                  |       | 7.4                                              |       | 5.3 |   |
| Financial income  (expenses), net |       | (0.1                                             | )          | 0.3 |   |
| Other income  (expenses), net     |       | 0.0                                              |       | 0.0 |   |
| Income before taxes on  income    |       | 7.3                                              |       | 5.7 |   |
|                              |       |                                             |       |   |   |
| Taxes on income                   |       | 1.4                                              |       | 1.1 |   |
| Net income                        |       | 5.9                                              |       | 4.5 |   |

 

### **ThreeMonths Ended March 31, 2007 Compared to the Three Months Ended March 31, 2006**

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

|                  | ** ** | **Three months ended  March 31,** | ** ** | **Increase** | ** ** |
|------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                         | ** ** | **2007**     | ** ** | **$** | ** ** | **%** | ** ** |
| Revenues         |       | $                                                | 107,042    |         | $          | 125,778 |   | 18,736 |   | 17.5 |   |
| Cost of revenues |       | 75,716                                           |       | 89,676       |       | 13,960 |   | 18.4 |   |
| Gross profit     |       | $                                                | 31,326     |         | $          | 36,102 |   | 4,776 |   | 15.2 |   |
| Gross margin     |       | 29.3                                             | %          | 28.7         | %          |   |   |   |   |

#### *** ***

#### ***Revenues***

Our revenues increased from $107.0 million in thethree months ended March 31, 2006 to $125.8 million in the three months endedMarch 31, 2007, representing an increase of $18.7 million, or 17.5%.Approximately $9.0 million this increase was attributable to acquisitions, asignificant portion of which was due to post-acquisition

19

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growth resulting from synergies with Ness. Of the$18.7 million increase in revenues, $5.6 million represents growth inoutsourcing and offshore engagements and $13.1 million represents growth in ourother offerings, comprised of system integration and application development,software and consulting, and quality assurance and training. Revenues fromoutsourcing and offshore services increased as a result of volume growth due toour sales initiatives related to these offerings, including the hiring of keypersonnel and aligning of our organizational structure. There was nosignificant change in our billing rates, or prices, from the three months endedMarch 31, 2006 to the three months ended March 31, 2007.

#### ***Cost of revenues***

Our cost of revenues, including salaries, wages andother direct and indirect costs, increased from $75.7 million in the threemonths ended March 31, 2006 to $89.7 million in the three months ended March31, 2007, representing an increase of $14.0 million, or 18.4%. Approximately$6.5 million of this increase was attributable to acquisitions, a significantportion of which was due to growth in our delivery staff needed to supportpost-acquisition revenue growth resulting from synergies with Ness, and $7.5million was due to normal growth in our delivery staff needed to support ourincreased revenues.

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

Our gross profit (revenues less cost of revenues)increased from $31.3 million in the three months ended March 31, 2006 to $36.1million in the three months ended March 31, 2007, representing an increase of$4.8 million, or 15.2 %. The increase was primarily due to our increase inrevenues. Approximately $2.4 million of the increase was attributable to acquisitions,a significant portion of which was due to post-acquisition revenue growthresulting from synergies with Ness, and $2.4 million was related to our otherrevenue growth. Gross margin for the three months ended March 31, 2007 was28.7%, compared to 29.3% in the three months ended March 31, 2006.

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

|                             | ** ** | **Three months ended  March 31,** | ** ** | **Increase** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                  | ** ** | **2006**                                         | ** ** | **2007**     | ** ** | **$** | ** ** | **%** | ** ** |
| Selling and marketing       |       | $                                                | 8,491      |         | $          | 9,472 |   | 981 |   | 11.6 |   |
| General and  administrative |       | 14,930                                           |       | 19,914       |       | 4,984 |   | 33.4 |   |
| Total operating  expenses   |       | 23,421                                           |       | 29,386       |       | 5,965 |   | 25.5 |   |
| Operating income            |       | $                                                | 7,905      |         | $          | 6,716 |   | (1,189 | ) | (15.0 | ) |

####  

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

Selling and marketing expenses increased from $8.5million in the three months ended March 31, 2006 to $9.5 million in the threemonths ended March 31, 2007, representing an increase of $1.0 million, or11.6%. This increase was due primarily to the inclusion of marketing and salesexpenses from our acquisitions, representing $0.6 million.

