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 March 31, 2005

 

¨                   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)

 

 

 

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.  ý Yes  o 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 April 20, 2005:

 

Title of Class		Number of Shares Outstanding
Common Stock, $0.01 par value		34,532,770

 

 

NESS TECHNOLOGIES, INC. AND SUBSIDIARIES

 

INDEX

 

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets – December 31, 2004 and March 31, 2005 (Unaudited)
Consolidated Statements of Income – Three months ended March 31, 2004 and 2005(Unaudited)
Consolidated Statements of Cash Flows – Three months ended March 31, 2004 and 2005 (Unaudited)
Notes to Interim Condensed Consolidated Financial Statements – March 31, 2005 (Unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Recent Developments
Consolidated Results of Operations
Three Months Ended March 31, 2005 Compared to the Three Months Ended March 31, 2004
Liquidity and Capital Resources
Forward-Looking Statements and Risk Factors
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Changes in Internal Control
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
EXHIBIT INDEX

 

2

 

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, 2004			March 31, 2005
					(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	104,229		$	108,723
Marketable securities		383			378
Trade receivables (net of allowance for doubtful accounts of $2,154 and $2,116 at December 31, 2004, and March 31, 2005 (unaudited), respectively)		75,183			77,808
Unbilled receivables		20,327			24,887
Other accounts receivable and prepaid expenses		9,127			11,030
Inventories		1,168			668
Total current assets		210,417			223,494
LONG-TERM ASSETS:
Long-term prepaid expenses		3,655			5,391
Marketable securities		69			169
Deferred income taxes		4,823			5,208
Severance pay fund		33,558			33,533
Total long-term assets		42,105			44,301
PROPERTY AND EQUIPMENT, NET		18,879			19,040
OTHER INTANGIBLE ASSETS, NET		4,262			4,893
GOODWILL		149,090			150,661
Total assets		$	424,756		$	442,389

 

The accompanying notes are an integral part of the interim condensed 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, 2004			March 31, 2005
					(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Short-term bank credit		$	1,275		$	1,335
Current maturities of long-term debt		13,364			17,564
Trade payables		31,280			32,942
Advances from customers		7,679			7,689
Other accounts payable and accrued expenses		64,271			68,349
Total current liabilities		117,869			127,879
LONG-TERM LIABILITIES:
Long-term debt, net of current maturities		36,918			31,336
Excess of losses over investment in affiliates		306			302
Accrued severance pay		36,888			37,412
Minority interests		295			—
Total long-term liabilities		74,407			69,050
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS’ EQUITY:
Common stock of $0.01 par value -
Authorized: 76,500,000 shares at December 31, 2004 and at March 31, 2005 (unaudited); issued and outstanding: 32,772,578 shares at December 31, 2004 and 34,417,148 shares at March 31, 2005 (unaudited)		328			344
Additional paid-in capital		270,967			282,678
Deferred stock compensation		(152		)	(102		)
Accumulated other comprehensive loss		(2,045		)	(5,769		)
Accumulated deficit		(36,618		)	(31,691		)
Total stockholders’ equity		232,480			245,460
Total liabilities and stockholders’ equity		$	424,756		$	442,389

 

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

 

4

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Interim Condensed Consolidated Statements of Income

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

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Revenues		$	71,146		$	88,405
Cost of revenues (*)		48,848			62,395
Provision for losses (reverse of losses) on uncompleted contracts		(442		)	85
Gross profit		22,740			25,925
Operating expenses:
Selling and marketing		6,086			7,031
General and administrative (*)		11,397			12,428
Stock-based compensation		51			611
Total operating expenses		17,534			20,070
Operating income		5,206			5,855
Financial expenses, net		(2,369		)	(426		)
Other income, net		84			—
Income before taxes on income		2,921			5,429
Taxes on income (tax benefit)		(111		)	602
Equity in net losses of affiliates		(615		)	(2		)
Minority interests in losses of a subsidiary		—			101
Net income		$	2,417		$	4,926
Allocation of undistributed earnings on Class B Convertible Preferred stock		$	(366	)	$	—
Net income after allocation of undistributed earnings		$	2,051		$	4,926
Basic net earnings per share		$	0.11		$	0.15
Diluted net earnings per share		$	0.10		$	0.14

