UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2006

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

For the transition period from                  to                 

Commission File Number 000-50954

NESS TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

 

Ness Tower
Atidim High-Tech Industrial Park
Building 4
Tel Aviv 61580, Israel
Telephone: +972 (3) 766-6800
(Address of registrant’s principal executive offices and registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer     o     Accelerated filer     x      Non-accelerated filer     o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

As of October 31, 2006, 36,750,316 shares of common stock, $0.01 par value per share, were outstanding.

 

NESS TECHNOLOGIES, INC. AND SUBSIDIARIES

INDEX

	Page
PART I – FINANCIAL INFORMATION	3
Item 1. Financial Statements	3
Condensed Consolidated Balance Sheets – December 31, 2005 and September 30, 2006 (Unaudited)	3
Condensed Consolidated Statements of Income – Three and nine months ended September 30, 2005 and 2006 (Unaudited)	5
Condensed Consolidated Statements of Cash Flows – Nine months ended September 30, 2005 and 2006 (Unaudited)	6
Notes to Interim Condensed Consolidated Financial Statements – September 30, 2006 (Unaudited)	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Overview	26
Recent Developments	27
Consolidated Results of Operations	27
Three Months Ended September 30, 2006 Compared to the Three Months Ended September 30, 2005	27
Nine Months Ended September 30, 2006 Compared to the Nine Months Ended September 30, 2005	29
Results by Business Segment	32
Liquidity and Capital Resources	33
Forward-Looking Statements and Risk Factors	35
Item 3. Quantitative and Qualitative Disclosure about Market Risk	35
Item 4. Controls and Procedures	36
Evaluation of Disclosure Controls and Procedures	36
Changes in Internal Control	36
PART II – OTHER INFORMATION	37
Item 1. Legal Proceedings	37
Item 1A. Risk Factors	37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3. Defaults upon Senior Securities	37
Item 4. Submission of Matters to a Vote of Security Holders	37
Item 5. Other Information	37
Item 6. Exhibits	37
SIGNATURES	38
EXHIBIT INDEX	39

 

2

 

PART I – FINANCIAL INFORMATION

U.S. dollars in thousands

		December 31,			September 30,
		2005			2006
					(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	33,579		$	40,186
Short-term bank deposits		39,561			4,862
Marketable securities		2,651			—
Trade receivables (net of allowance for doubtful accounts of $2,320 and $2,731 at December 31, 2005 and September 30, 2006 (unaudited), respectively)		99,097			103,567
Unbilled receivables		21,500			39,459
Other accounts receivable and prepaid expenses		13,664			19,459
Inventories and work in progress		2,506			888
Total current assets		212,558			208,421
LONG-TERM ASSETS:
Long-term prepaid expenses		4,816			6,482
Marketable securities		32			118
Trade and unbilled receivables		7,045			12,133
Deferred income taxes		5,271			3,884
Severance pay fund		35,845			41,270
Total long-term assets		53,009			63,887
PROPERTY AND EQUIPMENT, NET		21,308			25,418
INTANGIBLE ASSETS, NET		7,938			9,028
GOODWILL		159,421			186,324
Total assets		$	454,234		$	493,078

 

 

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

3

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

		December 31,			September 30,
		2005			2006
					(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Short-term bank credit		$	21,011		$	25,639
Current maturities of long-term debt		6,862			6,387
Trade payables		35,259			28,512
Advances from customers		7,670			9,078
Other accounts payable and accrued expenses		82,657			79,410
Total current liabilities		153,459			149,026
LONG-TERM LIABILITIES:
Long-term debt, net of current maturities		6,294			2,697
Excess of losses over investment in affiliates		257			480
Accrued severance pay		39,722			45,295
Total long-term liabilities		46,273			48,472
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS’ EQUITY:
Common stock of $0.01 par value -
Authorized: 76,500,000 shares at December 31, 2005 and at September 30, 2006 (unaudited); Issued and outstanding: 34,771,837 shares at December 31, 2005 and 36,267,424 shares at September 30, 2006 (unaudited)		348			363
Additional paid-in capital		282,642			295,019
Accumulated other comprehensive loss		(13,559		)	(5,098		)
Retained earnings (accumulated deficit)		(14,929		)	5,296
Total stockholders’ equity		254,502			295,580
Total liabilities and stockholders’ equity		$	454,234		$	493,078

 

