**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarter endedSeptember 30, 2006**

**Commission File Number:001-32033**

** **

**TNS, INC.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                                              |   | **36-4430020**                           |
|-----------------------------------------------------------|--------|------------------------------------------|
| (State or  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification Number) |

 

**11480 Commerce ParkDrive, Suite 600**

**Reston, VA 20191**

(Address of principal executive offices)

 

**(703) 453-8300**

(Registrant’s telephone number, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirement for the past 90 days   x   Yes   o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

Large acceleratedfiler   o      Acceleratedfiler  x      Non-acceleratedfiler  o

 

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

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

| **Shares Outstanding as of October 1, 2006**         |
|------------------------------------------------------|
| 24,107,988  Shares of Common Stock, $0.001 par value |

 

 

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**TNS, INC.**

**INDEX**
|                                      |       |         |   |                                                                                                                  |       |
|--------------------------------------|------------|--------------|--------|-----------------------------------------------------------------------------------------------------------------------|------------|
|                                 |       |         |   |                                                                                                                  |       |
|                                 |       | Item 1. |   | Condensed Consolidated Financial Statements  (Unaudited)                                                              |       |
|                                 |       |         |   | Condensed Consolidated Balance Sheets as of  December 31, 2005 and September 30, 2006                       |       |
|                                 |       |         |   | Condensed Consolidated Statements of Operations for  the three and nine months ended September 30, 2005 and 2006 |       |
|                                 |       |         |   | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2005 and 2006           |       |
|                                 |       |         |   | Notes to Condensed Consolidated Financial Statements                                                                  |       |
|                                 |       | Item 2. |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                           |       |
|                                 |       | Item 3. |   | Quantitative and Qualitative Disclosures About Market  Risk                                                           |       |
|                                 |       | Item 4. |   | Controls and Procedures                                                                                               |       |
|                                 |       |         |   |                                                                                                                  |       |
| **Part II:  OTHER INFORMATION** | ** ** |
|                                 |       |         |   | ** **                                                                                                            | ** ** |
|                                 |       | Item 1. |   | Legal  Proceedings                                                                                                    |       |
|                                 |       | Item 2. |   | Changes in Securities, Use of Proceeds and Issuer  Purchases of Equity Securities                                     |       |
|                                 |       | Item 3. |   | Default Upon Senior Securities                                                                                        |       |
|                                 |       | Item 4. |   | Submission of Matters to a Vote of Security Holders                                                                   |       |
|                                 |       | Item 5. |   | Other  Information                                                                                                    |       |
|                                 |       | Item 6. |   | Exhibits                                                                                                              |       |

 

2

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**PART I—FINANCIAL INFORMATION**

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

**TNS, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(dollars in thousands, except share and per share data)**
| ** **                                                                                                                                                                                                          | ** ** | **December 31,  2005** | ** ** | **September 30,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                          | ** ** | ** **                  | ** ** | **(unaudited)**              | ** ** |
| **ASSETS**                                                                                                                                                                                                          | ** ** | ** **                  | ** ** | ** **                   | ** ** |
| Current assets:                                                                                                                                                                                                     |       |                        |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                                                          |       | $                           | 26,628     |                         | $          | 12,435 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $5,260 and $6,167,  respectively                                                                                                                    |       | 48,773                      |       | 67,248                       |       |
| Prepaid expenses                                                                                                                                                                                                    |       | 4,407                       |       | 5,139                        |       |
| Deferred tax  assets                                                                                                                                                                                                |       | 5,236                       |       | 3,975                        |       |
| Other current  assets                                                                                                                                                                                               |       | 5,813                       |       | 10,585                       |       |
| Total current  assets                                                                                                                                                                                               |       | 90,857                      |       | 99,382                       |       |
| Property and equipment,  net                                                                                                                                                                                        |       | 52,448                      |       | 56,924                       |       |
| Identifiable intangible  assets, net                                                                                                                                                                                |       | 187,233                     |       | 200,417                      |       |
| Goodwill                                                                                                                                                                                                            |       | 5,160                       |       | 8,589                        |       |
| Other assets                                                                                                                                                                                                        |       | 16,486                      |       | 17,761                       |       |
| Total assets                                                                                                                                                                                                        |       | $                           | 352,184    |                         | $          | 383,073 |   |
| ** **                                                                                                                                                                                                          | ** ** | ** **                  | ** ** | ** **                   | ** ** |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                      | ** ** | ** **                  | ** ** | ** **                   | ** ** |
| Current liabilities:                                                                                                                                                                                                |       |                        |       |                         |       |
| Current portion  of long-term debt                                                                                                                                                                                  |       | $                           | —     |                         | $          | 1,238 |   |
| Accounts  payable, accrued expenses and other current liabilities                                                                                                                                                   |       | 46,933                      |       | 54,475                       |       |
| Deferred revenue                                                                                                                                                                                                    |       | 10,810                      |       | 15,574                       |       |
| Total current  liabilities                                                                                                                                                                                          |       | 57,743                      |       | 71,287                       |       |
| Long-term debt, net of  current portion                                                                                                                                                                             |       | 113,448                     |       | 120,210                      |       |
| Other liabilities                                                                                                                                                                                                   |       | 3,147                       |       | 9,380                        |       |
| Total  liabilities                                                                                                                                                                                                  |       | 174,338                     |       | 200,877                      |       |
|                                                                                                                                                                                                                |       |                        |       |                         |       |
| Commitments and  contingencies                                                                                                                                                                                      |       |                        |       |                         |       |
|                                                                                                                                                                                                                |       |                        |       |                         |       |
| Stockholders’ equity:                                                                                                                                                                                          |       |                        |       |                         |       |
| Common stock,  $0.001 par value; 130,000,000 shares authorized; 23,998,715 shares  issued and 23,971,001 shares outstanding and 24,139,139 shares issued  and 24,107,988 shares outstanding, respectively |       | 24                          |       | 24                           |       |
| Treasury stock,  27,714 shares and 31,151 shares, respectively                                                                                                                                                      |       | (517                        | )          | (586                         | )          |
| Additional  paid-in capital                                                                                                                                                                                         |       | 217,434                     |       | 216,296                      |       |
| Accumulated  deficit                                                                                                                                                                                                |       | (31,567                     | )          | (34,804                      | )          |
| Deferred stock  compensation                                                                                                                                                                                        |       | (7,150                      | )          | —                       |       |
| Accumulated  other comprehensive (loss) income                                                                                                                                                                      |       | (378                        | )          | 1,266                        |       |
| Total  stockholders’ equity                                                                                                                                                                                    |       | 177,846                     |       | 182,196                      |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                    |       | $                           | 352,184    |                         | $          | 383,073 |   |