 

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

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Cost of revenues		$	—		$	98
General and administrative		51			513

 

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

 

5

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Interim Condensed Consolidated Statements of Cash Flows

U.S. dollars in thousands

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Cash flows from operating activities:
Net income		$	2,417		$	4,926
Adjustments required to reconcile net income to net cash provided by (used in) operating activities:
Amortization of deferred stock compensation related to Ness GSG acquisition		51			50
Stock-based compensation related to warrants granted to banks		11			11
Stock-based compensation related to redeemable options		—			531
Equity in net losses of affiliates		615			2
Minority interests in losses of a subsidiary		—			(101		)
Currency fluctuation of long-term debt		2,348			1,096
Accrued interest on long-term debt		(1,057		)	(1,251		)
Depreciation and amortization		1,290			1,495
Deferred income taxes, net		(778		)	(1,432		)
Loss (gain) on sale of property and equipment		(23		)	6
Trading marketable securities, net		(6		)	—
Increase in trade receivables		(9,120		)	(3,536		)
Increase in unbilled receivables		(2,878		)	(4,810		)
Increase in other accounts receivable and prepaid expenses		(534		)	(270		)
Decrease (increase) in inventories		(308		)	486
Increase in long-term prepaid expenses		(94		)	(1,781		)
Increase in trade payables		28			2,043
Increase (decrease) in advances from customers		(1,758		)	103
Increase in other accounts payable and accrued expenses		7,167			4,223
Increase in accrued severance pay, net		846			590
Net cash provided by (used in) operating activities		(1,783		)	2,381
Cash flows from investing activities:
Proceeds from decrease in investment in a subsidiary, net of cash in the subsidiary at the time it ceased being consolidated		(168		)	—
Acquisition of minority interest in a subsidiary (a)		—			—
Purchase of short-term bank deposits		(118		)	—
Proceeds from sale of property and equipment		143			137
Purchase of property and equipment and capitalization of software developed for internal use		(1,851		)	(1,564		)
Capitalization of software development costs		(354		)	(924		)
Other		(96		)	—
Net cash used in investing activities		(2,444		)	(2,351		)

 

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

 

6

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Interim Condensed Consolidated Statements of Cash Flows

U.S. dollars in thousands

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Cash flows from financing activities:
Exercise of options and warrants		$	31		$	7,659
Short-term bank credit, net		(184		)	76
Proceeds from long-term debt		6,251			—
Principal payment of long-term debt		(15,282		)	(1,253		)
Net cash provided by (used in) financing activities		(9,184		)	6,482
Effect of exchange rate changes on cash and cash equivalents		(696		)	(2,018		)
Increase (decrease) in cash and cash equivalents		(14,107		)	4,494
Cash and cash equivalents at the beginning of the period		46,004			104,229
Cash and cash equivalents at the end of the period		$	31,897		$	108,723
Supplemental disclosures of cash flows information:
Cash paid during the period for:
Interest		$	917		$	435
Taxes		$	280		$	174

 

(a)                In conjunction with the acquisition of the minority interest in a subsidiary, the fair values of the assets acquired and liabilities assumed at the date of acquisition were as follows:

 

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

 

The accompanying notes are an integral part of the interim condensed 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 March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 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 March 31, 2005, the condensed consolidated statements of income for the three months ended March 31, 2004 and 2005, and the condensed consolidated statements of cash flows for the three months ended March 31, 2004 and 2005 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 March 31, 2005, our consolidated results of operations for the three months ended March 31, 2004 and 2005, and our consolidated cash flows for the three months ended March 31, 2004 and 2005.

 

The balance sheet at December 31, 2004 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, 2004 included in our Annual Report on Form 10-K dated March 31, 2005.

 

Results for the three months ended March 31, 2005 are not necessarily indicative of results that may be expected for the year ending December 31, 2005.