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

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

		Three months ended September 30,						Nine months ended September 30,
		2005			2006			2005			2006
		(Unaudited)						(Unaudited)
Revenues		$	97,719		$	119,135		$	280,342		$	342,791
Cost of revenues (*)		69,628			85,095			200,252			244,792
Gross profit		28,091			34,040			80,090			97,999
Operating expenses:
Selling and marketing		7,081			8,391			21,114			25,615
General and administrative (*)		13,344			15,489			40,538			46,845
Total operating expenses		20,425			23,880			61,652			72,460
Operating income		7,666			10,160			18,438			25,539
Financial expenses, net		(383		)	(492		)	(1,297		)	(1,130		)
Other income (expenses), net		(14		)	(8		)	(10		)	436
Income before taxes on income		7,269			9,660			17,131			24,845
Taxes on income		1,252			1,709			2,277			4,517
Equity in net losses of affiliates		—			(13		)	(29		)	(103		)
Minority interests in losses of a subsidiary		—			—			101			—
Net income		$	6,017		$	7,938		$	14,926		$	20,225
Basic net earnings per share		$	0.17		$	0.22		$	0.43		$	0.57
Diluted net earnings per share		$	0.17		$	0.22		$	0.42		$	0.56

(*)   Expenses include stock-based compensation, as follows:

		Three months ended September 30,						Nine months ended September 30,
		2005			2006			2005			2006
		(Unaudited)						(Unaudited)
Cost of revenues		$	—		$	—		$	98		$	—
General and administrative		76			204			1,875			495

 

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

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

U.S. dollars in thousands

		Nine months ended September 30,
		2005			2006
		(Unaudited)
Cash flows from operating activities:
Net income		$	14,926		$	20,225
Adjustments required to reconcile net income to net cash used in operating activities:
Stock-based compensation-related expenses		2,085			471
Equity in net losses of affiliates		29			103
Minority interests in losses of a subsidiary		(101		)	—
Currency fluctuation of long-term debt		2,281			353
Accrued interest on long-term debt		(634		)	(1,347		)
Depreciation and amortization		6,448			8,594
Deferred income taxes, net		(1,412		)	1,383
Loss on sale of property and equipment		21			105
Decrease (increase) in trade receivables		(15,561		)	2,010
Increase in unbilled receivables		(10,271		)	(18,554		)
Increase in other accounts receivable and prepaid expenses		(77		)	(5,575		)
Decrease (increase) in inventories and work in progress		(1,231		)	1,824
Increase in long-term prepaid expenses		(1,666		)	(1,026		)
Decrease in trade payables		(9,308		)	(10,049		)
Increase (decrease) in advances from customers		(3,608		)	862
Increase (decrease) in other accounts payable and accrued expenses		8,212			(11,352		)
Tax benefits related to exercise of options		—			628
Increase (decrease) in accrued severance pay, net		598			(103		)
Net cash used in operating activities		(9,269		)	(11,448		)
Cash flows from investing activities:
Net cash paid for acquisition of consolidated subsidiaries (a)		(4,364		)	(13,683		)
Additional payments in connection with acquisitions of subsidiaries in prior periods		—			(5,162		)
Acquisition of minority interest in a subsidiary (b)		(114		)	—
Proceeds from maturity of short-term bank deposits		—			35,211
Proceeds from sale of marketable securities		387			2,779
Acquisition of available-for-sale marketable securities		(5,202		)	—
Proceeds from sale of property and equipment		149			597
Purchase of property and equipment and capitalization of software development costs for internal use		(6,012		)	(9,396		)
Capitalization of software development costs		(1,633		)	(255		)
Net cash provided by (used in) investing activities		(16,789		)	10,091

 

 

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

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

U.S. dollars in thousands

		Nine months ended September 30,
		2005			2006
		(Unaudited)
Cash flows from financing activities:
Exercise of options and warrants		$	9,132		$	9,376
Short-term bank loans and credit, net		5,116			1,128
Proceeds from long-term debt		21,216			—
Principal payments of long-term debt		(34,345		)	(4,038		)
Net cash provided by financing activities		1,119			6,466
Effect of exchange rate changes on cash and cash equivalents		(4,987		)	1,498
Increase (decrease) in cash and cash equivalents		(29,926		)	6,607
Cash and cash equivalents at the beginning of the period		104,229			33,579
Cash and cash equivalents at the end of the period		$	74,303		$	40,186
Supplemental disclosures of cash flows information:
Cash paid during the period for:
Interest		$	895		$	1,384
Taxes		$	897		$	12,715

 

(a)

In conjunction with the acquisitions, the fair values of the assets acquired and liabilities assumed at the date of the related acquisition were as follows:

 

Working capital (capital deficiency), net (excluding cash and cash equivalents)		$	(1,859	)	$	(1,777	)
Long-term assets		—			519
Property and equipment		2,353			—
Other assets		48			(214		)
Long-term loans		(1,601		)	2,488
Customer relations and backlog		680			14,886
Goodwill		3,744			4,773
Workforce		1,069			(8,225		)
Accrual for additional consideration to be paid subsequent to the balance sheet date		—			—
Accrued severance pay, net		(70		)	$	13,683
Net cash used in acquisitions of consolidated subsidiaries		$	4,364		434

