**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarter ended March 31, 2004**

 

**Commission File Number: 001-32033**

 

**TNS, INC.**

(Exact name of registrant as specified in its charter)

 

**DELAWARE**

(State or jurisdiction of incorporation or organization)

 

**36-4430020**

(I.R.S. Employer Identification Number)

 

**11480 Commerce Park Drive, Suite 600**

**Reston, VA 20191**

(Address of principal executive offices)

 

**(703) 453-8300**

(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 requirement for the past 90 days.

o Yes  ý No

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

 

**Shares Outstanding as of April 30, 2004**

**26,778,322 Shares of Common Stock, $0.001 par value**

 

 

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**TNS, INC.**

 

**INDEX**

 
|         |                      | **Page Number**                                                                                          |
|--------------|---------------------------|----------------------------------------------------------------------------------------------------------|
| **Part I:**  | **FINANCIAL INFORMATION** | 2                                                                                                        |
|         | Item 1.                   | Financial Statements (unaudited);                                                                        | 2 |
|         |                      | Condensed Consolidated Balance Sheets as of  December 31, 2003 and March 31, 2004              | 2 |
|         |                      | Condensed Consolidated Statements of  Operations for the three months ended March 31, 2003 and 2004 | 3 |
|         |                      | Condensed Consolidated Statements of Cash  Flows for the three months ended March 31, 2003 and 2004 | 4 |
|         |                      | Notes to Condensed Consolidated Financial  Statements                                                    | 5 |
|         | Item 2.                   | Management’s Discussion and Analysis of Financial Condition and  Results of Operations              | 13 |
|         | Item 3.                   | Quantitative and Qualitative Disclosures About Market Risk                                               | 19 |
|         | Item 4.                   | Controls and Procedures                                                                                  | 20 |
| **Part II:** | **OTHER INFORMATION**     | 21                                                                                                       |
|         | Item 1.                   | Legal Proceedings                                                                                        | 21 |
|         | Item 2.                   | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity  Securities                        | 21 |
|         | Item 3.                   | Default Upon Senior Securities                                                                           | 21 |
|         | Item 4.                   | Submission of Matters to a Vote of Security Holders                                                      | 21 |
|         | Item 5.                   | Other Information                                                                                        | 21 |
|         | Item 6.                   | Exhibits and Reports on Form 8-K                                                                         | 21 |

 

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PART I -FINANCIAL INFORMATION

 

**Item 1.****  Condensed Consolidated Financial Statements (Unaudited)**

 

TNS, INC.

(formerly TNS Holdings, Inc.)

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share and per share data)

 
|                                                                                                                                                                                                                          |   | **December 31,  2003** |    | **March 31,  2004** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|---------------------|--------|
|                                                                                                                                                                                                                          |   |                        |    | **(unaudited)**     |   |
| **ASSETS**                                                                                                                                                                                                                    |   |                        |    |                |   |
| Current assets:                                                                                                                                                                                                               |   |                        |    |                |   |
| Cash and cash equivalents                                                                                                                                                                                                     |   | $                           | 11,074  |                | $      | 10,917 |   |
| Accounts receivable, net of allowance for  doubtful accounts of  $4,313 and  $4,419, respectively                                                                                                                        |   | 41,490                      |    | 44,429              |   |
| Other current assets                                                                                                                                                                                                          |   | 7,457                       |    | 9,033               |   |
| Total current assets                                                                                                                                                                                                          |   | 60,021                      |    | 64,379              |   |
| Property and equipment, net                                                                                                                                                                                                   |   | 45,745                      |    | 44,242              |   |
| Identifiable intangible assets, net                                                                                                                                                                                           |   | 223,919                     |    | 215,410             |   |
| Goodwill                                                                                                                                                                                                                      |   | 4,453                       |    | 4,453               |   |
| Other assets                                                                                                                                                                                                                  |   | 8,221                       |    | 7,781               |   |
| Total assets                                                                                                                                                                                                                  |   | $                           | 342,359 |                | $      | 336,265 |   |
|                                                                                                                                                                                                                          |   |                        |    |                |   |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT)  EQUITY**                                                                                                                                                                      |   |                        |    |                |   |
| Current liabilities:                                                                                                                                                                                                          |   |                        |    |                |   |
| Current portion of long-term debt                                                                                                                                                                                             |   | $                           | 28,731  |                | $      | 11,250 |   |
| Accounts payable, accrued expenses and  other current liabilities                                                                                                                                                             |   | 42,072                      |    | 35,999              |   |
| Deferred revenue                                                                                                                                                                                                              |   | 7,320                       |    | 8,687               |   |
| Total current liabilities                                                                                                                                                                                                     |   | 78,123                      |    | 55,936              |   |
| Long-term debt, net of current portion                                                                                                                                                                                        |   | 121,664                     |    | 67,010              |   |
| Other liabilities                                                                                                                                                                                                             |   | 3,614                       |    | 3,600               |   |
| Total liabilities                                                                                                                                                                                                             |   | 203,401                     |    | 126,546             |   |
| Commitments and contingencies                                                                                                                                                                                                 |   |                        |    |                |   |
| Class A redeemable convertible preferred  stock, $0.01 par value; 5,000,000 shares authorized; 134,846 shares issued  and outstanding as of December 31, 2003, and no shares issued or  outstanding as of March 31, 2004 |   | 176,470                     |    | —              |   |
| Stockholders’ (deficit) equity:                                                                                                                                                                                          |   |                        |    |                |   |
| Common stock, $0.001 par value; 130,000,000  shares authorized; 12,373,370 and 26,778,322 shares issued and outstanding,  respectively                                                                                        |   | 12                          |    | 27                  |   |
| Additional paid-in capital                                                                                                                                                                                                    |   | 2,277                       |    | 258,908             |   |
| Accumulated deficit                                                                                                                                                                                                           |   | (38,889                     | )       | (43,976             | )      |
| Deferred stock compensation                                                                                                                                                                                                   |   | (173                        | )       | (5,416              | )      |
| Accumulated other comprehensive (loss)  income                                                                                                                                                                                |   | (739                        | )       | 176                 |   |
| Total stockholders’ (deficit) equity                                                                                                                                                                                     |   | (37,512                     | )       | 209,719             |   |
| Total liabilities and stockholders’  (deficit) equity                                                                                                                                                                    |   | $                           | 342,359 |                | $      | 336,265 |   |

 

See accompanying notes to condensed consolidated financial statements(unaudited).

 

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TNS, INC.

(formerly TNS Holdings, Inc.)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(dollars in thousands, except share and per share data)

 
|                                                                         |   | **Three  months ended March 31,** |   |
|------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                         |   | **2003**                          |   | **2004** |   |
|                                                                         |   |                              |   |   |   |
| Revenues                                                                     |   | $                                 | 50,631 |   | $ | 60,156 |   |
| Operating expenses:                                                          |   |                              |   |   |   |
| Cost of network services, exclusive of the  items shown separately below     |   | 28,177                            |   | 30,692 |   |
| Engineering and development                                                  |   | 2,872                             |   | 3,439 |   |
| Selling, general, and administrative                                         |   | 8,988                             |   | 11,019 |   |
| Depreciation and amortization of property  and equipment                     |   | 4,782                             |   | 4,806 |   |
| Amortization of intangible assets                                            |   | 6,286                             |   | 8,508 |   |
| Total operating expenses                                                     |   | 51,105                            |   | 58,464 |   |
| (Loss) income from operations                                                |   | (474                              | )      | 1,692 |   |
| Interest expense                                                             |   | (2,878                            | )      | (4,433 | ) |
| Interest income                                                              |   | 35                                |   | 36 |   |
| Other income, net                                                            |   | 539                               |   | 101 |   |
| Loss before income taxes and equity in net  loss of unconsolidated affiliate |   | (2,778                            | )      | (2,604 | ) |
| Income tax benefit                                                           |   | 343                               |   | 982 |   |
| Equity in net loss of unconsolidated  affiliate                              |   | —                            |   | (37 | ) |
| Net loss                                                                     |   | (2,435                            | )      | (1,659 | ) |
| Dividends on preferred stock                                                 |   | (3,582                            | )      | (3,428 | ) |
| Net loss attributable to common  stockholders                                |   | $                                 | (6,017 | ) | $ | (5,087 | ) |
|                                                                         |   |                              |   |   |   |
| Basic and diluted net loss per common share                                  |   | $                                 | (0.49  | ) | $ | (0.34 | ) |
|                                                                         |   |                              |   |   |   |
| Basic and diluted weighted average common  shares outstanding                |   | 12,373,263                        |   | 14,906,191 |   |

 

See accompanying notes to condensed consolidated financial statements(unaudited).

