(Address of Registrants Principal Executive Offices and Registrants Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
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Name of Each Exchange on Which Registered
Common Stock, $0.01 par value per share
The NASDAQ Stock Market
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
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Accelerated filer x
Non-accelerated filer o
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2008 was $319.0 million, based on the closing price of the stock on that date. As of February 27, 2009, 38,703,331 shares of common stock, $0.01 par value per share, were outstanding.
The registrant intends to file, not later than April 30, 2009, a definitive proxy statement pursuant to Regulation 14A, promulgated under the Securities Exchange Act of 1934, as amended, to be used in connection with the registrants annual meeting of stockholders. The information required in response to Items 10-14 of Part III of this Form 10-K is hereby incorporated by reference to such proxy statement.
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and the Private Securities Litigation Reform Act of 1995, relating to our operations and our results of operations that are based on our current expectations, estimates and projections. Words such as expects, intends, plans, projects, believes, estimates and similar expressions are used to identify these forward-looking statements. These statements
are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Actual outcomes and results may differ materially from what is expressed or forecast in these forward-looking statements. The reasons for these differences include changes in general economic and political conditions, including fluctuations in exchange rates, and the factors discussed below under Item 1A Risk Factors.
Our website address is www.ness.com. We make available free of charge on the Investor Relations section of our website (investor.ness.com) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed or furnished with the Securities and Exchange Commission (the SEC) pursuant to Section 13(a) or 15(d) of the Exchange Act. We also make available through our website other reports filed with or furnished to the SEC under the Exchange Act, including our proxy statements and reports
filed by officers and directors under Section 16(a) of that Act, as well as our Code of Business Conduct and Ethics. We do not intend for information contained in our website to be part of this Annual Report on Form 10-K.
You also may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC, 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
In this Annual Report on Form 10-K, we use the terms Ness, we, our, us and the Company to refer to Ness Technologies, Inc. and its subsidiaries.
We are a global provider of information technology, or IT, and business services and solutions with specialized expertise in software product engineering; system integration, application development and consulting; and software distribution. We deliver our portfolio of services and solutions using a global delivery model combining offshore, near-shore and local teams.
We provide services to a significant number of clients in the commercial, industrial and government sectors. We have a highly skilled workforce of experienced IT employees and consulting professionals across our key vertical markets. The primary industries, or verticals, we serve include high-tech companies and independent software vendors, or ISVs; utilities and government; financial services; defense and homeland security; and life sciences and healthcare. We combine our knowledge of these vertical markets and our clients businesses with our technical expertise to deliver tailored solutions to our clients, many of whom are subject to rigorous
We have operations in 18 countries across North America, Europe, Israel and Asia Pacific. 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, we leverage our corporate knowledge and experience, intellectual property and global infrastructure to develop innovative solutions for clients across the geographies and verticals we serve. Through our global delivery model, which includes lower-cost offshore and near-shore delivery capabilities, we can achieve meaningful cost
reductions or other benefits for our clients.
We provide services to over 500 clients located throughout the world, including a number of Fortune 1000 and Global 2000 companies. We have achieved recurring revenues as a result of our multi-year contracts and long-standing relationships with clients such as Chordiant, CEZ a.s., Czech Telecom, Franklin Templeton, Invesco, Israel Aircraft Industries, Israels Ministry of Defense, Kaiser Permanente, Lockheed Martin, Quintiles and Standard & Poors, which are among the largest clients in each of our verticals, based on revenues.
In 2008, existing clients from prior years generated more than 85% of our revenues, with no single client accounting for more than 4% of our revenues. For 2006, 2007 and 2008, the percentage of our revenues generated by public and private sector clients in Israel was 48%, 44% and 34%, respectively. The percentage of our revenues derived, in aggregate, from agencies of the government of Israel for the same time periods was 10%, 11% and 12%, respectively.
Our service offerings and solutions are strengthened by our strategic alliances and close relationships with leading global software and infrastructure vendors, which allow our clients to benefit from a selection of technologies and innovation. We maintain the highest level of certification with many of our key partners, which allows us to influence their development of new products and obtain and offer our clients early access to new product offerings. These certifications are awarded by major ISVs and service providers to those partners that demonstrate high levels of professional and technical expertise. Some key alliances and partnerships that
are applicable across multiple industry verticals and geographies, and with whom we conduct business and maintain high levels of certification are EMC Documentum, IBM, Microsoft and SAP, as well as various companies for whom we distribute software products.
Our revenues have grown from $166.6 million in 2002 to $664.8 million in 2008, representing a compound annual growth rate of approximately 26%. Our results of operations have improved from net income of $0.9 million for 2002 to $35.5 million for 2008.
Ness Technologies, Inc. was incorporated in Delaware in March 1999 in connection with the acquisition between 1997 and 1999 of six Israeli IT services companies. These companies and each company we subsequently acquired have been successfully integrated into our corporate structure, and the acquired capabilities, know-how and staff have been assigned to our various business groups.
Our principal executive office in the United States is located at 3 University Plaza, Suite 600, Hackensack, New Jersey 07601. Our telephone number there is (201) 488-7222. Our principal executive office in Israel is located at Ness Tower, Atidim High-Tech Industrial Park, Building 4, Tel Aviv 61580, Israel. Our telephone number there is +972 (3) 766-6800.
Ness and V-Ness are our primary trademarks and trade names. All other trademarks, trade names and service marks used in this report are the property of their respective owners.
Unless otherwise noted, (1) all references to dollars or $ are to United States dollars and all references to NIS are to New Israeli Shekels, (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.
We offer three primary service lines: software product engineering; system integration, application development and consulting; and software distribution. We deliver these services and solutions using a global delivery model combining offshore, near-shore and local teams.
These three service lines correspond to our three reportable segments.
Independent Software Vendors, high-tech companies and other companies that build or rely on proprietary software to generate revenues are increasingly faced with challenges, including pricing pressures, increased competition, time to market pressure, shortages of domestic engineering talent, reduced development budgets, and, in the case of ISVs, lower license sales.
To address these challenges, we offer software product research and development services through a specialized business unit called Software Product Labs. We set up these product labs for clients and operate
them on an ongoing basis, enabling us to collaborate with our clients engineering teams to extend their capacity and budgets throughout the software product life cycle. We staff each lab with a dedicated client team that reflects the clients needs, providing an appropriate mix of functional engineering, domain and platform expertise; and we implement physical, electronic and legal security measures to ensure that the intellectual property of each client is secure. Software Product Labs are located predominantly in India and in Central and Eastern Europe and we operate them across multiple locations as needed to optimize global
delivery local to the client, offshore, or near-shore. Customers for this offering are located primarily in the United States and Western Europe.
Along with process and operations efficiency, we offer full product life cycle expertise including requirements analysis, architecture and design, coding, testing and quality assurance, release automation, maintenance, professional services, support, porting and migration. We also provide management consulting and process transformation services related to the globalization of software product research and development.
We function as a partner with our clients in the ongoing software product life cycle services we provide to them, including through their transition to a global software development model. During the transition, we manage their tactical needs at all phases of the globalization process. During the build phase, we provide strategic consulting to address our clients business challenges and investment goals. During the stabilize and scale phase, we help our clients track progress according to their plans. We report on the work in progress and advise our clients on how best to refine the model in order to optimize operations
in accordance with their business priorities. We have successfully executed this approach and currently operate Software Product Labs for over 55 clients. In certain cases, typically after 36 months of operation, our clients have the option of purchasing the offshore development center assets through a built-operate-transfer model.
Our expertise lies in both the management of global software product operations and full life cycle product engineering capabilities. Our engagement model for high-tech and ISV clients is uniquely suited to software product engineering and R&D services, whose needs are very different than IT services for enterprises.
Our offshore software product engineering center in Bangalore, India is ISO 9001 certified and accredited at CMMI Level 3, our offshore software product engineering center in Mumbai, India is accredited at CMM Level 5 and our offshore software product engineering center in Hyderabad, India is accredited at CMM Level 4 and is ISO/IEC 27001:2005 certified.
ISO 9001 is an international standard for quality management systems maintained by the International Organization of Standardization. The CMM, or Capability Maturity Model, is a widely accepted set of practices developed by the Software Engineering Institute at Carnegie Mellon aimed at producing defect free software by technical and management discipline, rather than by exhaustive testing. CMM Level 5 accreditation is reserved for organizations with the highest quality of disciplined and repeatable software development practices. CMMI, or Capability Maturity Model Integrated, accreditation measures an organizations maturity across multiple
software development and system engineering practices, consisting of best practices that address product development and maintenance covering the products life cycle from conception through delivery and maintenance. ISO/IEC 27001 (formerly BS 7700) certification formally attests to the rigorous implementation of the elements of IT security confidentiality, integrity, availability and legality in a companys services and solutions.
System Integration, Application Development and Consulting
We offer a broad set of IT services to our clients in the area of system integration, application development and consulting. We provide these services in 18 countries throughout North America, Europe, Israel and Asia Pacific. We deliver the services through a global delivery model that includes local teams as well as offshore and near-shore resources. We provide these services for a wide range of clients in selected verticals, including utilities and government, financial services, defense and homeland security, life sciences & healthcare, and others.
The services we offer include: enterprise resource planning and customer relationship management solutions; command and control and real-time systems; document management and knowledge management solutions; business intelligence and data warehousing systems; proprietary and turnkey solutions; enterprise
application integration solutions; geographic information systems; telecommunications systems; IT outsourcing; strategic consulting services; and quality assurance, testing, user interface engineering, training and user assimilation services designed to produce high quality business solutions with broad and rapid user acceptance.
Enterprise Resource Planning (ERP) and Customer Relationship Management (CRM) Solutions. ERP and CRM systems are integrated application software packages designed to support multiple business functions. For many organizations in the vertical markets we serve, ERP and CRM systems are the backbone of business transactions and communications. We offer a wide range of ERP and CRM solutions and services, including needs analysis, product selection and differentiation analysis, solution design, installation and administration, product adjustment and customization, data transfer from original information systems, integration with other
systems, including business partner systems, end-user and administrator training, manual production and routine operational support, including upgrades and ongoing development. Our client service teams provide support activities such as localization, basis team infrastructure, training and delivery of complementary products. Our solutions and expertise include supply chain management, supplier relationship management and life cycle management. The vast majority of our ERP and CRM engagements use SAP, Oracle Applications and PeopleSoft.
Business Intelligence (BI) and Data Warehousing. We enable organizations to develop what we believe to be complete state-of-the-art information systems for turning data into business intelligence. Our end-to-end BI and data warehousing solutions are designed to ensure accuracy, consistency and timeliness of information storage and retrieval to meet our clients business requirements. Examples include:
clinical trials management systems and scientific data management systems utilized in the research and development area of the life sciences vertical;
portfolio management systems, including balanced scorecard systems to measure business performance using data from clinical trials, research and development, and sales and marketing; and
sales, marketing and financial solutions, which analyze market share/size, revenues and costs to help increase profitability and produce other metrics relevant to business decisions.
Document Management and Knowledge Management. We offer a range of services and products designed to help our clients realize value from their corporate knowledge, including information storage, retrieval and sharing. Our specific offerings include:
document management and workflow solutions for facilitating the storage and management of electronic documents and images.
enterprise content management: business processes for delivering well-integrated information to key decision makers on a timely basis; and
enterprise portals: solutions integrating the necessary components for a knowledge-centric portal infrastructure;
Enterprise Application Integration (EAI). We offer EAI solutions focused on building software infrastructure platforms that simplify connectivity between diverse applications and dissimilar business systems. We integrate and leverage our clients investments in current systems while improving business efficiency and enabling the sharing of information across application boundaries. Our integration personnel are proficient in primary integration tools and standards.
Proprietary and Turnkey Solutions. We have developed software to market as proprietary turnkey solutions, which are customized applications designed and modified to meet client needs. We provide end-to-end business solutions from design to maintenance and are able to provide specialization according to the subtle differences within each specific industry. We retain certain intellectual property and rights which allow us to continue to exploit opportunities to market these products. Our turnkey solutions include:
our Financial Data EnterpriseTM solution which automates the acquisition, management and distribution of reference data and accelerates provisioning of higher quality and dynamic intelligence to end users;
emergency crisis management system and dispatching system for police, fire, ambulance and emergency response services;
electronic toll collection system, including CRM billing and payment for toll road systems;
pension management system, enabling large organizations and pension funds to manage all aspects of employee pensions;
business rules technology software, permitting IT organizations to develop business solutions with reduced coding;
paperless court system, bringing all court-related documents and communications online to enable electronic case filing.
The Ness Content OfficeTM solution, which automates the contract life cycle from content rights to financial operations, through distribution for media and entertainment organizations involved in broadcast, publishing and digital archiving; and
air traffic control systems, including various software solutions handling all aspects of the complicated task of air traffic control.
Command and Control and Real-Time Systems. We deliver high-end technical solutions for protecting the safety of national borders, improving data gathering mechanisms, and enhancing communications channels for military, homeland security and civilian organizations. These services include:
air defense command and control systems, including simulators, test beds, C4I systems, planning systems and air traffic control systems;
ground command and control systems, or GCCS, including strategic and tactical visualization systems, digital GCCS systems, and tactical command and control systems;
surveillance systems, including mission management systems and unmanned aerial vehicle interpretation systems;
intelligence systems, including IT solutions for organizations which collect, process and disseminate large volumes of information, in a demanding environment;
missile defense, including missile defense simulation and theater defense systems;
border control system used for identifying, controlling and registering passages through borders; and
electronic warfare systems, including modern human machine interfaces, resource allocation, parameter management, results acquisition and threats database management.