 

(b)

In conjunction with the acquisition of the minority interest in a subsidiary during the nine months ended September 30, 2005, the fair values of the assets acquired and liabilities assumed at the date of acquisition were as follows:

 

Minority interest		$	197		$	—
Goodwill		3,196			—
Customer-related intangible assets		139			—
		3,532			—
Issuance of shares		(3,418			—
Net cash used in acquisition of a consolidated subsidiary		$	114		$	—

 

 

(c)

Non-cash financing activity:

 

Capitalization of redeemable options accrual upon partial exercise of options

$

—

$

1,868

 

 

 

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

7

 

NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

Note 1: General

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

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

Note 2: Significant Accounting Policies

a.               Unaudited Interim Financial Information

The accompanying condensed consolidated balance sheet as of September 30, 2006, the condensed consolidated statements of income for the three and nine months ended September 30, 2005 and 2006, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2005 and 2006 are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with U. S. generally accepted accounting principles for interim financial information. In the opinion of management, the unaudited interim condensed consolidated financial statements include all adjustments of a normal recurring nature necessary for a fair presentation of our consolidated financial position as of September 30, 2006, our consolidated results of operations for the three and nine months ended September 30, 2005 and 2006, and our consolidated cash flows for the nine months ended September 30, 2005 and 2006.

The balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U. S. generally accepted accounting principles for complete financial statements.

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes for the year ended December 31, 2005 included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on March 15, 2006.

Results for the three and nine months ended September 30, 2006 are not necessarily indicative of results that may be expected for the year ending December 31, 2006.

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

b.              Use of estimates

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

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

c.               Financial statements in U.S. dollars

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

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

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

d.              Principles of consolidation

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

e.               Acquisition of subsidiaries

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

On November 12, 2004, we filed a Form S-4 Registration Statement in respect of an exchange offer for the remaining shares of Ness U.S.A. which we did not already own. The offer commenced on January 31, 2005 and ended on February 28, 2005. 96 of 98 offerees accepted the offer bringing our holdings in Ness U.S.A. following the offer to 99.9%. On March 1, 2005, we issued 260,316 shares to the offerees, for the consideration of $3,532. The acquisition was accounted for under the purchase method of accounting according to SFAS No. 141, “Business Combinations.”

In September 2005, Ness U.S.A. purchased the outstanding shares of Ness U.S.A.’s common stock from the remaining two offerees in a private transaction, and it immediately thereafter retired the shares, since which time we have held 100% of the shares of common stock of Ness U.S.A.

On January 3, 2006, Ness U.S.A. was merged into Ness Global Services, Inc. Subsequently the surviving company changed its name to Ness USA, Inc.

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

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

 

The allocation of the purchase price reflected in the consolidated balance sheet is according to a valuation of Ness U.S.A.’s current assets, current liabilities, long-term tangible assets, property and equipment and intangible assets.

2.           Ness Romania

On April 1, 2005, we acquired all of the outstanding shares of Radix Company SA (“Radix”), a provider of IT services and solutions based in Romania. The purchase price was €4 million, or $5,385, consisting of €2 million paid in cash at the closing and €2 million placed in escrow for six months contingent on the verification of the accuracy of certain representations made by the sellers. Additional payments of €1.5 million, or $1,775, were made in April 2006 based on achievement of certain revenue and operating income milestones in 2005. The additional payments were accrued for and recorded as goodwill in the December 31, 2005 consolidated balance sheet. An additional payment of up to €1.5 million will be required to be made in April 2007 based on achievement of certain revenue and operating income milestones for 2006. Currently, we cannot estimate the probability of achieving the 2006 milestones. Radix became a wholly-owned subsidiary of our Dutch subsidiary, Ness Technologies, B.V., and, accordingly, its results of operations have been included in our consolidated financial statements since the acquisition date. Upon completion of the acquisition, Radix Company SA changed its name to Ness Romania.

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

This acquisition was accounted for under the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their related fair values. Based upon a valuation of tangible and intangible assets acquired and liabilities assumed, we have allocated the total cost of the acquisition to Ness Romania’s assets and liabilities (as of the acquisition date, except for goodwill, which was updated to include the additional payments) as follows:

 

The allocation of the purchase price reflected in the consolidated balance sheet is according to a valuation of Radix’s current assets, current liabilities, long-term liabilities, property and equipment and intangible assets.

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

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

b.              The value assigned to the customer-related intangibles amounted to $680. The fair value of Radix’s customer-related intangibles was determined using the Income Approach.

