Keane, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Note 1.        Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and, accordingly, do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited condensed consolidated financial statements include the accounts of Keane, Inc. and our wholly and majority owned subsidiaries. In the opinion of management, all adjustments, consisting primarily of normal recurring accruals, considered necessary for a fair presentation of the results of operations for the interim periods reported and of our financial condition as of the date of the interim balance sheet have been included. Operating results for the three and six months ended June 30, 2005March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 20052006 or for any other period.

The balance sheet at December 31, 20042005 has been derived from our audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Certain reclassifications have been made to the 20042005 financial statements to conform to the 20052006 presentation. These reclassifications have no effect on previously reported net income or stockholder’s equity.

For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 20042005 filed with the Securities and Exchange Commission on March 15, 2005.16, 2006.

Note 2.Earnings Per Share Data

The computation of earnings per share for the three and six months ended June 30, 2005 and 2004 is as follows (in thousands, except per share data):

Potential common shares consist of employee stock options and restricted common stock. Employee stock options to purchase 1,704,403 and 1,378,836 shares for the three months ended June 30, 2005 and 2004, and

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1,702,702 and 1,352,097 shares for the six months ended June 30, 2005 and 2004, respectively, were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares during the period and, therefore, their effect would have been anti-dilutive.

Our 2.0% Convertible Subordinated Debentures due 2013 (the “Debentures”) are convertible at the option of the holder into shares of our common stock at an initial conversion rate of 54.4989 shares of common stock per $1,000 principal amount of Debentures, which is equivalent to an initial conversion price of approximately $18.349 per share. The Debentures become convertible under the following circumstances: (a) during any fiscal quarter commencing after September 30, 2003 when, among other circumstances, the closing price per share of our common stock is more than 120% of the conversion price (approximately $22.019 per share) for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter; (b) during the five business days after any five consecutive trading day period in which the trading price per $1,000 principal amount of Debentures for each day of that period was less that 98% of the product of the closing sale price per share of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the Debentures; (c) if the Debentures have been called for redemption; or (d) upon the occurrence of specified corporate transactions. Approximately 8.2 million shares of our common stock would be issuable upon the conversion of all of the outstanding Debentures.

We adopted the provisions of Emerging Issues Task Force (“EITF”) Issue No. 04-8 (“EITF 04-8”), “The Effect of Contingently Convertible Debt on Diluted Earnings per Share,” in the Fourth Quarter of 2004.  EITF 04-8 requires that we include contingently convertible debt in the calculation of diluted earnings per share using the if-converted method regardless of whether the market price trigger has been met. Under the if-converted method, the debt is considered converted to shares, with the resulting number of shares included in the denominator of the earnings per share calculation and the related interest expense (net of tax) added back to the numerator of the earnings per share calculation. EITF 04-8 also requires the restatement of previously reported diluted earnings per share upon adoption. Therefore, the weighted average impact of the 8.2 million shares issuable upon conversion of the Debentures has been included in the calculation of diluted earnings per share for the three and six months ended June 30, 2005 and 2004.

Note 3.Stock-Based2.        Stock Based Compensation

Effective January 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), (“SFAS 123(R)”) “Share Based Payment”. Generally, the approach in SFAS 123(R) is similar to the approach described in Statement of Financial Accounting Standard No 123, (“SFAS 123”) “Accounting for Stock Based Compensation”. However, SFAS 123(R) requires all share-based payments granted to employees that are ultimately expected to vest and do actually vest, including grants of employee stock options, to be recognized in the income statement based on their fair value at the date of grant. Pro forma disclosure is no longer an alternative.

We adopted SFAS 123(R) under the modified prospective method. Under this method, beginning on January 1, 2006, we recognized compensation cost for all share-based payments to employees based on the grant date estimate of fair value for those awards. We have stock-basedused the Black-Scholes option-pricing model to determine fair value for all share-based payments. Prior period financial information has not been restated.

As of March 31, 2006, we had several share-based compensation plans that are described below. The adoption of SFAS 123(R) on January 1, 2006 had the following impact on our results of operations for whichthe three months ended March 31, 2006: operating profit before tax was lower by approximately $0.5 million, net income was lower by approximately $0.4 million, basic EPS was lower by approximately $0.01 and diluted EPS was lower by less than one cent. The total income tax benefit recognized in the income statement for share-based compensation agreements for the three months ended March 31, 2006 was approximately $0.2 million.  There was no tax benefit realized from stock options exercised during the three months ended March 31, 2006.

We received $2.7 million from stock option exercises for the three months ended March 31, 2006. As of March 31, 2006, we have adoptedhad approximately $5.9 million of unrecognized compensation cost related to stock option awards that we expect to be recognized as expense over a weighted average period of 3.7 years.