Geographic Information Systems (GIS). We have been active in the field of digital mapping since 1985, developing advanced GIS that quickly and accurately process and transform large volumes of maps and photography into various digital and easily readable formats. For example, militaries are in critical need of accurate maps, GIS data and photographic intelligence for mission planning, operational command and control, and three dimensional mission rehearsal and training. Some of Israels national (including military, civilian and commercial) geographic databases were created using software we developed. These systems cover all
aspects of cartographic and photogrammetric data collection, manipulation, storage and retrieval.
Similarly, emergency response systems require accurate road maps, current location display, shortest route determination and other GIS capabilities that we provide. Also, municipalities and other government agencies require accurate maps and surveys to track property ownership as a basis of taxation.
Telecommunications Systems. We provide commercial, government and defense organizations with turnkey solutions, including complete systems and specifically-tailored projects designed to facilitate the management of telecommunications systems and networks. We have developed a wide range of network management products, including:
large scale integrated network management systems for switching, transmission and data;
IT Outsourcing. We offer customized IT outsourcing services, both onsite and off-site. Through our end-to-end service solution, we take responsibility for all or a portion of client operations and activities, including information security solutions, IT management, application development and maintenance, infrastructure implementation and management, network management, computer and communications hardware, help desk support, and disaster recovery planning, storage and backup solutions. We apply our proven methodologies, which cover every phase of a projects life cycle, with strong project management, senior staff supervision
and quality assurance mechanisms to ensure reliable delivery. We provide these services, including support on a 24-hour-a-day, seven-day-a-week basis, to clients in diverse fields for single-site and multi-site enterprises and organizations.
Strategic Consulting. We leverage our proven methodologies to help our clients analyze, plan and achieve objectives at various stages of the business life cycle. Our expertise, coupled with product and technology alliances, provides organizations with a one-stop solution. To deepen our specialization and understanding of our clients business needs, we have established teams with core competence in particular verticals. Our IT experience, combined with our technology independence, enables us to offer a range of IT solutions for combining business trends and company goals with IT implementation. This blend of IT and business
expertise enables us to unify IT and business needs to enhance our clients competitive advantage and growth. We also provide strategic staff augmentation services for a limited number of customers, as part of our methodology for penetrating strategic accounts.
Quality Assurance, Testing and User Interface Engineering. As technology platforms have become more complex at each of the application, operating system and hardware levels, there is a growing need to test, analyze and certify that software and hardware function as designed. Because of this growing complexity, together with reduced IT budgets, many companies outsource the testing and quality assurance, or QA, process to third party vendors. We target this market with our independent V-Ness software testing and QA service. In order to meet the needs of our client base, the V-Ness service provides a spectrum of solutions including:
time to market QA methodology; system integration performance and testing; user interface engineering and user experience engineering; validation and full traceability capabilities that allow us to verify that the end product meets the initial product specifications; enterprise QA solutions, such as ERP, CRM and data warehousing; test automation; load testing; and quality consulting. Our professionals have extensive experience in QA and testing using our documented and proven work methodologies.
Training and Assimilation. We offer clients comprehensive learning solutions by providing a wide range of training services. Our staff provides training across a wide range of information, technology and communication applications. We customize our training programs based on advanced proprietary training methodologies and evaluation tools satisfying our clients needs in terms of content, target audience, level of knowledge and training times. We complement traditional learning methods with learning management systems, e-learning platforms, and computer and web based self study kits, enabling end-users to learn at their own
pace and level. In addition to training, we offer assimilation services, designed to help organizations deploy new solutions rapidly and effectively. We include these services as part of every project, and also offer them separately to meet client needs.
We market and sell enterprise software licenses of third-party software vendors to corporate clients in geographies which are partially or completely uncovered by the software vendors own sales forces. We also provide a range of implementation, customization and support services related to those licenses.
We select what we believe to be the best products for our clients by working closely with major international vendors who specialize in software product engineering, integration, localization, marketing, service and maintenance. In this way, we are able to leverage the products and methodologies supplied by our partners in order to provide our clients with comprehensive value added solutions.
Through our partner relationships, we resell products, mostly in Israel, Italy, Spain and Portugal, for over 30 companies, including EMC Documentum, Sybase, Information Builders, Sterling Commerce, Serena and SyncSort.
The IT services industry is highly fragmented and has evolved from simply supporting business functions to enabling their expansion and transformation. To succeed in this transformation, companies of all types must respond rapidly to market trends, create new business models and improve productivity. In this dynamic, competitive environment, decisions with respect to technology are increasingly important. According to industry analysts, the global IT services market has been in a period of solid growth for several years now temporarily interrupted by the worldwide economic recession. Based on our review of publicly available
information, we believe the global IT services market will resume its growth following the macroeconomic recovery, and will grow from $820 billion in 2008 to $991 billion in 2012, representing a compound annual growth rate of approximately 4.8%.
Companies are increasingly seeking cost-effective alternatives to acquire high quality IT services. The use of offshore vendors is common among larger corporations and growing in popularity among medium-sized firms. Based on our review of publicly available information, we project an annual growth rate for offshore IT/BPO services of 16% to 17%, making offshore IT services a particularly high growth market.
These factors reflect a business opportunity for global IT services vendors with established vertical practices, effective global delivery mechanisms and limited reliance on long-term staff relocation from offshore locations to client locations in the United States and around the world.
Our Vertical Expertise. Since our inception, we have achieved leading positions in a number of the verticals in which we compete. We maintain a staff of highly skilled industry experts in each of these verticals and use this domain expertise on our engagements to provide a range of end-to-end business solutions.
Our Global Delivery Model. We have operations in 18 countries in North America, Europe, Israel and Asia Pacific. We provide services to our clients through a comprehensive global delivery model that integrates both local and global resources in a cost-effective manner. Our offshore and near-shore software engineering and outsourcing centers, including our CMM level 4 and 5 accredited, CMMI level 3 accredited and ISO/IEC 27001:2005 certified offshore facilities in India, enable us to minimize the difficulties other outsourcing vendors face in using foreign employees in the United States on a temporary basis due to tight immigration
Our Proven Track Record. By consistently providing high quality services, we have achieved a track record of project successes through the completion of numerous engagements around the world. Part of our success is attributable to our focus on methodology and repeatable high quality practices, which are ISO 9001 certified.
Our Focus on Quality. We believe strongly in quality throughout our organization. We maintain independent quality assurance capabilities in geographies where we operate, and we also provide stand-alone QA, testing and audit services to some of our clients on QA engagements.
Unique Business Model for Outsourced Software Engineering. We have developed a unique Software Product Labs offering, which supplements and extends the research and development facilities of high-tech companies, ISVs and other companies who rely on software product research and development in which we provide core software product engineering and related activities;
Innovative Intellectual Property. We have created sophisticated intellectual property in the defense and homeland security sector, which we incorporate in systems we deliver and which we market on a stand-alone basis.
End-to-End Service Offerings. Within the range of service offerings that we provide, our ability to deliver specialized end-to-end solutions distinguishes us from many of our competitors. We believe that with these offerings, we provide robust and comprehensive business solutions to meet the needs of our clients in the key verticals we cover.
Our Long-Term Relationships With a Diverse Client Base. We have long-term relationships with many of our clients, who frequently retain us for additional projects after an initial successful engagement. In 2008, existing clients from prior years generated more than 85% of our revenues. Moreover, our client base is diverse and we are not dependent on any single client. In 2008, no client accounted for more than 4% of our revenues and our largest twenty clients together accounted for approximately 30% of our revenues. Agencies of the government of Israel, in aggregate, represented 12% of our revenues in 2008.
Our Proven Ability to Scale. We have grown continuously and successfully since inception, and we have demonstrated the ability to expand our teams and facilities to meet the needs of our clients. For example, over the past three years we expanded our Indian headcount from approximately 1,400 to approximately 2,840 employees in response to our clients rapidly growing offshore development needs, and we expanded our employee base in Europe from approximately 750 to approximately 1,930 employees.
Our Organizational and Business Flexibility. Our flexible organizational structure, business culture and technological abilities have allowed us to adapt to rapidly changing economic conditions, as well as significant changes in our clients needs, enabling us to continue to grow and improve our performance during economic growth periods as well as during economic downturns. For example, during the economic downturn of 2002 to 2004, we increased our revenues, number of employees, geographic footprint and profitability. Additionally, our strong vertical alignment, the industry and technical experience of our employees, our
operational efficiency, our ability to secure and retain key clients and the effective use of our global delivery model help insulate us from some of the hardships experienced by our competitors.
Our Ability to Integrate Acquired Companies. Roughly half of our growth since our inception has been through acquisitions. Due in part to our significant focus on the abilities of the senior management of acquired firms, we have been able to retain the senior management of each of these companies. We have successfully integrated each acquired company into our corporate structure and culture, working together with existing management, employees and clients to facilitate an efficient and productive transition.
Our goal is to further solidify and enhance our position as a global IT services and solutions provider on the basis of our quality, professionalism, vertical expertise, reliability and technical innovation. We intend to extend our geographic and vertical reach through the following strategic initiatives:
Continue the Globalization of Ness. Over the last two years, we have made substantial progress toward our strategic goal of transforming the company from a federation of distinct geographic entities into an integrated global enterprise. During that time, we have expanded our Software Product Labs group from a local business unit serving North American customers into a global organization and single reportable segment with customers in three continents, delivery in three continents, and combined global management. Similarly we have expanded our defense and homeland security vertical, which originally supported only Israeli customers,
to a global business serving customers in over 10 countries in North America, Latin America, Europe, the Middle East and Asia. We have also combined our previously separate software product distribution businesses in Europe and Israel into a single business unit and reportable segment. We intend to continue this process of globalization going forward, driving increased synergies within the company, improving cross-regional sales, and further strengthening our global delivery model.
Further Penetrate the North American Market and the Eastern European Eemerging Market. We were formed in 1999 and quickly established a leading market position in the Israeli IT services market. In the last eight years we have expanded outside Israel with acquisitions and organic growth in North America, Europe and Asia Pacific. We generated approximately $23.0 million, or 14% of our revenues, in North America in 2002, which we expanded almost eight-fold to $178.1 million, or 27% of our revenues, by 2008. During the same period, we grew our European revenue over twenty-fold from approximately $11.0 million, or 7% of our revenues, to
$229.7 million, or 35% of our revenues. We intend to continue our focus on expanding our
revenues in North America and Europe, both organically and through acquisitions. Based on our review of publicly available information, in 2008, the North American market alone represented approximately 32% of total worldwide IT services spending, which concentration is expected to continue in the future. We intend to penetrate specific niches in that market utilizing our vertical products and technical expertise. Our acquisition strategy will also continue to target emerging markets in which we believe growth and potential profitability are higher, such as Eastern Europe and Asia.
Be a Market Leader in Key Verticals. In North America, we presently focus on several verticals: high-tech and ISVs, financial services, life sciences and healthcare, and defense and homeland security. In Europe, we are focused on the utilities, financial services and government verticals. In Israel, we have a strong focus on several verticals, including defense and homeland security, government, financial services and telecommunications. We intend to further solidify our position in each of these verticals through internal growth based on complementary offshore offerings and key partnerships and external growth through acquisitions.
Our goal is to establish ourselves in North America as a leading provider in outsourcing and offshore services for high-tech and ISVs, life sciences and healthcare.
Maintain a High Proportion of Long-Term and Recurring Revenues. We intend to maintain a high proportion of revenues generated from long-term, recurring contracts by focusing on long-term engagements, outsourcing, life cycle services and other multi-year services.
Pursue Strategic Alliances. We intend to continue to develop alliances that complement our core competencies. Our alliance strategy is targeted at leading business advisory companies and at leading technology providers, which allows us to take advantage of emerging technologies in a mutually beneficial and cost-competitive manner.
We operate in a significant number of commercial and industrial sectors and in many areas of government operations. As a result of our deep understanding of the different markets and environments in which our clients operate, and our ability to understand our clients needs and tailor solutions to meet those needs, we have developed a strong reputation for delivering systems to businesses that are subject to regulatory supervision, government control or other rigorous operational requirements. We are active in all of the following sectors, each influenced by fluctuating market conditions, as well as regulatory and oversight environments:
High-Tech and Independent Software Vendors. Software companies and other companies that build or rely on proprietary software to generate core revenues need to focus on their core competencies of developing software and other technology products. By utilizing our offshore capabilities, expertise and experience in developing software products, we enable our clients to meet this need through our Software Product Labs business to provide outsourced software product research and development centers that supplement those of the client. Our expertise lies in the design and development of new software products, re-development,
re-engineering, and maintenance of existing products, and global implementation and rollout support for existing products. We function as a partner with our clients to manage tactical needs at all phases of the development process.