3.           Ness DM a.s.

On June 1, 2005, we acquired all of the outstanding shares of Efcon a.s. (“Efcon”), a provider of IT services and solutions based in the Czech Republic. The purchase price was €0.6 million, or $738, consisting of €350,000 paid at closing and €250,000 paid in July 2005. An additional

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

payment of €0.2 million, or $237, was made in February 2006 based on achievement of certain 2005 performance goals. The additional payment was accrued for and recorded as goodwill in the December 31, 2005 consolidated balance sheet. Efcon became a wholly-owned subsidiary of Ness Czech s.r.o., a part of our Ness Europe group, and, accordingly, its results of operations have been included in our consolidated financial statements since the acquisition date. Following the acquisition, Efcon changed its name to Ness DM a.s.

This acquisition was accounted for under the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their related fair values. Based upon a valuation of tangible and intangible assets acquired and liabilities assumed, we have allocated the total cost of the acquisition to Ness DM’s assets and liabilities (as of the acquisition date, except for goodwill, which was updated to include the additional payment) as follows:

 

The allocation of the purchase price reflected in the consolidated balance sheet is according to a valuation of Ness DM’s current assets, current liabilities, long-term liabilities, property and equipment and intangible assets.

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

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

b.              The value assigned to the customer-related intangibles amounted to $64. The fair value of Ness DM’s customer-related intangibles was determined using the Income Approach.

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

4.           NTR

On September 12, 2005, we acquired all of the outstanding shares of N.T.R. Holding Ltd. (“NTR”), a provider of IT services and solutions based in Israel. The purchase price was $1,350. Additional payments of $150 were made in June 2006 based on achievement of certain 2005 performance goals. The additional required payments were accrued for and recorded as goodwill in the December 31, 2005 consolidated balance sheet. NTR became a wholly-owned subsidiary of Ness A.T., a part of our Ness Israel group, and, accordingly, its results of operations have been included in the consolidated financial statements since September 12, 2005.

This acquisition was accounted for under the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their related fair values. Based upon a valuation of tangible and intangible assets acquired and liabilities assumed, we have allocated the total cost of the acquisition to NTR’s assets and liabilities (as of the acquisition date, except for goodwill, which was updated to include the additional payments) as follows:

 

The allocation of the purchase price reflected in the consolidated balance sheet is according to a valuation of NTR’s current assets, current liabilities, long-term liabilities, property and equipment and intangible assets.

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

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

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

b.              The value assigned to the customer-related intangibles amounted to $464. The fair value of NTR’s customer-related intangibles was determined using the Income Approach.

5.           Delta

On October 3, 2005, we acquired all the outstanding shares of Delta Electronic Services a.s. (“Delta”), a provider of IT services and solutions in Slovakia. We acquired the outstanding shares for cash consideration of $8,000 and related purchase costs of approximately $115. In addition, as Delta achieved certain business goals by the end of 2005, we paid an additional amount of $3,000 during 2006. Upon completion of the acquisition, Delta changed its name to Ness Slovakia, and it operates as a part of Ness Europe. Delta became a wholly-owned subsidiary of Ness B.V., a part of the Ness Europe group, and, accordingly, its results of operations have been included in the consolidated financial statements since October 3, 2005.

This acquisition was accounted for under the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their related fair values. Based upon a valuation of tangible and intangible assets acquired and liabilities assumed, we have allocated the total cost of the acquisition to Delta’s assets and liabilities (as of the acquisition date, except for goodwill, which was updated to include the additional payment) as follows:

 

The allocation of the purchase price reflected in the consolidated balance sheet is according to a valuation of Delta’s current assets, current liabilities, long-term liabilities, property and equipment and intangible assets.

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

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

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

b.              The value assigned to the customer-related intangibles amounted to $1,881. The fair value of Delta’s customer-related intangibles was determined using the Income Approach.

6.           Innova

On February 28, 2006, we acquired all of the outstanding shares of Olas Software Solutions, Inc., d/b/a Innova Solutions (“Innova”), a provider of IT services and solutions based in the United States and India. We acquired the outstanding shares for cash consideration of $15,000 and related purchase costs of approximately $249. Additional payments of up to $10,000 are required to be made in April 2007 and April 2008 based on achievement of certain revenue and operating income milestones for the years 2006 and 2007, respectively. We have provided for a payment of $8,225 related to the milestones of 2006. Currently, we cannot estimate the probability of achieving the milestones of 2007.

Innova became a wholly-owned subsidiary of Ness Technologies, Inc. and, accordingly, its results of operations are included in our consolidated financial statements since the acquisition date. Upon completion of the acquisition, Innova changed its name to Ness Innovative Business Services.

