UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

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 September 30, 2004

 

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

 

For the transition period from                to               

 

Commission File Number 000-50954

 

 

NESS TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

 

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

 

Ness Tower

Atidim High-Tech Industrial Park

Building 4

Tel Aviv 61580, Israel

Telephone: +972 (3) 766-6800

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

 

 

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

 

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

 

Indicated below is the number of shares outstanding of the registrant’s stock at November 1, 2004:

 

 

 

NESS TECHNOLOGIES, INC. AND SUBSIDIARIES

 

INDEX

 

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - December 31, 2003 and September 30, 2004 (Unaudited)
Consolidated Statements of Operations - Three months and nine months ended September 30, 2003 and 2004 (Unaudited)
Consolidated Statements of Cash Flows - Nine months ended September 30, 2003 and 2004 (Unaudited)
Notes to Consolidated Financial Statements - September 30, 2004 (Unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Recent Developments
Three Months Ended September 30, 2004 Compared to the Three Months Ended September 30, 2003
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September 30, 2003
Liquidity and Capital Resources
Forward-Looking Statements and Risk Factors
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Changes in internal control
PART II – OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits
SIGNATURES
EXHIBIT INDEX

2

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands

 

		December 31, 2003			September 30, 2004
					(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	46,004		$	40,707
Short-term bank deposits		3,248			237
Marketable securities		368			340
Trade receivables (net of allowance for doubtful accounts of $1,785 and $1,888 at December 31, 2003 and September 30, 2004 (unaudited), respectively)		61,067			71,601
Unbilled receivables		14,921			19,041
Other accounts receivable and prepaid expenses		8,442			11,306
Work-in-progress		1,348			969
Total assets attributed to discontinued operations		1,314			36
Total current assets		136,712			144,237
LONG-TERM ASSETS:
Long-term prepaid expenses		2,067			3,361
Marketable securities		144			84
Deferred income taxes		5,626			4,380
Severance pay fund		30,421			31,480
Total long-term assets		38,258			39,305
PROPERTY AND EQUIPMENT, NET		14,436			18,200
OTHER INTANGIBLE ASSETS, NET		2,485			3,671
GOODWILL		147,592			144,256
Total assets		$	339,483		$	349,669

 

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

 

3

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

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

 

		December 31, 2003			September 30, 2004
					(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Short-term bank loans and credit		$	8,898		$	18,608
Current maturities of long-term debt (Note 3)		21,703			28,588
Trade payables		29,802			30,398
Advances from customers		3,940			3,419
Other accounts payable and accrued expenses		54,604			60,419
Total liabilities attributed to discontinued operations		995			—
Total current liabilities		119,942			141,432
LONG-TERM LIABILITIES:
Long-term debt, net of current maturities (Note 3)		59,852			39,988
Excess of losses over investment in affiliate		286			294
Accrued severance pay		32,912			34,538
Minority interests		136			199
Total long-term liabilities		93,186			75,019
COMMITMENTS AND CONTINGENT LIABILITIES (Note 4)
STOCKHOLDERS’ EQUITY (Note 5):
Common stock of $0.01 par value -		164			166
Authorized: 46,500,000 shares at December 31, 2003 and September 30, 2004 (unaudited); issued and outstanding: 16,460,138 at December 31, 2003 and 16,658,462 at September 30, 2004 (unaudited)
Class B Convertible Preferred stock of $0.01 par value -		47			47
Authorized: 4,676,986 shares at December 31, 2003 and September 30, 2004 (unaudited); issued and outstanding: 4,676,986 shares at December 31, 2003 and September 30, 2004 (unaudited); aggregate liquidation preference of $44,545 at December 31, 2003 and September 30, 2004 (unaudited)
Class C Convertible Preferred stock of $0.01 par value -		34			34
Authorized: 3,500,000 shares at December 31, 2003 and September 30, 2004 (unaudited); issued and outstanding: 3,352,654 shares at December 31, 2003 and September 30, 2004 (unaudited); aggregate liquidation preference of $43,585 at December 31, 2003 and September 30, 2004 (unaudited)
Preferred stock of $0.01 par value -		—			—
Authorized: 323,014 shares at December 31, 2003 and September 30, 2004 (unaudited); issued and outstanding: no shares at December 31, 2003 and September 30, 2004 (unaudited)
Additional paid-in capital		171,786			171,859
Deferred stock compensation		(365		)	(206		)
Accumulated other comprehensive loss		(4,111		)	(6,500		)
Accumulated deficit		(41,200		)	(32,182		)
Total stockholders’ equity		126,355			133,218
Total liabilities and stockholders’ equity		$	339,483		$	349,669