 

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TNS, INC.

(formerly TNS Holdings, Inc.)

CONDENDSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(dollars in thousands)

 
|                                                                             |   | **Three months  ended March 31,** |   |
|----------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                             |   | **2003**                          |   | **2004** |   |
|                                                                             |   |                              |   |   |   |
| Cash flows from operating activities:                                            |   |                              |   |   |   |
| Net loss                                                                         |   | $                                 | (2,435 | ) | $ | (1,659 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |   |                              |   |   |   |
| Depreciation and amortization of property  and equipment                         |   | 4,782                             |   | 4,806 |   |
| Amortization of intangible assets                                                |   | 6,286                             |   | 8,508 |   |
| Deferred income tax provision (benefit)                                          |   | 2,108                             |   | (1,244 | ) |
| Amortization and write-off of deferred  financing costs                          |   | 468                               |   | 2,486 |   |
| Equity in net loss of unconsolidated affiliate                                   |   | —                            |   | 37 |   |
| Stock compensation                                                               |   | 30                                |   | 76 |   |
| Changes in operating assets and  liabilities, net of effect of acquisitions:     |   |                              |   |   |   |
| Accounts receivable, net                                                         |   | 4,147                             |   | (2,939 | ) |
| Other current and noncurrent assets                                              |   | (2,042                            | )      | (586 | ) |
| Accounts payable, accrued expenses and  other current and noncurrent liabilities |   | (2,396                            | )      | (5,763 | ) |
| Deferred revenue                                                                 |   | 1,984                             |   | 1,367 |   |
| Net cash provided by operating activities:                                       |   | 12,932                            |   | 5,089 |   |
| Cash flows from investing activities:                                            |   |                              |   |   |   |
| Purchases of property and equipment                                              |   | (4,542                            | )      | (3,120 | ) |
| Purchase of Openet S.r.l., net of cash  acquired                                 |   | (1,985                            | )      | — |   |
| Net cash used in investing activities:                                           |   | (6,527                            | )      | (3,120 | ) |
| Cash flows from financing activities:                                            |   |                              |   |   |   |
| Proceeds from issuance of long-term debt,  net of financing costs of $1,979      |   | —                            |   | 79,031 |   |
| Repayments of long-term debt                                                     |   | (3,982                            | )      | (153,146 | ) |
| Payment of dividends on preferred stock                                          |   | —                            |   | (173 | ) |
| Proceeds from stock option exercises                                             |   | 14                                |   | 5 |   |
| Proceeds from issuance of common stock, net                                      |   | —                            |   | 71,598 |   |
| Net cash used in financing activities:                                           |   | (3,968                            | )      | (2,685 | ) |
| Effect of exchange rates on cash and cash  equivalents                           |   | (312                              | )      | 559 |   |
| Net increase (decrease) in cash and cash  equivalents                            |   | 2,125                             |   | (157 | ) |
| Cash and cash equivalents, beginning of  period                                  |   | 5,984                             |   | 11,074 |   |
| Cash and cash equivalents, end of period                                         |   | $                                 | 8,109  |   | $ | 10,917 |   |
|                                                                             |   |                              |   |   |   |
| Supplemental disclosures of cash flow  information:                              |   |                              |   |   |   |
| Cash paid for interest                                                           |   | $                                 | 2,543  |   | $ | 2,581 |   |
|                                                                             |   |                              |   |   |   |
| Cash paid for income taxes                                                       |   | $                                 | 13     |   | $ | 1,784 |   |

 

See accompanying notes to condensed consolidated financial statements(unaudited).

 

4

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

**1.****             ****Description of Business and Basis of Presentation**

 

TNS, Inc.(TNS or the Company, formerly TNS Holdings, Inc.) is a Delaware corporation. OnOctober 30, 2003, the Company changed its name to TNS, Inc.

 

TNS is aleading provider of business-critical data communications services toprocessors of credit card, debit card and automated teller machine (ATM)transactions. TNS is also a leading provider of call signaling and databaseaccess services to the domestic telecommunications industry and of secure dataand voice network services to the global financial services industry. TNS’ datacommunication services enable secure and reliable transmission oftime-sensitive, transaction-related information critical to its customers’operations. The Company’s customers outsource their data communicationrequirements to TNS because of the Company’s expertise, comprehensive customersupport, and cost-effective services. TNS provides services to customers in theUnited States and increasingly to international customers in 12 countries,including Canada and countries in Europe and the Asia-Pacific region.

 

The Companyprovides its services through its multiple data networks, each designedspecifically for transaction applications. These networks support a variety ofwidely accepted communications protocols and are designed to be scalable andaccessible by multiple methods, including dial-up, dedicated, wireless andInternet connections.

 

The Companyhas four business divisions: (1) the point-of-sale/point-of-service (POS)division, which provides data communications services to payment processors inthe U.S. and Canada, (2) the telecommunication services division (TSD),which provides call signaling services and database access services targetingprimarily the telecommunications industry, (3) the financial servicesdivision (FSD), which provides, primarily to the financial services community,data networking services in support of the Financial Information eXchange (FIX)messaging protocol and other transaction-oriented trading applications, and(4) the international services division (ISD), which markets the Company’sPOS and financial services in countries outside of the United States andCanada.

 

On March 15,2004, the Company declared a 1-for-7.84 reverse stock split. Accordingly, allshare and per share amounts have been retroactively adjusted to give effect tothis event.

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States (GAAP) for interim financial information and in conjunction withthe rules and regulations of the Securities and Exchange Commission (SEC).  Certain information and note disclosuresnormally included in the annual financial statements, required by GAAP, havebeen condensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationpresented not misleading.

 

In the opinionof management, the accompanying unaudited condensed consolidated financialstatements reflect all necessary adjustments (all of which are of a normal andrecurring nature) that are necessary for fair presentation for the periodspresented.  The results of operationsfor the three months ended March 31, 2004 are not necessarily indicative of theresults to be expected for any subsequent interim period or for the fiscalyear.  It is suggested that theseunaudited condensed consolidated financial statements be read in conjunctionwith the Company’s final initial public offering prospectus filed with the SECon March 16, 2004 (File No. 333-110188), which includes consolidated financialstatements and the notes thereto for the year ended December 31, 2003.

 

# **Use of Estimates**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of certain assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements. Significant estimates affecting the consolidatedfinancial statements include management’s judgments regarding the allowance fordoubtful accounts, reserves for excess and obsolete inventories, future

 

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cash flows from long-livedassets, and accrued expenses for probable losses. Actual results could differfrom those estimates.

 

**Revenue Recognition**

 

The Company recognizes revenue when persuasive evidence of an agreement exists, the terms are fixed and determinable, services are performed, and collection is probable. Cash received in advance of revenue recognition is recorded as deferred revenue. POS services revenue is derived primarily from per transaction fees paid by the Company’s customers for the transmission of transaction data, through the Company’s networks, between payment processors and POS or ATM terminals. Telecommunication services revenue is derived primarily from fixed monthly fees for call signaling services and per query fees charged for database access and validation services. Financial services revenue is derived primarily from monthly recurring fees based on the number of customer connections to and through the Company’s networks. Incentives granted to new customers or upon contract renewals are deferred and recognized ratably as a reduction of revenue over the contract period to the extent that the incentives are recoverable against the customer’s minimum purchase commitments under the contract.  In addition, the Company receives installation fees related to the configuration of the customers’ systems. Revenue from installation fees is being deferred and recognized ratably over the customer’s contractual service period, generally three years.