This acquisition was accounted for under the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their relative fair values. Based upon a valuation of tangible and intangible assets acquired and liabilities assumed, we have allocated the total cost of the acquisition to Innova’s assets and liabilities (as of the acquisition date) as follows:

 

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

 

The allocation of the purchase price reflected in the consolidated balance sheet is according to a valuation of Innova's current assets, current liabilities, long-term liabilities, property and equipment, other long-term assets and intangible assets.

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

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

b.              The value assigned to the customer-related intangibles amounted to $2,488. The fair value of Innova’s customer-related intangibles was determined using the Income Approach. Customer relations is amortized over its useful life, estimated as 4.83 years. Backlog is amortized according to its expected revenue recognition schedule.

Pro forma information in accordance with SFAS No. 141 has not been provided, since the revenues and net income of Ness Innovative Business Services were not material in relation to our total consolidated revenues and net income.

f.                 Goodwill

On January 1, 2006, we began segment reporting, and therefore we allocated our goodwill balance as of January 1, 2006 to our reportable segments based on their relative fair value as of that date.

In the nine months ended September 30, 2006, we recorded additional goodwill resulting from the acquisition of Innova and additional consideration to be paid subsequent to the balance sheet date, together representing $19,659.

We have elected to perform our annual goodwill impairment test during the fourth quarter of the year. No indications of impairment were identified during the three and nine months ended September 30, 2006.

g.              Accounting for stock-based compensation

On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”) utilizing the modified prospective transition method. SFAS 123(R) requires employee stock options to be valued at fair value on the date of grant and charged to expense over the applicable service period. Under the modified prospective method, compensation expense is recognized for all share-based payments issued on or after January 1, 2006 and for all share-based payments issued to employees prior to January 1, 2006 that remain unvested.

Our results of operations for the three and nine months ended September 30, 2006 include expenses of $204 and $495, respectively, in operating expense related to the adoption of SFAS 123(R). In accordance with the modified prospective method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

Adoption of SFAS 123(R) did not change our accounting for share-based payments issued to non-employees.

Prior to the adoption of SFAS 123(R), we accounted for share-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Additionally, prior to January 1, 2006, we provided pro forma disclosure amounts in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS No. 148”), as if the fair value method defined by SFAS 123 had been applied to stock-based compensation. Under APB Opinion No. 25, the exercise price of stock options granted to employees and directors equaled the fair market value of the underlying stock at the grant date, therefore, no share-based compensation expense was recognized in our condensed consolidated statement of income.

SFAS 123(R) requires companies to estimate the fair value of share-based awards on the date of grant using an option-pricing model, where applicable. Share-based compensation expense recognized in our condensed consolidated statement of income for the first and second quarters of fiscal 2006 includes compensation expense for share-based awards granted (i) prior to, but not yet vested as of, December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and (ii) subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). We recognize these compensation costs net of a forfeiture rate and recognize the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of three to four years. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In our pro forma information required under SFAS 123 for periods prior to fiscal 2006, we accounted for forfeitures as they occurred.

As of September 30, 2006, approximately $218 of total unrecognized compensation cost related to stock based compensation is expected to be recognized over a weighted-average period of 2.25 years. The total unrecognized stock-based compensation cost to be recognized in future periods as of September 30, 2006 does not consider the effect of stock options that may be issued in subsequent periods.

During the six months ended June 30, 2006, no options were granted. During the three months ended September 30, 2006, we extended the term of certain options previously granted to Aharon Fogel, our Chairman of the Board, and Raviv Zoller, our President and CEO, representing 366,262 and 154,323 options, respectively, to February 28, 2007, and we granted 26,974 options to a former employee. Our results of operations include expenses of $195 related to these modifications.

The fair value for options granted in the three and nine month periods ended September 30, 2005 and the options extended and granted in the three and nine months ended September 30, 2006 is amortized over their vesting periods and estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

		Three and nine months ended September 30, 2005		Three and nine months ended September 30, 2006
		(Unaudited)		(Unaudited)
Dividend yield		0	%	0	%
Expected volatility		0.38		0.31
Risk-free interest		4.25	%	5.15	%
Expected life (in years)		4		0.52

 

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

The pro forma information regarding net income and earnings per share required by SFAS No. 123 has been determined as if we accounted for our stock-based compensation plans under the fair value method. Had compensation cost for our stock-based compensation plans been determined in accordance with SFAS No. 123, as amended by SFAS No. 148, our net income and earnings per share would have been reduced to the pro forma amounts indicated below:

		Three months ended September 30, 2005			Nine months ended September 30, 2005
		(Unaudited)			(Unaudited)
Net income available to common stock, as reported		$	6,017		$	14,926
Add: Stock-based employee compensation – intrinsic value		76			1,973
Deduct: Stock-based employee compensation – fair value		(708		)	(4,201		)
Pro forma net income		$	5,385		$	12,698
Basic net earnings per share, as reported		$	0.17		$	0.43
Diluted net earnings per share, as reported		$	0.17		$	0.42
Pro forma basic net earnings per share		$	0.16		$	0.37
Pro forma diluted net earnings per share		$	0.15		$	0.36

 

h.              Impact of recently issued accounting pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of SFAS No. 157 is not expected to have a material impact on our financial position, results of operations or cash flows.