 

Unless otherwise noted, (1) all references to “dollars” or “$” are to United States dollars and all references to “NIS” 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 March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 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, 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 of 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 (“SFAS”) No. 52 “Foreign Currency Translation.” All transaction gains and losses of the re-measured monetary balance sheet items are reflected in the statement of income 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 the accounts of the company and its 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 Subsidiaries

 

1.               Ness U.S.A. Inc. (“Ness U.S.A.”)

 

On October 25, 2001, we and other investors incorporated Ness U.S.A., a corporation incorporated under the laws of the State of Delaware, for the purpose of acquiring certain assets and assuming certain liabilities of Blueflame Inc. (“Blueflame”) out of Blueflame’s chapter 11 bankruptcy proceeding. On the date of incorporation, we held 68% of the outstanding common stock of Ness U.S.A. and other investors held the remaining 32% of the outstanding common stock of Ness U.S.A. On November 1, 2001, Ness U.S.A. acquired these assets with a fair market value of approximately $6,656 for cash consideration and related purchase costs totaling approximately $5,140. The transaction was accounted for by the purchase method of accounting according to SFAS No. 141 “Business combinations.”

 

Ness U.S.A. is a full-service business and advanced technology solutions provider to the life sciences, financial services, telecommunications and other industries. Ness U.S.A. offers technical and management consulting services intended to create business improvements by building integrated business process and technology solutions to strategic problems.

 

9

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

U.S. dollars in thousands (information as of March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

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

 

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

 

b)             Payment of a contingent promissory note in the amount of $750, following the occurrence of the earlier of the following two events:

 

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

 

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

 

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

 

(ii)                  if the qualifying transaction occurs after December 31, 2003 but prior to January 1, 2005, the contingent payment will be equal to $650, unless the consideration for such qualifying transaction is in excess of $6,600, in which case the contingent payment will be equal to $750.

 

(iii)               if the qualifying transaction occurs after December 31, 2004 but prior to January 1, 2006, the contingent payment will be equal to $550, unless the consideration for such qualifying transaction is equal to or in excess of $750.

 

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

 

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

 

On December 27, 2002, we acquired additional stock of Ness U.S.A. from certain of the employees and other private investors so that, as of December 31, 2003, we held 86% of Ness U.S.A.’s common stock. The acquisition was accounted for under the purchase method of accounting according to SFAS No. 141. The total consideration of $5,001 (including $323 in transaction costs) for the shares purchased consisted of the issuance of 647,170 shares of our common stock, valued at a fair value of $4,678.

 

Under the securities exchange agreement, we agreed to offer the remaining stockholders of Ness U.S.A. shares of common stock in exchange for their shares of Ness U.S.A. at the same exchange ratio used in the December 2002 exchange on the earliest date practicable after receiving a no-action

 

10

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

U.S. dollars in thousands (information as of March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

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

 

On November 12, 2004, we filed a Form S-4 Registration Statement in respect of an exchange offer for the remaining shares Ness U.S.A. The offer commenced on January 31, 2005 and ended on February 28, 2005. 96 of 98 offerees accepted the offer bringing our holdings in Ness U.S.A. following the offer to 99.9%. On March 1, 2005, we issued 260,316 shares to the offerees, for the consideration of $3,531 (including $113 of transaction cost). The acquisition was accounted for under the purchase method of accounting according to SFAS No. 141.

 

Based upon a preliminary valuation of tangible and intangible assets acquired, we have allocated the total cost of the acquisition to Ness U.S.A.’s assets and liabilities as follows:

 

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

 

The allocation of the purchase price reflected in the March 31, 2005 condensed consolidated balance sheet is preliminary. We have arranged to obtain a valuation of Ness U.S.A.’s current assets, current liabilities, property and equipment and intangible assets. Management expects to obtain such completed report during the third quarter of 2005.

 

11

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

U.S. dollars in thousands (information as of March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

2.               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.

 

Pursuant to the merger agreement, we agreed to issue additional shares of common stock to the stockholders of Ness GSG if and when we issued shares of common stock in exchange for the remaining shares of Ness U.S.A. We agreed to issue the number of shares of our common stock 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 exchange for their Ness U.S.A. shares. Subsequent to the completion of Ness U.S.A. exchange offer, on March 2, 2005, we issued to the former stockholders of Ness GSG 89,305 additional shares of our common stock pursuant to the terms of the merger agreement. These shares were recorded at their aggregate par value, or $1, and reduced additional paid in capital in the same amount, at the date issued.