 

**Cost of Network Services**

 

Cost of network services is comprised primarily of telecommunications charges, which include data transmission and database access charges, leased digital capacity charges, circuit installation charges and activation charges. The cost of data transmission is based on a contract or tariff rate per minute of usage in addition to a prescribed rate per transaction for certain vendors. The costs of database access, circuits, installation and activation charges are based on fixed fee contracts with local exchange carriers and interexchange carriers. The cost of network services also includes salaries, equipment maintenance and other costs related to the ongoing operation of the Company’s data networks. These costs are expensed by the Company as incurred.  Direct costs of installations are deferred and amortized over three years.  The Company records its accrual for telecommunication charges based upon network services utilized at historical invoiced rates. Depreciation expense on our network equipment and amortization of developed technology are excluded from our cost of network services and included in depreciation and amortization of property and equipment and amortization of intangible assets in our condensed consolidated statement of operations.

 

**2.****             ****Initial Public Offering**

 

In March 2004, the Company completed its initial public offering (IPO) of common stock issuing 4,420,000 shares of common stock at $18.00 per share, which generated proceeds, net of offering costs, of approximately $71.6 million.  The net proceeds of the IPO were used to repay a portion of the Company’s long-term debt outstanding under its previous senior secured credit facility.

 

Upon the completion of the IPO, all of the outstanding shares of the Company’s Class A redeemable convertible preferred stock (Class A Preferred Stock), including accrued and unpaid dividends, was converted into 9,984,711 shares of common stock.

 

**3.  Debt**

 

Debt consists of the following (in thousands):

 
|                          |   | **December  31,  2003** |    | **March 31,  2004** |   |
|-------------------------------|--------|-------------------------|---------|---------------------|--------|
|                          |   |                    |    |                |   |
| Term A Loan                   |   | $                       | 10,314  |                | $      | — |   |
| Term B Loan                   |   | 140,081                 |    | —              |   |
| New Term Loan                 |   | —                  |    | 62,250              |   |
| New Revolving Credit Facility |   | —                  |    | 16,010              |   |
|                          |   | 150,395                 |    | 78,260              |   |
| Less: Current portion         |   | (28,731                 | )       | (11,250             | )      |
| Long-term portion             |   | $                       | 121,664 |                | $      | 67,010 |   |

 

6

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On March 19,2004, the Company entered into a new senior secured credit facility (New CreditFacility) to replace its prior credit facility. The New Credit Facilityconsists of a $65.0 million term loan (New Term Loan) and a revolvingcredit facility of $30.0 million (New Revolving Credit Facility). The NewCredit Facility matures March 19, 2009. Payments on the New Term Loan are duein quarterly installments over the five-year term, beginning on March 31,2004. Total payments for each year are as follows (in thousands):

 
| Year 1 |   | $      | 11,000 |   |
|--------|--------|--------|--------|--------|
| Year 2 |   | 12,000 |   |
| Year 3 |   | 13,000 |   |
| Year 4 |   | 14,000 |   |
| Year 5 |   | 15,000 |   |
|   |   | $      | 65,000 |   |

 

For the periodthrough June 30, 2004, borrowings on the New Revolving Credit Facility andthe New Term Loan generally bear interest at a rate, at the Company’s option,of either 1.25 percent over the lender’s base rate or 2.50 percentover the LIBOR rate (3.6% as of March 31, 2004). Thereafter, if the Companyachieves a leverage ratio of less than one, the borrowings on the New RevolvingCredit Facility and the New Term Loan generally will bear interest at a rate,at the Company’s option, of either 0.75 percent over the lender’s baserate or 2.0 percent over the LIBOR rate. If the Company achieves aleverage ratio of less than 1.5 but more than or equal to one, the borrowingson the New Revolving Credit Facility and the New Term Loan generally will bearinterest at a rate, at the Company’s option, of either 1.0 percent overthe lender’s base rate or 2.25 percent over the LIBOR rate. If the Companyachieves a leverage ratio of less than 2.2 but more than or equal to 1.5, theborrowings on the New Revolving Credit Facility and the New Term Loan generallywill bear interest at a rate, at the Company’s option, of either1.25 percent over the lender’s base rate or 2.5 percent over theLIBOR rate. The New Revolving Credit Facility is subject to an annualcommitment fee in an amount equal to 0.5 percent per annum multiplied bythe amount of funds available for borrowing under the New Revolving CreditFacility. Interest payments on the New Credit Facility are due monthly,bimonthly, or quarterly at the Company’s option.

 

The terms of the New Credit Facility require the Company to comply with financial and nonfinancial covenants, including maintaining certain leverage, interest and fixed charge coverage ratios at the end of each fiscal quarter. Certain of the financial covenants will become more restrictive over the term of the New Credit Facility. The New Credit Facility also contains nonfinancial covenants that restrict some of the Company’s corporate activities, including the Company’s ability to dispose of assets, incur additional debt, pay dividends, create liens, make investments, make capital expenditures and engage in specified transactions with affiliates. The Company’s future results of operations and its ability to comply with the covenants could be adversely impacted by increases in the general level of interest rates since the interest on a majority of the Company’s debt is variable. Noncompliance with any of the financial or nonfinancial covenants without cure or waiver would constitute an event of default under the New Credit Facility. An event of default resulting from a breach of a financial or nonfinancial covenant may result, at the option of the lenders, in an acceleration of the principal and interest outstanding, and a termination of the New Revolving Credit Facility. The New Credit Facility also contains other customary events of default, including defaults based on events of bankruptcy and insolvency, nonpayment of principal, interest or fees when due, subject to specified grace periods, breach of specified covenants, change in control and material inaccuracy of representations and warranties.  The Company was in compliance with the financial covenants of the New Credit Facility as of March 31, 2004.

 

In connectionwith the closing of the New Credit Facility, the Company incurred approximately$2.0 million in financing costs. These financing costs are being deferredand amortized using the effective interest method over the life of the NewCredit Facility. In connection with the termination of the prior creditfacility, the Company wrote-off approximately $2.0 million in unamortizeddeferred financing costs related to the prior credit facility.  Such write-off has been included in interestexpense in the accompanying condensed consolidated statement of operations forthe three months ended March 31, 2004.

 

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**4. Comprehensive Loss**

 

The components of comprehensive loss, net of tax effect are as follows (in thousands):

 
|                                          |   | **Three months ended March 31,** |   |
|-----------------------------------------------|--------|----------------------------------|--------|
|                                          |   | **2003**                         |   | **2004** |   |
|                                          |   |                             |   |   |   |
| Net loss                                      |   | $                                | (2,435 | ) | $ | (1,659 | ) |
| Change in market value of interest rate  swap |   | (180                             | )      | — |   |
| Foreign currency translation adjustments      |   | 201                              |   | 915 |   |
| Total comprehensive loss                      |   | $                                | (2,414 | ) | $ | (744 | ) |

 

**5.  Net Loss Per Common Share**

 

Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share, requires the presentation of basic and diluted earnings per share.  Basic earnings (loss) per common share is computed by dividing income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period.  The diluted earnings (loss) per common share data is computed using the weighted average number of common shares outstanding plus the dilutive effect of common stock equivalents, unless the common stock equivalents are anti-dilutive.  For the period prior to the IPO, the effect of the Class A Preferred Stock converting into shares of common stock was not included in the computation of diluted net loss per common share as the effect would be anti-dilutive.  In addition, options to purchase 318,103 and 1,013,341 shares of common stock that were outstanding as of March 31, 2003 and 2004, respectively, were excluded from the computation of diluted net loss per common share as their effect would be anti-dilutive.  The treasury stock effect of 295,500 shares of unvested common stock held by executives and employees as of March 31, 2004 was not included in the computation of diluted net loss per common share as their effect would be anti-dilutive.