Utilities and Government. Globalization, escalating market competition and deregulation throughout the world are forcing utility companies to modify their IT strategies and adopt advanced solutions. We provide high-end e-business services in areas such as CRM, ERP, e-procurement, asset management and metering solutions. Similarly, competitive pressures are causing telecommunications companies to find ways to reduce costs and make more informed decisions about their IT investments. We deliver reliable telecommunications systems and portals that help carriers reduce operating costs and increase revenue, while helping
telecommunications companies evaluate the impact of new technologies and make informed planning decisions about their IT investments. We offer innovative information system solutions for improving time-to-market and enhancing telecommunications service delivery, addressing the specific needs of operators of all sizes from traditional wireline to wireless and internet service provider to broadband.
Government agencies are increasingly required to modernize their traditional operating processes and models in order to improve and accelerate delivery of services to citizens. We have developed a track record
in the public sector for helping government agencies deliver IT services to the public more effectively and efficiently. In Israel and Eastern Europe, we are a leading provider of integrated solutions for the government sector.
Financial Services. The financial services industry, which traditionally has had the greatest worldwide demand for IT services, operates in a highly regulated environment, which creates significant demand for services such as ours. Financial services organizations must strategically employ advanced technology in order to maximize their operational excellence and provide the best possible services to their clients. We combine advanced solutions, industry best practices, and the products and services of business partners to help our clients streamline their business processes and ensure long-term success in this fast-paced
environment. We provide services to a number of segments of this vertical including: retail, private and investment banks; credit card companies; insurance and reinsurance companies; consumer finance organizations; and pension funds. Services we provide include implementations of our reference data management product suite and our transfer agency solution, IT outsourcing, offshore services, turnkey solutions, custom development and system integration.
Defense and Homeland Security. The defense and homeland security industry faces a multitude of challenges, including protecting the safety of national borders, improving command & control and intelligence gathering mechanisms, enhancing communications channels throughout the military and performing scenario analysis. We possess extensive experience in delivering high-end technical solutions and intellectual property (much of which is confidential) to the defense and homeland security industry to help surmount these challenges.
Life Sciences and Healthcare. Effectively managing and improving the efficiency of a life sciences business requires innovative cross functional information management solutions. Our expertise lies in improving time-to-market of new products through clinical trial optimization, safety and adverse event tracking, knowledge management, BI and data warehousing, strategic planning and budgeting. We have been delivering business performance oriented data and document management solutions to large pharmaceutical and biotechnology firms for many years.
Increased government regulations and rising costs require healthcare organizations to address complex patient information management needs and share information across various hospitals and facilities more effectively. We help healthcare organizations remain competitive with services designed to simplify their administrative processes, reduce costs and improve the quality of care.
We have local, near-shore and offshore delivery facilities in North America, Europe, Israel and Asia Pacific, with a range of industry expertise, software language and product focuses, and also with varying costs. Each facility has a high level of management skill, vertical expertise, IT services capabilities and quality at each location.
We apply our expertise to serve both our local clients and our clients throughout the world as part of our global delivery model. As expertise in certain technologies, skills or verticals is needed, we have the capability to assemble teams spanning several of our locations around the world. By doing this, we reduce or eliminate the need to carry potentially non-billable staff at each location to handle unanticipated needs or surge capacity, which results in lower costs on average.
For example, we are providing software product engineering services to a global software development company from a large extended development center in India and a large near-shore extended development center in Eastern Europe. Similarly, we have executed regional European SAP projects for multi-national corporations using resources from the Czech Republic, Slovakia, Romania, Israel and Switzerland. In these and virtually all other projects staffed using our global delivery model, the teams work in their home locations except for periodic travel to the client location for knowledge transfer, client meetings and implementation work. This model also
means that we are substantially less affected by changing immigration regulations than other well-known offshore vendors. In our model, the team that remains at the client site throughout the engagement comprises our local resources, complementing our local presence with our strong vertical experience to the engagement from inception through completion.
As of December 31, 2008, we employed approximately 8,425 employees worldwide, including approximately 2,840 in India, 2,710 in Israel, 1,930 in Europe, 580 in North America and 365 in the Asia Pacific region.
We market our services to large organizations in North America, Europe, Israel and Asia. We have a leading market presence in Israel and a growing presence in North America and Europe, especially in selected verticals. We sell and market our services from sales offices located in 18 countries. We manage our business and results of operations as part of a global sales and marketing strategy. As of December 31, 2008, we had approximately 220 direct sales persons and account managers.
Our sales and marketing strategy focuses on increasing awareness of and gaining new business from target clients and promoting client loyalty and repeat business among existing clients. We constantly seek to expand the nature and scope of our engagements with existing clients by increasing the volume of our business and extending the breadth of services offered. Members of our executive management team are actively involved in business development and in managing key client relationships through targeted interaction with our clients senior management.
For each prospective project, we assemble a team of our senior employees, drawn from various disciplines within our company. The team members assume certain roles in a formalized process, using their combined knowledge and experience to understand the clients needs, design a solution, identify key decision makers and maximize the strength of our bid. This approach allows for a smooth transition to execution once the sale is completed. We often bid against other IT services providers in response to requests for proposals.
Our sales and marketing teams work with our technical team as the sales process moves closer to the clients selection of an IT service provider. The duration of the sales process varies depending on the type of service, ranging from approximately two months to over one year. Throughout the process, the account manager or sales executive works with the technical team to:
define the scope, deliverables, assumptions and execution strategies for a proposed project;
develop project work estimates;
prepare pricing and margin analysis; and
finalize sales proposals.
Our management reviews and approves proposals, which are then presented to the prospective clients. Our sales and account management personnel remain actively involved in the project through the execution phase. We focus our marketing efforts on businesses with extensive information processing needs. We maintain what we believe to be a state-of-the-art prospect/client database that is continuously updated and used throughout the sales cycle from prospect qualification to close. As a result of this marketing system, we are able to pre-qualify sales opportunities and direct sales representatives are able to minimize the time spent on prospect
qualification. In addition, substantial emphasis is placed on client retention and expansion of services provided to existing clients. In this regard, our account managers play an important marketing role by leveraging their ongoing relationships with each client to identify opportunities to expand and diversify the type of services provided to that client.
We presently serve over 500 clients in a wide range of industries. Our clients vary in size and include a number of Fortune 1000 and Global 2000 companies. For 2008, no client represented more than 4% of our annual revenues, and our largest twenty clients together represented approximately 30% of our revenues, compared to 31% in 2007. Agencies of the government of Israel, in aggregate, represented 12% of our revenue in 2008, versus 11% in 2007.
The percentage of our revenues derived from Israeli clients has been steadily decreasing as we have expanded our global presence. Our revenues for the periods presented, broken down by geographic area, are as follows:
Year Ended December 31,
Asia and the Far East
Due to rounding, the aggregate percentage for this period does not appear to equal 100%.
Our client base includes leading worldwide and regional entities. The clients listed alphabetically below are among our largest clients, based on revenues, in each of our verticals:
We have strategic alliances and partnerships with leading global software, infrastructure and consulting vendors, thereby expanding the variety of technologies and capabilities we offer to our clients. We continuously evaluate partnership opportunities and add new partners so that we are positioned to deliver what we believe to be the most effective and advanced solutions to our clients. We also maintain the highest level of certification with many of our key partners in order to obtain early access to new product offerings and to influence the development of new products and offerings. We take great pride in being technology independent
in that we approach each project we undertake with no preconceived notions regarding the technology that will ultimately be deployed, and we recommend what we believe to be the most effective technology for our clients needs.
We have many alliances and partnerships around the world. Some alliances are specific to certain verticals and others are specific to certain markets in which we operate. Some key alliances and partnerships that are applicable across multiple industry verticals and across multiple geographies, and with whom we conduct business, are described in the chart below:
We provide professional services to Chordiants customers through our worldwide partnership, including the implementation of systems to automate and manage operational business processes for service-driven global organizations in retail banking, card services, lending, insurance and telecommunications.
We partner with EMC worldwide to deliver robust, validated and high performing Documentum document and content management systems and workflow solutions to our clients. In addition, we are the sole sales channel in Israel for Documentum enterprise content management solutions. We also provide customized storage solutions to enterprise clients.
We work with IBM around the world to offer a broad array of scalable solutions built on IBM software and hardware platforms. We also work with IBM to provide ISVs with re-platforming services, enabling them to migrate existing applications to open-standards-based IBM platforms and to stay current with IBM platform changes. In addition, we have supplier agreements with IBM in the United States, Asia Pacific, India and Israel for services, software and hardware.
We work with Hewlett Packard to provide end-to-end solutions for customer business needs. We also partner with Mercury Interactive, which was acquired by Hewlett Packard, as their certified partner for the implementation and deployment of testing and QA enterprise projects around the world.
We work with Microsoft around the world to offer a broad array of scalable solutions built on Microsofts .NET enterprise platform and other Microsoft platforms. We are a global Microsoft Gold Partner with certifications on many platforms and products, and we have won numerous Microsoft awards for our solutions.
We work with Oracle around the world to provide a range of ERP and database solutions to our customers, and in addition we resell Oracle software in some geographic regions.
We partner with SAP in Israel as a Gold Partner, and with SAP worldwide, to deliver innovative ERP solutions and professional services.
While we are not substantially dependent on any one of these partnerships, we believe they collectively represent a significant competitive advantage for us. Through these partnerships and alliances, we:
perform joint engagements;
gain access to additional opportunities and engagements;
influence the products and services of our partners, through participation in advisory and/or steering committees;
in several cases, enhance and extend the products of our partners;
gain early access to new technologies and products, both for us and for our clients, as well as enhanced support for their products and platforms; and
further demonstrate our qualifications for leading technologies and key verticals.
In addition to these benefits, the relationships: enhance our ability to deliver a broad range of IT services outsourcing; provide us channels to sell additional services to our clients, such as quality assurance and training; and make us a more attractive employer, based on our employees use of these advanced platforms and access to our partners.
Some of the certification levels our partners require are difficult to attain, requiring the demonstration of significant technical expertise, high levels of training and certification, the influencing of a certain amount of product sales for the partner, certain levels of investment in the products and technologies of our partners, or other factors.
We have written agreements with some, but not all, of our partners and alliances. The terms of the agreements vary. In some cases our partners are restricted from using other companies to provide similar services in certain markets. Some of our partners require that we achieve certain minimum sales levels to maintain our
partner status level. We have oral contracts and working arrangements with the remainder of our partners and alliances. Although these oral contracts and other arrangements may be terminated by either party at any time without penalty, they also afford greater flexibility to our partners and alliances as well as to us.
The IT services market became increasingly competitive a few years ago as a result of the economic downturn and associated decline in IT service spending during 2002 to 2004, followed by the consolidation of players in the IT services industry over the last few years. The current global economic recession has further intensified this competitiveness. While some vendors have not survived, others have become more aggressive and many low-cost offshore vendors have entered new markets traditionally dominated by large multinational consultancy firms.
The IT services vendors with whom we compete include:
consulting firms, such as Accenture Ltd. and Capgemini;
divisions of large multinational technology firms, such as Hewlett Packard Company and IBM;
IT outsourcing firms, such as Computer Sciences Corporation;
U.S.-based offshore IT services firms, such as Cognizant Technology Solutions Corp., Syntel Inc., HCL Technologies and Perot Systems;
large Indian IT services firms, such as Infosys Technologies Limited, Tata Consultancy Services and Wipro Limited and smaller firms such as MindTree Consulting, Patni, Persistent Systems, Sonata Software and Symphony;
regional IT services firms in certain geographic markets, such as Elbit, Malam, Matrix and Teldor in Israel and Atos Origin, Logica and T-Systems in Europe; and
in some cases, internal IT departments of our clients.
Some of these competitors are more established, enjoy greater market recognition and have significantly greater financial, technical and marketing resources than we do. Moreover, the IT services industry continues to experience rapid changes, primarily consolidation, that affect the competitive landscape. These changes may result in a greater number of competitors with significantly larger resources than ours. In addition, some of our competitors have added cost competitive offshore capabilities to their service offerings, which may adversely affect our ability to compete successfully against these competitors. We expect competition to remain intense
in the future as current competitors enhance their service offerings and new competitors penetrate the market. Existing or future competitors may develop or offer services and products that provide significant performance, price or other advantages over those we offer.
Our future success will depend in part on our ability to develop and market new or enhanced services that adequately address changes in technology, industry standards and client requirements and gain commercial acceptance. Any delay or failure to develop new services or to adapt our services to technological change and market requirements could have a material adverse effect on our competitive position. We believe that the principal competitive factors in our business include the ability to:
provide and leverage deep industry vertical expertise, and integrate this expertise with superior system integration, software development, QA and support abilities to deliver tailored, high quality business solutions that generate high returns on investments;
deliver solutions quickly and cost-effectively, using an integrated global delivery model with industry leading methodologies and practices and appropriate SEI certification levels;
attract and retain experienced, high-quality IT professionals;
work effectively with leading partners and alliances to offer superior solutions and drive additional business;
respond rapidly to meet the challenging demands of each engagement; and
Our intellectual property rights are important to our business. We rely on a combination of copyright, trademark and design laws, trade secrets, confidentiality procedures and contractual provisions to protect our intellectual property. We currently have no issued patents. We require employees, independent contractors and, whenever possible, vendors to enter into confidentiality agreements upon the commencement of their relationships with us. These agreements generally provide that any confidential or proprietary information developed by us or on our behalf be kept confidential. These agreements also provide that any confidential or proprietary
information disclosed to third parties in the course of our business be kept confidential by such third parties. However, our clients usually own the intellectual property in the software we develop for them.