 

See accompanyingnotes to condensed consolidated financial statements (unaudited).

3

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**TNS, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)(dollars in thousands, except share and per share data)**
| ** **                                                                                                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                                                                                       |       | $                                                    | 64,836     |                                                | $          | 73,187 |   | $ | 193,321 |   | $ | 211,755 |   |
| Operating expenses:                                                                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of network  services, exclusive of the items shown separately below                                                                       |       | 30,074                                               |       | 37,442                                              |       | 91,270 |   | 107,627 |   |
| Engineering and  development                                                                                                                   |       | 3,813                                                |       | 5,269                                               |       | 11,753 |   | 15,305 |   |
| Selling,  general, and administrative                                                                                                          |       | 13,796                                               |       | 20,985                                              |       | 39,847 |   | 55,103 |   |
| Depreciation and  amortization of property and equipment                                                                                       |       | 4,541                                                |       | 5,574                                               |       | 14,367 |   | 15,947 |   |
| Amortization of  intangible assets                                                                                                             |       | 4,249                                                |       | 5,459                                               |       | 17,763 |   | 15,735 |   |
| Total operating  expenses                                                                                                                      |       | 56,473                                               |       | 74,729                                              |       | 175,000 |   | 209,717 |   |
| Income (loss) from  operations                                                                                                                 |       | 8,363                                                |       | (1,542                                              | )          | 18,321 |   | 2,038 |   |
| Interest expense                                                                                                                               |       | (2,997                                               | )          | (2,466                                              | )          | (7,036 | ) | (6,785 | ) |
| Interest income                                                                                                                                |       | 172                                                  |       | 143                                                 |       | 422 |   | 407 |   |
| Other (expense) income,  net                                                                                                                   |       | (22                                                  | )          | 688                                                 |       | (521 | ) | 1,210 |   |
| Income (loss) before  income taxes, equity in net loss of unconsolidated affiliates and cumulative  effect of a change in accounting principle |       | 5,516                                                |       | (3,177                                              | )          | 11,186 |   | (3,130 | ) |
| Income tax (provision)  benefit                                                                                                                |       | (2,085                                               | )          | 2,240                                               |       | (4,919 | ) | 2,711 |   |
| Equity in net loss of  unconsolidated affiliates                                                                                               |       | (797                                                 | )          | (904                                                | )          | (1,929 | ) | (2,902 | ) |
| Income (loss) before  cumulative effect of a change in accounting principle                                                                    |       | 2,634                                                |       | (1,841                                              | )          | 4,338 |   | (3,321 | ) |
| Cumulative effect of a  change in accounting principle, net of tax provision                                                                   |       | —                                               |       | —                                              |       | — |   | 84 |   |
| Net income (loss)                                                                                                                              |       | $                                                    | 2,634      |                                                | $          | (1,841 | ) | $ | 4,338 |   | $ | (3,237 | ) |
|                                                                                                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Basic net income (loss)  per common share:                                                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  before cumulative effect of a change in accounting principle                                                                    |       | $                                                    | 0.12       |                                                | $          | (0.08 | ) | $ | 0.18 |   | $ | (0.13 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                                   |       | —                                               |       | —                                              |       | — |   | — |   |
| Net income  (loss)                                                                                                                             |       | $                                                    | 0.12       |                                                | $          | (0.08 | ) | $ | 0.18 |   | $ | (0.13 | ) |
| Diluted net income  (loss) per common share:                                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  before cumulative effect of a change in accounting principle                                                                    |       | $                                                    | 0.12       |                                                | $          | (0.08 | ) | $ | 0.17 |   | $ | (0.13 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                                   |       | —                                               |       | —                                              |       | — |   | — |   |
| Net income  (loss)                                                                                                                             |       | $                                                    | 0.12       |                                                | $          | (0.08 | ) | $ | 0.17 |   | $ | (0.13 | ) |
| Basic weighted average  common shares outstanding                                                                                              |       | 22,040,253                                           |       | 24,105,525                                          |       | 24,703,641 |   | 24,063,633 |   |
| Diluted weighted average common shares outstanding                                                                                             |       | 22,631,624                                           |       | 24,105,525                                          |       | 25,110,688 |   | 24,063,633 |   |

 

See accompanyingnotes to condensed consolidated financial statements (unaudited).