The following table illustrates the disclosure-onlyeffect on net income and earnings per share as if we had applied the fair value recognition provisions of SFAS No. 148 (“SFAS 148”), “Accounting123 to our stock-based employee compensation for Stock-Based Compensation—Transition and Disclosure,” an amendmentthe three months ended March 31, 2005.

(1)             See Note 3 “Earnings Per Share” for reconciliation of net income as reported to net income used in calculation of diluted earnings per share.

For periods prior to the adoption of SFAS No. 123 (“SFAS 123”)123(R), “Accounting for Stock-Based Compensation.” Accordingly, no compensation expense has been recognized for our stock-based compensation plans other than for restricted stock and certain stock options. As permitted by SFAS 148 and SFAS 123, we account for our stock-based compensation in accordance withelected to follow Accounting Principles Board Opinion (“APB”) Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.Employees,”

In accordance with APB 25 we use the intrinsic value-based method to account for stock option grants and restricted stock awards. We grant stock options for a fixed number of shares to employees with an exercise price equal to the closing price of the shares at the date of grant and therefore, do not recognize compensation expense. We also grant restricted stock for a fixed number of shares to employees for nominal consideration. In 2003, in connection with our acquisition of a majority interest in Keane Worldzen, certain employees were granted Keane Worldzen stock options. In accordance withrelated Financial Accounting Standards Board (“FASB”) Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions Involving Stock Compensation,” and SFAS No. 141 (“SFAS 141”), “Business Combinations,” theseCompensation” in accounting for our share based payment awards. Under APB 25, since the exercise price of our employee stock options were recorded as unearned compensation atequaled the market price of the underlying stock on the date of acquisition and vest over the life ofgrant, no compensation expense was recorded in the stock option. Compensationfinancial statements.  However, compensation expense related to restricted stock awards and thecertain Keane Worldzen stock options iswas recorded ratably over the restriction and vesting period, respectively, and iswas included in the selling, general, and administrative expenses in the accompanying unaudited condensed consolidated statements of income.

Prior to the adoption of SFAS 123(R) and during the Fourth Quarter of 2005, we accelerated the vesting of certain stock options in which the exercise price of the awards had exceeded the market price of the stock on the date of modification. As a result, of the acceleration, approximately 2.1 million shares subject to options, constituting approximately 47% of the total of unvested options outstanding at that time became immediately exercisable. The acceleration impacted approximately 570 employees. Under APB 25 and FIN 44, no compensation expense was recognized in the financial statements for the acceleration of vesting of these options since the closing price per share of our common stock on the dates of acceleration were greater than the exercise prices of the unvested options that we accelerated. The primary purpose of the accelerated vesting was to enable us to avoid recognizing in our income statement non-cash compensation expense associated with these options in future periods, upon our adoption of SFAS 123(R) on January 1, 2006. Absent the acceleration of the options described above, from and after our adoption of SFAS 123(R), we would have been required to recognize approximately $10.5 million in pre-tax non-cash compensation expense over the remaining vesting terms of the stock options, based on valuation calculations using the Black-Scholes option pricing model.

Share Based Compensation Plans:

Stock Incentive Plans

        Our 1998 Stock Incentive Plan, amended in December 1999, provides for grants of stock options and restricted stock for up to 7,000,000 shares of our common stock to our employees, officers, directors, consultants, and advisors. The contractual life of options granted under this plan ranges from five to ten years from the date of grant; the plan requires a purchase price of not less than 100% of the fair market value of the stock as of the date of grant; and the options may be exercisable at such time or times as our Board of Directors in each case determines. In general, our stock options vest over a five-year period on a graded vesting schedule and their compensation cost is recorded on a straight-line basis over the share-vesting period.  Our restricted stock awards typically vest over a five-year period on a graded vesting schedule. We value restricted stock awards based on the closing price of our common stock on the date of grant, less the nominal consideration received. We record compensation cost on a straight-line basis over the share-vesting

period. The cumulative amount of compensation cost recorded on stock options and restricted stock at any date is at least equal to the fair value of the awards that have actually vested as of that date.

        In December 2000, we initiated a “Time Accelerated Restricted Stock Award Plan” (“TARSAP”) under our 1998 Stock Incentive Plan, whereby the vesting of certain stock options is directly impacted by our performance. The vesting of stock options granted under the TARSAP accelerates when we achieve specified profitability criteria. If these criteria are not met, these options will vest five years after the date of grant and expire at the end of 10 years. Since our TARSAP awards vest based upon performance or service, we use the Black-Scholes option pricing model to value these awards. We recognize compensation expense for TARSAP awards on a straight-line basis over the vesting period unless we determine that the achievement of the performance criteria is probable. Once probable, we recognize all remaining unrecognized compensation over the remaining period from which it becomes probable to the performance achievement date.