 

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

 

4

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

		Three months ended September 30,						Nine months ended September 30,
		2003			2004			2003			2004
		(Unaudited)
Revenues (Note 6)		$	64,327		$	77,152		$	156,689		$	222,177
Cost of revenues		45,288			53,969			110,319			154,602
Provision for losses (reverse of losses) on uncompleted contracts		224			26			547			(459		)
Gross profit		18,815			23,157			45,823			68,034
Operating expenses:
Selling and marketing		5,634			6,822			15,424			18,952
General and administrative		11,263			10,945			24,633			34,142
Research and development, net		37			—			1,153			—
Other		460			—			460			—
Total operating expenses		17,394			17,767			41,670			53,094
Operating income		1,421			5,390			4,153			14,940
Financial expenses, net		(1,820		)	(1,177		)	(1,496		)	(4,327		)
Other income (expenses), net		536			(16		)	280			79
Income before taxes on income		137			4,197			2,937			10,692
Taxes on income (tax benefit)		(2		)	473			(35		)	958
Equity in net earnings (losses) of affiliates		18			(3		)	57			(651		)
Minority interests in losses (earnings) of a subsidiary		74			(30		)	286			(65		)
Income from continuing operations		231			3,691			3,315			9,018
Loss from discontinued operations		(42		)	—			(746		)	—
Net income		$	189		$	3,691		$	2,569		$	9,018
Allocation of undistributed earnings on Class B Convertible Preferred stock		$	(29	)	$	(554	)	$	(1,360	)	$	(1,356	)
Net income after allocation of undistributed earnings		$	160		$	3,137		$	1,209		$	7,662
Net earnings per share (Note 7):
Basic net earnings per share from continuing operations		$	0.01		$	0.16		$	0.13		$	0.40
Basic net loss per share from discontinued operations		$	—	(*)	$	—		$	(0.05	)	$	—
Basic net earnings per share		$	0.01		$	0.16		$	0.08		$	0.40
Diluted net earnings per share from continuing operations		$	0.01		$	0.14		$	0.13		$	0.36
Diluted net loss per share from discontinued operations		$	—	(*)	$	—		$	(0.05	)	$	—
Diluted net earnings per share		$	0.01		$	0.14		$	0.08		$	0.36

 

(*)  Represents an amount less than $0.01.

 

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

 

5

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands

 

		Nine months ended September 30,
		2003			2004
		(Unaudited)
Cash flows from operating activities:
Net income		$	2,569		$	9,018
Adjustments required to reconcile net income to net cash provided by (used in) operating activities:
Amortization of deferred stock compensation related to Ness GSG acquisition		52			159
Stock based compensation related to warrants granted to banks and options granted to consultants		33			32
Equity in net (earnings) losses of affiliates		(57		)	651
Minority interests in losses (earnings) of a subsidiary		(286		)	65
Currency fluctuation of long-term debt		(87		)	1,882
Accrued interest on long-term debt		(3,018		)	(542		)
Depreciation and amortization		1,914			3,691
Deferred income taxes, net		(2,747		)	(784		)
Loss (gain) on sale of property and equipment		(66		)	31
Trading marketable securities, net		—			19
Decrease (increase) in trade receivables		3,225			(11,590		)
Increase in unbilled receivables		(7,622		)	(4,589		)
Increase in other accounts receivable and prepaid expenses		(1,633		)	(770		)
Decrease (increase) in work in progress		(56		)	370
Decrease (increase) in long-term prepaid expenses		2,020			(1,337		)
Increase (decrease) in trade payables		(824		)	1,174
Decrease in advances from customers		(1,209		)	(428		)
Increase (decrease) in other accounts payable and accrued expenses		(2,165		)	7,126
Increase in accrued severance pay, net		527			742
Net cash provided by (used in) operating activities		(9,430		)	4,920
Cash flows from investing activities:
Net cash paid for acquisitions of consolidated subsidiaries (a)		(9,007		)	(168		)
Proceeds from sale of short-term bank deposits		8,277			2,920
Proceeds from sale of property and equipment		467			540
Purchase of property and equipment and capitalization of software developed for internal use		(1,856		)	(8,491		)
Capitalization of software development costs		—			(2,030		)
Other		(406		)	(61		)
Net cash used in investing activities		(2,525		)	(7,290		)