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

General and administrative expenses increased from$14.9 million in the three months ended March 31, 2006 to $19.9 million in thethree months ended March 31, 2007, representing an increase of $5.0 million, or33.4%. This increase was due primarily to exceptional expenses associated withthe transition of management, representing $1.8, and our acquisitions,representing $2.2 million.

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

Operating income decreased from $7.9 million in thethree months ended March 31, 2006 to $6.7 million in the three months endedMarch 31, 2007, representing a decrease of $1.2 million, or 15.0%. The decreasewas mainly attributable to the increase in our general and administrativeexpenses.

20

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

|                                   | ** ** | **Three months ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                        | ** ** | **2006**                                         | ** ** | **2007**                 | ** ** | **$** | ** ** | **%** | ** ** |
| Operating income                  |       | $                                                | 7,905      |                     | $          | 6,716 |   | (1,189 | ) | (15.0 | ) |
| Financial income  (expenses), net |       | (61                                              | )          | 389                      |       | 450 |   | (737.7 | ) |
| Other income  (expenses), net     |       | (39                                              | )          | 6                        |       | 45 |   | (115.4 | ) |
| Income before taxes on  income    |       | 7,805                                            |       | 7,111                    |       | (694 | ) | (8.9 | ) |
| Taxes on income                   |       | 1,468                                            |       | 1,396                    |       | (72 | ) | (4.9 | ) |
| Net income                        |       | $                                                | 6,337      |                     | $          | 5,715 |   | (622 | ) | (9.8 | ) |

####  

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

Financial income (expenses), net, changed fromexpenses of $0.1 million in the three months ended March 31, 2006 to income of$0.4 million in the three months ended March 31, 2007, representing an increaseof $0.5 million. The increase is primarily due to the increase in our averagenet cash from $24.3 million to $36.3 million, which allowed us to generatehigher interest income, net, representing $0.2 million, along with therepayment of relatively expensive loans and favorable foreign currency exchangeeffects, together representing $0.3 million.

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

Other income (expenses), net changed from expenses of$39,000 in the three months ended March 31, 2006 to income of $6,000 in thethree months ended March 31, 2007. This change was not significant.

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

Our taxes on income decreased from $1.5 million in thethree months ended March 31, 2006 to $1.4 million in the three months endedMarch 31, 2007, representing a decrease of $0.1 million, or 4.9%. This decreaseis due primarily to the decrease in our income before taxes, partially offsetby the utilization of tax loss carry-forwards in the United States and Israel.We expect our tax rate for the remainder of the year to be above 20%, due tothe utilization of those tax loss carry-forwards and the proposed changes inthe tax rates in India.

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

Net income decreased from $6.3 million in the threemonths ended March 31, 2006 to $5.7 million in the three months ended March 31,2007, representing a decrease of $0.6 million, or 9.8%. The decrease in netincome was due primarily to our decrease in operating income of $1.2 million,partially offset by the increase in financial income (expenses), net, of $0.5million.

### **Resultsby Business Segment**

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

On January 1, 2006 we completed the reorganization ofour operations into operating segments. Our chief operating decision-maker isour chief executive officer, who evaluates our performance and allocatesresources based on segment revenues and operating profit.

On January 1, 2007, weexpanded our Managed Strategic Services (MSS) segment to include thenon-financial services portions of Ness IBS (formerly Innova), a component ofour “Other” segment, and we changed the name of MSS to Ness North America; andwe moved our Ness UK organization from our “Other” segment to our Ness Europesegment. 2006 data for these three segments is reclassified to reflect thecurrent organization of the segments.

21

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#### Our operating segments are:

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

2.       **Technologies & Systems Group**, which includes system integration and applicationdevelopment, real-time systems development, consulting and outsourcing servicesfor the defense, government and homeland security vertical, as well as systemsfor the telecommunications vertical.

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

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

5.       **Other**, which comprises operations representing,individually, less than 10% of our consolidated revenues and operating profit.These include our operations in Asia Pacific, the financial services componentof Ness IBS division (formerly Innova) as well as the recently acquired NessPROSpain (formerly Selesta España).