 

The following details the computation of the net loss per common share (dollars in thousands, except share and per share data):

 
|                                                |   | **Three months ended March 31,** |   |
|-----------------------------------------------------|--------|----------------------------------|--------|
|                                                |   | **2003**                         |   | **2004** |   |
|                                                |   |                             |   |   |   |
| Net loss                                            |   | $                                | (2,435 | ) | $ | (1,659 | ) |
| Dividends on preferred stock                        |   | (3,582                           | )      | (3,428 | ) |
| Net loss  attributable to common stockholders       |   | $                                | (6,017 | ) | $ | (5,087 | ) |
| Weighted average  common share calculation:         |   |                             |   |   |   |
| Basic weighted  average common shares outstanding   |   | 12,373,263                       |   | 14,906,191 |   |
| Conversion of  Class A Preferred Stock              |   | —                           |   | — |   |
| Treasury stock  effect of unvested common stock     |   | —                           |   | — |   |
| Treasury stock  effect of options                   |   | —                           |   | — |   |
| Diluted weighted  average common shares outstanding |   | 12,373,263                       |   | 14,906,191 |   |
| Net loss per  common share:                         |   |                             |   |   |   |
| Basic loss per  common share                        |   | $                                | (0.49  | ) | $ | (0.34 | ) |
| Diluted loss per  common share                      |   | $                                | (0.49  | ) | $ | (0.34 | ) |

 

The pro forma net loss per common share is computed using the pro forma net loss attributable to common stockholders and the pro forma weighted average common shares outstanding during the

 

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period.  The pro forma weighted average common shares outstanding assume the conversion of the Class A Preferred Stock plus accrued and unpaid dividends into common stock at the IPO price of $18.00 per share as if the conversion had occurred at the beginning of each period presented.

 
|                                                          |   | **Three months ended March 31,** |   |
|---------------------------------------------------------------|--------|----------------------------------|--------|
|                                                          |   | **2003**                         |   | **2004** |   |
|                                                          |   |                             |   |   |   |
| Net loss                                                      |   | $                                | (2,435 | ) | $ | (1,659 | ) |
| Dividends on preferred stock                                  |   | —                           |   | — |   |
| Pro forma net  loss attributable to common stockholders       |   | $                                | (2,435 | ) | $ | (1,659 | ) |
|                                                          |   |                             |   |   |   |
| Weighted average  common share calculation:                   |   |                             |   |   |   |
| Basic weighted  average common shares outstanding             |   | 12,373,263                       |   | 14,906,191 |   |
| Conversion of  Class A Preferred Stock                        |   | 9,168,074                        |   | 8,229,157 |   |
| Pro forma basic  weighted average common shares outstanding   |   | 21,541,337                       |   | 23,135,348 |   |
| Treasury stock  effect of unvested common stock               |   | —                           |   | — |   |
| Treasury stock  effect of options                             |   | —                           |   | — |   |
| Pro forma diluted  weighted average common shares outstanding |   | 21,541,337                       |   | 23,135,348 |   |
| Pro forma net  loss per common share:                         |   |                             |   |   |   |
| Pro forma basic  loss per common share                        |   | $                                | (0.11  | ) | $ | (0.07 | ) |
| Pro forma diluted  loss per common share                      |   | $                                | (0.11  | ) | $ | (0.07 | ) |

 

**6.  Stock Based Compensation**

 

In February 2004, the Board of Directors of the Company adopted the TNS, Inc. 2004 Long-Term Incentive Plan (the Plan) and the Company’s stockholders approved the Plan in March 2004.  The Plan reserves 1,586,384 shares of common stock for grants of incentive stock options, nonqualified stock options, restricted stock awards and performance shares to employees, non-employee directors and consultants performing services for the Company.  Options granted under the Plan have an exercise price equal to or greater than the fair market value of the underlying common stock at the date of grant, and become exercisable based on a vesting schedule determined at the date of grant, generally in equal monthly installments over four years.  The options expire 10 years from the date of grant.  Restricted stock awards and performance shares granted under the Plan are subject to a vesting period determined at the date of grant, generally in equal annual installments over four years.  On March 16, 2004, the Company granted 295,500 shares of restricted stock and recorded approximately $5.3 million of deferred compensation related to these shares of restricted stock.  The deferred compensation is being amortized over the four-year vesting period of the shares of restricted stock.  For the three months ended March 31, 2004, the Company recorded compensation expense of approximately $55,000 related to these shares of restricted stock.

 

TheCompany continues to account for employee stock options or similar equity instrumentsto employees under the intrinsic value method prescribed by APB OpinionNo. 25, “Accounting for Stock Issued to Employees.” Under the intrinsicvalue method, compensation cost is the excess, if any, of the fair value of thestock at the grant date or other measurement date over the amount an employeemust pay to acquire the stock. SFAS No. 123, “Accounting for Stock-BasedCompensation” defines a fair value method of accounting for employee stockoptions or similar equity instruments. Under the fair value method,compensation cost is measured at the grant date based on the value of the awardand is recognized over the service period. SFAS No. 123 allows an entityto continue to use the intrinsic value method. However, entities electing toaccount for employee stock options or similar instruments pursuant to APBOpinion No. 25 must make pro forma disclosures of net income, as if thefair value method of accounting had been applied.

 

9

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If stockcompensation expense had been determined based upon the fair value method atthe grant dates, the Company’s net loss attributable to common stockholderswould have increased to the pro forma amounts indicated below (in thousands,except per share data):

 
|                                                                                                             |   | **Three months  ended March 31,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                             |   | **2003**                          |   | **2004** |   |
|                                                                                                             |   |                              |   |   |   |
| Net loss attributable to common  stockholders, as reported                                                       |   | $                                 | (6,017 | ) | $ | (5,087 | ) |
| Add:   Stock-based employee compensation expense included in reported net  loss, net of related tax effects |   | 18                                |   | 46 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards |   | (177                              | )      | (260 | ) |
| Pro forma net loss attributable to common  stockholders                                                          |   | $                                 | (6,176 | ) | $ | (5,301 | ) |
|                                                                                                             |   |                              |   |   |   |
| Basic and diluted net loss per common  share, as reported                                                        |   | $                                 | (0.49  | ) | $ | (0.34 | ) |
| Pro forma basic and diluted net loss per  common share                                                           |   | $                                 | (0.50  | ) | $ | (0.36 | ) |

 

**7.****             ****Segment Information**

 

The Company’sreportable segments are strategic business units that offer different productsand services. The Company classifies its business into four segments: POS, TSD,FSD and ISD. However, the Company’s management only evaluates revenues forthese four segments. A significant portion of the Company’s North Americanoperating expenses are shared between the POS, TSD and FSD segments, andtherefore, management analyzes operating results for these three segments on acombined basis.

 

Managementevaluates the North American and ISD performance on EBITDA, as adjusted,because operating expenses are distinguishable between North American and ISDoperations. The Company defines EBITDA, as adjusted, as income from operationsbefore depreciation and amortization. EBITDA, as adjusted, is not a generallyaccepted accounting principle measure, but rather a measure employed by managementto view operating results adjusted for major noncash items. The Company’sdefinition of EBITDA, as adjusted, may not be comparable to similarly titledmeasures used by other entities. Assets are not segregated between reportablesegments, and management does not use asset information by segments to evaluatesegment performance. As such, no information is presented related to fixedassets by reportable segment and capital expenditures for each segment.