 

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

 

6

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands

 

			Nine months ended September 30,
			2003			2004
			(Unaudited)
Cash flows from financing activities:
Exercise of options and warrants			$	—		$	43
Short-term bank loans and credit, net			1,356			10,214
Proceeds from long-term debt			7,154			10,765
Principal payment of long-term debt			(14,446		)	(23,158		)
Net cash used in financing activities			(5,936		)	(2,136		)
Effect of exchange rate changes on cash and cash equivalents			980			(791		)
Decrease in cash and cash equivalents			(16,911		)	(5,297		)
Cash and cash equivalents at the beginning of the period			43,494			46,004
Cash and cash equivalents at the end of the period			$	26,583		$	40,707
(a)	In conjunction with the acquisitions, the fair values of the assets acquired and liabilities assumed  at the dates of related acquisitions were as follows:
Working capital, net (excluding cash and cash equivalents)			$	16,929	(*)	$	1,571
Long-term receivables			1,193		(*)	—
Property and equipment			2,401			(487		)
Long-term loans and convertible loan			(1,524		)(*)	—
Accrued severance pay			—			129
Goodwill			44,150			—
Customer related intangible assets			1,514			—
Investment in a subsidiary			—			(1,045		)
Issuance of shares			(55,656		)	—
Net cash provided from acquisitions of consolidated subsidiaries			$	9,007		$	168
Supplemental disclosures of cash flows information:
Cash paid during the period for:
Interest			$	3,687		$	2,573
Taxes			$	428		$	661

 

(*) Reclassified

 

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

 

7

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

Note 1: General

 

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

 

We are a global provider of information technology services and solutions designed to help clients improve their competitiveness and effectiveness. Our portfolio of solutions and services includes system integration and application development, outsourcing, software and consulting, and quality assurance and training. Offshore services and development are a significant component of each of these categories. We and our subsidiaries primarily serve the following vertical markets: defense and government, financial services, life sciences and healthcare, telecommunications and utilities, and independent software vendors.

 

Note 2: Significant Accounting Policies

 

a.               Unaudited Interim Financial Information

 

The accompanying condensed consolidated balance sheet as of September 30, 2004, the condensed consolidated statements of operations for the three and nine months ended September 30, 2003 and 2004, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2003 and 2004 are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information. In the opinion of management, the unaudited interim condensed consolidated financial statements include all adjustments of a normal recurring nature necessary for a fair presentation of our consolidated financial position as of September 30, 2004, our consolidated results of operations for the three and nine months ended September 30, 2003 and 2004, and our consolidated cash flows for the nine months ended September 30, 2003 and 2004.

 

The balance sheet at December 31, 2003 has been derived from the 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.

 

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes for the year ended December 31, 2003 included in our registration statement on Form S-1 dated May 7, 2004, as amended (File No. 333-115260).

 

Results for the three months and nine months ended September 30, 2004 are not necessarily indicative of results that may be expected for the year ending December 31, 2004.

 

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

 

b.              Use of estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

8

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

c.               Financial statements in U.S. dollars

 

Our subsidiaries’ transactions are recorded in local currencies. We have designated the U.S. dollar as the primary functional currency of our operations in the United States and the Czech Republic, the NIS as the primary functional currency of our subsidiaries’ operations in Israel, and local currencies as the primary functional currencies of our operations elsewhere.  Accordingly, for all subsidiaries for which the dollar is the functional currency, monetary accounts maintained in other currencies are re-measured into U.S. dollars, in accordance with Statement of Financial Accounting Standards No. 52 “Foreign Currency Translation” (“SFAS 52”). All transaction gains and losses of the re-measured monetary balance sheet items are reflected in our statement of operations as financial income or expenses, as appropriate.

 

For those foreign subsidiaries whose functional currency has been determined to be their local currency, assets and liabilities are translated at period-end exchange rates and statement of operations items are translated at average exchange rates prevailing during that period. Such translation adjustments are recorded as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity.

 

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

 

d.     Principles of consolidation

 

Our consolidated financial statements include our accounts and the accounts of our wholly and majority owned subsidiaries, or the Group.  Inter-company transactions and balances, including profit from inter-company sales not yet realized outside the Group, have been eliminated in consolidation.

 

e.               Acquisition of Ness GSG Inc.