        Our 2001 Stock Incentive Plan provides for grants of stock options for up to 7,000,000 shares of our common stock to our employees, officers, directors, and advisors. The contractual life of options granted under the plan ranges from five to ten years from the date of grant; the plan requires a purchase price of not less than 100% of the fair market value of the stock as of the date of grant;  and the options may be exercisable at such time or times as our Board of Directors in each case determines.  The vesting of stock options under this plan is done on a pro-rata basis over the service life of the award. We recognize compensation expense for awards under this plan on a straight-line basis over the vesting period of the entire award.

        Under all of our stock plans, we may grant options that are intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code (“incentive stock options”) or nonstatutory options not intended to qualify as incentive stock options.

        Upon exercise of stock options, we issue shares from our authorized, but unissued shares.

        In October 2005, we announced the approval by our Board of Directors of a program for the repurchase of 3.0 million shares of our common stock (“the October 2005 Program”). The repurchases may be made on the open market or in negotiated transactions, and the timing and amount of shares to be purchased will be determined by our management based on its evaluation of market and economic conditions and other factors. As of March 31, 2006, there were approximately 2.2 million shares that remained available for repurchase under this program.

Employee Stock Purchase Plan

Our Employee Stock Purchase Plan (“ESPP”) isprovides for the purchase of 6,550,000 shares of our common stock. Effective January 1, 2006, we modified our ESPP to allow qualifying employees to purchase shares at 95% of the market value of our common stock on the last day of each six-month purchase period. Previously, qualifying employees were able to purchase stock at 85% of the market value of the stock on the offering commencement date or the last day of the purchase period, whichever was lower. Prior to January 1, 2006, our ESPP was non-compensatory as defined in APB 25, and accordingly, we dodid not recognize compensation expense in our consolidated financial statements. However, our ESPP would have been compensatory under SFAS 123(R) had we not modified the terms of the ESPP. Our modification of the ESPP effective January 1, 2006 reduced the purchase discount to 5% of the market value of our common stock and removed the look-back provision and therefore, the ESPP is non-compensatory under SFAS 123(R).

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HadOn February 13, 2003, our Board of Directors approved a UK ESPP. We allocated 500,000 shares of the total number of shares reserved under our ESPP for issuance under the UK ESPP. Our modification of the ESPP was also effective for the UK ESPP. Consistent with the terms of our ESPP, the options under the UK ESPP are non-compensatory under SFAS 123(R) and accordingly, we have not recognized any stock-based compensation expense forassociated with our stock-based compensation plans been determined based onESPP or UK ESPP during the First Quarter of 2006.

        The fair market value at the grant dates as calculated in accordance with SFAS 123 andof each stock option is estimated using the Black-Scholes option-pricing model, assuming no expected dividends with the following weighted-average assumptions:

        We derived our estimate of an expected option life based on a review of our historic option holding periods, including a consideration of the holding period inherent in currently vested but unexercised options. We believe that this historical data is currently the best estimate of the expected term of a new option. We reviewed historical data for groups of employees and determined that the type of award was an indicator of the exercise behavior.  For 2006, the option lives range from 4.4 years to 5.5 years.

        We derived the estimated stock price volatility based on a review of our actual historic stock prices commensurate with the expected life of the award. For the First Quarter of 2006, the estimated volatility ranges from 41.1% to 46.9%. We believe that the historical stock price volatility is an accurate indicator of future stock price performance.

         SFAS 123(R) requires that we wouldestimate forfeitures at the time of grant and that we revise, if necessary, in subsequent periods if actual forfeitures differ from these estimates. The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered option. Similar to the analysis for the expected option life, we reviewed historical forfeiture data for groups of employees and determined the appropriate forfeiture rate ranges from 0-23% for the applicable employee group. Therefore, we have applied an annual forfeiture rate of 0-23% to all unvested options as of December 31, 2005. We will re-evaluate this analysis quarterly and adjust the forfeiture rate as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those shares that vest.

         The risk-free interest rate is the yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life assumption is used as the risk-free interest rate.

         A summary of stock option activity under all of our plans for the First Quarter ended March 31, 2006 is as follows:

The total intrinsic value of options exercised (i.e., the difference between the market price at exercise and the price paid by the employee to exercise the options) during the three months ended March 31, 2006 and 2005, was approximately $­­­­­­­1.0 million and $0.1 million, respectively. The aggregate intrinsic value of options outstanding and options exercisable as of March 31, 2006 is based on the difference between the closing price of our common stock on March 31, 2006, which was $15.75, and the exercise price of the applicable option. In calculating the aggregate intrinsic value, we excluded those options whose exercise price was greater than the closing price per share of our common stock as of March 31, 2006. Shares available for future issuance under our stock option plans at March 31, 2006 were 8,596,318.