We regard our trade name, trademarks, service marks and domain names as important to our success. We rely on the law to protect our proprietary rights to them and we have taken steps to enhance our rights by filing trademark applications where appropriate. We have registered our key brand Ness or Ness Technologies as a trademark in the United States, Israel and the Czech Republic. We have also registered Ness Financial Data Enterprise as a trademark and applied for trademark registration for Ness Software Product Labs and Ness Content Office in the United States.
Third parties may assert infringement claims against us or claim that we have violated their intellectual property rights. We are obligated under some client contracts to indemnify our clients if claims are made against us alleging that we infringe on the proprietary rights of third parties. These claims, regardless of merit or ultimate outcome, could result in significant legal and other costs, harm to our reputation and a distraction to management. In particular, growth in the number of business method and software patents issued to others may greatly limit the solutions we are able to offer our clients.
As of December 31, 2008, we employed approximately 8,425 employees, including approximately 7,425 IT professionals.
Our employees are our most important asset. We believe that the quality and level of service that our professionals deliver are among the highest in the global IT services industry. We believe we provide a challenging, entrepreneurial and empowering work environment that demands dedication and a strong work ethic.
Our training, continuing education and career development programs are primarily designed to ensure that our IT professionals enhance their skill-sets in alignment with their respective roles. We continually provide our IT professionals with challenging assignments and exposure to new skills, technologies and global opportunities. We have an appraisal program that incorporates a feedback system, recognizing high performers and providing constructive feedback and coaching to underperformers. Leadership development is also a key part of our training programs.
We believe that our IT professionals receive competitive salaries and benefits and many are eligible to participate in our stock option plans. We have also adopted a performance-linked compensation program that links compensation to both the employees and our performance.
None of our employees is represented by a labor union, and we have not experienced any strikes or work stoppages. We believe our relations with our employees are good.
Our employees in Israel are subject to Israeli labor laws and regulations and other special practices and employment customs. The laws and regulations principally concern matters such as paid annual vacation, paid sick days, the length of the workday, payment for overtime and severance pay. Israeli law generally requires severance pay equal to one months salary for each year of employment upon the retirement or death of an employee or termination of employment without a valid legal reason. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which is similar to the
U.S. Social Security Administration. These amounts also include payments for national health insurance. Our payments to the National Insurance Institute amount to approximately 15% of wages up to a specified amount, of which the employee contributes two-thirds and the employer contributes one-third.
In addition, by order of the Israeli Ministry of Labor and Welfare, the provisions of a collective bargaining agreement between the Histadrut (the General Federation of Labor in Israel) and the Industrialists Association in Israel may be applicable to our employees in Israel. This collective bargaining agreement principally concerns cost of living increases, vacation and holiday pay, length of the workday, wage tariffs, termination and severance payments. We provide our employees with benefits and working conditions that are at least as favorable as the conditions specified in the collective bargaining agreement.
Ness Technologies, Inc. was incorporated in Delaware in March 1999 in connection with the acquisition of six Israeli IT services companies and their consolidation into a single operating structure. Compro Software Industries, a privately-held Israeli software consulting company, was acquired by our founders in December 1997 and by us in April 1999. We subsequently acquired five Israeli IT services companies, between April 1999 and November 1999: Gilad Software and Systems Integration, a privately-held Israeli integration and networking company; Contahal, a publicly-traded Israeli IT services company; Advanced Technology, a publicly-traded Israeli IT
services company specializing in defense solutions and real time systems; IPEX, a privately-held Israeli systems integration company; and IPEX ISI, a privately-held Israeli software development company.
Towards the end of 2001, after becoming a leading IT services company in Israel, we embarked on our global expansion strategy. We made the following material acquisitions as part of that strategy:
Blueflame Inc., a privately-held, U.S.-based application development and system integration provider focused primarily on the life sciences industry, in 2001;
APP Group CEE B.V., a privately-held IT services firm in the Czech Republic and Slovakia serving the utilities, telecommunication, finance, government and manufacturing sectors, in 2002;
Apar Holding Corp., a privately-held U.S./Indian IT services provider of software services to the financial services, manufacturing, telecom, retail sales and logistics sectors, and of sophisticated offshore software engineering development services to software product companies; in 2003;
Three privately-held providers of IT services and solutions in Eastern Europe, in 2005: Radix Company SA, based in Romania; Delta Electronic Services a.s., based in Slovakia; and Efcon a.s.;
Olas Software Solutions, Inc., d/b/a Innova Solutions, a privately-held IT services provider and system integrator based in California and India, offering IT services and solutions to the financial services industry, in 2006;
Three privately-held software distribution and integration companies in Europe and Asia Pacific, in 2006 and 2007: Selesta España, based in Spain and Portugal; Advanced Industrial Management Company Limited, based in Thailand; and Selesta S.p.A., based in Italy;
MS9 Consulting LLC, a privately-held, U.S.-based IT services company serving the healthcare vertical, in 2007;
FMC Consulting and Informatics Ltd., a privately-held IT consulting and services company based in Hungary serving the financial services sector, in 2007;
Logos a.s., a privately-held IT services and consulting company based in the Czech Republic, serving the financial and telecom sectors, in 2008.
The acquired companies were integrated into our corporate structure, with capabilities and staff assigned to the various divisions and business groups.
We are continuously seeking to acquire new companies and businesses in order to expand our global presence and improve our position in our targeted verticals and geographies.
Investing in our common stock involves risks. You should carefully consider the following risk factors and other information in this report before purchasing our common stock. Any of the risks described below could result in a material adverse effect on our business, results of operations and financial condition. The trading price of our common stock may decline due to any of these risks, and you could lose all or part of your investment.
Our revenue and profitability depend significantly on general economic conditions and the demand for IT services in the markets in which we compete. Economic weakness and constrained IT spending has resulted, and may result in the future, in decreased revenue and profitability. Uncertainty about future economic conditions makes it difficult for us to forecast operating results and to make decisions about future investments. Delays or reductions in IT spending could have a material adverse effect on demand for our services, and consequently our results of operations, prospects and stock price.
We have experienced, and expect to continue to experience, significant fluctuations in our quarterly results of operations. During the past eight quarters, our quarterly net income ranged from a loss of approximately $7.1 million to income of approximately $16.1 million. In future periods, our operating results could be below public expectations, which would likely cause the market price of our common stock to decline. Numerous factors, some of which are beyond our control, may affect our quarterly results of operations, including:
currency exchange fluctuations;
unanticipated changes in the demand for our services due to changing macroeconomic factors;
the size, timing and terms and conditions of significant projects;
variations in the duration, size and scope of our projects;
contract terminations or cancellation or deferral of projects;
our ability to manage costs, including personnel and support services costs, and investments required by us to maintain our existing operations and support future growth;
changes in pricing policies by us or our competitors;
the introduction of new services by us or our competitors; and
acquisition and integration costs related to possible acquisitions of other businesses.
During recent years, our quarterly results have also fluctuated as a result of the number of working days in each period and the seasonality of client demand in the segments of the IT services industry we serve. Typically our fourth quarter is strongest, when client demand is greatest, and the second quarter is weakest, when the number of working days in the quarter is lowest in Israel, one of our largest employee locations. We expect these factors to continue to be significant in the future, although we believe that the impact of the number of working days on our results of operations will decrease as our international business continues to grow.
Our clients typically retain our services for set engagements pursuant to contracts that may be terminated by them with little or no notice and without termination fees. The termination, cancellation or deferral of one or more significant projects could materially and adversely affect our operating results in any fiscal quarter. In addition, we base our current and future expense levels on our internal operating plans and sales forecasts, and our near-term operating costs are, therefore, to a large extent, fixed. As a result, we may not be able to sufficiently reduce our costs on a timely basis in any quarter to compensate for an unexpected near-term
shortfall in revenues.
Our clients typically retain us on a non-exclusive basis. Many of our client contracts, including those that are on a fixed price, fixed timeframe basis, can be terminated by the client with or without cause upon 90 days notice or less and generally without termination-related penalties. Additionally, our contracts with clients are typically limited to discrete projects without any commitment to a specific volume of business or future work and may involve multiple stages. In addition, the increased breadth of our service offerings may result in larger and more complex projects for our clients that require us to devote resources to more
thoroughly understand their operations. Despite these efforts, our clients may choose not to retain us for additional stages or may cancel or delay planned or existing engagements due to any number of factors, including:
financial difficulties of a current client;
a change in strategic priorities;
a demand for price reductions; and
a decision by our clients to utilize their in-house IT capacity or work with our competitors.
These potential terminations, cancellations or delays in planned or existing engagements could make it difficult for us to use our personnel efficiently. In addition, some of our client contracts restrict us from engaging in business with certain competitors of our clients during the term of the agreements and for a limited period following termination of these agreements. Any of the foregoing factors may negatively impact our revenues and profitability.
As an IT services provider, our ability to attract and retain clients depends to a large extent on our relationships with our clients and our reputation for high quality professional services and integrity. As a result, if a client is not satisfied with our services or solutions, including those of subcontractors we engage, our reputation may be damaged. In addition, a number of our contracts provide for incentive-based or other pricing terms pursuant to which some of our fees are contingent on our ability to meet revenue enhancement, cost-saving or other contractually defined performance goals. Our failure to meet these goals or a clients
expectations in such performance-based contracts may result in a less profitable or an unprofitable engagement. Moreover, if we fail to meet our clients performance expectations, we may lose clients and be subject to legal liability, particularly if such failure has a consequential adverse impact on our clients businesses.
In addition, many of our projects are critical to the operations of our clients businesses. Our exposure to legal liability may be increased in the case of outsourcing contracts in which we become more involved in our clients operations. While our contracts typically include provisions designed to limit our exposure to legal claims relating to our services and the solutions we develop, these provisions may not adequately protect us or may not be enforceable in all cases. The general liability insurance coverage that we maintain, including coverage for errors and omissions, is subject to important exclusions and limitations. We cannot be
certain that this coverage will continue to be available on reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. A successful assertion of one or more large claims against us that exceeds our available insurance coverage or changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could adversely affect our profitability.
We offer a portion of our services on a fixed price basis, rather than on a time-and-materials basis. In 2006, 2007 and 2008, revenues from fixed price projects accounted for approximately 27%, 30% and 29% of our total revenues, respectively. Under these contractual arrangements, we bear the risk of cost overruns,
completion delays and wage inflation. If we fail to estimate accurately the resources and time required to complete a project or fail to complete our contractual obligations within the scheduled timeframe, our profitability may suffer.
In connection with some of our more complex engagements, we have been required, and may in the future be required, to assume contingent responsibility for the performance of business partners. Our being required to perform the third party obligations of these commitments could have a material adverse affect on our margins and profitability because we would be required to incur additional costs, possibly without any corresponding recovery against the third parties. While we will continue to manage liabilities or risks through rigorous transaction review, we expect that clients may require us to assume certain additional contractual obligations and
potential liabilities when we are responsible for the performance of business partners we do not control.
Under Israeli law, we must provide severance for all our employees in Israel. We fund the severance through monthly deposits in externally managed funds, invested mostly in conservative investments such as government and corporate bonds. In the current capital markets downturn, the value of these investments has declined, and they may lose additional value in the future. The magnitude of the future potential loss is unpredictable, because it is based on the market value of investments at a future date. The severance pay fund is recorded at fair value on our balance sheet, and if the value of the investments falls, we will be required to write down
the value of the severance pay fund asset on our balance sheet. If the write-down is significant, it would result in a significant non-cash expense on our income statement, materially adversely affecting our results of operations.
Our balance sheet contains a significant amount of goodwill and other amortizable intangible assets in long-term assets, totaling about $312 million at December 31, 2008. We review goodwill annually for impairment, or more frequently when indications for potential impairment exist. We review other amortizable intangible assets for impairment when indicators for impairment exist. In the current capital markets downturn, our stock price, and consequently our market capitalization, have declined, and may decline further in the future. If the value of our market capitalization falls below the value of our stockholders equity, it might indicate that
a write-down is required. A write-down of goodwill is required if the carrying amount of a reporting unit exceeds its fair value.
We determine the fair value of each reporting unit using the Income Approach, which utilizes a discounted cash flow model, as we believe that this approach best approximates our fair value at this time. We have corroborated the fair values using the Market Approach. Judgments and assumptions related to future growth rates, weighted average cost of capital, interest, cash flows and market conditions are inherent in developing the discounted cash flow model; see Application of Critical Accounting Policies and Estimates. As part of our goodwill impairment analysis, we compare our market capitalization to the fair value of the Company
based on a third-party valuation study. Our market capitalization declined during the fourth quarter of 2008, and subsequently, as a result of market-driven declines in our stock trading price. Our ability to reconcile the gap between our market capitalization and our aggregate fair value depends on various factors, some of which are quantitative, such as an estimated control premium that an investor would be willing to pay for a controlling interest in us, and some of which are qualitative and involve management judgment, including stable relatively high backlog coverage and experience in meeting operating cash flow targets. If our market capitalization stays below the value of our stockholders equity, or actual results of operations differ materially from our modeling estimates and related assumptions, or if any of our qualitative reconciliation factors changes in the future, we may be required to record impairment charges for our goodwill.