 

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 three months ended March 31, 2005.

 

g.              Accounting for stock-based compensation

 

We have elected to follow Accounting Principles Board Opinion (“APB”) No. 25 “Accounting for Stock Issued to Employees” and FASB Interpretation (“FIN”) No. 44 “Accounting for Certain Transactions Involving Stock Compensation” in accounting for our employee stock option plans. Under APB No. 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 SFAS No. 148, “Accounting for Stock-Based Compensation - transition and disclosure,” which amended certain provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” 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 prior fiscal year. We continue to apply the provisions of APB No. 25 in accounting for stock-based compensation.

 

Pro forma information regarding our net income and net earnings per share is required by SFAS No. 123 and has been determined as if we had accounted for our employee stock options under the fair value method prescribed by SFAS No. 123.

 

12

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

U.S. dollars in thousands (information as of March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

The fair value for options granted in the three month period ended March 31, 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 March 31, 2004
		(Unaudited)
Dividend yield		0	%
Expected volatility		0.52
Risk-free interest		2.5	%
Expected life of up to (in years)		4

 

During the first quarter of 2005 no new options were granted.

 

Pro forma information under SFAS No. 123 is as follows:

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Net income available to common stock, as reported		$	2,051		$	4,926
Add: Allocation of undistributed earnings on Class B Convertible Preferred Stock, as reported		366			—
Deduct: Pro forma allocation of undistributed earnings on Class B Convertible Preferred Stock		(259		)	—
Add: Stock-based employee compensation – intrinsic value		51			611
Deduct: Stock-based employee compensation – fair value		(752		)	(2,565		)
Pro forma net income		$	1,457		$	2,972
Basic net earnings per share, as reported		$	0.11		$	0.15
Diluted net earnings per share, as reported		$	0.10		$	0.14
Pro forma basic net earnings per share		$	0.08		$	0.09
Pro forma diluted net earnings per share		$	0.07		$	0.08

 

h.              Impact of recently issued accounting pronouncements

 

On December 16, 2004, the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” which requires companies to recognize in the statement of income, all share-based payments to employees, including grants of employee stock options, based on their fair values. Accounting for share-based compensation transactions using the intrinsic method supplemented by pro forma disclosures will no longer be permissible. The new statement will be effective for public entities no later than the beginning of the first fiscal year beginning after June 15, 2005. We will adopt the new statement on January 1, 2006. We have not yet completed our analysis of the impact of adopting SFAS 123R and are therefore currently unable to quantify the effect on our financial statements. However, the adoption of this new statement will have an impact on our results of operations and net earnings per share as we will be required to expense the fair value of all share-based payments.

 

13

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

U.S. dollars in thousands (information as of March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

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, 2004			March 31, 2005
		(Unaudited)
Banks (1)		$	48,292		$	46,845
Loan from stockholders		1,000			1,000
Loans from others		990			1,055
		50,282			48,900
Less current maturities		13,364			17,564
		$	36,918		$	31,336

 

(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, 2004 and March 31, 2005, management believes that the subsidiaries are in compliance with foregoing conditions. The weighted average interest rate on the bank loans as of December 31, 2004 is 6%.

 

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, 2004		March 31 2005		December 31, 2004			March 31, 2005
				(Unaudited)					(Unaudited)
In, or linked to dollar		5-8		5-8		$	33,027		$	33,398
In NIS - linked to CPI		6-8		6-8		17,255			15,502
						$	50,282		$	48,900

 

c.               Maturities

 

The liabilities mature as follows:

 

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

 

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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 March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

Note 4: Commitments and Contingent Liabilities

 

a.               Litigation

 

In 2004 and the three-month period ended March 31, 2005, several employees filed lawsuits against subsidiaries of ours claiming payments due to them in the total amount of $73. Our management and our legal advisor believe that the provision in our consolidated financial statements is adequate to cover probable costs arising from these matters.