4

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**TNS, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)(dollars in thousands)**
| ** **                                                                                | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                                | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                    |       |                                                    |       |   |   |
| Net income (loss)                                                                         |       | $                                                       | 4,338      |   | $ | (3,237 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                                    |       |   |   |
| Non-cash and  working capital items                                                       |       | 29,117                                                  |       | 27,990 |   |
| Net cash  provided by operating activities:                                               |       | 33,455                                                  |       | 24,753 |   |
| Cash flows from  investing activities:                                                    |       |                                                    |       |   |   |
| Purchases of  property and equipment                                                      |       | (14,087                                                 | )          | (18,276 | ) |
| Cash paid for  business acquisitions, net of cash acquired                                |       | (4,059                                                  | )          | (27,824 | ) |
| Investments in  unconsolidated affiliates                                                 |       | (5,505                                                  | )          | — |   |
| Net cash used in  investing activities:                                                   |       | (23,651                                                 | )          | (46,100 | ) |
| Cash flows from  financing activities:                                                    |       |                                                    |       |   |   |
| Proceeds from  issuance of long-term debt                                                 |       | 165,188                                                 |       | 8,000 |   |
| Repayment of  long-term debt                                                              |       | (99,740                                                 | )          | — |   |
| Payment of  long-term debt financing costs                                                |       | (75                                                     | )          | (225 | ) |
| Proceeds from  stock option exercises, inclusive of tax benefit                           |       | 1,554                                                   |       | 351 |   |
| Purchase of  treasury stock                                                               |       | (511                                                    | )          | (69 | ) |
| Purchase of  common stock, inclusive of fees of $996                                      |       | (116,869                                                | )          | — |   |
| Proceeds from  issuance of common stock, net                                              |       | 46,065                                                  |       | — |   |
| Net cash (used  in) provided by financing activities:                                     |       | (4,388                                                  | )          | 8,057 |   |
| Effect of exchange  rates on cash and cash equivalents                                    |       | (640                                                    | )          | (903 | ) |
| Net increase (decrease)  in cash and cash equivalents                                     |       | 4,776                                                   |       | (14,193 | ) |
| Cash and cash  equivalents, beginning of period                                           |       | 19,788                                                  |       | 26,628 |   |
| Cash and cash  equivalents, end of period                                                 |       | $                                                       | 24,564     |   | $ | 12,435 |   |
| Supplemental disclosures  of cash flow information:                                       |       |                                                    |       |   |   |
| Cash paid for  interest                                                                   |       | $                                                       | 4,543      |   | $ | 4,469 |   |
| Cash paid for income  taxes                                                               |       | $                                                       | 4,186      |   | $ | 7,821 |   |

 

See accompanyingnotes to condensed consolidated financial statements (unaudited).

5

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**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS (UNAUDITED)**

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

TNS, Inc.(TNS or the Company) is a Delaware corporation. TNS is a leading provider ofbusiness-critical data communications services to processors of credit card,debit card and automated teller machine (ATM) transactions. TNS is also aleading provider of call signaling and database access services to the domestictelecommunications industry and of secure data and voice network services tothe global financial services industry. TNS’ data communication services enablesecure and reliable transmission of time-sensitive, transaction-relatedinformation critical to its customers’ operations. The Company’s customersoutsource their data communication requirements to TNS because of the Company’sexpertise, comprehensive customer support, and cost-effective services. TNSprovides services to customers in the United States and increasingly tocustomers in 27 countries, including Canada and countries in Europe, LatinAmerica 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, are designed to be scalable and areaccessible by multiple methods, including dial-up, dedicated, wireless andInternet connections.

The Company hasfour 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 data and voice communications services to thefinancial services community 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 theCompany’s POS and financial services in countries outside of the United Statesand Canada.

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with United States generally accepted accounting principles (GAAP)for interim financial information and in conjunction with the rules andregulations of the Securities and Exchange Commission (SEC). Certaininformation and note disclosures normally included in the annual financialstatements, required by GAAP, have been condensed or omitted pursuant to thoserules and regulations, although the Company believes that the disclosuresmade are adequate to make the information presented not misleading.

In the opinion ofmanagement, 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 operations for the three and nine months endedSeptember 30, 2006 are not necessarily indicative of the results to be expectedfor any subsequent interim period or for the fiscal year. It is suggested thatthese unaudited condensed consolidated financial statements be read inconjunction with the Company’s annual report on Form 10-K datedMarch 16, 2006 and amended July 21, 2006 as filed with the SEC, whichincludes consolidated financial statements and the notes thereto for the yearended December 31, 2005.

*Stock Repurchase and Offerings ofCommon Stock*

On May 5,2005, the Company purchased and retired 6,263,435 shares of its common stock,pursuant to a modified Dutch auction tender offer, for $18.50 per share plusexpenses of approximately $1.0 million. Of the shares tendered,6 million shares were tendered by the Company’s then controllingstockholder, GTCR Golder Rauner L.L.C. and its affiliated investment funds(“GTCR”).

OnSeptember 21, 2005, the Company completed a follow-on offering of commonstock issuing 1,200,000 common shares at $23.25 per share, which generatedproceeds, net of offering costs, of approximately $26.1 million. OnSeptember 21, 2005, in connection with the following-on offering, theunderwriters exercised their over-allotment option and the Company issued anadditional 900,000 shares of common stock at $23.25 per share, whichgenerated proceeds net of offering costs of approximately $20.0 million.The net proceeds from the follow-on offering were used to repay a portion ofthe Company’s long-term debt outstanding under its existing credit-facility.

6

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** **

**Use ofEstimates**

The preparation offinancial statements in conformity with GAAP 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, future cash flows from long-lived assets, accrued expensesfor probable losses and estimates related to the fair value of employee stockoptions, including volatility, expected term and estimates of forfeitures infuture periods. Actual results could differ from those estimates.

**RevenueRecognition**

The Companyrecognizes revenue when persuasive evidence of an agreement exists, the termsare fixed or determinable, services are performed, and collection is probable.Cash received in advance of revenue recognition is recorded as deferredrevenue. POS services revenue is derived primarily from the transmission oftransaction data through the Company’s networks between payment processors andPOS or ATM terminals. Telecommunication services revenue is derived primarilyfrom fixed monthly recurring fees for the Company’s call signaling services andper query fees charged for the Company’s database access and validationservices. Financial services revenue is derived primarily from monthlyrecurring fees based on the number of customer connections to and through theCompany’s networks. Customer incentives granted to new customers or uponcontract renewals are deferred and recognized ratably as a reduction of revenueover the contract period to the extent that the incentives are recoverableagainst the customer’s minimum purchase commitments under the contract. Inaddition, the Company receives installation fees related to the configurationof the customer’s systems. Revenue from installation fees are deferred and recognizedratably over the customer’s contractual service period, generally three years.The Company performs periodic evaluations of its customer base and establishesallowances for estimated credit losses.