Such a write-down could result in a significant non-cash expense on our income statement, which could have a material adverse effect on our results of operations, and may affect our ability to meet our bank covenants.
In the last two years we acquired five companies. We may seek to acquire or make strategic investments in complementary businesses, technologies, services or products, or enter into strategic partnerships or alliances with third parties in the future in order to expand our business. However, we may be unable to identify suitable acquisition, strategic investment or strategic partnership candidates, or if we do identify suitable candidates, we may not complete those transactions on terms commercially favorable to us or at all, which may adversely affect our competitive position and our growth prospects.
If we acquire another business, we may face difficulties, including:
integrating that business personnel, products, technologies or services into our operations;
retaining the key personnel of the acquired business;
failing to adequately identify or assess liabilities of that business;
failure of that business to fulfill its contractual obligations;
failure of that business to achieve the forecasts we used to determine the purchase price; and
diverting our managements attention from normal daily operations of our business.
These difficulties could disrupt our ongoing business and increase our expenses. As of the date of this report, we have no agreements to enter into any material acquisition, investment, partnership, alliance or other joint venture transaction.
We perform work for a wide range of Israeli governmental agencies, including defense, education, justice and finance, which collectively represented approximately 12% of our revenues in 2008. Any reduction in total Israeli government spending for political or economic reasons, such as occurred in the Israeli recession ending in 2004, would reduce, possibly materially, our revenues and profitability. In addition, the government of Israel has experienced significant delays in the approval of its annual budget in most of the last five years. Such delays in the future could materially and negatively affect our cash flows by delaying receipt of payment
from the government of Israel for services performed.
Our success depends largely on the contributions of our employees and our ability to attract and retain qualified personnel, including technology, consulting, engineering, marketing and management professionals. Competition for qualified personnel in the IT services industry, in the markets in which we operate, particularly in India, can be intense and, accordingly, we may not be able to retain or hire all of the personnel necessary to meet our ongoing and future business needs. If we are unable to attract and retain the highly skilled IT professionals we need, we may have to forego projects for lack of resources or be unable to staff projects
optimally. In addition, the competition for highly skilled employees may require us to increase salaries of highly skilled employees, and we may be unable to pass on these increased costs to our clients, which would reduce our profitability.
8,425 as of December 31, 2008. We expect to resume our growth following the macroeconomic recovery, and this growth may significantly strain our management and other operational and financial resources. In particular, continued growth increases the integration challenges involved in:
recruiting, training and retaining skilled technical, marketing and management personnel;
maintaining high quality standards;
preserving our corporate culture, values and entrepreneurial environment;
developing and improving our internal administrative infrastructure, particularly our financial, operational, communications and other internal controls; and
maintaining high levels of client satisfaction.
The rapid execution necessary to exploit the market for our business model requires an effective planning and management process. Our systems, procedures or controls may not be adequate to support the growth in our operations, and our management may not be able to achieve the rapid execution necessary to exploit the market for our business model. Our future operating results will also depend on our ability to expand our development, sales and marketing organizations. If we are unable to manage growth effectively, our profitability will likely decline.
We are highly dependent on the senior members of our management team. We do not maintain key man life insurance for any of the senior members of our management team. Competition for senior management in our industry is intense, and we may not be able to retain our senior management personnel or attract and retain new senior management personnel in the future. The loss of one or more members of our senior management team could have a negative effect on our ability to attract and retain clients, execute our business strategy and otherwise operate our business, which could reduce our revenues, increase our expenses and reduce our profitability.
Many of our clients, particularly those in the financial services, life sciences, healthcare and defense verticals, are subject to complex and constantly changing regulatory requirements. On occasion, these regulatory requirements change unpredictably. These regulations may increase our potential liabilities if our services are found to contribute to a failure by our clients to comply with the requirements applicable to them and may increase compliance costs as regulatory requirements increase or change. These increased costs could negatively impact our profits.
A significant element of our global delivery model is to continue to leverage and expand our global development centers. Our global development centers are linked with a network architecture that uses multiple telecommunication service providers and various links with alternate routing, including some routing via virtual private networks on the internet. We may not be able to maintain active voice and data communications between our various global development centers and between our global development centers and our clients sites at all times. Any significant loss or impairment of our ability to communicate could result in a disruption in our
business, which could hinder our performance or our ability to complete client projects on time. This, in turn, could lead to client dissatisfaction and have a material adverse effect on our operations.
Our success will depend, in part, on our ability to obtain and maintain protection in the United States and other countries for certain intellectual property incorporated into our software solutions and our proprietary methodologies. We may be unable to obtain patents relating to our technology. Even if issued, patents may be
challenged, narrowed, invalidated or circumvented, which could limit our ability to prevent competitors from marketing similar solutions that limit the effectiveness of our patent protection and force us to incur unanticipated costs. In addition, existing laws of some countries in which we provide services or solutions may offer only limited protection of our intellectual property rights.
While we attempt to retain intellectual property rights arising from client engagements, our clients often have the contractual right to such intellectual property. For intellectual property that we own, we rely upon a combination of trade secrets, confidentiality, nondisclosure and other contractual arrangements. These measures may not adequately prevent or deter infringement or other misappropriation of our intellectual property, and we may not be able to detect unauthorized use of, or take appropriate and timely steps to enforce, our intellectual property rights.
In order to achieve our strategic business objectives, we may be required to seek additional financing. For example, future acquisitions may require additional equity and/or debt financing. In addition, we may require further capital to continue to develop our technology and infrastructure and for working capital purposes. These financings may not be available on acceptable terms, or at all. Our failure to secure additional financing could prevent us from completing acquisitions, developing new technologies and competing effectively, all of which would have a negative impact on our continued development and growth.
We spend a substantial amount of management time and resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Global Select Market rules. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires managements annual review and evaluation of our internal control systems, and attestations as to the effectiveness of these systems by our independent registered public accounting firm. We have expended and expect to continue to expend significant resources and management time documenting and testing our
internal control systems and procedures. This process has been complicated by the decentralized nature of our operations and information systems. Although we have evaluated our internal controls as effective as of the date of this annual report, in future fiscal years, we may encounter unanticipated delays or problems in assessing our internal controls as effective or in completing our assessments by the required dates. In addition, we cannot assure that our independent registered public accountants will attest our internal controls as effective in future years. If we cannot assess our internal controls as effective, investor confidence may be negatively impacted.
To date, most of our sales have been denominated in NIS, dollars, Euros and other European currencies, while a significant portion of our expenses is incurred in the local currencies of countries in which we operate. For financial reporting purposes, we translate all non-United States denominated transactions into dollars in accordance with United States generally accepted accounting principles. Despite our use of certain forward foreign currency exchange contracts to hedge our balance sheet exposure against foreign currency exchange fluctuations and to partially hedge against the effect of foreign currency exchange rate fluctuations on cash flows
denominated in Indian Rupees, we are exposed to the risk that fluctuations in the value of these currencies relative to the dollar could increase the dollar cost of our operations and therefore have an adverse effect on our profitability, or could reduce our revenue growth rate in dollar terms.
Currently, we benefit from the tax holiday that India provides to exporters of IT services. Until recently, this tax holiday provided a complete exemption from corporate income tax for exported IT services, compared to an ordinary corporate tax rate of approximately 34%. In mid-2007, India imposed a
minimum alternative tax (MAT) of approximately 11%, but India permits amounts due under the MAT to be offset against future taxes that would be due when the tax holiday ends. As a result, our operations in India have been subject to relatively low tax rates.
The tax holiday was originally scheduled to end on March 31, 2009. It was recently extended by the Indian government to expire on March 31, 2010 with the stipulation that no exporter of Indian IT services may benefit from the tax holiday for more than 10 fiscal years. Our largest Indian delivery center, located in Bangalore, will lose its tax exemption on March 31, 2009 because it has benefitted from the exemption since the beginning of the original ten year tax holiday, and this will increase our tax expense and reduce our profitability.
The tax holiday may be extended again in its current form or a reduced form. Even if the tax holiday expires, exporters of IT services may still be able to maintain a full or partial exemption from Indian corporate taxes by moving their operations to special economic zones (SEZ) in certain Indian cities.
If the tax holiday is eliminated on March 31, 2010 as currently scheduled, or eliminated or reduced earlier as the result of political or other changes in India; or if the tax holiday is extended but we are not able to take full advantage of it in its new form; or if we are unable to, or decide not to, move each of our operations to a SEZ; or if we remain exempt from taxes but are no longer permitted to offset MAT amounts due against future taxes, then our tax expense will increase, reducing our profitability.
Our growth strategy relies in part on the expansion of our offshore development centers. If we fail to retain needed employees in India and other offshore locations, or to manage growth in these regions, our business, financial condition and results of operations may be adversely affected. Employee attrition rates in India are significantly higher than in other geographies. Wage costs in India have historically been significantly lower than wage costs in North America and Western Europe for comparably skilled professionals; however, wages in India continue to increase at a significantly faster rate than in North America and Western Europe, which
could result in increased costs for IT professionals, particularly project managers and other mid-level professionals. As a result of competing demand in the Indian employment market, we may need to increase the levels of our employee compensation unduly to remain competitive. Compensation increases may hinder our planned growth and could materially adversely affect our business, financial condition and results of operations.
Our growth strategy also relies on the expansion of our near-shore development centers. If we fail to retain needed employees in Eastern Europe and other near-shore locations, or to manage growth in these regions, our business, financial condition and results of operations may be adversely affected. Skilled IT professionals are in short supply in Eastern Europe, and we may be unable to achieve the headcount growth needed to fulfill our committed work, or we may have to increase the levels of our employee compensation to attract the needed number of employees. Such shortfalls of employees and/or compensation increases may hinder our planned growth and
could materially adversely affect our business, financial condition and results of operations.
We currently operate in 18 countries and intend to further penetrate key markets, primarily in North America and Europe, while continuing to establish and expand offshore and near-shore development centers in lower-cost Asian and Eastern European markets. We expect to devote significant resources to this effort but may not be successful in this regard. Risks inherent in our international business activities include:
difficulties in staffing international projects and managing international operations;
difficulties in collecting accounts receivable;
local competition, particularly in North America and Europe;
Annual wage inflation for IT professionals in India over the past several years has exceeded world-wide averages significantly. Based on our review of publicly available information, we believe that this trend will continue for the foreseeable future. Similarly, wage inflation for IT professionals in our other geographies has been higher in the last several years. If we are unable to provide adequately for such wage increases in our contracts with our customers, or if unexpectedly large wage increases occur, we may experience a material adverse effect on our profitability.
We generated approximately 34% of our revenues in Israel in 2008. In addition, our principal offices and a significant portion of our employees are located in Israel. Therefore, political, economic and military conditions in Israel directly affect our operations. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors. We cannot predict the effect on our business of any increase in the degree of violence by the Palestinians against Israel or the effect of military action elsewhere in the Middle East. The future of peace efforts between Israel and its Arab neighbors
remains uncertain. Any future armed conflicts or political instability in the region would likely negatively affect business conditions and adversely affect our results of operations. Furthermore, several countries restrict or prohibit business with Israel or companies that do business in Israel. These restrictive laws and policies may severely limit our ability to provide services in those countries.
Some of our employees in Israel are currently obligated to perform up to 36 days, depending on rank and position, of military reserve duty annually and are subject to being called for active duty at any time under emergency circumstances. If a military conflict or war arises, these individuals could be required to serve in the military for extended periods of time. Our operations could be disrupted by the absence for a significant period of one or more of our executive officers or key employees or a significant number of other employees due to military service. Any consequent disruption in our operations could adversely affect our profitability.
We also generate significant revenues from services we deliver from India. India has from time to time experienced instances of civil unrest and hostilities with Pakistan. In recent years, there have been military confrontations between India and Pakistan in the region of Kashmir and along the India-Pakistan border as well as terrorist activity in Mumbai. Although the relations between the two countries have been generally improving, military activity or terrorist attacks in the future could adversely affect the Indian economy by disrupting communications and making travel more difficult, which may have a material adverse effect on our ability to
deliver services from India. Disruption in our operations could adversely affect our profitability.
Over the past several years, the issue of outsourcing of services abroad by American companies has been a topic of political discussions in the United States. Measures aimed at limiting or restricting outsourcing by United States companies are under discussion in Congress and in as many as one-half of the state legislatures. While no substantive anti-outsourcing legislation has been introduced to date, given the intense debate over this issue, the introduction of such legislation is possible. If introduced, such measures are likely to fall within two categories: (1) measures that extend restrictions on outsourcing by federal government agencies and
on government contracts with firms that outsource services directly or indirectly, and (2) measures that affect
A portion of our revenues is derived from offshore outsourcing, which requires some personnel from our offshore locations in India and elsewhere to travel to client sites for rotational assignments. The ability of those IT professionals to work in North America, Europe and in other countries depends on their ability to obtain the necessary visas and work permits. The United States has reduced the number of H-1B visas authorized annually, and has also increased the level of scrutiny in granting H-1B, L-1 and ordinary business visas. A number of European countries are considering changes in immigration policies as well. The inability of key project
personnel to obtain necessary visas could delay or prevent our fulfillment of client projects, which could hamper our growth and cause our revenues to decline.