 

Our Israeli subsidiary currently has a dispute in respect of an outsourcing contract in which it has provided services as a subcontractor to the Israeli Ministry of Environment. The Israeli Ministry of Environment submitted a claim for approximately $1,100 and our subsidiary submitted two counterclaims amounting aggregately to $660. The dispute is currently discussed through arbitration. Our management and our legal advisor are unable to determine with any certainty the ultimate outcome of the dispute and, accordingly, no accrual was provided for.

 

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, 2004 and March 31, 2005, is $21,948 and $20,647, 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.

 

Note 5: Stockholders’ Equity

 

a.               Redeemable options:

 

Our Executive Committee approved and resolved on August 31, 2004 to provide to certain optionees (specifically, those who exchanged their options in two previously public entities acquired by us for options in Ness) the right to redeem 391,499 of their options, all of which were vested at the time of grant, for a cash payment. The grant date occurred in the fourth quarter of 2004. During the first quarter of 2005, certain optionees exercised their options and one optionee exercised his redemption rights and had his options redeemed.  Accordingly, as of March 31, 2005, the total number of shares of common stock for which these redeemable options are exercisable is 370,957, and the aggregate redemption value is $3.3 million. The redemption right is exercisable from October 1, 2004 until May 31, 2006. Each option subject to the redemption right may be transferred by the employee to us for a cash payment that is linked, at the employee’s sole discretion, either to the Israeli CPI and shall bear an NIS interest at the rate of 5% per year, or to the dollar with interest at the rate of 6% per year, calculated from the original option grant date of September 23, 1999 or October 3, 1999, up to the redemption date. Each of 280,917 options (“Group A”) may be exercised to acquire one share of our common stock at a price of $3.49 and are redeemable at the NIS equivalent of $9.46 per option as of March 31, 2005. Each of 90,040 options (“Group B”) may be exercised to acquire one share of our common stock at a price of $7.45, and are redeemable at the NIS equivalent of $7.12 per option as of March 31, 2005. The exercise prices and

 

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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 March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

redemption amounts are subject to adjustments for stock splits, dividends, recapitalizations and the like, as set forth in our share option plan to which each option is subject. We account for the rights following the guidance of FIN No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” relating to tandem awards and Emerging Issues Task Force (“EITF”) No. 00-23 “Issues Related to the Accounting for Stock Compensation under APB No. 25 and FIN No. 44.” Accordingly, once we believe it is likely that the rights would be exercised in the future, a liability is recorded at the then value of the redemption rights, with a corresponding charge to compensation expense. The liability will be accreted periodically to equal the amount that would be payable if the awards were redeemed at each balance sheet date.

 

As of March 31, 2005, we believed it was likely that the rights in respect of Group B would be exercised, and accordingly, we recorded a liability in that respect in the total amount of $641, included in other accounts payable and accrued expenses, reflecting the value of the redemption rights at March 31, 2005. Related stock based compensation expense was recorded in the statement of income in the total amount of $346, net of taxes.

 

b.              Total comprehensive income (loss):

 

		Three months ended March 31
		2004			2005
		(Unaudited)
Net income		$	2,417		$	4,926
Foreign currency translation adjustment, net		(3,322		)	(3,791		)
Net unrealized losses on available-for-sale marketable securities		(21		)	67
Comprehensive income (loss)		$	(926	)	$	1,202

 

Note 6: Geographic Information

 

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

 

The following present total revenues for the three month periods ended March 31, 2004 and 2005, and long-lived assets as of March 31, 2004 and 2005:

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Revenues from sales to unaffiliated customers:
Israel		$	41,587		$	51,708
United States		16,235			20,752
Europe		9,872			10,377
Asia and the Far East		2,888			4,356
Others		564			1,212
		$	71,146		$	88,405

 

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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 March 31, 2005 and for the three month periods ended March 31, 2004 and 2005 is unaudited)

 

		March 31,
		2004			2005
		(Unaudited)
Long-lived assets:
Israel		$	96,313		$	103,351
United States		56,006			60,283
Europe		2,508			2,730
Asia and the Far East		4,549			8,222
Others		8			8
		$	159,384		$	174,594

 

Note 7: Basic and Diluted Net Earnings per Share

 

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

 

The total weighted average number of shares related to the outstanding options, warrants, Convertible Preferred stock and convertible loan from stockholders excluded from the calculations of diluted net earnings per share, as they would have been anti-dilutive for all periods presented, was 186,401, 155,521 and 19,755 for the year ended December 31, 2004 and the three months ended March 31, 2004 and 2005, respectively.