 

Revenue forthe Company’s four business units is presented below (in thousands):

 
|           |   | **Three  months ended March 31,** |   |
|----------------|--------|-----------------------------------|--------|
|           |   | **2003**                          |   | **2004** |   |
|           |   |                              |   |   |   |
| Revenues:      |   |                              |   |   |   |
| POS            |   | $                                 | 29,482 |   | $ | 28,885 |   |
| TSD            |   | 7,149                             |   | 8,611 |   |
| FSD            |   | 4,762                             |   | 5,994 |   |
| ISD            |   | 9,238                             |   | 16,666 |   |
| Total revenues |   | $                                 | 50,631 |   | $ | 60,156 |   |

 

10

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EBITDA, as adjusted, for North American and ISD operations is reflectedbelow (in thousands):

 
|                      |   | **Three  months ended March 31,** |   |
|---------------------------|--------|-----------------------------------|--------|
|                      |   | **2003**                          |   | **2004** |   |
|                      |   |                              |   |   |   |
| EBITDA, as adjusted:      |   |                              |   |   |   |
| North America             |   | $                                 | 10,385 |   | $ | 10,657 |   |
| ISD                       |   | 209                               |   | 4,349 |   |
| Total EBITDA, as adjusted |   | $                                 | 10,594 |   | $ | 15,006 |   |

 

EBITDA, asadjusted, differs from loss before income taxes and equity in net loss ofunconsolidated affiliate reported in the condensed consolidated statements ofoperations as follows (in thousands):

 
|                                                                           |   | **Three  months ended March 31,** |   |
|--------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                           |   | **2003**                          |   | **2004** |   |
|                                                                           |   |                              |   |   |   |
| EBITDA, as adjusted                                                            |   | $                                 | 10,594 |   | $ | 15,006 |   |
| Reconciling items:                                                             |   |                              |   |   |   |
| Depreciation and amortization of property  and equipment and intangible assets |   | (11,068                           | )      | (13,314 | ) |
| Interest expense                                                               |   | (2,878                            | )      | (4,433 | ) |
| Interest and other income, net                                                 |   | 574                               |   | 137 |   |
| Loss before income taxes and equity in net  loss of unconsolidated affiliate   |   | $                                 | (2,778 | ) | $ | (2,604 | ) |

 

Goodwill and intangible assets are located in the following reportingsegments (in thousands):

 
|                                 |   | **December  31,  2003** |    | **March 31,  2004** |    |
|--------------------------------------|--------|-------------------------|---------|---------------------|---------|
|                                 |   |                    |    |                |    |
| POS                                  |   | $                       | 160,271 |                | 153,101 |   |
| TSD                                  |   | 3,305                   |    | 3,263               |    |
| FSD                                  |   | 30,503                  |    | 29,984              |    |
| ISD                                  |   | 34,293                  |    | 33,515              |    |
| Total goodwill and intangible assets |   | $                       | 228,372 |                | $       | 219,863 |   |
|                                      |        |                         |         |                     |         |  |  |

 

**Geographic Information**

 

The Company sellsits services through foreign subsidiaries in the United Kingdom, Australia,Canada, France, Germany, Ireland, Italy, Japan, New Zealand, Spain, Sweden andThe Netherlands. Information regarding revenues and long-lived tangible assetsattributable to each geographic region is stated below.

 

11

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The Company’srevenues were generated in the following geographic regions (in thousands):

 
|           |   | **Three  months ended March 31,** |   |
|----------------|--------|-----------------------------------|--------|
|           |   | **2003**                          |   | **2004** |   |
|           |   |                              |   |   |   |
| Revenues:      |   |                              |   |   |   |
| North America  |   | $                                 | 41,393 |   | $ | 43,490 |   |
| Europe         |   | 8,950                             |   | 14,830 |   |
| Asia-Pacific   |   | 288                               |   | 1,836 |   |
| Total revenues |   | $                                 | 50,631 |   | $ | 60,156 |   |

 

The Company’slong-lived tangible assets including goodwill and intangible assets werelocated as follows (in thousands):

 
|                    |   | **December  31,  2003** |    | **March 31,  2004** |   |
|-------------------------|--------|-------------------------|---------|---------------------|--------|
|                    |   |                    |    |                |   |
| North America           |   | $                       | 232,393 |                | $      | 223,445 |   |
| Europe                  |   | 45,057                  |    | 43,703              |   |
| Asia-Pacific            |   | 4,888                   |    | 4,738               |   |
| Total long-lived assets |   | $                       | 282,338 |                | $      | 271,886 |   |

 

12

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

 

You should read the following discussion of the financial condition and results of operations of TNS, Inc. in conjunction with the consolidated financial statements and the related notes included in our registration statement on Form S-1 (File No.333-110188) filed with the SEC on March 16, 2004 and available directly from the SEC at www.sec.gov and the condensed consolidated financial statements and the related notes of TNS, Inc., included elsewhere in this quarterly report.

 

There are statements made herein which may not address historical facts and, therefore, could be interpreted to be forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, forecasts and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in, or implied by, the forward-looking statements. The Company has attempted, whenever possible, to identify these forward-looking statements using words such as “may,” “will,” “should,” “projects,” “estimates,” “expects,” “plans,” “intends,” “anticipates,” “believes,” and variations of these words and similar expressions. Similarly, statements herein that describe the Company’s business strategy, prospects, opportunities, outlook, objectives, plans, intentions or goals are also forward-looking statements. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including: the Company’s reliance upon a small number of customers for a significant portion of its revenue; competitive factors such as pricing pressures; our customer’s ability to direct their data communications from the Company’s networks to other networks; the Company’s ability to grow its business domestically and internationally by generating greater transaction volumes, acquiring new customers or developing new service offerings; fluctuations in the Company’s quarterly results because of the seasonal nature of the business and other factors outside of the Company’s control; the Company’s ability to identify, execute or effectively integrate future acquisitions; the Company’s ability to adapt to changing technology; additional costs related to compliance with the Sarbanes-Oxley Act of 2002, any revised New York Stock Exchange listing standards, SEC rule changes or other corporate governance issues; and other risk factors described in the Company’s prospectus filed with the SEC on March 16, 2004. In addition, the statements in this quarterly report are made as of the date of this filing. The Company expects that subsequent events or developments will cause its views to change. The Company undertakes no obligation to update any of the forward-looking statements made herein, whether as a result of new information, future events, changes in expectations or otherwise. These forward-looking statements should not be relied upon as representing the Company’s views as of any date subsequent to the date of this filing.

 

**Overview**

 

We are aleading provider of business-critical data communications services toprocessors of credit card, debit card and ATM transactions. We are also aleading provider of secure data and voice network services to the globalfinancial services industry. We operate one of four unaffiliated SignalingSystem No. 7 networks in the United States capable of providing servicesnationwide, and we utilize this network to provide call signaling and databaseaccess services to the domestic telecommunications industry. Our datacommunications services enable secure and reliable transmission oftime-sensitive, transaction-related information critical to our customers’operations. Our customers outsource their data communications requirements tous because of our substantial expertise, comprehensive customer support andcost-effective services. We provide services to customers in the United Statesand increasingly to international customers in 12 countries, including Canadaand countries in Europe and the Asia-Pacific region.

 

We provide ourservices through multiple data networks, each designed specifically fortransaction applications. Our networks support a variety of widely acceptedcommunications protocols and are designed to be scalable and accessible bymultiple methods, including dial-up, dedicated, wireless and Internetconnections.

 

We generaterevenues through four business divisions:

 

•***                                          POSservices***. We provide fast, secure and reliable data communicationsservices primarily to payment processors in the United States and Canada. POSservices revenue is derived primarily from per transaction fees paid by ourcustomers for the transmission of

 

13

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transaction data through our networks between payment processors andPOS or ATM terminals.

 

•***                                          Internationalservices***. We are one of the leading providers of data communicationsservices to the POS industry in the United Kingdom. We also provide ourservices in Australia, France, Germany, Ireland, Italy, Japan, The Netherlands,New Zealand, Spain and Sweden. Our international services division generatesrevenues from our POS and financial services offerings abroad.

 

•***                                          Telecommunicationservices***. We provide call signaling services that enabletelecommunications carriers to establish and terminate telephone calls placedby their subscribers. We also provide database access services that enable ourcustomers to provide intelligent network services, such as calleridentification and local number portability, and credit card, calling card,third-party billing and collect calling. Our telecommunication servicesdivision generates revenues primarily from fixed monthly fees charged for ourcall signaling services and per-query fees charged for our database access andvalidation services.

 

•***                                          Financialservices.*** We provide fast, secure and reliable private data networkingservices that enable seamless communications and facilitate electronic tradingamong commercial banks, mutual funds, pension funds, broker-dealers,alternative trading systems, electronic communications networks, securities andcommodities exchanges and other market participants. Our networks supportmultiple communications protocols including the Financial Information eXchange,or FIX, protocol. Our financial services division generates revenues frommonthly recurring fees based on the number of customer connections to andthrough our networks.