Terrorist attacks, such as the attacks of September 11, 2001 in the United States, and other acts of violence or war, like the conflict in Iraq, could affect us or our clients by disrupting normal business practices for extended periods of time and reducing business confidence. In addition, these attacks may make travel more difficult and may effectively curtail our ability to serve our clients needs, any of which could negatively affect our financial results and prospects.
The market price of our stock may fluctuate significantly in response to a number of factors, including the following, several of which are beyond our control:
changes in financial estimates or investment recommendations by securities analysts relating to our stock;
changes in market valuations of IT service providers and other high technology companies;
economic disruptions, such as the 2008 2009 world recession or the credit and liquidity crisis among major financial institutions;
announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
loss of a major client or changes in our employee utilization rate;
unfavorable legal or arbitration judgments; and
changes in key personnel.
In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We could be the target of similar litigation in the future. Securities litigation, regardless of merit or ultimate outcome, would likely cause us to incur substantial costs, divert managements attention and resources, harm our reputation in the industry and the securities markets and reduce our profitability.
In order to maintain the listing of our common stock on the Nasdaq Global Select Market, we must remain in compliance with Nasdaq Marketplace Rules, including but not limited to, minimum bid price requirements. If we are unable to comply with these rules, our common stock may be delisted from Nasdaq. Nasdaq has suspended the minimum $1.00 closing bid price rule through Friday, April 17, 2009, and may
extend this suspension based on then prevailing market conditions. As of February 27, 2009, the closing price per share of our common stock was $2.93. If our stock price trades below $1.00 after April 20, 2009, we cannot assure you that Nasdaq will not take action to enforce its listing requirements. In the event that our common stock is delisted from Nasdaq, the market for our common stock may be limited and it may be difficult for our stockholders to sell their shares at an acceptable price, or at all.
Provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware corporate law, may discourage, delay or prevent a merger, acquisition or other change in control of our company, even if such a change in control would be beneficial to our stockholders. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include:
prohibiting the stockholders from fixing the number of our directors;
authorizing our board of directors to designate the terms of and issue new series of preferred stock without additional stockholder approvals;
limiting the individuals who may call a special meeting to our chairman, chief executive officer, the majority of our board of directors or the majority of our stockholders;
requiring advance notice for stockholder proposals and nominations; and
prohibiting stockholders from acting by written consent, unless unanimous.
We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which limits business combination transactions with stockholders of 15% or more of our outstanding voting stock that our board of directors has not approved. These provisions and other similar provisions make it more difficult for stockholders or potential acquirers to acquire us without negotiation. These provisions may apply even if some stockholders may consider the transaction beneficial to them.
These provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for our common stock.
Our principal executive office is located in leased premises of approximately 265,000 square feet in Tel Aviv, Israel. Our principal executive office in the United States is located in leased premises of approximately 12,000 square feet in Hackensack, New Jersey. We have offices of various sizes at approximately 29 locations in 18 countries totaling approximately 965,000 square feet, all of which are leased, including approximately 410,000 square feet in India, primarily in Bangalore, Hyderabad and Mumbai.
We believe that there is sufficient office space available at favorable leasing terms both to replace existing office space and to satisfy any additional needs we may have as a result of future expansion.
We are periodically a party to routine litigation incidental to our business. Other than as disclosed below, we do not believe that we are a party to any pending legal proceeding that is likely to have a material adverse effect on our business, financial condition or results of operations.
One of our Israeli subsidiaries is currently involved in legal proceedings with the Israeli Ministry of Justice (the MOJ). The legal proceedings relate to a contract for the provision of an information system for the MOJ, executed in November 2005 (the Contract). Following continued disputes, correspondence and discussions, on February 9, 2009 we filed a claim with the Israeli District Court located in Jerusalem claiming, among other things, a breach of the Contract by the MOJ, including in connection with the MOJs
demands for revisions and changes to the software that were not contemplated in the Contract. Our claim is for damages in the amount of NIS 20.7 million, or approximately $5.1 million. On February 11, 2009, the MOJ filed a claim against our Israeli subsidiary in the Israeli District Court located in Jerusalem claiming, among other things, that our Israeli subsidiary breached the Contract and failed to fulfill its undertakings and obligations set forth therein. The MOJs claim is for damages in the amount of NIS 79.5 million, or approximately $19.6 million. The MOJ and our subsidiary have filed answers to the respective claims. We believe that we
have a substantial basis with respect to our claim and valid defenses with respect to the MOJs claim. While we intend to vigorously prosecute our claim and defend against the MOJs claim, we cannot at this point predict the outcome of either claim. Adverse decisions on these claims may materially adversely affect our financial condition.
Our common stock is quoted on the Nasdaq Global Select Market under the symbol NSTC. The following table shows the high and low per share sale prices of our common stock for each full quarterly period within the two most recent fiscal years, as reported on the Nasdaq Global Select Market. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
First Quarter (through February 27, 2009)
We have never paid any cash dividends. We currently intend to retain our future earnings to finance the operation and expansion of our business, and we do not anticipate paying cash dividends on our common stock in the foreseeable future. Any future determination as to the payment of dividends will be at the discretion of our board of directors.
On February 27, 2009, the last reported sale price per share of our common stock on the Nasdaq Global Select Market was $2.93. As of February 27, 2009, there were approximately 42 holders of record of our common stock, although the number of beneficial shareholders was considerably larger.
On November 3, 2008, we announced that our board of directors had authorized a stock repurchase program, under which we may repurchase up to 4,000,000 shares of our common stock, or approximately 10% of the outstanding shares, in the succeeding twelve months. During the quarter ended December 31, 2008, we purchased a total of 541,741 shares at an average price of $4.41 per share, for an aggregate purchase price of $2,388,717. The remaining authorized number of shares that may be repurchased under the plan is 3,458,259.
Total Number of Shares Repurchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
Set forth below are a graph and a table comparing cumulative total return on $100 invested, alternatively, in our common stock, the Nasdaq U.S. Index and the S&P 500 Information Technology Sector Index for the
period commencing on September 29, 2004, the date of our initial public offering, and ending on December 31, 2008. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns.
Comparison of Cumulative Total Return*
Ness Technologies, Inc.
Nasdaq U.S. Index
S&P 500 Information Technology Sector
Assumes $100 invested on September 29, 2004 in our common stock, at our initial offering price, and in each index, at the closing price on the date of our initial public offering; and that all dividends have been reinvested. No cash dividends have been declared on our common stock. Prepared by Standard & Poors.
You should read the following selected consolidated financial data together with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes included elsewhere in this report.
The selected consolidated statement of operations data for the years ended December 31, 2006, 2007 and 2008 and the selected consolidated balance sheet data as of December 31, 2007 and 2008 are derived from our audited consolidated financial statements included elsewhere in this report. The selected consolidated statement of operations data for the years ended December 31, 2004 and 2005 and the selected consolidated balance sheet data as of December 31, 2004, 2005 and 2006 are derived from our audited consolidated financial statements not included in this report. These financial statements have been prepared in accordance with U.S. generally
accepted accounting principles. Our historical results may not be indicative of the operating results to be expected in any future period and our results for interim periods may not be indicative of results to be expected for the entire year.
Year Ended December 31,
(In Thousands, Except Per Share Data)
Statement of Operations Data:
Cost of revenues
Selling and marketing
General and administrative
Arbitration settlement and related charges
Gain from sale of Israeli SAP sales and distribution operations, net
Total operating expenses
Financial expenses, net
Gain on sale of a cost investment
Other income (expenses), net
Income before taxes on income
Taxes on income
Equity in earnings (losses) of affiliates and gain from disposal of an affiliate
Minority interests in losses (earnings) of a subsidiary
Income from continuing operations
Extraordinary income, net of taxes
Basic earnings per share
Diluted earnings per share
Basic earnings per share excluding extraordinary income
Diluted earnings per share excluding extraordinary income
Weighted average number of shares used in computing basic earnings per share
Weighted average number of shares used in computing diluted earnings per share
Gives effect to issuance of additional shares of our common stock as payment of accrued dividends on Class B preferred stock.
You should read the following discussion and analysis together with our audited 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 in this report, particularly under the headings Disclosure Statement and Risk Factors.
We are a global provider of information technology, or IT, and business services and solutions with specialized expertise in software product engineering; system integration, application development and consulting; and software distribution. We deliver our portfolio of services and solutions using a global delivery model combining offshore, near-shore and local teams. The primary industries, or verticals, we serve include high-tech companies and independent software vendors, or ISVs; utilities and government; financial services; defense and homeland security; and life sciences and healthcare.
We have operations in 18 countries across North America, Europe, Israel and Asia Pacific. 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, we leverage our corporate knowledge and experience, intellectual property and global infrastructure to develop innovative solutions for clients across the geographies and verticals we serve. Through our global delivery model, which includes lower-cost offshore and near-shore delivery capabilities, we can achieve meaningful cost
reductions or other benefits for our clients.
On October 1, 2008, we reorganized our operating segments to correspond to our three primary service lines: software product engineering; system integration, application development and consulting; and software distribution.
Our revenues increased to $664.8 million for 2008, from $560.3 million for 2007. Net income increased to $35.5 million for 2008, from $10.1 million for 2007. Net income in 2008 was helped by a gain from the sale of our Israeli SAP sales and distribution operations, representing $9.6 million net of related expenses, net of taxes, and was hurt by a non-cash write-down in the asset value of our Israeli severance pay fund, representing $2.1 million, net of taxes. Net income in 2007 was negatively impacted by a one-time arbitration settlement, representing $15.6 million, including related and other expenses, net of taxes.
Our revenue growth is attributable to a number of factors, including acquisitions we made, 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 2008, no client accounted for more than 4% of our revenues and our largest twenty clients together accounted for approximately 30% of our revenues. For 2008, the percentage of our revenues derived in aggregate from agencies of the government of Israel was 12%. Existing clients from prior years generated more than 85% of our revenues in 2008.
Our backlog as of December 31, 2008 was $736 million compared to $734 million as of December 31, 2007. This represents year-over-year backlog growth of $28 million, offset by the divestiture of two business units in 2008 with their associated backlog, representing $23 million, and a reduction in the dollar value of our non-U.S. backlog due to the strengthening dollar, representing $3 million. 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.
As of December 31, 2008, we had approximately 8,425 employees, including approximately 7,425 IT professionals. Of the 8,425 employees, approximately 2,840 were in India, 2,710 were in Israel, 1,930 were in Europe, 580 were in North America and 365 were in the Asia Pacific region.
Our discussion and analysis of our financial condition and results of operations are based on consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. The actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and which could result in materially different results under different assumptions and conditions. Application of these policies is particularly important to the portrayal of our financial condition and results of operations. We believe that the accounting policies described below meet these characteristics. Our significant accounting policies are more fully described in the notes to the accompanying consolidated financial statements.
We generate our revenues from contracts for software product engineering; system integration, application development and consulting services; and sales of third party software licenses. We provide services on either a fixed price or time and materials basis. For time and materials contracts, we recognize revenues as services are performed based on the hours actually incurred at the negotiated billing rates. We also charge our clients for certain costs and expenses, such as the installation of hardware and cost of subcontractors.
Our fixed price contracts relate primarily to long-term development projects. Such projects that require significant customization, integration and installation are recognized in accordance with Statement of Position No. 81-1 Accounting for Performance of Construction-Type and Certain Production-Type Contracts. We recognize revenues related to these contracts using the percentage of completion method based on the percentage of costs incurred to date in relation to the total estimated costs expected upon completion. This requires us to make estimates and assumptions regarding the resources and time required to fulfill the contracts
obligations including work effort and subcontractors. We rely on our experience from other projects in making these estimates, and, in addition, use our internal project management and financial systems to track and manage the projects. Employees and project managers regularly submit updates to these systems, which are then used by executive management to monitor the projects and revise the estimates, if necessary. Historically, our estimates have been indicative of our actual results; however, there have been a few cases where we had to adjust assumptions, primarily regarding work effort.
We generally recognize revenues on a gross basis, representing the entire amount, because we bear the risks and rewards of ownership, including the risk of loss for collection, delivery and returns, and have latitude in establishing product pricing above specific minimums. Management determines whether we bear the risks and rewards of ownership based on relevant sale contract terms. Whenever the majority of contract terms indicate that we bear the risks and rewards, revenues are recognized on a gross basis. For most software license sales and hardware sales, we record revenues on a net basis, based on managements determination that majority of
contract terms indicate that we do not bear the risks and rewards related to such contracts.
For arrangements that involve multiple revenue activities, (i.e., the delivery or performance of multiple products and services), management allocates the associated consideration to the separate activities based on
their relative fair values. In order to determine the fair values of the different activities covered by each agreement, management applies standard pricing used for products and services in similar arrangements and hourly rates based on similar activities we have performed for other clients.
Our revenue recognition approach for software licensing requires that, in accordance with Statement of Position No. 97-2 Software Revenue Recognition (as amended), four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) is based on managements judgments regarding the fixed nature of the fee charged for services rendered and products delivered, and the collectibility of those fees. Should changes in
conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. The allowance for doubtful accounts is determined by evaluating the credit worthiness of each client based upon market capitalization and other information, including the aging of the receivables. If the financial condition of our clients were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. In each financial period, we estimate the likelihood of collecting every receivable and record a cumulative allowance.