 

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

 

		Three months ended March 31,
		2004			2005
		(Unaudited)
Numerator:
Net income		$	2,417		$	4,926
Allocation of undistributed earnings on Class B Convertible Preferred Stock		(366		)	—
Numerator for basic and diluted per share data: Net income after allocation of undistributed earnings on Class B Convertible Preferred Stock		$	2,051		$	4,926
Denominator:
Weighted average number of shares of common stock		16,478			33,755
Weighted average number of shares of preferred stock		2,412			—
Denominator for basic net earnings per share		18,890			33,755
Effect of dilutive securities:
Employee stock options and warrants		2,401			1,790
Denominator for diluted net earnings per share – adjusted weighted average assuming conversions and exercise of options and warrants		21,291			35,545

 

Note 8: Subsequent Events

 

On April 1, 2005, we completed the acquisition of Radix Company SA (“Radix”), a privately held leading provider of IT services and solutions based in Romania. The purchase price in the all-cash transaction was €4 million, or approximately $5.2 million. In addition, should Radix achieve certain performance goals over the next two years, we will pay an additional amount of up to €3 million, or approximately $3.9 million. Upon completion of the acquisition, Radix Company SA changed its name to Ness Romania and it now operates as a wholly-owned subsidiary of our Dutch subsidiary, Ness Technologies, B.V.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion and analysis together with our unaudited consolidated financial statements and the accompanying notes.  This discussion contains forward-looking statements, within the meaning of Section 27A of Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, including statements regarding our expected financial position, business and financing plans.  These statements involve risks and uncertainties. Our actual results could differ materially from the results described in or implied by these forward-looking statements as a result of various factors, including those discussed below and elsewhere our Annual Report on Form 10-K dated March 31, 2005, as filed with the Securities and Exchange Commission, particularly under the headings “Disclosure Statement” and “Risk Factors.”

 

Overview

 

We are a global provider of information technology, or IT, services and end-to-end business solutions designed to help clients improve their competitiveness and effectiveness. End-to-end business solutions encompass all stages of a client’s business process and incorporate all technologies and IT services related to that process. Our portfolio of solutions and services includes outsourcing, system integration and application development, software and consulting, and quality assurance and training. The primary industries, or verticals, we serve include government and defense, financial services, life sciences and healthcare, telecommunications and utilities, and independent software vendors, or ISVs.

 

We have operations in 15 countries across North America, Europe and Asia. We combine our deep vertical expertise and strong technical capabilities to provide a complete range of high quality services on a global scale. By integrating our local and international personnel in focused business and project teams, this global delivery model leverages our corporate knowledge and experience, intellectual property and global infrastructure to develop innovative solutions for clients across the geographies and verticals we serve. We complement this global delivery model with our offshore delivery capabilities to achieve meaningful cost reductions or other benefits for our clients.

 

Our revenues increased to $88.4 million for the three months ended March 31, 2005 from $71.1 million for the three months ended March 31, 2004.  Net income increased to $4.9 million for the three months ended March 31, 2005 from $2.4 million for the three months ended March 31, 2004.

 

Our revenue growth is attributable to a number of factors, increases in the number and size of projects for existing clients, and the addition of new clients. Our client base is diverse, and we are not dependent on any single client. In the three months ended March 31, 2005, no client accounted for more than 5% of our revenues and our largest twenty clients together accounted less than approximately 35% of our revenues. For the three months ended March 31, 2005, the percentage of our revenues generated by public and private clients in Israel was 58%, and the percentage of our revenues derived, in aggregate, from agencies of the government of Israel was 13%. Existing clients from prior years generated more than 85% of our revenues in the three months ended March 31, 2005.

 

Our backlog as of March 31, 2005 was $412 million compared to $314 million as of March 31, 2004. This $98 million increase in our backlog was due exclusively to new bookings. We achieve backlog through new signings of IT services projects and outsourcing contracts, including for new and repeat customers. We recognize backlog as revenue when we perform the services related to backlog.