In September 2006, the FASB also issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post-Retirement Plans — an Amendment of FASB Statements No. 87, 88, 106 and 132(R).” This standard requires recognition of the funded status of benefit plans in statements of financial position. The standard also requires recognition in other comprehensive income of certain gains and losses that arise during the period but are deferred under pension accounting rules; and it modifies the timing of reporting and adds certain disclosures. The recognition and disclosure elements of SFAS No. 158 are effective for fiscal years ending after December 15, 2006 and the measurement elements are effective for fiscal years ending after December 15, 2008. Management is currently evaluating the effect that the adoption of SFAS No. 158 would have on our financial position and results of operations.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”). FIN 48 creates a single model to address uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 clearly scopes out income taxes from Financial Accounting Standards Board Statement No. 5, “Accounting for Contingencies.” FIN 48 utilizes a two-step approach for evaluating tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) is only addressed if step one has been satisfied (i.e., the position is more-likely-than-not to be sustained). FIN 48 applies to all tax positions related to income taxes subject to Financial

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

Accounting Standards Board Statement No. 109, “Accounting for Income Taxes.” This includes tax positions considered to be “routine” as well as those with a high degree of uncertainty. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is in the process of evaluating the possible impact of the adoption of FIN 48 on our consolidated financial statements.

In March 2006, the FASB issued FASB Statement No. 156, “Accounting for Servicing of Financial Assets,” (“FAS 156”) which amends FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This statement addresses the recognition and measurement of separately recognized servicing assets and liabilities, such as those common with mortgage securitization activities, and provides an approach to simplify efforts to obtain hedge-like accounting. It also clarifies when an obligation to service financial assets should be separately recognized as a servicing asset or servicing liability and requires that those separately recognized assets or liabilities be initially measured at fair value, if practicable. FAS 156 permits an entity to choose either the amortization method or the fair value method for subsequent measurement and also permits a servicer that uses derivative financial instruments to offset risks on servicing to report both the derivative financial instrument and related servicing asset or liability by using a consistent measurement attribute – fair value. This statement shall be effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s first fiscal year beginning after September 15, 2006, with early adoption permitted. Management believes this statement will not have a material effect on our consolidated financial statements.

 In February 2006, the FASB issued FASB Statement No. 155, “Accounting for Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140.” This statement amends FASB Statements No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”), and No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”). This statement allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. It also clarifies which interest-only strips and principal-only strips are not subject to the requirements of FAS 133; establishes a requirement to evaluate interests in securitized financial assets to identify interest that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends FAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement shall be effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year beginning after September 15, 2006. Management believes this statement will not have a material effect on our consolidated financial statements.

i.                  Reclassification

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

Note 3: Long-Term Debt

a.               Composition

Our long-term debt is comprised as follows:

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

		December 31,  2005			September 30, 2006
					(Unaudited)
Banks (1)		$	11,610		$	8,660
Loans from others		1,546			424
		13,156			9,084
Less current maturities		6,862			6,387
		$	6,294		$	2,697

 

(1)            The long-term loans default upon the failure of any of our subsidiaries named as borrowers under the loans to satisfy certain conditions and comply with covenants. As of December 31, 2005 and September 30, 2006, management believes that the subsidiaries are in compliance with foregoing conditions. The weighted average interest rate on the bank loans as of December 31, 2005 was 6.75% and as of September 30, 2006 was 6.57%.

b.              Classification

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

		Interest rate (%)				Amount
		December 31,		September 30,		December 31,			September 30,
		2005		2006		2005			2006
				(Unaudited)					(Unaudited)
In, or linked to dollar		5-6		5-6		$	2,169		$	424
In NIS - linked to CPI		6-8		6-8		10,987			8,660
						$	13,156		$	9,084

 

c.               Maturities

The liabilities mature as follows:

As of December 31,
2006 (current maturity)						$         6,862
2007						4,158
2008						1,080
2009						1,056
						$       13,156

 

Note 4: Commitments and Contingent Liabilities

a.               Litigation

There are several outstanding claims filed against our subsidiaries by ex-employees and others. Our management believes that the provision in our consolidated financial statements and our insurance coverage are adequate to cover probable costs arising from these matters.