In accordance with business combination accounting, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values. We engage third-party appraisal firms to assist management in determining the fair values of certain assets acquired and liabilities assumed. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets.
Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain assets acquired and liabilities assumed include but are not limited to: future expected cash flows from license and service sales, maintenance agreements, customer contracts and estimated cash flows from the projects when completed, the acquired companys brand awareness and discount rate. Unanticipated events and circumstances may occur that may affect the accuracy or
validity of such assumptions, estimates or actual results.
In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we perform tests for impairment of long-lived assets whenever events or circumstances suggest that long-lived assets may not be recoverable. This analysis differs from our goodwill analysis in that an impairment is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related to the assets are less than the carrying value of the assets we are testing for impairment. If the forecasted undiscounted cash flows are less than the carrying value, then we
must write down the carrying value to its estimated fair value based primarily upon forecasted discounted cash flows. Based on the impairment test performed as of December 31, 2008, no impairment was identified.
These forecasted undiscounted cash flows include estimates and assumptions related to revenue growth rates and operating margins, future economic and market conditions. Our estimates of market segment growth and our market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying business. Our business consists of both established and emerging technologies and our forecasts for emerging technologies are based upon internal estimates and external sources rather than historical
information. If future forecasts are revised, they may indicate or require future impairment charges. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates.
We perform our annual impairment analysis of goodwill as of December 31 of each year, or more often if there are indicators of impairment present. The provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, require that a two-step impairment test be performed on goodwill at the level of the reporting units. In the first step, or Step 1, we compare the fair value of each reporting unit to its carrying value. If the fair value exceeds the carrying value of the net assets, goodwill is considered not impaired, and we are not required to perform further testing. If the carrying value of the net
assets exceeds the fair value, then we must perform the second step, or Step 2, of the impairment test in order to determine the implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference. To determine the fair value used in Step 1, we use discounted cash flows. If and when we are required to perform a Step 2 analysis, determining the fair value of our net assets and our off-balance sheet intangibles would require us to make judgments that involve the use of significant estimates and assumptions. We performed our annual impairment test as of December 31, 2008 and determined that the goodwill was not impaired.
We determine the fair value of a reporting unit using the Income Approach, which utilizes a discounted cash flow model, as we believe that this approach best approximates our fair value at this time. We have corroborated the fair values using the Market Approach. Judgments and assumptions related to revenue, gross profit, operating expenses, future short-term and long-term growth rates, weighted average cost of capital, interest, capital expenditures, cash flows, and market conditions are inherent in developing the discounted cash flow model. If these estimates or their related assumptions change in the future, we may be required to record impairment
charges for our goodwill. Additionally, we evaluated the reasonableness of the estimated fair value of our reporting units by reconciling to our market capitalization. This reconciliation allowed us to consider market expectations in corroborating the reasonableness of the fair value of our reporting units. In addition, we compared our market capitalization, including an estimated control premium that an investor would be willing to pay for a controlling interest in us, to the fair value of the Company based on a third-party valuation study. The determination of a control premium requires the use of judgment and is based primarily on comparable industry and deal-size transactions, related synergies and other benefits. Our market capitalization declined during the fourth quarter of 2008, and subsequently, as a result of market-driven declines in our stock trading price. This decline is consistent with overall market conditions and is not a result of changes in our expectations of future
cash flows. Our reconciliation of the gap between our market capitalization and the aggregate fair value of the Company depends on various factors, some of which are qualitative and involve management judgment, including stable relatively high backlog coverage and experience in meeting operating cash flow targets. We will continue to monitor our market capitalization and expectations of future cash flows and will perform impairment testing if deemed necessary. When we reorganize our operating segments to correspond to changes in our management structure, we reallocate our goodwill balance to the new reportable segments based on their relative fair values. This process, which is based on a discounted cash flow analysis, is subjective and involves management judgment and related assumptions.
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to these
uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period. Effective January 1, 2007, we adopted Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109, Accounting for Income Taxes. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover a substantial majority of the deferred tax assets recorded on our consolidated balance sheets. However, should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determined that the recovery was not likely.
Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as
well as the related net interest.
Our effective tax rates have differed from the statutory rate primarily due to the tax impact of foreign operations. Our effective tax rate was 21%, 31% and 19% for 2006, 2007 and 2008. Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, accounting principles, or interpretations thereof. In addition, we are subject to the continuous examination of our income tax
returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.
We are the defendants in various lawsuits, including employment claims and other legal proceedings in the normal course of our business. In determining whether provisions should be recorded for pending litigation claims, we assess the allegations made and the likelihood that we will successfully defend ourselves. When we believe that it is probable that we will not prevail in a particular matter, we then estimate the amount of the provision required based in part on our legal counsels' advice.
Our revenues increased from $560.3 million in 2007 to $664.8 million in 2008, representing an increase of $104.5 million, or 18.7%. Approximately $66.2 million of the increase was attributable to acquisitions. Of the remaining amount, $45.2 million represents growth in our System Integration and Application Development segment, $19.1 million represents growth in our Software Product Engineering segment and $8.9 million represents growth in our Software Distribution segment, offset by the divestiture in January 2008 of our staff supplementation business in Israel, representing $24.2 million, a write-off of trade receivables resulting from the sale of
our Israeli SAP sales and distribution operations, representing $3.2 million, and the sale in August 2008 of our Israeli SAP sales and distribution operations, representing $7.5 million. We expect our revenues to grow modestly in 2009 due to continued expansion into North American and European markets in key verticals, possibly including through acquisitions, offset by foreign currency effects on non-U.S. revenues attributable to the stronger dollar.
Our cost of revenues, including salaries, wages and other direct and indirect costs, increased from $399.4 million in 2007 to $475.1 million in 2008, representing an increase of $75.8 million, or 19.0%. Approximately $46.4 million of this increase was attributable to acquisitions, and the remaining amount was
due to normal growth in our delivery staff needed to support our increased revenues. In 2009, we expect our cost of revenues to increase modestly due to an increase in the number of IT professionals needed to support our expected revenue growth and to salary increases, especially in India, where wage inflation remains higher for experienced IT professionals than elsewhere in the world.
Our gross profit (revenues less cost of revenues) increased from $160.9 million in 2007 to $189.7 million in 2008, representing an increase of $28.8 million, or 17.9%. Approximately $19.7 million of the increase was attributable to acquisitions, and the remaining amount was related to our other revenue growth. Gross margin declined slightly from 28.7% in 2007 to 28.5% in 2008 as a result of a slowdown in our U.S.-based financial services business and a write-off of trade receivables resulting from the sale of our Israeli SAP sales and distribution operations, offset by an increase in gross margin resulting from the expansion of our higher-margin
NessPRO Global software product distribution business and a gross margin improvement in our European system integration business. In 2009, we expect that gross profit will increase modestly as a result of our anticipated revenue growth, while gross margin will remain relatively flat.
The following table summarizes certain line items from our consolidated statement of operations (dollars in thousands):
Year Ended December 31,
Selling and marketing
General and administrative
Arbitration settlement and related charges
Gain from sale of Israeli SAP sales and distribution operations, net
Selling and marketing expenses increased from $41.7 million in 2007 to $56.6 million in 2008, representing an increase of $14.9 million, or 35.6%. This increase was due primarily to the inclusion of marketing and sales expenses from our acquisitions, representing $9.7 million, and special marketing events and campaigns in Israel and Europe, representing $1.0 million. In 2009, we expect selling and marketing expenses to increase modestly to support growth in new vertical markets and regions as well as to enhance our brand recognition.
General and administrative expenses increased from $88.4 million in 2007 to $101.6 million in 2008, representing an increase of $13.2 million, or 15.0%. This increase was due primarily to acquisitions, representing $8.4 million, and additional expenses related to the sale of our Israeli SAP sales and distribution operations, representing $5.6 million, offset by management transition expenses in 2007 for which there was no corresponding expense in 2008, representing $3.4 million. In 2009, we expect our general and administrative expenses to increase modestly to support our anticipated revenue growth.
In 2007, we recorded charges of $15.2 million attributable to the settlement of a long-running arbitration case with a former customer with whom we were in dispute over a contract issue, for which there was no corresponding amount in 2008. The charges consisted of a settlement payment of $9.0 million, and a write-off of trade and other receivables and provision for legal expenses related to the case, together representing $6.2 million.
In 2008, we recorded a gain of $18.4 million related to the sale to SAP AG of our Israeli SAP sales and distribution operations. The gain represents the portion of the purchase price, €13.0 million, or approximately $20.0 million, that was settled at closing, offset by expenses of $1.6 million related to the sale. There was no corresponding gain in 2007.
Operating income increased from $15.6 million in 2007 to $49.8 million in 2008, representing an increase of $34.3 million, or 220.1%. The major factors contributing to this increase were our 2007 arbitration settlement and related charges, representing $15.2 million, the gain from the 2008 sale of our Israeli SAP sales and distribution operations, net of related expenses and other charges, representing $13.1 million, and growth in operating income of our System Integration and Application Development segment and our Software Product Engineering segment, representing $10.2 million and $0.8 million, respectively, offset by a decrease in operating
income of our Software Distribution segment, representing $4.4 million, and an increase in unallocated expenses, representing $0.7 million. See also Results by Business Segment.
The following table summarizes certain line items from our consolidated statement of operations (dollars in thousands):
Financial expenses, net, increased from $30,000 in 2007 to $5.7 million in 2008, representing an increase of $5.6 million. The increase resulted primarily from higher interest expense related to debt obtained for the purpose of financing acquisitions, representing $3.6 million, and an unfavorable foreign currency exchange effect of $2.2 million. Our average net cash changed from $11.0 million in 2007 to average net debt of $26.7 million in 2008 due to long-term loans related to our 2007 acquisitions and long-term loans obtained during 2008. In 2009, we expect our financial expenses to increase somewhat as a result of higher interest expenses related
to our use of debt for acquisitions.
Other expenses, net decreased from $0.8 million in 2007 to $0.4 million in 2008, representing a decrease of $0.4 million, or 52.0%. This decrease was due primarily to the write-off of a cost investment in 2007, representing $0.7 million, partially offset by a loss on the sale of an investment at cost in 2008, representing $0.3 million.
Our taxes on income increased from $4.6 million in 2007 to $8.3 million in 2008, representing an increase of $3.7 million, or 79.3%. This increase was due primarily to the increase in our taxable income, offset partially by the use of tax loss carry forwards. Our effective tax rate in 2008 was 19.0%, compared to 31.5% in 2007. We expect our effective tax rate in 2009 to increase to the range of 24% to 26%, on a full-year basis, due to the expiration of the Indian tax holiday benefit for our Bangalore delivery center, which will reach its ten-year maximum benefit period on March 31, 2009.
Net income increased from $10.1 million in 2007 to $35.5 million in 2008, representing an increase of $25.4 million, or 251.5%. The increase in net income was due primarily to our increase in operating income of $34.3 million, partially offset by our increase in financial expenses, representing $5.6 million, and our increase in taxes, representing $3.7 million.
Our revenues increased from $474.3 million in 2006 to $560.3 million in 2007, representing an increase of $85.9 million, or 18.1%. Approximately $34.4 million of this increase was attributable to acquisitions. Of the remaining amount, $30.5 million represents growth in our System Integration and Application Development segment, $20.0 million represents growth in our Software Product Engineering segment and $1.1 million represents growth in our Software Distribution segment.
Our cost of revenues, including salaries, wages and other direct and indirect costs, increased from $343.2 million in 2006 to $399.4 million in 2007, representing an increase of $56.2 million, or 16.4%. Approximately $20.4 million of this increase was attributable to acquisitions, and the remaining amount was due to normal growth in our delivery staff needed to support our increased revenues.
Our gross profit (revenues less cost of revenues) increased from $131.1 million in 2006 to $160.9 million in 2007, representing an increase of $29.8 million, or 22.7%. The increase was primarily due to our increase in revenues. Approximately $14.0 million of the increase was attributable to acquisitions, and the remaining amount was related to our other revenue growth. Gross margin increased from 27.7% in 2006 to 28.7% in 2007, primarily due to the expansion of our higher-margin NessPRO Global software product distribution business.
The following table summarizes certain line items from our consolidated statement of operations (dollars in thousands):
Selling and marketing expenses increased from $34.3 million in 2006 to $41.7 million in 2007, representing an increase of $7.4 million, or 21.5%. This increase was due primarily to the inclusion of marketing and sales expenses from our acquisitions, representing $4.4 million.
General and administrative expenses increased from $63.2 million in 2006 to $88.4 million in 2007, representing an increase of $25.2 million, or 39.9%. This increase was due primarily to increases in salary expenses and related benefits, representing $13.3 million, expenses associated with our management transitions, representing $3.4 million, acquisitions, representing $3.5 million and consulting expenses, representing $1.3 million.
In 2007, we recorded charges of $15.2 million attributable to the settlement of a long-running arbitration case with a former customer with whom we were in dispute over a contract issue, for which there was no
corresponding amount in 2006. The charges consisted of a settlement payment of $9.0 million, and a write-off of trade and other receivables and provision for legal expenses related to the case, together representing $6.2 million.