 

Our most significant expense is cost of network services, which is comprised primarily of telecommunications charges, including data transmission and database access, leased digital capacity charges, circuit installation charges and activation charges. The cost of data transmission is based on a contract or tariff rate per minute of usage in addition to a prescribed rate per transaction for some vendors. The costs of database access, circuits, installation charges and activation charges are based on fixed fee contracts with local exchange carriers and interexchange carriers. The cost of network services also includes salaries, equipment maintenance and other costs related to the ongoing operation of our data networks. Depreciation expense on our network equipment and amortization of developed technology are excluded from our cost of network services and included in depreciation and amortization of property and equipment and amortization of intangible assets in our condensed consolidated statement of operations.

 

Our engineering and development expenses include salaries and other costs related to product development, engineering and materials. The majority of these costs are expensed as incurred, including costs related to the development of internal use software in the preliminary project, the post-implementation and operation stages. Development costs we incur during the software application development stage are capitalized and amortized over the estimated useful life of the developed software.

 

Our selling, general and administrative expenses include costs related to sales, marketing, administrative and management personnel, as well as outside legal, accounting and consulting services. We believe that selling, general and administrative expenses as a percentage of revenues will remain constant or increase to support expansion of the international services division, as well as from the additional costs of being a publicly traded company, including the legal, audit, insurance and board of directors compensation costs needed to establish and maintain compliance with the Sarbanes-Oxley Act of 2002.

 

In March 2004, we completed our initial public offering (IPO) of common stock issuing 4,420,000 shares of common stock at $18.00 per share, which generated proceeds, net of offering costs, of approximately $71.6 million.  The net proceeds of the IPO were used to repay a portion of the outstanding debt under our then-existing senior secured credit facility.  Concurrent with the closing of the IPO, we entered into a new senior secured credit facility and used the net proceeds from borrowings to repay the remaining debt outstanding under our then-existing senior secured credit facility.  In connection with the termination of our previous senior secured credit facility, we recognized a charge of approximately $2.0

 

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million related to the write-off of unamortized deferred financing costs.  Such write-off was included in interest expense in the accompanying condensed consolidated statement of operations for the three months ended March 31, 2004.

 

Upon the completion of the IPO, all of the outstanding shares of our Class A redeemable convertible preferred stock, including accrued and unpaid dividends, converted into 9,984,711 shares of common stock.

 

**Results of Operations**

 

The following table sets forth the periods indicated, selected statement of operations data (dollars in thousands):

 
|                                                                                                  |   | **Three  months ended March 31,** |   |
|-------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                  |   | **2003**                          |   | **2004** |   |
|                                                                                                  |   |                              |   |   |   |
| Revenues                                                                                              |   | $                                 | 50,631 |   | $ | 60,156 |   |
| Operating expenses:                                                                                   |   |                              |   |   |   |
| Cost of network services                                                                              |   | 28,177                            |   | 30,692 |   |
| Engineering and development                                                                           |   | 2,872                             |   | 3,439 |   |
| Selling, general, and administrative                                                                  |   | 8,988                             |   | 11,019 |   |
| Depreciation and amortization of property  and equipment                                              |   | 4,782                             |   | 4,806 |   |
| Amortization of intangible assets                                                                     |   | 6,286                             |   | 8,508 |   |
| Total operating expenses                                                                              |   | 51,105                            |   | 58,464 |   |
| (Loss) income from operations before income  taxes and equity in net loss of unconsolidated affiliate |   | (474                              | )      | 1,692 |   |
| Interest expense                                                                                      |   | (2,878                            | )      | (4,433 | ) |
| Interest and other income, net                                                                        |   | 574                               |   | 137 |   |
| Income tax benefit                                                                                    |   | 343                               |   | 982 |   |
| Equity in net loss of unconsolidated  affiliate                                                       |   | —                            |   | (37 | ) |
| Net loss                                                                                              |   | $                                 | (2,435 | ) | $ | (1,659 | ) |

 

***Three months ended March 31, 2004 compared to the three months ended March 31, 2003***

 

***Revenues.*** Total revenues increased$9.6 million, or 19.0%, to $60.2 million for the three months endedMarch 31, 2004, from $50.6 million for the three months ended March31, 2003. We generate revenues through four operating divisions.

 

***POS division.***  Revenues from the POS division decreased$0.6 million, or 2%, to $28.9 million for the three months endedMarch 31, 2004, from $29.5 million for the three months ended March 31,2003. The $0.6 million decrease in POS revenues resulted from a decreasein revenue per transaction as a result of negotiated price reductions uponrenewal of certain contracts primarily in the fourth quarter of 2002, and to alesser extent in 2003, partially offset by an increase in transactionvolumes.  POS transaction volumesincreased 0.5% to 1.86 billion transactions for the three months endedMarch 31, 2004, from 1.85 billion transactions for the three months endedMarch 31, 2003. We expect that in 2004 in connection with contract renewalssome of our POS customers may seek to negotiate greater pricing discounts inexchange for maintaining or increasing their minimum transaction or revenuecommitments. As a result, it is likely our revenue per transaction willdecrease and, depending upon the number of transactions we transport, our POSrevenues may continue to decrease.

 

*** International services division.***  Revenues from the international servicesdivision increased $7.5 million, or 81.5%, to $16.7 million for the threemonths ended March 31, 2004, from $9.2 million for the three months ended March31, 2003. The increase was primarily due to additional revenues generated fromour POS customers in the U.K., Australia, France and Spain and to a lesserextent we benefited from favorable foreign exchange. Revenues from our U.K.subsidiary increased $3.6 million, or 50.0%, to $10.8 million for thethree months ended March 31, 2004, from $7.2 million for the three monthsended March 31, 2003.

 

15

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***Telecommunicationservices division.***  Revenues from the telecommunication services division increased$1.5 million, or 21.1%, to $8.6 million for the three months endedMarch 31, 2004, from $7.1 million for the three months ended March 31,2003. The growth in revenues was primarily due to increased usage of our callsignaling services.

 

***Financial servicesdivision.*** Revenues from the financial services division increased$1.2 million, or 25.0%, to $6.0 million for the three months endedMarch 31, 2004, from $4.8 million for the three months ended March 31,2003. The increase in revenues was due to the growth in the number of customerconnections to and through our networks.

 

*** Cost of network services.***  Cost of network services increased$2.5 million, or 8.9%, to $30.7 million for the three months endedMarch 31, 2004, from $28.2 million for the three months ended March 31,2003. Cost of network services represented 51.0% of revenues for the threemonths ended March 31, 2004, compared to 55.7% of revenues for the three monthsended March 31, 2003. The increase in cost of network services resultedprimarily from higher usage charges from increased transactions and otherservices partially offset by decreased usage-based vendor telecommunicationcharges. Gross profit represented 49.0% of total revenues for the three monthsended March 31, 2004, compared to 44.3% for the three months ended March 31,2003. The increase in gross profit as a percentage of total revenues resultedprimarily from increased contribution of our financial services division andinternational services division.

 

Future cost of network services depends on anumber of factors including total transaction and query volume growth, therelative growth and contribution to total transaction volume of each of ourcustomers, the success of our new service offerings, the timing and extent ofour network expansion and the timing and extent of any network cost reductions.In addition, any significant loss or significant reduction in transactionvolumes could lead to a decline in gross margin since significant portions ofour network costs are fixed costs.

 

***Engineering anddevelopment expense. ***Engineeringand development expense increased $0.5 million, or 17.2%, to$3.4 million for the three months ended March 31, 2004, from$2.9 million for the three months ended March 31, 2003. Engineering anddevelopment expense represented 5.6% of revenues for the three months endedMarch 31, 2004 compared to 5.7% for the three months ended March 31, 2003.Engineering and development expense increased primarily from an increase inengineering expenses required to support our international expansion.

 

***Selling, general andadministrative expense.***  Selling, general and administrative expense increased$2.0 million, or 22.2%, to $11.0 million for the three months endedMarch 31, 2004, from $9.0 million for the three months ended March 31,2003. Selling, general and administrative expense represented 18.3% of revenuesfor the three months ended March 31, 2004, compared to 17.8% of revenues forthe three months ended March 31, 2003. Selling, general and administrativeexpense increased primarily from the expenses required to support our revenuegrowth, mainly within the international services division.