 

Effective June 30, 2003, we acquired through merger all of the outstanding stock of Ness GSG Inc. (formerly, Apar Holding Corp.), or Ness GSG, for the purpose of expanding our information technology services capabilities. Ness GSG was incorporated under the laws of the Commonwealth of Pennsylvania, with operations, through its subsidiaries, in Asia, the United States and Europe. The Ness GSG subsidiaries specialize in hardware and software consulting. Some of our principal stockholders, who owned approximately 53% of the outstanding common stock of Ness GSG prior to the acquisition, received 3,955,169 shares of our common stock upon the closing of the merger.

 

The total consideration of $67,650 (including $1,542 of transaction costs) for the merger consisted of (i) the issuance of 6,221,712 shares of our common stock valued at the fair value of $52,677, (ii) the assumption of options to purchase 540,121 shares of our common stock at a weighted average exercise price of $3.64 per share valued at the fair value of $2,979 of which $548 was allocated to deferred stock compensation and (iii) $11,000 in cash. The value of the options issued was determined based on the Black-Scholes option pricing model. Pursuant to the merger agreement, we agreed to issue additional shares of common stock to the stockholders of Ness GSG if and when we issue shares of common stock in exchange for the remaining shares of Ness U.S.A.. We agreed to issue the number of shares necessary to preserve the ownership percentage of the former stockholders of Ness GSG at the same percentage ownership they held prior to the issuance of such shares to the Ness U.S.A. remaining stockholders, in

 

9

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

exchange for their Ness U.S.A. shares. These shares will be recorded at their par value and reduced from additional paid in capital, when and if issued. The transaction was accounted for by the purchase method of accounting according to Statement of Financial Accounting Standards No. 141 “Business Combinations” (“SFAS 141”). The results of Ness GSG operations have been included in our consolidated financial statements since July 1, 2003.

 

Based upon a valuation of tangible and intangible assets acquired, we allocated the total cost of the acquisition to Ness GSG’s assets and liabilities as follows:

 

		At June 30, 2003
Cash and cash equivalents		$	3,423
Short-term investments		9,707
Trade receivables		11,807
Unbilled receivables		1,327
Employee advances and other current assets		1,668
Other long-term tangible assets		1,193
Property and equipment		2,373
Total tangible assets acquired		31,498
Customer related intangible asset (five years useful life)		1,514
Goodwill		43,524
Total intangible assets acquired		45,038
Total tangible and intangible assets acquired		76,536
Accounts payable		(3,426		)
Other account payable		(3,936		)
Long-term debt		(1,524		)
Total liabilities assumed		(8,886		)
Net assets acquired		$	67,650

 

Goodwill includes but is not limited to the synergistic value and potential competitive benefits that could be realized by us from the acquisition, as well as Ness GSG’s skilled and specialized workforce. The goodwill is not deductible for tax purposes.

 

In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), goodwill arising from acquisitions will not be amortized.

 

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

 

i.                  Ness GSG’s current assets and liabilities are recorded at their carrying amounts. The carrying amounts of the current assets and liabilities were reasonable proxies for their market values due to their short-term maturity. Property and equipment are presented at current replacement cost. Long-term debt is presented at present value of amounts to be paid determined at appropriate current interest rates.

 

ii.               The value assigned to the customer-related intangibles amounted to $1,514. The fair value of Ness GSG’s customer base was determined using the Income Approach.

 

10

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

Pro forma results:

 

The following unaudited pro forma information does not purport to represent what our results of operations would have been had the acquisition been consummated on January 1, 2003, nor does it purport to represent our results of operations for any future period.

 

Pro forma results of operations for the period:

 

		Nine months ended September 30, 2003
		(Unaudited)
Revenues		$	187,374
Net income		970
Allocation of undistributed earnings on Class B Convertible Preferred Stock		(1,043			)
Net loss after allocation of undistributed earnings		$		(73	)
Basic and diluted net loss per share		—			(*)
Weighted average number of shares of common and Preferred stock used in computation of basic and diluted net loss per share (in thousands)		16,854

 

(*) Represents an amount less than $0.01.

 

 

Effective August 1, 2004, Ness GSG was merged with and into us, and, as a result, the Ness GSG operating subsidiaries are direct, rather than indirect, subsidiaries.

 

f.                 Goodwill

 

We have elected to perform our analysis of goodwill during the fourth quarter of the year. No indications of impairment were identified during the nine months ended September 30, 2004.

 

g.              Accounting for stock-based compensation

 

We have elected to follow Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and Interpretation No. 44 “Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”) in accounting for our employee stock option plans. Under APB 25, when the exercise price of our stock options is less than the market price of the underlying shares on the date of grant, compensation expense is recognized.