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

The table below presentsfinancial information for our five reportable segments (dollars in thousands):

|                                         | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **(unaudited)**                                  | ** ** |
| **Segment Data:**                       |       |                                             |       |   |   |
| ** **                              |       |                                             |       |   |   |
| **Revenues:**                           |       |                                             |       |   |   |
| Ness North  America                     |       | $                                                | 20,798     |   | $ | 26,101 |   |
| Technologies  & Systems Group (TSG) |       | 14,784                                           |       | 14,153 |   |
| Ness Europe                             |       | 21,086                                           |       | 22,874 |   |
| Ness Israel                             |       | 44,059                                           |       | 50,600 |   |
| Other                                   |       | 6,315                                            |       | 12,050 |   |
|                                    |       | $                                                | 107,042    |   | $ | 125,778 |   |
| **Operating Income (Loss):**            |       |                                             |       |   |   |
| Ness North  America                     |       | $                                                | 2,584      |   | $ | 2,003 |   |
| Technologies  & Systems Group (TSG) |       | 1,861                                            |       | 2,370 |   |
| Ness Europe                             |       | 1,682                                            |       | 1,451 |   |
| Ness Israel                             |       | 3,136                                            |       | 3,089 |   |
| Other                                   |       | 101                                              |       | 593 |   |
| Unallocated  Expenses                   |       | (1,459                                           | )          | (2,790 | ) |
|                                    |       | $                                                | 7,905      |   | $ | 6,716 |   |

 

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**Liquidityand Capital Resources**

#### ***Overview***

As of March 31, 2007, we had cash, cash equivalentsand short-term bank deposits of $46.2 million compared to $48.7 million as ofDecember 31, 2006. The funds held at locations outside of the United States arefor future operating expenses and capital expenditures, and we have nointention of repatriating those funds. We are not, however, restricted in repatriatingthose funds back to the United States, if necessary. While we expect that cashgenerated by our non-U.S. subsidiaries will be reinvested in their respectivegeographies to support expansion of our business, to the extent that funds wereremitted to the United States in the form of dividend payments, those paymentsmay be subject to withholding taxes in their respective countries, and would besubject to tax in the United States.

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

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

 

|                                                               | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
| Net cash used in  operating activities                        |       | $                                                | (14,831    | ) | $ | (646 | ) |
| Net cash used in  investing activities                        |       | (3,155                                           | )          | (2,231 | ) |
| Net cash provided by  (used in) financing activities          |       | 15,619                                           |       | (1,643 | ) |
| Effect of exchange rate  changes on cash and cash equivalents |       | 26                                               |       | 349 |   |
| Decrease in cash and  cash equivalents                        |       | (2,341                                           | )          | (4,171 | ) |
| Cash and cash  equivalents at the beginning of the period     |       | 33,579                                           |       | 46,675 |   |
| Cash and cash  equivalents at the end of the period           |       | $                                                | 31,238     |   | $ | 42,504 |   |
|                                                          |       |                                             |       |   |   |

 

*Threemonths ended March 31, 2007 compared to the three months ended March 31, 2006*

Net cash used in operating activities was $0.6 millionin the three months ended March 31, 2007, compared to $14.8 million in thethree months ended March 31, 2006. The major factors contributing to thedecrease were tax payments in the three months ended March 31, 2006 to theIsraeli Tax Authority related to prior periods for which there was no correspondingamount in the three months ended March 31, 2007, representing $7.2 million, anda decrease in trade payables, other accounts payable and accrued expenses,representing $6.1 million.

Net cash used in investing activities was $2.2 millionin the three months ended March 31, 2007, compared with $3.2 million in thethree months ended March 31, 2006. The major factors contributing to thedecrease were payments in respect of the acquisitions we made during the firstthree months of 2006 for which there was no corresponding amount in the threemonths ended March 31, 2007, representing $13.6 million, net of cash acquired,offset by the difference between proceeds from short-term bank deposits in thethree months ended March 31, 2006 and investment in short-term bank deposits inthe three months ended March 31, 2007, representing $14.2 million, and receiptof the remaining net proceeds from the sale of our interest in dbMotion,representing $1.9 million.

Net cash used in financing activities was $1.6 millionin the three months ended March 31, 2007, compared with net cash provided of$15.6 million in the three months ended March 31, 2006. The decrease wasprimarily due to a lower utilization of short-term bank loans and credit,representing $15.1 million, partially offset by a decrease in the exercise ofoptions, representing $1.8 million. In the three months ended March 31, 2006and 2007, cash flows from the exercise of options amounted to $3.1 million and$1.3 million, respectively.