Restricted Stock

The majority of our restricted stock awards vest over a five-year period on a graded vesting schedule. We have valued the restricted stock awards based on the closing price of our common stock on the date of grant, less the nominal consideration received. We record compensation cost on a straight-line basis over the share-vesting period. The weighted average grant date fair value of restricted stock awards granted during the three months ended March 31, 2006 was $11.15. We did not grant any restricted stock awards during the First Quarter of 2005. We recorded additionalexpense of approximately $0.1 million for each of the three months ended March 31, 2006 and 2005, respectively, associated with our restricted stock awards. As of March 31, 2006, there was approximately $2.6 million of unrecognized compensation cost related to restricted stock awards that we will recognize as expense and our net income andover a weighted average period of 3.9 years. As of March 31, 2006, there were no vested restricted stock awards.

Note 3.         Earnings Per Share

Basic earnings per share is computed using only the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of potential future issuances of common stock relating to stock option awards and other potentially dilutive securities. In calculating diluted earnings per share, the dilutive effect of stock options is computed using the average market price for the six months ended June 30, 2005respective period. Potential shares related to certain of our outstanding stock options and 2004 would have been reduced torestricted stock awards were excluded from the pro forma amounts indicated belowcomputation of earnings per share because they were anti-dilutive in the periods presented, but could be dilutive in the future. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

 (1) See Note 2 “Earnings Per Share Data” for reconciliationOur 2.0% Convertible Subordinated Debentures due 2013 (the “Debentures”) are convertible at the option of net income as reportedthe holder into shares of our common stock at an initial conversion rate of 54.4989 shares of common stock per $1,000 principal amount of Debentures, which is equivalent to net income usedan initial conversion price of approximately $18.349 per share. Approximately 8.2 million shares of our common stock would be issuable upon the conversion of all of the outstanding Debentures. In accordance with the Emerging Issues Task Force’s (“EITF”) Issue No 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share,” we are required to include contingently convertible debt in the calculation of diluted earnings per share.share using the if-converted method regardless of whether the market price trigger has been met. See Note 9 “Convertible Subordinated Debentures” for further discussion on the Debentures and their conversion features.

Note 4.        Comprehensive Income and Accumulated Other Comprehensive Loss

SFAS No. 130 (“SFAS 130”), “Reporting Comprehensive Income,” establishes rules for the reporting and display of comprehensive income and its components. Components of comprehensive income include net income and certain transactions that have generally been reported in the consolidated statement of stockholders’ equity. Other comprehensive income is comprised of currency translation adjustments, available-for-sale securities valuation adjustments, and adjustments related to a foreign defined benefit plan.

Total comprehensive income (i.e., net income plus available-for-sale securities valuation adjustments, currency translation adjustments and adjustments related to a foreign defined benefit plan, net of tax) was $6.5$7.5 million and $13.3$6.8 million for the three and six

months ended June 30,March 31, 2006 and 2005, respectively, and was $5.7 million and $7.2 million for the three and six months ended June 30, 2004, respectively. See Note 56 “Pension Plan” for a discussion of the minimum pension liability adjustments.

The following table summarizes the components of accumulated other comprehensive loss, net of taxes (dollars

in thousands):

Note 5.       Significant Contracts

Victoria TTA Contract

        On July 26, 2005, Keane Australia Micropayment Consortium Pty Ltd (“Kamco”), a wholly-owned subsidiary of Keane and the Public Transport Ticketing Body trading as Transport Ticketing Authority (the “TTA”) of the State of Victoria, Australia, entered into a $494.0 million AUD, or approximately $367.0 million (based on the exchange rate of $.74285 AUD per $1.00), contract (the “Victoria TTA contract”) to deliver a public transit ticketing system for the State of Victoria. The Victoria TTA contract has a term of approximately twelve years, including two years of development work, referred to as the Build phase, and ten years of operation and maintenance, referred to as the Operate phase. The Build phase represents the development and implementation of the comprehensive solution including hardware, card distribution and software. The Operate phase represents the maintenance of the software, hardware and comprehensive solution, refurbishments and replacements, hosting and management of the subcontractors. The TTA has an option to extend the contract for an additional two years at the completion of the Operate phase. The Build phase of the project is comprised of twelve phases beginning with the mobilization phase and ending with the operational proving phase. Each phase during the Build phase requires acceptance by the TTA. At the end of the fifth year of the Operate phase, the TTA can cancel the Victoria TTA contract at its option. Keane has established and is leading a consortium of four transit and technology experts to design, build, implement and maintain a micropayment smartcard technology system and related equipment for the TTA. Keane’s consortium includes automatic fare collection specialists ACS Solutions Schweiz AG (a subsidiary of Affiliated Computer Services, Inc.), ERG, and Giesecke & Devrient Australasia (“G&D”). In connection with the Victoria TTA contract, Keane delivered a guarantee to the TTA (the “Guarantee”) pursuant to which Keane has guaranteed certain obligations of Kamco under the Victoria TTA contract.