One of our Israeli subsidiaries is currently in a dispute with one of its clients, an Israeli insurance company, regarding the terms and conditions of a software development contract (the “Contract”). The insurance company claims that we have breached the Contract by not timely delivering the required software. The insurance company has issued a contract termination notice and is demanding payment of the amounts

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

paid so far, as well as unspecified damages. Furthermore, termination could affect our reputation and impair our relations with another client as well as with additional prospects for the software. We believe that we have not breached the Contract and that the delays were caused by the insurance company’s actions. The Contract provides for mandatory arbitration, which has not yet commenced, in which we intend to vigorously defend our position. The total scope of the project is approximately $9.0 million and the amount paid so far is $5.3 million. We can give no assurance at the present time of the exposure, if any, for these claims, but we believe that our liability insurance policy should cover such exposure. Accordingly, we concluded that no accrual is required in our consolidated financial statements as of September 30, 2006 in connection with the insurance company’s demand for repayments of amounts paid to us so far or for unspecified damages. In addition, we have not written off amounts we believe the insurance company owes us as of the balance sheet date based on the agreement. If the outcome of the dispute is not in our favor and not in line with our position described above, it may adversely affect our financial position, results of operations and cash flows.

b.              Guarantees

Guarantees are contingent commitments issued by us generally to guarantee our performance in different projects to our customers, such as tenders. The term of a guarantee generally is equal to the term of the related projects, which can be as short as 30 days or as long as 8 years. The maximum potential amount of future payments we could be required to make under our guarantees at December 31, 2005 and September 30, 2006, is $36,168 and $38,525, respectively. Included in these amounts are guaranties provided to the insurance company described in Note 4(a) above, which might require us to make future payments related to the agreement in the maximum amount of $2,060 as of September 30, 2006. No accrual was provided in the consolidated financial statements as of September 30, 2006 in connection with these contingencies. We do not hold collateral to support guarantees when deemed necessary.

c.               Liens and charges

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

Note 5: Stockholders’ Equity

a.               Redeemable options:

Our Executive Committee approved and resolved on August 31, 2004 to provide to certain optionees (specifically, those who exchanged their options in two previously public entities acquired by us for options in Ness) the right to redeem their options for a cash payment. The grant date occurred during the fourth quarter of 2004.

The redemption right was exercisable from October 1, 2004 until May 31, 2006. Each option subject to the redemption right was transferable by the employee to us for a cash payment linked, at the employee’s sole discretion, either to the Israeli CPI with NIS interest at the rate of 5% per year, or to the U.S. dollar with U.S. dollar interest at the rate of 6% per year, calculated from the original option grant date of September 23, 1999 or October 3, 1999 up to the redemption date. Each of 272,976 options were exercisable to acquire one share of our common stock at a price of $3.49 and were redeemable at the NIS equivalent amount of $10.12 per option as of May 31, 2006. Each of 77,382 options were exercisable to acquire one share of our common stock at a price of $7.45 and were redeemable at the NIS equivalent amount of $7.63 per option as of May 31, 2006.

We accounted for the rights following the guidance of FIN No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” relating to tandem awards and EITF No. 00-23, “Issues Related to the Accounting for Stock Compensation under APB No. 25 and FIN No. 44.” Accordingly, once we believed it was likely that the rights would be exercised in the future, a liability was recorded at the then value of the redemption rights with a corresponding charge to compensation expense.

On May 31, 2006, the redemption value of the redeemable options was higher than the difference between the market price of our shares and the strike price of the options. We had previously recorded all

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

the expected redemption value. The holders of 289,836 options preferred to exercise their options and sell their shares and receive from us in cash only the difference between the redemption values and the proceeds they received from the sale. The holders of the remaining 60,522 options elected to fully redeem the options.

The net cash payment was therefore only $1,485 and the remaining balance of the previously recorded liability, or $1,868, was classified as equity.

b.              Total comprehensive income:

		Three months ended September 30,						Nine months ended September 30,
		2005			2006			2005			2006
		(Unaudited)						(Unaudited)
Net income		$	6,017		$	7,938		$	14,926		$	20,225
Foreign currency translation adjustments, net		255			4,925			(8,956		)	8,460
Net unrealized losses (gains) on available-for-sale marketable securities		(86		)	43			(28		)	23
Comprehensive income (loss)		$	6,186		$	12,906		$	5,942		$	28,708

 

c.               Option exercises:

In the nine months ended September 30, 2006, a total of 1,495,587 options were exercised into common stock, including the aforementioned redeemable options, for aggregate consideration of $9,376.

Note 6: Segment Reporting

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.

At the end of 2005, we completed the reorganization of our operations into operating segments. Our chief operating decision-maker is our chief executive officer, who evaluates our performance and allocates resources based on segment revenues and operating profit.