The effect of exchange rate changes on cash and cashequivalents was $0.3 million in the three months ended March 31, 2007, comparedto $26,000 in the three months ended March 31, 2006. The change was notsignificant.

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

At March 31, 2007, we had aggregate short-term andlong-term bank borrowings of $4.3 million, consisting of various notesdenominated in dollars and NIS (linked to index) with interest rates rangingfrom approximately 6.5% to 7.5% and a weighted average interest rate ofapproximately 7.44%, with maturities of one to two years. These aggregate bankborrowings included $4.0 million from Israel Discount Bank, with interest ratesof approximately 7.5% and maturities of one to two years; and $0.5 million fromMizrahi Bank, with interest rates of approximately 6.5% and maturities of up toone year.

Our only material indebtedness is amounts owed by NessA.T. Ltd., one of our subsidiaries, to Israel Discount Bank. The relevant debtinstruments contain customary restrictive covenants relating to the borrower,including the following:

·                  a negative pledge;

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

·                  limitations on merging or transferringassets.

As of March 31, 2007, we are in compliance and expectto remain in compliance with all of our covenants. Our failure to comply withthese covenants could lead to an event of default under the agreementsgoverning some or all of the indebtedness, permitting the applicable lender toaccelerate all borrowings under the applicable agreement, and to foreclose onany collateral.

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

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

#### ***Critical Accounting Estimates***

Preparation of our financial statements requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses. We believe the most complex andsensitive judgments, because of their significance to the our consolidatedfinancial statements, result primarily from the need to make estimates aboutthe effects of matters that are inherently uncertain. Management’s Discussionand Analysis and Note 1 to the consolidated financial statements presented inour 2006 Annual Report on Form 10-K, filed with the SEC on March 14, 2007,describe the significant accounting estimates and policies used in preparationof our consolidated financial statements. Actual results in these areas coulddiffer from management’s estimates. As discussed below and in Note 7 to thecondensed consolidated financial statements, we have adopted the provisions ofFIN 48, “Accounting for Uncertainty in Income Taxes” on January 1, 2007. Otherthan this change, there have been no significant changes in our criticalaccounting estimates during the first three months of 2007.

In the ordinary course of business there is inherentuncertainty in quantifying our income tax positions. We assess our income taxpositions and record tax benefits for all years subject to examination basedupon management’s evaluation of the facts, circumstances, and informationavailable at the reporting date. For those tax positions where it is morelikely than not that a tax benefit will be sustained, we have recorded thelargest amount of tax benefit with a greater than 50 percent likelihood ofbeing realized upon ultimate settlement with a taxing authority that has fullknowledge of all relevant information. For those income tax positions where itis not more likely than not that a tax benefit will be sustained, no taxbenefit has been recognized in the financial statements. Where applicable,associated interest has also been recognized.

24

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***Contractual Obligations***

In our 2006 Annual Report on Form 10-K, filed with theSEC on March 14, 2007, we disclosed contractual obligations. At March 31, 2007,there have been no material changes to our contractual obligations other thanas noted below.

On March 12, 2007, we granted options to purchase anaggregate of 350,000 shares to two of our executive officers in connection withtheir hiring, at an exercise price equal to the closing price on the NasdaqStock Market the prior business day, or $13.00. The options were grantedsubject to stockholder approval of our proposed 2007 Stock Option Plan, whichis described in the proxy statement for our 2007 annual meeting of stockholdersfiled with the SEC on April 30, 2007.

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

This Quarterly Report on Form 10-Q, includingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995. Forward-looking statementsoften are proceeded by words such as “believes,” “expects,” “may,” “anticipates,”“plans,” “intends,” “assumes,” “will” or similar expressions. Forward-lookingstatements reflect management’s current expectations, as of the date of thisreport, and involve certain risks and uncertainties. Our actual results coulddiffer materially from those anticipated in these forward looking statements asa result of various factors. Some of the factors that could cause futureresults to materially differ from the recent results or those projected inforward-looking statements include the “Risk Factors” described in our 2006Annual Report on Form 10-K filed with the SEC on March 14, 2007.