         Payments under the Victoria TTA contract are based on the completion of milestones during the Build phase. Payments during the Operate phase are based on the level of service provided and are billed monthly. During the Operate phase the TTA may benchmark rates following the fourth and ninth anniversary dates of the Victoria TTA contract and negotiate adjustments if the rates exceed prevailing market costs for comparable services.

        The TTA may terminate the Victoria TTA contract for convenience at any time and pay only for work completed, subject to specified termination fees. These termination fees consist primarily of 1% of the remaining amount of contractual revenues over the twelve-year term. During the contract term, the TTA may terminate the Victoria TTA contract for events of default, subject to Kamco’s right to cure. Upon the failure to perform by Kamco or its subcontractors, the TTA may step in and take over the role of prime contractor in place of Kamco.

        Kamco has obligations under the Victoria TTA contract with respect to both project management and performance of subcontractors. There are numerous indemnification provisions within the Victoria TTA contract, some of which are customarily included through the normal course of business. We have agreed to hold TTA harmless against losses arising from a breach of representations related to such matters as title to assets sold and licensed or certain intellectual property rights, improper disclosures of confidential information, personal injuries or property damages. As the prime contractor for the Victoria TTA contract, in certain cases Kamco is entitled to the benefit of corresponding indemnifications from its subcontractors. We also retain the right to enforce the subcontracts and to seek damages for nonperformance from our subcontractors. Subject to a number of exclusions, Kamco’s maximum liability is capped at $72 million ($100 million AUD). Under the Victoria TTA contract, liquidated damages, for which Kamco may be liable, are assessed at $36,000 ($50,000 AUD) per day for each day the specified phase completion is behind schedule, but are limited to $7.2 million ($10 million AUD). The first $3.6 million ($5 million AUD) in liquidated damages is split evenly amongst Kamco and certain subcontractors. The next $3.6 million ($5 million AUD) is apportioned based on responsibility for the delay.

        The Victoria TTA contract also requires that Kamco provide security and performance bonds in the amount of $21.5 million ($30 million AUD) during the two-year Build phase and in the amount of $10.8 million ($15 million AUD) during the twelve-year term. One of the banks associated with our credit facility issued a $32.3 million ($45 million AUD) letter of credit dated July 14, 2005 against our credit facility in fulfillment of the security and performance bonds. Keane has guaranteed performance and payment by

Kamco in the event that Kamco is unable to complete the work or meet its payment obligations.

        Under Emerging Issues Task Force (“EITF”) No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables,” in order to account for the deliverables within a contract separately, all delivered items must have standalone value, the vendor must have objective and reliable evidence of fair value of the undelivered item(s) and if the client has a general right of return relative to the delivered item, delivery or performance of the undelivered items is probably and substantially within the vendor’s control. We have concluded that objective evidence of fair value does not exist for all of the elements within the Operate phase. Accordingly, the elements within the Build and Operate phases cannot be separated into multiple units of accounting and therefore, must be accounted for as a single unit of accounting. As a result, we are deferring all revenues and costs directly associated with the delivery of services during the Build phase and we will recognize all revenues and direct costs for the contract over the ten-year period of the Operate phase currently estimated to begin in mid-2007.

         The mobilization phase of the project is complete and during the Fourth Quarter of 2005, Kamco received its first milestone payment of $8.5 million USD ($12 million AUD). For the three months ended March 31, 2006 and for the year ended December 31, 2005, we deferred all revenues and direct costs and expensed approximately $0.7 million and $3.4 million, respectively in indirect costs. As of March 31, 2006 and December 31, 2005, there was approximately $8.5 million ($12 million AUD) and $8.8 million ($12 million AUD), respectively of deferred long-term revenue and approximately $12.3 million ($17.5 million AUD) and $8.6 million ($11.7 million AUD) of deferred costs included in the accompanying unaudited condensed consolidated balance sheets. See Note 12 “Segment Information” for a discussion on the determination of reportable segments.