Our operating segments are:

1. Managed Strategic Services, which includes India-based offshore services as well as system integration and application development and consulting services. Verticals served by this segment are: independent software vendors, life sciences and healthcare and others.

2. Technologies & Systems Group, which includes system integration and application development, real-time systems development, consulting and outsourcing services for the defense, government and homeland security vertical, as well as systems for the telecommunications vertical.

3. Ness Europe, which includes system integration and application development, outsourcing and software and consulting for Eastern European and Western European customers, including near-shore services from

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

Eastern Europe for Western European customers. Verticals served by this segment are: telecommunications and utilities, financial services and others.

4. Ness Israel, which includes system integration and application development, outsourcing, software and consulting and quality assurance and training for customers in Israel within the following verticals: financial services, government, life sciences and healthcare, manufacturing, retail, transportation and others.

5. Other, which comprises operations representing, individually, less than 10% of our consolidated revenues and operating profit. These include our operations in the United Kingdom and Asia Pacific as well as the recently acquired Ness Innovative Business Services division (formerly Innova).

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 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 five reportable segments. Prior period data is presented on a pro forma basis, as we were not organized into SFAS No. 131 operating segments at that time.

 

 

Our total revenues are attributed to geographic areas based on the location of the end customer.

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

The following presents total revenues for the three and nine month periods ended September 30, 2005 and 2006, and long-lived assets as of September 30, 2005 and 2006:

 

 

Note 7: Basic and Diluted Net Earnings per Share

Basic net earnings per share are computed based on the weighted average number of shares of common stock outstanding during each period. Diluted net earnings per share are computed based on the weighted average number of shares of common stock outstanding during each period, plus dilutive potential shares of common stock considered outstanding during the period, in accordance with SFAS No. 128, “Earnings per Share.”

The total weighted average number of shares related to the outstanding options and warrants excluded from the calculations of diluted net earnings per share, as they would have been anti-dilutive for all periods presented, was 1,230,265, 1,183,597, 2,203,644, 782,223 and 2,372,532 for the year ended December 31, 2005, the three months ended September 30, 2005 and 2006, and the nine months ended September 30, 2005 and 2006, respectively.

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

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NESS TECHNOLOGIES, INC. AND ITS SUBSIDIARIES

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

		Three months ended September 30,						Nine months ended September 30,
		2005			2006			2005			2006
		(Unaudited)						(Unaudited)
Numerator:
Net income, numerator for basic and diluted per share		$	6,017		$	7,938		$	14,926		$	20,225
Denominator:
Weighted average number of shares of common stock		34,648			35,910			34,314			35,471
Denominator for basic net earnings per share		34,648			35,910			34,314			35,471
Effect of dilutive securities:
Employee stock options and warrants		851			987			1,248			956
Denominator for diluted net earnings per share – adjusted weighted average assuming exercise of options		35,499			36,897			35,562			36,427

 

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

You should read the following discussion and analysis together with our unaudited consolidated financial statements and the accompanying notes. This discussion contains forward-looking statements, within the meaning of Section 27A of Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, including statements regarding our expected financial position, business and financing plans. These statements involve risks and uncertainties. Our actual results could differ materially from the results described in or implied by these forward-looking statements as a result of various factors, including those discussed below and elsewhere in our Annual Report on Form 10-K filed with the SEC on March 15, 2006, particularly under the headings “Disclosure Statement” and “Risk Factors.”

Overview

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

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

Our revenues increased to $119.1 million and $342.8 million for the three and nine months ended September 30, 2006, respectively, from $97.7 million and $280.3 million for the three and nine months ended September 30, 2005, respectively. Net income increased to $7.9 million and $20.2 million for the three and nine months ended September 30, 2006, respectively, from $6.0 million and $14.9 million for the three and nine months ended September 30, 2005, respectively.

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 the three and nine months ended September 30, 2006, no client accounted for more than 4% of our revenues and our largest twenty clients together accounted for approximately 29% and 33% of our revenues, respectively. For the three and nine months ended September 30, 2006, the percentage of our revenues generated from agencies of the government of Israel was 9%. Existing clients from prior years generated more than 85% of our revenues in the three and nine months ended September 30, 2006.

Our backlog as of September 30, 2006 was $548 million compared to $439 million as of September 30, 2005. This $109 million increase in our backlog was due primarily to new bookings. We achieve backlog through new signings of IT services projects and outsourcing contracts, including for new and repeat customers. We recognize backlog as revenue when we perform the services related to backlog.

For the three and nine months ended September 30, 2006, the percentage of our revenues derived from clients in Israel was 51% and 48%, respectively; in the United States, 24% and 26%, respectively; in Europe, 21% and 21%, respectively; in Asia and the Far East, 4% and 4%, respectively; and in other countries, 1% and 1%, respectively.

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