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

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

We have direct operations in 16 different countriesand commercial relationships in many other parts of the world. Our foreignoperations contract with clients in their applicable local currencies ordollars. As a result, we are subject to adverse movements in foreign currencyexchange rates in those countries where we conduct business. In order tominimize the effect of such movements, we entered into certain forward foreigncurrency exchange contracts to hedge our exposure against foreign currencieswhich differ from the local functional currencies. In the future, we may enterinto additional forward foreign currency exchange or other derivativescontracts to further hedge our exposure to foreign currency exchange rates.

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

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

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

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

25

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

### **Changesin Internal Control**

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

 

26

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**PART II — OTHERINFORMATION**

***Item 1. LegalProceedings***

One of our Israeli subsidiaries is currently in adispute with one of its clients, an Israeli insurance company, regarding theterms and conditions of a software development contract (the “Contract”). Theinsurance company claims that we have materially breached the Contract by nottimely delivering the required software. The insurance company issued acontract termination notice on September 21, 2006, collected autonomousguarantees provided by our subsidiary in the amount of about $2.1 million onNovember 23, 2006, and is demanding payment of the amounts paid so far, as wellas damages. Furthermore, this termination could affect our reputation andimpair our relations with another client as well as with additional prospectsfor the software. We believe that we have not materially breached the Contractand that the delays were caused by the insurance company’s actions. However, wedo not contest the insurance company’s right to terminate the contract for convenience,subject to certain provisions including proper settlement of payments, as perthe Contract. The Contract provides for mandatory arbitration, which commencedin January 2007, in which we intend to vigorously defend our position. Theinsurance company and our subsidiary have both issued their respective claimsto the arbitrator, as well as responses to the other party’s claims. The totalscope of the project is approximately $9 million. With respect to thiscontract, approximately $3 million is included in our accounts receivable andapproximately $2 million is included in other accounts receivable and prepaidexpenses. We can give no assurance at the present time of the exposure, if any,for these claims. We believe that our liability insurance policy, which has acap of $5 million per claim, should cover such exposure. At this stage we cannot estimate the result of the arbitration and we expect that the arbitrationprocess may be protracted. If the outcome of the dispute is not in our favor andnot in line with our position described above, it may adversely affect ourfinancial position, results of operations and cash flows.

***Item 1A. RiskFactors***

There are no material changes in the risk factorspreviously disclosed in our Annual Report on Form 10-K filed with the SEC onMarch 14, 2007.

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

Not applicable.

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

None.

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

None.

***Item 5. Other Information***

On May 6, 2006, we amended our employmentagreement with Tuvia Feldman, our chief operating officer. EffectiveApril 1, 2007, the term of Mr. Feldman’s employment agreement wasextended to December 31, 2008, and Mr. Feldman was granted a retentionbonus of $135,000. If Mr. Feldman resigns before December 31, 2008,the grant will be proportionately reduced.

***Item 6. Exhibits***

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

| Exhibit Number | ** ** | **Description**                                                                                                   |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------|
| 10.1           |       | Amendment to Employment Agreement, effective as of  April 1, 2007, between the Registrant and Tuvia Feldman. |
|           |       |                                                                                                              |
| 31.1           |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.         |

 

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

 

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**SIGNATURES**

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

NESS TECHNOLOGIES, INC.(Registrant)

| Date:  May 10, 2007 |   | By:    |   | /s/ ISSACHAR  GERLITZ                                                                              |
|---------------------|--------|--------|--------|----------------------------------------------------------------------------------------------------|
|                |   |   |   | Issachar Gerlitz                                                                                   |
|                |   |   |   | Chief Executive Officer, President, Director  (Principal executive officer)                        |
| Date: May 10, 2007  |   | By:    |   | /s/ OFER SEGEV                                                                                     |
|                |   |   |   | Ofer Segev                                                                                         |
|                |   |   |   | Executive Vice President and Chief Financial Officer  (Principal financial and accounting officer) |

 

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**EXHIBIT INDEX**
| Exhibit Number | ** ** | **Description**                                                                                                                                      |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1           |       | Amendment to Employment  Agreement, effective as of April 1, 2007, between the Registrant and Tuvia  Feldman.                                        |
| 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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