 

We adopted the disclosure provisions of Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - transition and disclosure” (“SFAS 148”), which amended certain provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation, effective as of the beginning of the fiscal year. We continue to apply the provisions of APB 25 in accounting for stock-based compensation.

 

Pro forma information regarding our net income (loss) and net earnings (loss) per share is required by SFAS 123 and has been determined as if we had accounted for our employee stock options under the fair value method prescribed by SFAS 123.

 

The fair value for options granted in 2001, 2002 and 2003 and in the three month and nine month periods ended September 30, 2003 and 2004 is amortized over their vesting period and estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

		Three months ended September 30,				Nine months ended September 30,
		2003		2004		2003		2004
		(Unaudited)
Dividend yield		0	%	0	%	0	%	0	%
Expected volatility		0.42		0.52		0.42		0.52
Risk-free interest		3.1		2.5		3.1		2.5
Expected life of up to (in years)		4		4		4		4

 

11

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

Pro forma information under SFAS 123 is as follows:

 

		Three months ended September 30,						Nine months ended September 30,
		2003			2004			2003			2004
		(Unaudited)
Net income available to common stock after allocation of undistributed earnings, as reported		$	160		$	3,137		$	1,209		$	7,662
Add: Allocation of undistributed earnings on Class B Convertible Preferred Stock, as reported		29			554			1,360			1,356
Deduct: Pro forma allocation of undistributed earnings on Class B Convertible Preferred Stock		—			(441		)	(1,090		)	(1,022		)
Add: Stock-based employee compensation – intrinsic value		52			54			52			159
Deduct: Stock-based employee compensation – fair value		(430		)	(805		)	(1,738		)	(2,362		)
Pro forma net income (loss)		$	(189	)	$	2,499		$	(207	)	$	5,793
Basic net earnings per share, as reported		$	0.01		$	0.16		$	0.08		$	0.40
Diluted net earnings per share, as reported		$	0.01		$	0.14		$	0.08		$	0.36
Pro forma basic net earnings (losses) per share		$	(0.01	)	$	0.13		$	(0.01	)	$	0.31
Pro forma diluted net earnings (losses) per share		$	(0.01	)	$	0.11		$	(0.01	)	$	0.27

 

h.              Impact of recently issues accounting pronouncements

 

In March 2004, the EITF reached a consensus on Issue No. 03-06, “Participating Securities and the two-Class Method under FASB Statements No. 128” (“EITF 03-06”) , related to “participating securities” and the application of the “two-class method” under Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“SFAS 128”). EITF 03-06 provides guidance in determining when a security participates in dividends such that the two-class method must be used to calculate earnings per share. The consensuses of EITF 03-06 should be applied retroactively beginning with the first reporting period (annual or interim) beginning after March 31, 2004. The adoption of EITF 03-06 is not expected to have a significant impact on our financial statements.

 

i.                  Reclassification

 

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

 

Note 3: Long-Term Debt

 

a.               Composition

 

Our long-term debt is composed as follows:

 

		December 31, 2003			September 30, 2004
					(Unaudited)
Banks (1)		$	78,805		$	65,204
Loan from stockholders		1,000			1,000
Convertible loan from stockholders		1,000			1,000
		80,805			67,204
Less current maturities		21,703			28,588
		59,102			38,616
Promissory note with respect to acquisition cost		750			750
Other		—			622
		$	59,852		$	39,988
Balances with related parties:
Long-term loan and convertible loan from related party (interest accumulated is included in other accounts payable)		$	2,079		$	2,134

 

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

(1)  The long-term loans default upon the failure of any of our subsidiaries named as borrowers under the loans to satisfy certain conditions and comply with covenants.  As of December 31, 2003 and September 30, 2004, management believes that the subsidiaries are in compliance with such conditions and covenants. The weighted average interest rate on the bank loans as of December 31, 2003 is 5%. The loan repayments will be carried out primarily over the next five years.

 

b.              Classification

 

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

 

		Interest rate (%)				Amount
		December 31, 2003		September 30, 2004		December 31, 2003			September 30, 2004
				(Unaudited)					(Unaudited)
In, or linked to dollar		3-5		3-6		$	47,514		$	41,170
In NIS - linked to CPI		6-8		6-8		33,291			26,034
						$	80,805		$	67,204

 

c.     Maturities

 

The liabilities mature as follows:

 

 

Note 4: Commitments and Contingent Liabilities

 

a.               Litigation

 

In 2003 and the nine-month period ended September 30, 2004, several employees filed lawsuits against subsidiaries of ours claiming payments due to them in the total amount of $40. Our management and our legal advisor believe that the provision in the consolidated financial statements is adequate to cover probable costs arising from these matters.

