Based in Tel Aviv, Israel, Ness Technologies (NSTC) is a global provider of IT services. With operations in 17 countries across North America, Europe, and Asia, Ness provides services to over 500 clients worldwide and employs over 7,700 people. The company generated 48% of fiscal 2006 revenue from Israel, 25% from North America, 22% from Europe, 4% from Asia and the Far East, and 1% from the rest of the world. Ness completed its initial offering in the U.S. in October 2004.
Ness operates in four main business areas:
Systems Integration (SI) and Application Development This segment contributed 32% of fiscal 2006 revenue, and delivers comprehensive SI services including planning, design, implementation, training, and support. The SI services cover a wide range of areas, such as enterprise resource planning (ERP), customer relationship management (CRM), enterprise application integration (EAI), telecommunication systems, geographic information systems (GIS), command and control and real-time systems, knowledge management, and business intelligent (BI) and data warehousing.
Outsourcing and Offshore This segment contributed 43% of 2006 revenue. The company has established offshore facilities in India and Israel.
Software and Consulting This segment, which contributed 15% of 2006 revenue, provides product representation (establishing partnerships with over 30 leading international independent software vendors or ISVs to resell and support their products in Israel), proprietary and turnkey solutions (offering customized applications aimed at verticals), and strategic consulting services.
Quality Assurance and Training This segment, which contributed 7%, offers a range of QA and training services providing clients with independent software testing and QA services, customized training programs, and assimilation services.
The remaining 2% came from other offerings. The primary industries or verticals where Ness serves include government and defense, financial services, life sciences and healthcare, telecommunications and utilities, and ISVs.
Ness reports revenue under following five segments:
Ness North America (Ness NA), which includes India-based offshore services as well as system integration and application development and consulting services. Verticals served by this segment are independent software vendors, life sciences and healthcare and others.
Technologies & Systems Group (TSG), which includes system integration and application development, real-time systems development, consulting and outsourcing services for the defense, government and homeland security vertical, as well as systems for the telecommunications vertical.
Ness Europe, which includes system integration and application development, outsourcing, and software and consulting for Eastern European and Western European customers, including near-shore services from Eastern Europe for Western European customers. Verticals served by this segment are telecommunications and utilities, financial services and others.
Ness Israel, which includes system integration and application development, outsourcing, software and consulting, and quality assurance and training for customers in Israel within the following verticals: financial services, government, life sciences and healthcare, manufacturing, retail, transportation and others.
Other, which comprises operations representing, individually, less than 10% of our consolidated revenues and operating profit. These include our operations in Asia Pacific, the financial services component of Ness IBS division (formerly Innova) as well as the recently acquired NessPRO Spain (formerly Selesta Espa a), NessPRO Thailand (formerly AIM) and NessPro Italy (formerly Selesta Italia).
On January 1, 2007, the company expanded its Managed Strategic Services (MSS) segment to include the non-financial services portions of Ness IBS (formerly Innova), which was a component of the Other segment, and changed the name of MSS to Ness North America and moved the Ness U.K. organization from the Other segment to the Ness Europe segment.
Ness is undergoing a major leadership transition as both the CEO and CFO left the company earlier in the year and in May 2007, both its Chief Operating Officer and Chief Marketing Officer also announced to leave. Although change could be a positive for Ness, we believe the current year will likely be a transition year for the company, with the new management team focused on improvements in 2008. Moreover, Ness faces intense competition from many established firms like Accenture, IBM, Hewlett Packard, Cognizant Technology, Computer Sciences Corporation, Electronic Data Systems, and many more. Moreover, the IT service industry is undergoing rapid changes, primarily consolidation. With the leading IT vendors looking to consolidate share, Ness will have to compete against companies with much greater resources. To fund NessPRO's global growth, Ness has leveraged its balance sheet, increasing long-term debt to $17.1 million in the third quarter of 2007 versus $3.7 million in the second quarter. The company had previously announced that it had secured a $50 million credit facility from commercial banks, which we assume has been drawn. This will convert automatically to long-term loans, with an interest rate of approximately 7% and a term of up to seven years.
Ness has a high level of exposure to its domestic market, Israel. While working to diversify, revenue generated in Israel contributed close to half of revenue in 2006, including a significant portion from Israeli government agencies. Although the company maintains a diverse customer base, this geographic concentration of business adds risk. A deterioration of the political situation in the Mideast would have negative repercussions for the firm. Moreover, the company operates in many international countries and faces the risk of exchange rate fluctuation.
Ness has a history of weak cash flow generation, which is in decline. During fiscal 2006, the company generated $4.2 million cash from operating activities versus $6.8 million in fiscal 2005 and $15.4 million in fiscal 2004. The company had burned $5.8 million cash during six months ended June 30, 2007. Although positive cash flow in Q3 improved the nine months total, to a positive number of $17,000, we believe this might be a short-term affair given the rising working capital requirements and expect the full-year number to be well below 2006. We, therefore, remain apprehensive on the firm's inability to mechanize a process to generate cash.
Ness had a difficult time predicting results, leaving us a low level of confidence in current estimates. Following its Q1 2007 results, the company had lowered its Q2 guidance, which it still failed to meet, with revenue coming in at the low-end of the guidance and EPS below the guidance. The company again reported disappointing third quarter results and guided full year estimates lower. Historically, results have been unpredictable at Ness as its segments have performed inconsistently forcing the company to report lower-than expected revenues in the last few quarters. Moreover, it appears as if Ness' Technologies & Systems Group (TSG) business has been in decline since the third quarter of 2006 when it posted a sequential increase of 15.1% in the third quarter of 2006.