 

For the three months ended March 31, 2005, the percentage of our revenues derived from clients in Israel was 58%; in the United States, 23%; in Europe, 12%; in Asia and the Far East, 5%; and in other countries, 1%.  For the three months ended March 31, 2005, we derived 30% of our revenues from system integration and application development; 47% from outsourcing (including offshore development); 14% from software and consulting; 6% from quality assurance and training; and 4% from our other offerings.

 

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As of March 31, 2005, we had approximately 5,170 employees, including approximately 4,515 IT professionals.  Of the 5,170 employees, approximately 2,760 were in Israel, 1,325 were in India, 360 were in North America, 410 were in Europe and 315 were in the Asia Pacific region.

 

Recent Developments

 

On April 1, 2005, we completed the acquisition of Radix Company SA, a privately held leading provider of IT services and solutions based in Romania. The purchase price in the all cash transaction was €4 million, or approximately $5.2 million. In addition, should Radix achieve certain performance goals over the next two years, we will pay an additional amount of up to €3 million, or approximately $3.9 million.  For the full year 2004, Radix Company SA generated revenues in excess of $12 million and was profitable.  Radix Company SA is one of the leading Romanian IT services and solutions providers and is expected to provide synergies with Ness’ current operations in Central and Eastern Europe. Upon completion of the acquisition, Radix Company SA changed its name to Ness Romania and it now operates as a wholly-owned subsidiary of our Dutch subsidiary, Ness Technologies, B.V.

 

Consolidated Results of Operations

 

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

 

		Three months ended March 31,
		2004		2005
Revenues		100.0	%	100.0	%
Cost of revenues		68.7		70.6
Provision for losses (reverse of losses) on uncompleted contracts		(0.6	)	0.1
Gross profit		32.0		29.3
Operating expenses:
Selling and marketing		8.6		8.0
General and administrative		16.0		14.1
Stock-based compensation		0.1		0.7
Total operating expenses		24.6		22.7
Operating income		7.3		6.6
Financial expenses, net		(3.3	)	(0.5	)
Other income, net		0.1		0.0
Income before taxes on income		4.1		6.1
Taxes on income (tax benefit)		(0.2	)	0.7
Equity in net losses of affiliates		(0.9	)	0.0
Minority interests in losses of a subsidiary		—		0.1
Net income		3.4		5.6

 

Three Months Ended March 31, 2005 Compared to the Three Months Ended March 31, 2004

 

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

 

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		Three months ended March 31,								Increase (Decrease)
		2004				2005				$		%
Revenues		$		71,146		$	88,405			17,259		24.3
Cost of revenues		48,848				62,395				13,547		27.7
Provision for losses (reverse of losses) on uncompleted contracts		(442			)	85				527		N/A
Gross profit		$	22,740			$		25,925		3,185		14.0
Gross margin		32.0			%	29.3			%

 

Revenues

 

Our revenues increased from $71.1 million in the three months ended March 31, 2004 to $88.4 million in the three months ended March 31, 2005, representing an increase of $17.3 million, or 24.3%.  Our $17.3 million revenue increase was primarily due to growth in outsourcing and offshore engagements, representing $7.8 million, while $9.5 million was attributable to growth in our other offerings, comprised of system integration and application development, software and consulting, and quality assurance and training. Revenues from outsourcing and offshore services increased as a result of volume growth due to our sales initiatives related to these offerings, including the hiring of key personnel and aligning of our organizational structure, and expansion into geographical areas in which we currently do business but previously had not offered outsourcing and offshore services. There was no significant change in our billing rates, or prices, from the three months ended March 31, 2004 to the three months ended March 31, 2005.

 

Cost of revenues and provision for losses (reverse of losses) on uncompleted contracts

 

Our cost of revenues, including salaries, wages and other direct costs, increased from $48.8 million in the three months ended March 31, 2004 to $62.4 million in the three months ended March 31, 2005, representing an increase of $13.5 million, or 27.7 %. The increase was attributable to growth in our delivery staff needed to support our increased revenues.  The change in our provision for losses (reverse of losses) on uncompleted contracts changed from ($0.4) million in the three months ended March 31, 2004 to $0.1 million in the three months ended March 31, 2005, as a result of net changes in our fixed price project loss provisions.