 

***Depreciation andamortization of property and equipment.***  Depreciation and amortization of propertyand equipment was $4.8 million for the three months ended March 31, 2004 and2003, respectively.  Depreciation andamortization of property and equipment represented 8.0% of revenues for thethree months ended March 31, 2004, compared to 9.5% of revenues for the threemonths ended March 31, 2003.

 

***Amortization ofintangible assets.***  Amortization of intangible assets increased $2.2 million, or34.9%, to $8.5 million for the three months ended March 31, 2004, from$6.3 million for the three months ended March 31, 2003. The increase wasattributable to the accelerated amortization of a portion of our customerrelationship intangible asset in connection with the loss of two POS customersduring the first quarter of 2004.  Theamortization of intangible assets for the three months ended March 31, 2004 and2003 relates solely to the intangible assets resulting from acquisitions.

 

***Interest expense.***  Interest expense increased $1.5 millionto $4.4 million for the three months ended March 31, 2004, from$2.9 million for the three months ended March 31, 2003. This increase wasprimarily due to the write-off of $2.0 million of deferred financing costs inconnection with the termination of our previous senior secured credit facilitypartially offset by the reduction of interest expense resulting from quarterlyprincipal payments we made on our term borrowings under our previous seniorsecured credit facility.

 

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***Interest and otherincome, net.*** Interest and other income, net was $0.1 million for the threemonths ended March 31, 2004 compared to $0.6 million for the three monthsended March 31, 2003. Included in interest and other income, net for the threemonths ended March 31, 2003 was a gain of $0.6 million on the sale of ourequity method investment in a related entity.

 

***Income tax benefit.***  For the three months ended March 31, 2004,our income tax benefit was $1.0 million compared to $0.4 for the threemonths ended March 31, 2003.

 

**Seasonality**

 

Credit card and debit card transactionsaccount for a major percentage of the transaction volume processed by ourcustomers. The volume of these transactions on our networks generally isgreater in the fourth quarter holiday season than during the rest of the year.Consequently, revenues and earnings from credit card and debit cardtransactions in the first quarter generally are lower than revenues andearnings from credit card and debit card transactions in the fourth quarter ofthe immediately preceding year. We expect that our operating results in theforeseeable future will be significantly affected by seasonal trends in thecredit card and debit card transaction market.

 

**Liquidity and Capital Resources**

 

Our primaryliquidity and capital resource needs are to finance the costs of ouroperations, to make capital expenditures and to service our debt.  The proceeds from our initial publicoffering in March 2004, along with the proceeds from borrowings under our newsenior secured credit facility, were used to repay the amounts outstandingunder our previous senior secured credit facility.  Based upon our current level of operations, we expect that ourcash flow from operations, together with the amounts we are able to borrow underour existing credit facility, will be adequate to meet our anticipated needsfor the foreseeable future. Although we have no specific plans to do so, to theextent we decide to pursue one or more significant strategic acquisitions, wewill likely need to incur additional debt or sell additional equity to financethose acquisitions.

 

Our operationsprovided us cash of $5.1 million for the three months ended March 31,2004, which was attributable to a net loss of $1.7 million, depreciation,amortization and other non-cash charges of $14.7 million and an increasein working capital of $7.9 million. Our operations provided us cash of$12.9 million for the three months ended March 31, 2003, which wasattributable to a net loss of $2.4 million, depreciation, amortization andother non-cash charges of $13.6 million and a decrease in working capitalof $1.7 million.

 

We used cashof $3.1 million in investing activities for the three months ended March31, 2004, which consisted of capital expenditures of $3.1 million. We usedcash of $6.5 million in investing activities for the three months endedMarch 31, 2003, which consisted primarily of capital expenditures of $4.5million and in addition we spent $2.0 million in January 2003 topurchase the remaining 49.9% interest of Openet S.r.l., an Italian provider ofPOS services.  Significant portions ofour capital expenditures in each period were for network equipment, third-partysoftware and capitalized software development costs we incurred to expand ournetwork platforms and service our customer requirements. Our remaining capitalexpenditures were for office equipment and leasehold improvements and forgeneral corporate purposes. We currently have no significant capital spendingor purchase commitments but expect to continue to engage in capital spending inthe ordinary course of business.

 

We used cash of $2.7 million forfinancing activities for the three months ended March 31, 2004, which consistedprimarily of $2.7 million of long-term debt repayments on our new seniorsecured credit facility.  In addition,we repaid $150.4 million of long-term debt under our previous senior securedcredit facility with the net proceeds generated from our IPO of $71.6 millionand borrowings under our new credit facility, net of financing costs, of $79.0million. We used cash of $4.0 million for financing activities for thethree months ended March 31, 2003, which consisted primarily of$4.0 million of long-term debt repayments.

 

17

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***New Senior Secured Credit Facility***

 

On March 19,2004, we entered into a new senior secured credit facility (New CreditFacility) to replace our existing senior secured credit facility. The NewCredit Facility consists of a $65.0 million term loan (New Term Loan) anda revolving credit facility of $30.0 million (New Revolving CreditFacility). The New Credit Facility matures March 19, 2009. Payments on the NewTerm Loan are due in quarterly installments over the five-year term, beginningon March 31, 2004. Total payments for each year are as follows (inthousands):

 
| Year 1 |   | $      | 11,000 |   |
|--------|--------|--------|--------|--------|
| Year 2 |   | 12,000 |   |
| Year 3 |   | 13,000 |   |
| Year 4 |   | 14,000 |   |
| Year 5 |   | 15,000 |   |
|   |   | $      | 65,000 |   |

 

For the periodthrough June 30, 2004, borrowings on the New Revolving Credit Facility andthe New Term Loan generally bear interest at a rate, at our option, of either1.25 percent over the lender’s base rate or 2.50 percent over theLIBOR rate (3.6% as of March 31, 2004). Thereafter, if we achieve a leverageratio of less than one, the borrowings on the New Revolving Credit Facility andthe New Term Loan will generally bear interest at a rate, at our option, ofeither 0.75 percent over the lender’s base rate or 2.0 percent overthe LIBOR rate. If we achieve a leverage ratio of less than 1.5 but more thanor equal to one, the borrowings on the New Revolving Credit Facility and theNew Term Loan will generally bear interest at a rate, at our option, of either1.0 percent over the lender’s base rate or 2.25 percent over theLIBOR rate. If we achieve a leverage ratio of less than 2.2 but more than orequal to 1.5, the borrowings on the New Revolving Credit Facility and the NewTerm Loan will generally bear interest at a rate, at our option, of either1.25 percent over the lender’s base rate or 2.5 percent over theLIBOR rate. The New Revolving Credit Facility is subject to an annualcommitment fee in an amount equal to 0.5 percent per annum multiplied bythe amount of funds available for borrowing under the New Revolving CreditFacility. Interest payments on the New Credit Facility are due monthly,bimonthly, or quarterly at the Company’s option.

 

The terms of the New Credit Facility require us to comply with financial and nonfinancial covenants, including maintaining certain leverage, interest and fixed charge coverage ratios at the end of each fiscal quarter. Certain of the financial covenants will become more restrictive over the term of the New Credit Facility. The New Credit Facility also contains nonfinancial covenants that restrict some of our corporate activities, including our ability to dispose of assets, incur additional debt, pay dividends, create liens, make investments, make capital expenditures and engage in specified transactions with affiliates. Our future results of operations and our ability to comply with the covenants could be adversely impacted by increases in the general level of interest rates since the interest on a majority of our debt is variable. Noncompliance with any of the financial or nonfinancial covenants without cure or waiver would constitute an event of default under the New Credit Facility. An event of default resulting from a breach of a financial or nonfinancial covenant may result, at the option of the lenders, in an acceleration of the principal and interest outstanding, and a termination of the New Revolving Credit Facility. The New Credit Facility also contains other customary events of default, including defaults based on events of bankruptcy and insolvency, nonpayment of principal, interest or fees when due, subject to specified grace periods, breach of specified covenants, change in control and material inaccuracy of representations and warranties.  We are in compliance with our financial and nonfinancial covenants.