PacifiCare

In 2004, PacifiCare, one of our largest clients, reduced the level of service from the stated baseline contract amounts in accordance with its right under the contract terms, thereby reducing the original contract value. We provided services at or above the baseline levels set forth in the original contract at agreed upon rates. On December 20, 2005, UnitedHealth Group Incorporated, an affiliate of United HealthCare Services, Inc. (“United HealthCare”), completed its acquisition of PacifiCare. On January 20, 2006, we entered into a five-year master services agreement with United HealthCare Services, Inc. effective January 1, 2006. Simultaneously, we and PacifiCare terminated our Information Technology Services Agreement, dated January 11, 2002, effective January 1, 2006. Our original Information Technology Services Agreement with PacifiCare provided for an outsourcing arrangement with a ten-year term and $500 million in contract value. As a result of the ending of the original agreement with PacifiCare we will receive a $10.1 million payment in two equal installments on July 30, 2006 and July 30, 2007. The first half will be recognized over the 18 month period January 1, 2006 to June 30, 2007. The second half will be recognized at such time the amount becomes due in management’s judgment. If additional services are procured pursuant to the master services agreement, any remaining portion of the payments will be recognized over the period such services are provided. Under the new master services agreement with United HealthCare we will receive approximately $21 million for a specified level of services provided from January 1, 2006 through June 30, 2007. Revenues from PacifiCare in the First Quarter ended March 31, 2006, were approximately $2.1 million lower than revenues from PacifiCare in the First Quarter ended March 31, 2005.

Note 6.         Pension Plan

Our United Kingdom (“UK”) defined benefit plan (“DBP”) provides pension benefits to employees of our UK subsidiary who were active on August 4, 1999, and not to employees who joined after that date, anddate. Benefits are based on the employees’ compensation and service. Our policy is to fund amounts required by applicable government regulations.  The measurement date for the UK DBP is December 31.

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During the First Quarter of 2004, we decided to close our UK DBP to future salary accruals effective April 1, 2004. Accordingly, we accounted for the closing of the UK DBP as a curtailment under SFAS No. 88 (“SFAS 88”),  “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits.”  In 2004, we recorded a curtailment loss of approximately $0.2 million to expense the unrecognized prior service cost, and we recorded an additional required minimum liability of approximately $6.6 million through Accumulated other comprehensive loss in the accompanying condensed consolidated balance sheets.  As a result of the availability of more recent measurements of both the plan assets and obligations under the UK DBP, during the Second Quarter of 2005,three months ended March 31, 2006, we recorded an additionala decrease in the required minimum liability of approximately $1.7 million through Accumulated other comprehensive loss. As of June 30,March 31, 2006, and December 31, 2005, the UK pension liability was approximately $14.6$13.8 million and $15.3 million, respectively, and is included in Other long-term liabilities in the accompanying unaudited condensed consolidated balance sheets.

 Recent legislation in the UK could have a significant impact on the future funding levels required under the UK DBP. We are currently reviewing various alternatives regarding the structure of the UK Pension. Based upon information available to date, we expect the increase in funding levels could range from approximately $1.0 million to $2.0 million on an annual basis in 2006 and beyond.

Net periodic pension cost of the UK DBP for the three and six months ended June 30,March 31, 2006 and 2005 and 2004 is presented as follows (dollars in thousands):

Note 6.7.         Business Acquisitions

Cresta Testing, Inc.

On June 1, 2005, we acquired Cresta Testing, Inc. (“Cresta”), a software testing company that specializesspecialized in managed services, test strategy and training, and functional and performance testing. In exchange for all of the outstanding capital stock of Cresta, we paid $0.6 million in cash, of which $60,000 was held back to secure indemnification obligations of the Cresta stockholders. We also agreed to pay up to an additional $0.5 million in earn-out consideration over the next two years from the acquisition date, contingent upon the achievement of certain future financial targets. The earn-out consideration is also dependent on the employment of a certain Cresta employee,employee; therefore, in accordance with SFAS No. 141 (“SFAS 141”), “Business Combinations,”Combinations”, we will record any additional earn-out consideration as compensation expense. The $60,000 held back was deposited as restricted cash and accrued and included in Accrued expenses and other liabilities in the accompanying unaudited condensed consolidated balance sheet. The acquisition has been accounted for under the purchase method in accordance with SFAS 141 and SFAS No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.”Assets”. The total cost of the acquisition through June 30, 2005March 31, 2006 was $0.6 million, which included net assets acquired of approximately $0.4 million. Total assets acquired of $0.7 million consisted primarily of cash of $0.1 million and accounts receivable of $0.6 million. The purchase price allocation is preliminarywas finalized as of June 30,December 31, 2005. The operating results of Cresta have been included in our condensed consolidated statement of operations beginning June 2, 2005.

ArcStream Solutions, Inc.