**Cost ofNetwork Services**

Cost of networkservices is comprised primarily of telecommunications charges, which includedata transmission and database access, leased digital capacity charges, circuitinstallation charges and activation charges. The cost of data transmission isbased on a contract or tariff rate per minute of usage in addition to aprescribed rate per transaction for certain vendors. The costs of databaseaccess, circuits, installation charges and activation charges are based onfixed fee contracts with local exchange carriers and interexchange carriers.The cost of network services also includes salaries, equipment maintenance andother costs related to the ongoing operation of the Company’s data networks.These costs are expensed as incurred. The Company records its accrual fortelecommunications charges based upon network services utilized at historicalinvoiced rates. Depreciation expense on the Company’s network equipment andamortization of developed technology are excluded from the Company’s cost ofnetwork services and included in depreciation and amortization of property andequipment and amortization of intangible assets in the condensed consolidatedstatement of operations.

**Stock-BasedCompensation**

EffectiveJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards (SFAS) No. 123R, “Share-Based Payment” (SFAS 123R), using themodified prospective transition method. SFAS 123R requires all stock-basedcompensation to employees be measured at fair value and expensed over therequisite service period and also requires an estimate of forfeitures whencalculating compensation expense. The Company recognizes compensation cost onawards with graded vesting on a straight-line basis over the requisite serviceperiod for the entire award. In accordance with the Company’s chosen method ofadoption, results for prior periods have not been restated. Share-basedexpenses for all non-vested awards outstanding as of January 1, 2006, arebeing recognized based on the grant date fair value estimated in accordancewith the provisions of SFAS No. 123 “Accounting for Stock-BasedCompensation” and in accordance with SFAS 123R for all awards granted ormodified after January 1, 2006. Prior to the adoption of SFAS 123R, theCompany followed Accounting Principles Board (APB) Opinion No. 25, whichaccounts for share-based payments to employees using the intrinsic value methodand, as such, the Company generally recognized no compensation cost foremployee stock options. Refer to Note 7 for additional discussion regardingdetails of the Company’s stock-based compensation plans and the adoption ofSFAS 123R.

7

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** **

**IdentifiableIntangible Assets**

Amortization ofintangible assets is recorded on a straight-line basis over their expecteduseful lives. The Company evaluates the useful lives assigned to intangibleassets on a regular basis.

Developedtechnology represents the Company’s proprietary knowledge, including processesand procedures, used to configure its networks. Network equipment and software,both purchased and internally developed, are components used to build thenetworks and are separately identified assets classified within property andequipment.

For purposes ofmeasuring and recognizing impairment of long-lived assets, includingintangibles, the Company assesses whether separate cash flows can be attributedto the individual asset.  For the customer relationship intangible assets,the Company recognizes and measures impairment upon the significant loss ofrevenue from a customer. Included in amortization of intangibles expense for thenine months ended September 30, 2005 and 2006 is approximately $3.1 million and$0.1 million, respectively, in accelerated amortization on a portion of theCompany’s customer relationship assets in connection with the loss of certaincustomers during those respective periods.  The Company has experiencedrevenue and transaction volume declines with a major customer during 2005 and2006.  The customer relationship intangible asset assigned to thiscustomer is approximately $22.7 million as of September 30, 2006.  TheCompany assessed the recoverability of this customer relationship intangibleasset based upon undiscounted anticipated future cash flows and concluded thatno impairment existed as of September 30, 2006.

**Income Taxes**

The Companyaccounts for income taxes in accordance with SFAS No. 109, “Accounting forIncome Taxes.” Under SFAS No. 109, deferred tax assets or liabilities arecomputed based upon the difference between financial statement and income taxbases of assets and liabilities using the enacted marginal tax rate. TheCompany provides a valuation allowance on its net deferred tax assets when itis more likely than not that such assets will not be realized. Deferred incometax expense or benefits are based upon the changes in the asset or liabilityfrom period to period.

For the three andnine months ended September 30, 2005, the Company’s effective tax rate wasapproximately 44.2% and 53.1%, respectively. For the three and nine monthsended September 30, 2006 the Company’s effective tax rate was approximately54.9% and 44.9%, respectively.  The Company’s tax rate fluctuates from theU.S. Federal statutory tax rate of 34.0% as a result of losses in certaininternational jurisdictions and losses on equity method investments for which avaluation allowance has been established on the deferred tax assets created bysuch net losses. In addition, the majority of the Company’s operations inforeign countries that are generating pre-tax income are generally taxed atrates less than 34.0%.

**New Accounting Pronouncements**

In July 2006, the Financial Accounting Standards Board(FASB) issued FASB Interpretation No. 48 “Accounting for Uncertainty in IncomeTaxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in a company’s financial statements in accordance with SFASNo. 109 “Accounting for Income Taxes”. FIN 48 provides guidance on recognizing,measuring, presenting and disclosing in the financial statements uncertain taxpositions that a company has taken or expects to take on a tax return. FIN 48is effective for the Company as of January 1, 2007. The Company is currentlyassessing the impact, if any, of FIN 48 on its consolidated financialstatements. The Company is formulating an implementation plan that identifiesand categorizes its uncertain tax positions and each position will be evaluatedand assessed for recognition and measurement under the guidelines of FIN 48.