Operating income decreased from $33.6 million in 2006 to $15.6 million in 2007, representing a decrease of $18.0 million, or 53.7%. The decrease was mainly attributable to our arbitration settlement and related charges, representing $15.2 million, and the increase in our general and administrative expenses, representing $25.2 million.
The following table summarizes certain line items from our consolidated statement of operations (dollars in thousands):
Year Ended December 31,
Financial expenses, net.
Gain on sale of a cost investment
Other income (expenses), net
Income before taxes on income
Taxes on income.
Equity in (losses) and gain from disposal of an affiliate
Financial expenses, net, decreased from $1.3 million in 2006 to $30,000 in 2007, representing a decrease of $1.3 million. The decrease resulted primarily from a decrease in our interest expenses due to a repayment of high interest loans in 2006, representing $0.7 million, and favorable foreign currency exchange effects, representing $0.8 million, partially offset by interest expenses from new debt obtained for the purpose of financing acquisitions in 2007, representing $0.4 million. Our average net cash decreased from $14.9 million in 2006 to $11.0 million in 2007.
In 2006, we had a one-time gain from the sale of our non-controlling interest in the company dbMotion, net of related expenses, representing $5.0 million, for which there was no corresponding income in 2007.
Other income (expenses), net changed from income of $0.3 million in 2006 to expenses of $0.8 million in 2007. This change was primarily due to the write-off of a cost investment in 2007, representing $0.7 million, and consideration received in 2006 for a third party transaction, representing $0.4 million, net of expenses.
Our taxes on income decreased from $8.0 million in 2006 to $4.6 million in 2007, representing a decrease of $3.4 million, or 42.4%. This decrease was primarily due to the decrease in our income before taxes, which resulted in an approximately $4.8 million reduction in taxes, and settlement of a prior-year tax assessment in 2006, representing $2.4 million, offset mainly by United States taxes on foreign income, representing $3.1 million.
Net income decreased from $29.8 million in 2006 to $10.1 million in 2007, representing a decrease of $19.7 million, or 66.2%. The decrease in net income was due primarily to our decrease in operating income of $18.0 million, and our $5.0 million gain in 2006 on sale of a cost investment for which there was no corresponding amount in 2007, partially offset by the reduction in our taxes, representing $3.4 million.
Quarterly Results of Operations
The following table presents our unaudited quarterly results of operations for the eight quarters in the period ended December 31, 2008. You should read the following table together with the consolidated financial statements and related notes contained elsewhere in this report. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. This table includes normal recurring adjustments that we consider necessary for fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future
quarters or for a full year.
Three Months Ended
Mar 31, 2007
Jun 30, 2007
Sep 30, 2007
Dec 31, 2007
Mar 31, 2008
Jun 30, 2008
Sep 30, 2008
Dec 31, 2008
(Unaudited) (Dollars in Thousands)
Cost of revenues
Selling and marketing
General and administrative
Arbitration settlement and related charges
Gain from sale of SAP sales and distribution operations, net
Our segment information has been prepared in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Operating segments are defined as components of an enterprise engaging in business activities about which separate financial information is available that is evaluated regularly by our chief operating decision-maker in deciding how to allocate resources and assess performance. Our chief operating decision-maker is our chief executive officer, who evaluates our performance and allocates resources based on segment revenues and operating profit.
In October 2008, we reorganized our operating segments to correspond to our three primary service lines, in line with changes made in the Companys management structure. Segment data for prior periods has been restated to reflect the current organization of the segments.
Our operating segments are:
Software Product Engineering, in which, through our Software Product Labs business unit, we offer software product research and development services. We set up these labs for clients and operate them on an ongoing basis, enabling us to collaborate with our clients engineering teams to
extend their capacity and budgets throughout the software product life cycle. We locate our Software Product Labs predominantly in India and in Central and Eastern Europe and we operate them across multiple locations as needed to optimize global delivery. They serve primarily customers in North America and Europe, and may include team members local to the client.
System Integration and Application Development, in which we offer a broad set of IT services to our clients in the area of system integration, application development and consulting. We provide these services in 18 countries throughout North America, Europe, Israel and Asia Pacific. We deliver the services through a global delivery model that includes local teams as well as offshore and near-shore resources. We provide these services for a wide range of clients in many verticals, including utilities and government, financial services, defense and homeland security, life sciences & healthcare, manufacturing and transportation, retail, and others.
Software Distribution, in which, through our NessPRO business unit, we market and sell enterprise software licenses of third-party software vendors to corporate clients in geographies which are partially or totally uncovered by the software vendors own sales forces. We also provide a range of implementation, customization and support services related to those licenses. We resell products mostly in Israel, Italy, Spain and Portugal for over 30 third-party software vendors.
Segment operating profit is defined as income from operations excluding unallocated headquarters costs. Expenses included in segment operating profit consist principally of direct selling, general, administrative and delivery costs. Certain general and administrative expenses, stock-based compensation and a portion of depreciation and amortization are not specifically allocated to specific segments as management believes they are not directly attributable to any specific segment. Accordingly, these expenses are categorized as Unallocated Expenses and adjusted against our total income from operations. Additionally, our management has
determined that it is not practical to allocate certain identifiable assets by segment, when such assets are used interchangeably among the segments.
The table below presents financial information for our three reportable segments (dollars in thousands).
As of December 31, 2008, we had cash and cash equivalents, restricted cash and short-term bank deposits of $58.7 million compared to $46.1 million as of December 31, 2007. The funds held at locations outside of the United States are for future operating expenses and capital expenditures, and we have no intention of repatriating those funds. We are not, however, restricted in repatriating those funds back to the United States, if necessary. While we expect that cash generated by our non-U.S. subsidiaries will be reinvested in their respective geographies to support expansion of our business, to the extent that funds were remitted to the United States
in the form of dividend payments, those payments may be subject to withholding taxes in their respective countries, and would be subject to tax in the United States.
The following table summarizes our cash flows for the periods presented (dollars in thousands):
Year Ended December 31,
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by financing activities
Effect of exchange rate changes on cash and cash equivalents
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at the beginning of the year
Cash and cash equivalents at the end of the year
2008 Compared to 2007
Net cash provided by operating activities was $33.9 million in 2008, compared to $16.1 million in 2007. The major factors contributing to the increase were higher net income, net of a gain from the sale of our Israeli SAP sales and distribution operations, representing $7.0 million, an increase in advances from customers and deferred revenues in 2008 compared to a decrease during 2007, representing $20.0 million, and an improvement in our cash collection efforts reflected in a smaller increase in our total trade receivables, representing $8.8 million, offset by a decrease in trade payables in 2008 compared to an increase in trade payables in 2007,
representing $12.6 million, and a $9.5 million payment made in the first quarter of 2008 in respect of an arbitration settlement with a former customer provided for in the fourth quarter of 2007.
Net cash used in investing activities was $43.8 million in 2008, compared with $57.2 million in 2007. The major factors contributing to the decrease were proceeds from the sale of our Israeli SAP sales and distribution operations, representing $14.9 million, a decrease in net cash paid for the acquisition of consolidated subsidiaries, representing $7.9 million, and lower payments in connection with acquisitions of subsidiaries in prior periods, representing $2.6 million, offset by increased investments in short-term bank deposits, representing $5.9 million, an increase in purchase of property and equipment, representing $4.4 million, and receipt of
the remaining net proceeds from the sale of our interest in dbMotion in 2007 for which there was no corresponding amount in 2008, representing $1.9 million.
Net cash provided by financing activities was $28.8 million in 2008, compared with $33.4 million in 2007. The major factors contributing to the decrease were lower proceeds from new long-term bank loans, representing $20.7 million, and an acquired subsidiarys dividends paid to its former shareholder in 2008 for which there was no corresponding amount in 2007, representing $10.0 million, the repurchase of shares as part of our share repurchase plan, representing $2.4 million, offset by net proceeds from short-term bank credit in 2008 compared to net repayment in 2007, representing $26.2 million.
The effect of exchange rate changes on cash and cash equivalents was ($11.3) million in 2008, compared to $4.1 million in 2007. The change was primarily due to the effect of translation adjustments on our net current assets.
In March 2008, one of our Israeli subsidiaries obtained a long-term loan of NIS 21.0 million (approximately $5.5 million at the exchange rate prevailing on December 31, 2008), from a commercial bank. The loan matures over five years and bears interest at a fixed rate. Principal and interest are paid quarterly. In addition, in October 2008, one of our Israeli subsidiaries obtained a short-term loan of NIS 30.0 million (approximately $7.9 million at the exchange rate prevailing on December 31, 2008) from a commercial bank. The principal of the loan matures over a period of one year, and bears interest at a fixed rate which is paid semi-annually. The
long-term loan and short-term loans obtained by this Israeli subsidiary contain covenants, which, among other things, require a minimum stockholders equity of this Israeli subsidiary; and which place limitations on merging, transferring or pledging assets. Our failure to comply with the covenants could lead to an event of default under the agreements governing some or all of the indebtedness, permitting the applicable lender to accelerate all borrowings under the applicable agreement, and to foreclose on any collateral. As of December 31, 2008, we were in compliance and expect to remain in compliance with these covenants.
In March 2008, we obtained a long-term loan in the amount of €12.0 million (approximately $17.0 million at the exchange rate prevailing on December 31, 2008) from a commercial bank. The loan matures over five years with principal payments commencing in the third year, and bears interest at a variable rate paid quarterly. In addition, in March 2008, we obtained a short-term loan in the amount of $5.5 million from a commercial bank. The loan bore interest at a variable rate and matured on April 30, 2008, and interest was paid upon maturity of the loan. The loan was renewed at maturity for an additional six months on substantially similar terms.
In October and November 2008, the short-term loan was renewed again, and we obtained additional short-term loans totaling $8.0 million. The loans bear a weighted average interest rate of 5.34% and mature over a period of approximately six months. The long-term loan and the short-term loan contain covenants, which, among other things, require a certain ratio of total financial obligations to consolidated EBITDA and a minimum consolidated stockholders equity; and which place limitations on merging, transferring or pledging assets. Our failure to comply with the covenants could lead to an event of default under the agreements governing some or all of the indebtedness, permitting the applicable lender to accelerate all borrowings under the applicable agreement. As of December 31, 2008, we were in compliance and expect to remain in compliance with these covenants. In connection with the above-mentioned covenants, we received the consent of the commercial banks during 2008 to record a
fixed charge on deposits in the amount of $2.3 million held by our Indian subsidiary related primarily to the mark-to-market of foreign exchange forward contracts into which we entered to hedge against the effect of exchange rate fluctuations on cash flows denominated in Indian Rupee.
At December 31, 2008, we had three long-term loans taken in 2007 to fund acquisitions: a long-term loan from a commercial bank in the amount of €9.0 million, or $12.7 million, to fund the acquisition of NessPRO Italy S.p.A., taken in September 2007; a long-term loan from a commercial bank in the amount of €13.9 million, or $19.7 million, to fund the acquisition of FMC Consulting and Informatics Ltd., taken in November 2007; and a long-term loan from a commercial bank in the amount of $12.0 million to fund the acquisition of MS9 Consulting LLC, taken in November 2007. The loans mature over five years with principal payments commencing in
the third year, and bear interest at fixed and variable rates paid quarterly. The long-term loans contain covenants, which, among other things, require a certain ratio of total financial obligations to consolidated EBITDA and a minimum consolidated stockholders equity; and which place limitations on merging or transferring assets. As of December 31, 2008, we are in compliance and expect to remain in compliance with these covenants. Our failure to comply with the covenants could lead to an event of default under the agreements governing some or all of the indebtedness, permitting the applicable lender to accelerate all borrowings under the applicable agreement.
At December 31, 2008, one of our Israeli subsidiaries had a long-term loan denominated in NIS (linked to the Israeli Consumer Price Index), of $1.3 million. The long-term loan, borrowed from a commercial bank in December 2003, bore an annual interest rate of 6.5%, and was repaid on January 1, 2009.
Bank guarantees obtained by the above-mentioned Israeli subsidiary contain covenants, which, among other things, require a minimum net income of our subsidiary and a minimum stockholders equity of our Israeli subsidiary; and which place limitations on merging or transferring assets. Our failure to comply with the covenants could lead to an event of default under the agreements governing some or all of the indebtedness, permitting the applicable lender to accelerate all borrowings under the applicable agreement, and to foreclose on any collateral. As of December 31, 2008, we were in compliance with these covenants.
At December 31, 2008, one of our non-U.S. subsidiaries had short-term borrowings denominated in Euros aggregating to $2.0 million with a weighted average interest rate of 6.84%.
We anticipate funding a portion of our global growth through financing from commercial banks.
We intend to fund future growth through future cash flow from operations and available bank borrowings. We believe the borrowings and future cash flow from operations will be sufficient to fund continuing operations for the foreseeable future.
In order to achieve our strategic business objectives, we may be required to seek additional financing. For example, future acquisitions may require additional equity and/or debt financing. In addition, we may require
We do not have any significant off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. In addition, we have not entered into any derivative contracts, other than as disclosed in Note 2n of our financial statements included elsewhere in this report, or any synthetic leases.
Our major outstanding contractual obligations related to our long-term debt, operating leases and accrued severance pay. We have summarized in the table below our fixed contractual cash obligations for long-term debt and operating leases as of December 31, 2008 (dollars in thousands):