 

In connectionwith the closing of the New Credit Facility, we incurred approximately $2.0 millionin financing costs. These financing costs are being deferred and amortizedusing the effective interest method over the life of the New Credit Facility.In connection with the termination of the prior credit facility, we wrote-offapproximately $2.0 million of unamortized deferred financing costs related tothe prior credit facility.  Suchwrite-off has been included in interest expense in the accompanying condensedconsolidated statement of operations for the three months ended March 31, 2004.

 

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**Commitments**

 

The following table summarizes our contractual obligations as of March 31, 2004 that require us to make future cash payments (dollars in thousands):

 
|                                                     |   |      |    |                                         |   | **Year  ending December 31,** |   |
|----------------------------------------------------------|--------|-----------|---------|----------------------------------------------|--------|-------------------------------|--------|
|                                                     |   | **Total** |    | **Nine  months  ending  December  31, 2004** |   | **2005**                      |   | **2006** |   | **2007** |   | **2008** |   | **2009 and  thereafter** |   |
|                                                     |   |      |    |                                         |   |                          |   |   |   |   |   |   |   |   |   |
| **Contractual Cash Obligations by Period:**              |   |      |    |                                         |   |                          |   |   |   |   |   |   |   |   |   |
| Long-term debt under the senior secured  credit facility |   | $         | 78,260  |                                         | $      | 8,250                         |   | $ | 12,000 |   | $ | 13,000 |   | $ | 14,000 |   | $ | 15,000 |   | $ | 16,010 |   |
| Operating lease obligations                              |   | 42,028    |    | 3,857                                        |   | 4,932                         |   | 4,435 |   | 4,101 |   | 3,934 |   | 20,769 |   |
|                                                     |   | $         | 120,288 |                                         | $      | 12,107                        |   | $ | 16,932 |   | $ | 17,435 |   | $ | 18,101 |   | $ | 18,934 |   | $ | 36,779 |   |
|                                                          |        |           |         |                                              |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 3****.  Quantitative and Qualitative Disclosures About Market Risk**

 

***Interestrates***

 

Our principalexposure to market risk relates to changes in interest rates. As ofMarch 31, 2004, we had $78.3 million outstanding under our new seniorsecured credit facility with interest rates tied to changes in the lender’sbase rate or the LIBOR rate. Based upon the outstanding borrowings onMarch 31, 2004 and assuming repayment of the New Term Loan in accordancewith scheduled maturities, each 1.0% increase in these rates could add anadditional $0.7 million to our annual interest expense.

 

As ofMarch 31, 2004, we did not hold derivative financial or commodityinstruments and all of our cash and cash equivalents were held in money marketor commercial accounts.

 

***Foreigncurrency risk***

 

Our earningsare affected by fluctuations in the value of the U.S. dollar as compared withforeign currencies, predominately the euro, the British pound and theAustralian dollar due to our operations in Europe and Australia.

 

We provideservices in 12 countries outside of the U.S., including the United Kingdom,Australia, Canada, France, Germany, Ireland, Italy, Japan, The Netherlands, NewZealand, Spain and Sweden. We manage foreign exchange risk through thestructure of our business. In the substantial majority of our transactions, wereceive payments denominated in the U.S. dollar, British pound, euro orAustralian dollar. Therefore, we do not rely on international currency marketsto obtain and pay illiquid currencies. The foreign currency exposure that doesexist is limited by the fact that the majority of transactions are paidaccording to our standard payment terms, which are generally short-term innature. Our policy is not to speculate in foreign currencies, and we promptlybuy and sell foreign currencies as necessary to cover our net payables andreceivables, which are denominated in foreign currencies. For the three monthsended March 31, 2004, we recorded a foreign exchange translation gain ofapproximately $100,000.

 

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**Item 4.**** Controls and Procedures**

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

**Evaluation**

 

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2004. Based on the foregoing, the Company’s Chief Executive Officer and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2004.

 

There have been no significant changes during the quarter covered by this report in the Company’s internal control over financial reporting or in other factors that could significantly affect the internal control over financial reporting.

 

**Audit Committee Pre-Approval**

 

Our audit committee has resolved to pre-approve all audit and non-audit services to be performed for us by our independent auditors, Ernst & Young LLP.  Non-audit services that have received pre-approval include tax preparation and related tax consultation and advice, review and support for securities issuances and acquisition assistance.

 

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**PART II - OTHER INFORMATION**

 

**Item 1.****                                                          ****Legal****Proceedings**

 

We are party to various legal proceedings in the normal course of business.  Please see the description under the caption “Legal Proceedings” in the prospectus filed with the Commission on March 16, 2004 pursuant to Rule 424(b)(4) under the Securities Act in connection with the Company’s Registration Statement on Form S-1 (File No. 333-110188).

 

**Item 2.****                                                          ****Changes****in Securities, Use of Proceeds and Issuer Purchases of Equity Securities**

 

(d)  *Use ofProceeds from Registered Securities*.  On March 16, 2004, in connection with our initial publicoffering, a Registration Statement on Form S-1 (No. 333-110188) was declaredeffective by the Securities and Exchange Commission, pursuant to which4,442,000 shares of our common stock were offered and sold for our account at aprice of $18.00 per share, which generated proceeds, net of offering costs, ofapproximately $71.6 million.  Themanaging underwriters were J.P. Morgan Securities Inc. and Lehman BrothersInc.  The total underwriting discountsand commissions were approximately $5.6 million, none of which was paiddirectly or indirectly to our directors or officers or their associates or topersons owning 10% or more of any class of our equity securities or to anyaffiliate.  The net proceeds ofthe offering were used to repay a portion of our long-term debt outstandingunder our then-existing senior secured credit facility.

 

**Item 3.****                                                          ****Default****Upon Senior Securities**

 

None.

 

**Item 4.****                                                          ****Submission****of Matters to a Vote of Security Holders**

 

In March 2004, prior to the completion of our initial public offering,our then 99% stockholder, TNS Holdings LLC, took action by written consent inlieu of a stockholders meeting.  By thiswritten consent, TNS Holdings LLC approved:

 

(a)  the election of John J.McDonnell, Jr., Brian J. Bates, John J. McDonnell III, Bruce V. Rauner, PhilipA. Canfield, Collin E. Roche, John B. Benton, Stephen X. Graham and George G.Moore to serve as the Company’s directors until the annual meeting ofstockholders to be held in 2005;

 

(b) approved and adopted an amendment to the Company’s certificate ofincorporation effecting a one-for-7.84 reverse split of the Company’s commonstock as part of the initial public offering;

 

(c) approved and adopted the Company’s amended and restated certificateof incorporation effective upon the completion of the initial public offering;and

 

(d) approved the Company’s 2004 Long-Term Incentive Plan.

 

**Item 5.****                                                          ****Other****Information**

 

None.

 

**Item 6.****                                                          ****Exhibits****and Reports on Form 8-K**

 

(a)           Exhibits

 
| (31.1) |   | Certification - Chief Executive Officer                                  |
|--------|--------|--------------------------------------------------------------------------|
|   |   |                                                                     |
| (31.2) |   | Certification - Chief Financial Officer                                  |
|   |   |                                                                     |
| (32.1) |   | Written Statement of Chief Executive Officer and Chief Financial Officer |

 

(b)           Reports on Form 8-K

 

None.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
|               |   | TNS, Inc.                  |
|--------------------|--------|----------------------------|
|               |   | (Registrant)               |
|               |   |                       |
|               |   |                       |
| Date: May 17, 2004 | By:    | /s/ JOHN J. MCDONNELL, JR. |   |
|               |   | John J. McDonnell, Jr.     |
|               |   | Chairman and Chief         |
|               |   | Executive Officer          |
|               |   |                       |
|               |   |                       |
| Date: May 17, 2004 | By:    | /s/ HENRY H. GRAHAM, JR.   |   |
|               |   | Henry H. Graham, Jr.       |
|               |   | Chief Financial Officer    |
|                    |        |                            |  |  |  |

 

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