On April 4, 2005, we acquired certain assets and assumed specified liabilities of ArcStream Solutions, Inc. (“ArcStream”) for a base purchase price of zero ($0.00) dollars, subject to a working capital adjustment, and an additional earn-out consideration based on the performance of the ArcStream business during the remainder of 2005. The earn-out period ended on December 31, 2005 and no earn-out consideration was paid. ArcStream iswas a business and technology consulting firm based in Watertown, Massachusetts, that specializesspecialized in helping organizations compete through the use of advanced technologies and process improvement. As a former stockholder of ArcStream, John Keane, Jr. will bewould have been entitled to a portion of any additional consideration. John Keane, Jr. iswas the founder, President and Chief Executive Officer of ArcStream. He is also the brother of Brian Keane, theour CEO, of the Company, the son of John Keane, Sr., the Chairman of theour Board, and a member of Keane’sour Board of

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Directors. In addition, in connection with the transaction, John Keane, Jr., agreed to guarantee certain indemnification obligations of ArcStream and the Companywe paid John Keane, Jr. $21,875 pursuant to a consulting arrangement to assist in the transition of the acquired business. The transaction was approved by both theour Audit Committee and theour Board of Directors of the Company.Directors. The operating results of the acquired ArcStream assets have been included in our condensed consolidated statement of operations beginning April 5, 2005.

netNumina Solutions, Inc.

On February 28, 2005, we acquired netNumina Solutions, Inc. (“netNumina”), a software development company based in Cambridge, Massachusetts that specializesspecialized in technology strategy, architecture, and custom development, to enhance our capabilities in Development and Integration services. In exchange for all of the outstanding capital stock of netNumina, we agreed to pay $5.7 million, of which $0.6 million was held back to secure indemnification obligations of the netNumina stockholders. As of June 30, 2005,March 31, 2006, we had paid $4.7 million of the $5.1 million not held back based onand during the stock certificates surrendered for cancellation. TheFirst Quarter of 2006, the $0.6 million held back was deposited as restricted cash, and accrued and included withdelivered to the remaining $0.4 million for netNumina stock certificates to be surrendered in Accrued expenses and other liabilities in the accompanying unaudited condensed consolidated balance sheet.  As of July 19, 2005, we had paid $0.1 million of the remaining $0.4 million not held back.shareholders. The acquisition has been accounted for under the purchase method in accordance with SFAS 141 and SFAS 142. The total cost of the transaction through June 30, 2005March 31, 2006 was $4.8 million, which included net assets of approximately $5.2 million. Total assets acquired of $7.8 million consisted primarily of cash of $4.6 million and accounts receivable of $2.3 million. In connection with the purchase price allocation we recorded a $0.4$0.5 million fair value adjustment to reduce property and equipment that resulted from an excess book value of the assets acquired over the purchase price and recorded deferred tax assets of $2.0 million. As a result, we have not recorded any goodwill or intangible assets in connection with this acquisition. The valuation and purchase price allocation are preliminaryfinal as of June 30,December 31, 2005. The operating results of netNumina have been included in our unaudited condensed consolidated statements of income beginning March 1, 2005.

At the date of the acquisition of NetNumina, we entered into a plan to implement a workforce reduction of eight non-billable employees. As a result, we initially recorded a restructuring liability of $1.0 million related to severance.severance, all of which has been paid as of March 31, 2006. In accordance with EITF Issue No. 95-3 (“EITF 95-3”), “Recognition of Liabilities in Connection with a Purchase Business Combination,” these costs, which are not associated with the generation of future revenues and have no future economic benefit, arewere reflected as assumed liabilities in the allocation of the purchase price to the net assets acquired.

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percentage in Keane Worldzen as follows: (i) carryover basis related to assets and liabilities contributed to Keane Worldzen for which the individual shareholder had a prior interest; and (ii) fair value for assets and liabilities for which an individual shareholder had no prior interest. The acquisition was intended to strengthen our position in the BPO market. As a result, we initially recorded goodwill of approximately $13.8 million in the accompanying unaudited condensed consolidated balance sheets.

On April 1, 2005, we increased our equity position in Keane Worldzen pursuant to the purchase option discussed below to approximately 81% with an additional capital contribution of approximately $5.0 million in cash and $3.0 million from the conversion of an outstanding loanexisting cash advances to equity. We purchased approximately 36.0 million shares at a cost of approximately $.22 per share. As a result of the additional capital contribution, we continue to consolidate the results of Keane Worldzen, but are also able to consolidate its results for tax purposes beginning April 1, 2005. Upon our additional capital contribution, the minority interest shareholders ownowned approximately 19% of the issued and outstanding capital stock of Keane Worldzen. In December 2005, the minority shareholders executed their right under the first put option to require us to purchase approximately 5% of their shares for a stated value of $2.8 million as discussed below. As a result, we paid the $2.8 million for an additional 5% ownership interest associated with the first put option and as of March 31, 2006, own approximately 86% of the issued and outstanding capital stock of Keane Worldzen.