In September 2006, the FASB issued SFAS No. 157 “FairValue Measurements” (SFAS 157). SFAS 157 provides a new single authoritativedefinition of fair value and provides enhanced guidance for measuring the fairvalue of assets and liabilities and requires additional disclosures related tothe extent to which companies measure assets and liabilities at fair value, theinformation used to measure fair value, and the effect of fair valuemeasurements on earnings. SFAS 157 is effective for the Company as of January1, 2008. The Company is currently assessing the impact, if any, of SFAS 157 onits consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158 “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans — anamendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158). SFAS 158requires balance sheet recognition of the overfunded or underfunded status ofpension and postretirement benefit plans. Under SFAS 158, actuarial gains andlosses, prior service costs or credits, and any remaining transition assets orobligations that have not been recognized under previous accounting standardsmust be recognized as a component of accumulated other comprehensive income(loss) within stockholders’ equity, net of tax effects, until they areamortized as a component of net periodic benefit cost. In addition, the measurementdate and the date at which plan assets and the benefit obligation are measured,are required to be the company’s fiscal year-end. SFAS 158 is effective for theCompany as of December 31, 2007, except for the measurement date provisions,which are effective December 31, 2009. The adoption of SFAS 158 is not expectedto have a material impact on the Company’s consolidated financial statements.

In September 2006, the SEC released Staff AccountingBulletin No. 108 “Considering the Effects of Prior Year Misstatements WhenQuantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB108 provides interpretative guidance on how public companies quantify financialstatement misstatements. There have been two common approaches used to quantifysuch

8

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errors.Under an income statement approach, the “roll-over” method, the error isquantified as the amount by which the current year income statement ismisstated. Alternatively, under a balance sheet approach, the “iron curtain”method, the error is quantified as the cumulative amount by which the currentyear balance sheet is misstated. In SAB 108, the SEC established an approachthat requires quantification of financial statement misstatements based on theeffects of the misstatements on each of the company’s financial statements andthe related financial statement disclosures. This model is commonly referred toas a “dual approach” because it requires quantification of errors under boththe roll-over and iron curtain methods. SAB 108 is effective for the Company asof January 1, 2007. The adoption of SAB 108 is not expected to have a materialimpact on the Company’s consolidated financial statements.

**2.****                                            Acquisitionsand Long-term Investments**

**Acquisitionof Connet-Ro**

OnDecember 13, 2005, the Company completed the acquisition of a Romaniancompany, SC Connet-Ro SRL (Connet-Ro) for an initial purchase price of $1.4million, including direct acquisition costs of approximately $0.1 million. TheCompany accounted for the transaction as a purchase under the provisions ofSFAS No. 141 “Business Combinations”. The purchase agreement allowed foradditional consideration of up to $0.4 million to be paid, based upon theresults of operations of Connet-Ro for the year ended December 31,2005.  In May 2006, the Company made an additional payment of $0.2 millionbased upon the results of operations of Connet-Ro.  This contingentconsideration has been allocated to the customer relationship intangible asset.

The purchase pricewas allocated, on a preliminary basis, as follows (in thousands):

| Other current assets                                      |   | $     | 450    |   |
|-----------------------------------------------------------|--------|-------|--------|--------|
| Property and  equipment                                   |   | 294   |   |
| Customer  relationship                                    |   | 1,292 |   |
| Non-compete  agreements                                   |   | 125   |   |
| Accounts  payable, accrued expenses and other liabilities |   | (572  | )      |
| Net assets  acquired                                      |   | $     | 1,589  |   |

 

The amountsallocated to the customer relationship and to the non-compete agreements arebeing amortized on a straight-line basis over their estimated useful life offive years and three years, respectively. Unaudited pro forma results of operations are not provided because thehistorical operating results were not significant and pro forma results wouldnot be significantly different from reported results for the periods presented.

**Acquisition of CommsXL**

On January 6,2006, the Company completed the acquisition of two companies in the UnitedKingdom, CommsXL Services and CommsXL Limited (collectively, CommsXL). Pursuantto two separate purchase agreements, the Company paid approximately$11.7 million, plus direct acquisition costs of approximately $0.3million, for CommsXL. The Company purchased CommsXL to advance its end-to-endPOS service offerings in the United Kingdom as well as to penetrate newvertical markets.

The purchase pricefor CommsXL was allocated, on a preliminary basis, as follows (in thousands):

| Current assets                                            |   | $      | 2,328  |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Property and  equipment                                   |   | 70     |   |
| Other assets                                              |   | 130    |   |
| Customer  relationships                                   |   | 6,578  |   |
| Developed  technology                                     |   | 1,835  |   |
| Non-compete  agreements                                   |   | 1,167  |   |
| Goodwill                                                  |   | 2,092  |   |
| Deferred revenue                                          |   | (993   | )      |
| Accounts  payable, accrued expenses and other liabilities |   | (1,221 | )      |
| Net assets  acquired                                      |   | $      | 11,986 |   |

 

The amountsallocated to the customer relationships, developed technology and to thenon-compete agreements are being amortized on a straight-line basis over theirestimated useful life of five years, five years and three years, respectively.Unaudited pro forma results of operations are not provided because thehistorical operating results were not significant and pro forma results wouldnot be significantly different from reported results for the periods presented.The Company’s results of operations for the nine months ended September 30,2006 include the operating results of these acquisitions from January 6,2006.

9

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** **

**Acquisitionof InfiniRoute Assets**

OnFebruary 28, 2006, the Company acquired certain tangible and intangibleassets from InfiniRoute Networks, Inc. (InfiniRoute) for a purchase priceof approximately $2.5 million. The assets acquired include the right to provideTSD services under customer contracts, developed technology, certain fixedassets and a non-compete agreement. The Company purchased these assets toadvance its TSD service offerings to enable traditional telecommunicationscarriers and next-generation service providers to interconnect directly overInternet Protocol (IP) packet networks, reducing the cost and complexityassociated with these interconnections.