 

b.              Guarantees

 

Guarantees are contingent commitments issued by us generally to guarantee our performance in different projects to our customers, such as tenders. The term of a guarantee generally is equal to the term of the related projects, which can be as short as 30 days or as long as 5 years. The maximum potential amount of future payments we could be required to make under our guarantees at December 31, 2003 and September 30, 2004, is $19,480 and $19,682, respectively.  We do not hold collateral to support guarantees when deemed necessary.

 

c.               Liens and charges

 

To secure our liabilities, we and our subsidiaries recorded fixed and floating charges on our holdings in subsidiaries, and on our and our subsidiaries’ property and equipment, share capital and goodwill.

 

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands (information as of September 30, 2004 and for the three month and nine month periods ended September 30, 2003 and 2004 is unaudited)

 

Note 5: Stockholders’ Equity

 

a.               Our Board of Directors and our stockholders approved on September 2, 2004 a 0.7193-for-1 reverse split of our shares of common stock, to be effected on the effective date of filing an amendment to our certificate of incorporation in respect of the reverse split. Such filing became effective on September 20, 2004. All common shares, options, warrants and per share data included in these financial statements for all periods presented as well as the exchange ratios for the Preferred shares and convertible loan from stockholders have been retroactively adjusted to reflect this 0.7193-for-1 reverse split.

 

b.              Our Board of Directors approved and resolved on April 1, 2004 to recommend that holders of the Class B Preferred stock convert accumulated dividends on our Class B Preferred stock (approximately $9,474) to common stock at a conversion price of $18.07 per share. On September 20, 2004, the Class B convertible Preferred stock certificate of designations was amended to reflect such change. Our Board of Directors also approved and resolved on April 1, 2004 to recommend that holders of our Class C Preferred stock waive their redemption right upon an initial public offering, or IPO, and that the ratchet protection granted to holders of our Class C Preferred stock be reduced to $18.07 per share.

 

c.               Additionally, our Board of Directors and our stockholders approved and resolved on September 2, 2004 an amendment to our Class C Convertible Preferred stock certificate of designation. Such amendment became effective on September 20, 2004. Accordingly, if we consummated an IPO prior to December 31, 2004 at a price below $19.44, the conversion ratio of each share of Class C Preferred stock would be revised to the quotient obtained in accordance with the following formula: 18.07/(IPO price/1.075); provided, that if less than all of the shares of common stock underlying our Class C Convertible Preferred Stock is not sold in such IPO, the conversion ratio applicable to such shares would be calculated according to the following formula: 18.07/(IPO price/1.15). If we had consummated an IPO subsequent to January 1, 2005 at a price below $20.78, the conversion ratio would have been calculated according to the following formula: 18.07/(IPO price/1.15).

 

d.              On September 2, 2004, our Board of Directors and our stockholders approved an increase of 400,000 options to the U.S. 2003 Stock Option Plan and 600,000 options to the 2003 Israeli Stock Option Plan.

 

e.               Total comprehensive income (loss):

 

		Three months ended September 30,						Nine months ended September 30,
		2003			2004			2003			2004
		(Unaudited)
Net income		$	189		$	3,691		$	2,569		$	9,018
Foreign currency translation adjustment, net		4,676			533			1,915			(2,354		)
Net unrealized losses on available-for-sale marketable securities		90			(3		)	(14		)	(35		)
Comprehensive income		$	4,955		$	4,221		$	4,470		$	6,629

 

Note 6: Geographic Information

 

We adopted Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). We operate in one reportable segment. Our total revenues are attributed to geographic areas based on the location of the end customer.

 

The following presents total revenues for the three month and nine month periods ended September 30, 2003 and 2004 and long-lived assets as of September 30, 2003 and 2004:

 

		Three months ended September 30,						Nine months ended September 30,
		2003			2004			2003			2004
		(Unaudited)
Revenues from sales to unaffiliated customers:
Israel		$	36,745		$	43,175		$	110,244		$	127,636
United States		13,966			19,486			20,550			53,697
Europe		10,314			9,671			22,593			28,188
Asia and the Far East		3,302			4,105			3,302			10,720
Others		—			715			—			1,936
		$	64,327		$	77,152		$	156,689		$	222,177

 

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