In connection with our acquisition of a controlling interest in Keane Worldzen in October 2003, we obtained the right to purchase certain of the remaining shares held by the minority shareholders of Keane Worldzen at different times during 2006 to 2009 (“call options”) and the right to acquire additional shares directly from Worldzen at a fixed price stated at the acquisition date through 2005 (“purchase option”). Our purchase option allowed us to purchase additional shares directly from Worldzen to obtain up to 80% of the total outstanding shares of Worldzen through December 31, 2005. Our first call option is exercisable during the period beginning on January 1, 2006 and ending on December 31, 2006, and is based on a stated value for the underlyingsame fixed price as is the purchase option and allows us to acquire up to 80% of the total outstanding shares of $6.5 million.Worldzen at the time the first call option is exercised. The fair value of the purchase and first call option, using a Black ScholesBlack-Scholes valuation model, iswas approximately $3.8 million and is included in other assets inwas recorded at the accompanying unaudited condensed consolidated balance sheets.original acquisition date. During 2005, we acquired 80% of the outstanding shares of Keane Worldzen through the exercise of the purchase option and reclassified the value of the purchase and first call option to goodwill. The other call options are exercisable at the fair market value of the underlying shares to obtain specified ownership levels during the call periods, which are exercisable at certain times during the period January 1, 2007 through December 31, 2009. Since these other call options can only be exercised at the fair value of the underlying shares, no amounts have been recorded for these call options in our unaudited condensed consolidated financial statements.

Also in connection with the acquisition, the minority shareholders were given the right to require us to purchase certain of their remaining shares at various times (“put options”) subject to the achievement of certain operating and financial milestones related to Keane Worldzen’s business performance. The first put option, the term of which iswas October 17, 2003 through December 31, 2005, iswas exercisable based on a stated value for the underlying shares of $2.8 million.million and was exercised and paid in December 2005. The fair value of this put option, using a Black ScholesBlack-Scholes valuation model, was approximately $279,000 at the acquisition date and is currently beingwas recognized as compensation expense in the accompanying unaudited condensed consolidated financial statements through the expiration date of the option.December 31, 2005. The other put options are exercisable at fair market value for the underlying shares during the put periods, which are exercisable at certain times during the period January 1, 2008 through March 1, 2010. Because these other put options can only be exercised at the fair value of the underlying shares, no amounts have been recorded as of March 31, 2006 for these put options in our unaudited condensed consolidated financial statements.

The results of operations of these acquired companies have been included in our unaudited condensed consolidated statements of income from the datedates of acquisition. The excess of the purchase price over the fair value of the net assets has been allocated to identifiable intangible assets and goodwill. Identifiable intangible assets associated with these acquisitions are being amortized on a straight-line basis over periods ranging from two to 10 years and approximate the expected periods of benefit. Pro forma results of operations for Cresta, ArcStream, netNumina, and Fast TracknetNumina have not been provided since these acquisitions were not material either individually or in the aggregate in the year of acquisition.

Note 7.8.         RestructuringsRestructurings

Workforce reductions

       During the First Quarter of 2006 we reduced our workforce at certain locations by 53 employees due to our One Keane Transformation, most of whom had an expected termination date in the First Quarter of 2006. The employees affected in the reduction were both non-billable and billable and we believe were employees whose roles could be reduced based upon the current business needs in their respective locations. As a result, we recorded approximately $1.3 million for severance costs in the accompanying unaudited condensed consolidated financial statements. Of this amount, approximately $0.5 million related to personnel in the United Kingdom and approximately $0.8 million related to personnel from our locations in the US. In accordance with SFAS No. 146 (“SFAS 146”) “Accounting for Costs Associated with Exit or Disposal Activities”, for those employees whose service period was greater than 60 days, the expense is being booked ratably over the service period. Cash expenditures in the First Quarter of 2006 related to this workforce reduction were approximately $0.8 million.  As of March 31, 2006, the remaining reserve balance was $0.5 million, which we expect to be paid in the Second and Third Quarters of 2006.

In connection with the netNumina acquisition noted above,discussed in Note 7 “Business Acquisitions”, we entered into a plan to reduce the workforce by eight employees, most of whom had an expected termination date in the Second Quarter of 2005. The employees affected in the reduction arewere non-billable personnel whose responsibilities we plan to integratehave been integrated into our existing operations to realize the synergies of the two operations. We recorded a liability of $1.0 million associated with severance and other termination benefits and expect the plan to be substantially completed by September 30, 2005.was complete as of March 31, 2006. In accordance with EITF 95-3, these costs have been reflected as assumed liabilities in the allocation of the purchase price to the net assets acquired. CashDuring the First Quarter of 2006, cash expenditures for the six months ended June 30, 2005 related to the netNuminanetNumima severance and retention accruals was $0.6were $0.2 million. As of June 30, 2005, the remaining balance was $0.4 million.

In connection with the Fast Track acquisition noted above,discussed in Note 7 “Business Acquisitions”, we entered into a plan to reduce the workforce by seven employees, most of whom had a termination date of October 31, 2004. The employees affected in the reduction

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The activity for the sixthree months ended June 30,March 31, 2006 and March 31, 2005 associated with restructuring charges is as follows (in thousands, except per share data)thousands):