The purchase pricefor the InfiniRoute assets was allocated, on a preliminary basis, as follows(in thousands):

| Current assets          |   | $   | 272    |   |
|-------------------------|--------|-----|--------|--------|
| Property and  equipment |   | 764 |   |
| Customer  relationships |   | 696 |   |
| Developed  technology   |   | 695 |   |
| Non-compete  agreements |   | 109 |   |
| Net assets  acquired    |   | $   | 2,536  |   |

 

The amountsallocated to the customer relationships, developed technology and to thenon-compete agreements are being amortized on a straight-line basis over theirestimated useful lives of three years. Unaudited pro forma results ofoperations are not provided because the historical operating results were notsignificant and pro forma results would not be significantly different fromreported results for the periods presented. The Company’s results of operationsfor the nine months ended September 30, 2006 include the operating results ofthis acquisition from March 1, 2006.

**Acquisition of Sonic Assets**

On March 13,2006, the Company acquired certain tangible and intangible assets from SonicGlobal PTY Ltd. (Sonic) and all of the capital stock of a subsidiary of Sonicfor a purchase price of approximately $6.0 million, plus direct acquisitioncosts of approximately $0.1 million. The assets acquired include the right toprovide POS services under customer contracts, developed technology, certainfixed assets and non-compete agreements. The Company purchased these assets toenhance its end-to-end POS service offerings.

The purchase pricefor the Sonic assets was allocated, on a preliminary basis, as follows (inthousands):

| Current assets                                            |   | $     | 251    |   |
|-----------------------------------------------------------|--------|-------|--------|--------|
| Property and  equipment                                   |   | 41    |   |
| Customer  relationships                                   |   | 3,257 |   |
| Developed  technology                                     |   | 1,334 |   |
| Non-compete  agreements                                   |   | 634   |   |
| Goodwill                                                  |   | 1,111 |   |
| Deferred revenue                                          |   | (430  | )      |
| Accounts  payable, accrued expenses and other liabilities |   | (128  | )      |
| Net assets  acquired                                      |   | $     | 6,070  |   |

 

The amountsallocated to the customer relationships, developed technology and to thenon-compete agreements are being amortized on a straight-line basis over theirestimated useful life of five years, five years and three years, respectively.Unaudited pro forma results of operations are not provided because thehistorical operating results were not significant and pro forma results wouldnot be significantly different from reported results for the periods presented.The Company’s results of operations for the nine months ended September 30,2006 include the operating results of this acquisition from March 1, 2006.

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** **

**JPGTelecom, SAS Acquisition**

On September 8,2006, the Company acquired all of the outstanding shares of JPG Telecom, SAS(JPG), a French telecommunications provider to the POS market, for a purchaseprice of $8.3 million, plus direct acquisition costs of approximately $0.2million.  The Company purchased JPGprimarily to increase its market share of the French POS market.

The purchase price for JPG was allocated, on a preliminary basis, asfollows (in thousands):

| Current assets                                            |   | $      | 493    |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Accounts  receivable                                      |   | 2,808  |   |
| Customer  relationships                                   |   | 10,876 |   |
| Non-compete  agreements                                   |   | 679    |   |
| Deferred tax  liability                                   |   | (3,813 | )      |
| Accounts  payable, accrued expenses and other liabilities |   | (2,530 | )      |
| Net assets  acquired                                      |   | $      | 8,513  |   |

 

The amountsallocated to the customer relationships and to the non-compete agreements arebeing amortized on a straight-line basis over their estimated useful life offive years and three years, respectively. Unaudited pro forma results ofoperations are not provided because the historical operating results were notsignificant and pro forma results would not be significantly different fromreported results for the periods presented. The Company’s results of operationsfor the nine months ended September 30, 2006 include the operating results ofthis acquisition from September 1, 2006.

**WaySystems Investment**

InAugust 2004, the Company made an investment in WAY Systems, Inc.(WAY), which provides mobile POS transaction infrastructure and solutions formobile merchants. The Company purchased 5,952,381 shares or 38.5 percent of WAY’sSeries B convertible preferred stock for $2.5 million and became entitledto representation on WAY’s board of directors. In March 2005, the Companymade an additional investment of $0.8 million to purchase 1,910,401 shares ofWAY’s Series B convertible preferred stock for an additional 1.9 percentof WAY’s outstanding shares. In July 2005, the Company made an additionalinvestment of $0.7 million in exchange for a convertible note bearing interestat a rate of 8 percent per annum and due January 1, 2009. InSeptember 2005, the Company exercised its right on the convertible note toconvert the outstanding principal and accrued interest of approximately $0.8million to 1,185,085 shares of WAY’s Series C convertible preferred stockand made an additional investment of $1.1 million to purchase 1,676,429 sharesof WAY’s Series C convertible preferred stock. The Company owned 17.1percent of WAY’s total outstanding shares as of September 30, 2006. The Companyis accounting for its investment under the equity method of accounting as theCompany has significant influence over the financing and operating activitiesof WAY through its representation on the WAY board of directors. Due to timingof the receipt of WAY’s financial statements, the Company is accounting for theloss in this equity method investment on a one-month lag.