 

Gross Profit

 

Our gross profit (revenues less cost of revenues and provision for losses (reverse of losses) on uncompleted contracts) increased from $22.7 million in the three months ended March 31, 2004 to $25.9 million in the three months ended March 31, 2005, representing an increase of $3.2 million, or 14.0 %. The increase was primarily related to our increase in revenues, representing $5.6 million, offset by a decrease in our gross margin, representing approximately ($2.4) million. Gross margin for the three months ended March 31, 2005 was 29.3%, compared to 32.0% in the three months ended March 31, 2004. The decrease in gross margin resulted primarily from higher than planned contract setup costs associated with new outsourcing and offshore engagements attributable to our greater than anticipated revenue growth in the quarter and from an increase in our use of subcontractors and vendors in order to meet certain delivery commitments.

 

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

 

		Three months ended March 31,						Increase (Decrease)
		2004			2005			$		%
Selling and marketing		$	6,086		$	7,031		945		15.5
General and administrative		11,397			12,428			1,031		9.0
Stock-based compensation		51			611			560		1,098
Total operating expenses		17,534			20,070			2,536		14.4
Operating income		$	5,206		$	5,855		649		12.5

 

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Selling and marketing

 

Selling and marketing expenses increased from $6.1 million in the three months ended March 31, 2004 to $7.0 million in the three months ended March 31, 2005, representing an increase of $0.9 million, or 15.5%. This increase was due primarily to a $0.8 million increase in marketing expenses, especially in Europe, and increases in our sales commissions and other sales expenses of $0.1 million. These other marketing expenses are related primarily to our efforts to enhance our brand recognition.

 

General and administrative

 

General and administrative expenses increased from $11.4 million in the three months ended March 31, 2004 to $12.4 million in the three months ended March 31, 2005, representing an increase of $1.0 million, or 9.0%. This increase was due primarily to increased general and administrative expenses necessary to support our revenue growth, representing $0.3 million, and certain additional expenses associated with being a public company, including implementation of compliance measures required by the Sarbanes-Oxley Act, representing $0.6 million.

 

Stock-based compensation

 

Non-cash stock-based compensation expenses increased from $0.1 million in the three months ended March 31, 2004 to $0.6 million in the three months ended March 31, 2005, representing an increase of $0.6 million. This increase was due primarily to a charge to compensation expense in respect of redeemable options, representing $0.5 million, described in note 5(a) to our interim condensed consolidated financial statements – March 31, 2005.

 

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

 

		Three months ended March 31,						Increase (Decrease)
		2004			2005			$		%
Operating income		$	5,206		$	5,855		649		12.5
Financial expenses, net		(2,369		)	(426		)	1,943		(82.0	)
Other income, net		84			—			(84	)	(100.0	)
Income before taxes on income		2,921			5,429			2,508		85.9
Taxes on income (tax benefit)		(111		)	602			713		N/A
Equity in net losses of affiliates		(615		)	(2		)	613		(99.7	)
Minority interests in losses of a subsidiary		—			101			101		N/A
Net income		$	2,417		$	4,926		2,509		103.8

 

Financial expenses, net

 

Financial expenses, net, decreased from $2.4 million in the three months ended March 31, 2004 to $0.4 million in the three months ended March 31, 2005, representing a decrease of $1.9 million, or 82.3%. The decrease was due primarily to investment income from the proceeds of our initial public offering and reduced debt service expenses following our reduction of net long-term debt in the fourth quarter of 2004.

 

Other income, net

 

Other income, net, changed from income of $0.1 million in the three months ended March 31, 2004 to no expenses in the three months ended March 31, 2005. This change was not significant.

 

Taxes on income (tax benefit)

 

Our taxes on income (tax benefit) changed from a benefit of $0.1 million in the three months ended March 31, 2004 to taxes of $0.6 million in the three months ended March 31, 2005. This change was attributable to the increase in our income before taxes and the depletion of our net operating loss carry forwards in Israel and the United States.

 

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