Summarizedfinancial information for WAY is as follows (in thousands):

|                         | ** ** | **December 31,  2005** | ** ** | **September 30,  2006** | ** ** |
|-------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **              | ** ** | ** **                  | ** ** | **(unaudited)**              | ** ** |
| Current assets          |       | $                           | 12,473     |                         | $          | 7,029 |   |
| Non-current  assets     |       | 743                         |       | 822                          |       |
| Current  liabilities    |       | 1,956                       |       | 2,881                        |       |
| Non-current liabilities |       | —                      |       | 2,500                        |       |
|                         |            |                             |            |                              |            |  |  |

 
| ** **                         | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **(unaudited)**                                          | ** ** | **(unaudited)**                                         | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenue                            |       | $                                                        | 1,178      |                                                    | $          | 2,282 |   | $ | 2,601 |   | $ | 5,875 |   |
| Gross profit                       |       | 454                                                      |       | 859                                                     |       | 943 |   | 1,979 |   |
| Net loss                           |       | (1,913                                                   | )          | (2,099                                                  | )          | (4,995 | ) | (8,722 | ) |
| Company’s equity in net  loss |       | $                                                        | (355       | )                                                       | $          | (487 | ) | $ | (990 | ) | $ | (1,540 | ) |

 

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**IPCommerce Investment**

InJanuary 2005, the Company made an investment in IP Commerce, a companythat provides operating software to facilitate the authorization of IP-basedretail payment transactions. The Company purchased 2,368,545 Series Apreferred shares or 39.9 percent of IP Commerce’s total outstanding shares for$2.0 million and became entitled to representation on IP Commerce’s board ofdirectors. In September 2005, the Company made an additional investment of$0.9 million in exchange for a convertible note bearing interest at a rate of 8percent per annum which was payable on demand, no earlier than February 1,2007. In March 2006, the Company exercised its right on the convertiblenote to convert the outstanding principal and accrued interest of approximately$0.9 million to 675,901 shares of IP Commerce’s Series B convertiblepreferred stock. The Company owned 27.2 percent of IP Commerce’s totaloutstanding shares as of September 30, 2006. The Company is accounting for itsinvestment under the equity method of accounting. Due to timing of the receiptof IP Commerce’s financial statements, the Company is accounting for the lossin this equity method investment on a one-month lag.

Summarizedfinancial information for IP Commerce is as follows (in thousands):

|                         | ** ** | **December 31, 2005** | ** ** | **September 30, 2006** | ** ** |
|-------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | ** **                      | ** ** | **(unaudited)**                  | ** ** |
| Current assets          |       | $                               | 1,426      |                             | $          | 2,975 |   |
| Non-current assets      |       | 274                             |       | 424                              |       |
| Current liabilities     |       | 258                             |       | 785                              |       |
| Non-current liabilities |       | 2,596                           |       | —                           |       |
|                         |            |                                 |            |                                  |            |  |  |

 
| ** **                        | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                        | ** ** | **(unaudited)**                                          | ** ** | **(unaudited)**                                         | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenue                           |       | $                                                        | —     |                                                    | $          | — |   | $ | 198 |   | $ | — |   |
| Gross profit                      |       | —                                                   |       | —                                                  |       | 198 |   | — |   |
| Net loss                          |       | (792                                                     | )          | (1,458                                                  | )          | (2,113 | ) | (4,313 | ) |
| Company’s equity in net loss |       | $                                                        | (419       | )                                                       | $          | (400 | ) | $ | (826 | ) | $ | (1,338 | ) |

 

**3.            Long-term Debt**

On May 4,2005, the Company entered into an amended and restated senior secured creditfacility (the May 4, 2005 Credit Facility) to finance the stock repurchaseand to replace its prior senior secured credit facility (March 19, 2004Credit Facility). The May 4, 2005 Credit Facility consists of a$165.0 million Term B Loan (Term B Loan) and a revolving credit facilityof $30.0 million (New Revolving Credit Facility), under which there were$8 million of borrowings as of September 30, 2006. The May 4, 2005 CreditFacility matures May 4, 2012. Payments on the Term B Loan are due inquarterly installments over the seven-year term, which began on June 1,2005, with the remainder payable on May 4, 2012. Voluntary prepayments onthe Term B Loan are first applied pro-rata to the scheduled quarterlyinstallments due within the next succeeding twelve-month period until paid infull and then applied to the term loan in inverse order of maturity.

As of September30, 2006, total remaining payments on the Term B Loan are as follows (inthousands):

| Three months ending  December 31, 2006 |   | $       | —  |   |
|---------------------------------------------|--------|---------|---------|--------|
| 2007                                        |   | 1,650   |    |
| 2008                                        |   | 1,650   |    |
| 2009                                        |   | 1,650   |    |
| 2010                                        |   | 1,650   |    |
| Thereafter                                  |   | 114,848 |    |
|                                        |   | $       | 121,448 |   |

 

For the threemonths ended September 30, 2006, borrowings on the New Revolving CreditFacility and the Term B Loan bore interest at a rate of 2.0 percentover the LIBOR rate (7.4 percent as of September 30, 2006). Thereafter, if theCompany achieves a leverage ratio of less than 1.75, the borrowings on the NewRevolving Credit Facility and the Term B Loan generally will bear interest at arate, at the Company’s option, of either 0.75 percent over the lender’sbase rate or 1.75 percent over the LIBOR rate. The Company’s leverageratio as of September 30, 2006 was 2.0 to 1.0. The New Revolving CreditFacility is subject to an annual non-use commitment fee in an amount equal to0.375 percent or 0.5 percent per annum, depending on the Company’s leverageratio, multiplied by the amount of funds available for borrowing under the NewRevolving Credit Facility. Interest payments on the May 4, 2005 CreditFacility are due monthly, bimonthly, quarterly, semi-annually or annually atthe Company’s option.

Theterms of the May 4, 2005 Credit Facility require the Company to complywith financial and nonfinancial covenants, including maintaining certainleverage, interest and fixed charge coverage ratios at the end of each fiscalquarter. As of September 30, 2006, the Company was required to maintain aleverage ratio of less than 2.4 to 1.0, an interest coverage ratio of greaterthan 4.0 to 1.0 and a fixed charge ratio of greater than 2.5 to 1.0. Certain ofthe financial covenants will become more restrictive over the term of theMay 4, 2005 Credit Facility. The May 4, 2005 Credit Facility alsocontains nonfinancial covenants that restrict some of the

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Company’s corporate activities, including the Company’sability to dispose of assets, incur additional debt, pay dividends, createliens, make investments, make capital expenditures and engage in specifiedtransactions with affiliates. The Company’s future results of operations andits ability to comply with the covenants could be adversely impacted byincreases in the general level of interest rates since the interest on amajority of the Company’s debt is variable. Noncompliance with any of thefinancial or nonfinancial covenants without cure or waiver would constitute anevent of default under the May 4, 2005 Credit Facility. An event ofdefault resulting from a breach of a financial or nonfinancial covenant mayresult, at the option of the lenders, in an acceleration of the principal andinterest outstanding, and a termination of the May 4, 2005 Credit Facility.The May 4, 2005 Credit Facility also contains other customary events ofdefault (subject to specified grace periods), including defaults based onevents of bankruptcy and insolvency, nonpayment of principal, interest or feeswhen due, breach of specified covenants, change in control and materialinaccuracy of representations and warranties. The Company was in compliancewith the financial and nonfinancial covenants of the May 4, 2005 CreditFacility as of September 30, 2006.

In connection withthe closing of the May 4, 2005 Credit Facility, the Company incurredapproximately $2.7 million in financing costs. These financing costs weredeferred and are being amortized using the effective interest method over thelife of the May 4, 2005 Credit Facility. In connection with thetermination of the March 19, 2004 Credit Facility in May 2005, the Companywrote—off approximately $1.1 million in unamortized deferred financingcosts related to the March 19, 2004 Credit Facility. Such write—off has beenincluded in interest expense in the accompanying condensed consolidatedstatement of operations for the three and nine months ended September 30, 2005.

**4.****                                        ComprehensiveIncome (Loss)**

The components ofcomprehensive income (loss), net of tax effect are as follows (in thousands):
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income (loss)                         |       | $                                                    | 2,634      |                                                | $          | (1,841 | ) | $ | 4,338 |   | $ | (3,237 | ) |
| Foreign currency  translation adjustments |       | (426                                                 | )          | 264                                                 |       | (2,597 | ) | 1,644 |   |
| Total comprehensive income (loss)         |       | $                                                    | 2,208      |                                                | $          | (1,577 | ) | $ | 1,741 |   | $ | (1,593 | ) |

 

**5.****                                        NetIncome (Loss) Per Common Share**

SFAS No. 128,“Earnings Per Share”, requires the presentation of basic and diluted earningsper share. Basic earnings (loss) per common share is computed by dividingincome (loss) attributable to common stockholders by the weighted averagenumber of common shares outstanding for the period. The diluted earnings (loss)per common share data is computed using the weighted average number of commonshares outstanding plus the dilutive effect of common stock equivalents, unlessthe common stock equivalents are anti-dilutive. During the three and ninemonths ended September 30, 2006, the treasury stock effect of options topurchase 1,824,537 shares of common stock and 447,868 restricted stock unitswas not included in the computation of diluted loss per common share as theeffect would have been anti-dilutive.

The followingdetails the computation of the net income (loss) per common share (dollars inthousands, except share and per share data):
| ** **                                                                                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income (loss) from  continuing operations before cumulative effect of a change in accounting  principle |       | $                                                    | 2,634      |                                                | $          | (1,841 | ) | $ | 4,338 |   | $ | (3,321 | ) |
| Cumulative effect of a  change in accounting principle, net of tax                                          |       | —                                               |       | —                                              |       | — |   | 84 |   |
| Net income (loss)                                                                                           |       | $                                                    | 2,634      |                                                | $          | (1,841 | ) | $ | 4,338 |   | $ | (3,237 | ) |
| Weighted average common  share calculation:                                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Basic weighted  average common shares outstanding                                                           |       | 22,040,253                                           |       | 24,105,525                                          |       | 24,703,641 |   | 24,063,633 |   |
| Treasury stock  effect of unvested restricted stock units                                                   |       | 437,541                                              |       | —                                              |       | 343,725 |   | — |   |
| Treasury stock  effect of options                                                                           |       | 153,830                                              |       | —                                              |       | 63,322 |   | — |   |
| Diluted weighted  average common shares outstanding                                                         |       | 22,631,624                                           |       | 24,105,525                                          |       | 25,110,688 |   | 24,063,633 |   |
| Net income (loss) per  common share:                                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Basic income  (loss) per common share                                                                       |       | $                                                    | 0.12       |                                                | $          | (0.08 | ) | $ | 0.18 |   | $ | (0.13 | ) |
| Diluted income (loss)  per common share                                                                     |       | $                                                    | 0.12       |                                                | $          | (0.08 | ) | $ | 0.17 |   | $ | (0.13 | ) |

 

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** **

**6.****                                        SegmentInformation**

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 for thesefour segments. A significant portion of the Company’s North American operatingexpenses are shared between the POS, TSD and FSD segments, and therefore,management analyzes operating results for these three segments on a combinedbasis.

Management evaluatesthe North American and ISD performance on EBITDA before stock compensationexpense because operating expenses are distinguishable between North Americanand ISD operations. The Company defines EBITDA before stock compensationexpense as income from operations before depreciation, amortization and stockcompensation expense. EBITDA before stock compensation expense is not agenerally accepted accounting principle measure, but rather a measure employedby management to view operating results adjusted for significant noncash items.The Company’s definition of EBITDA before stock compensation expense may not becomparable to similarly titled measures used by other entities. Assets are notsegregated between reportable segments, and management does not use assetinformation by segments to evaluate segment performance. As such, noinformation is presented related to fixed assets by reportable segment andcapital expenditures for each segment.

Revenue for theCompany’s four business units is presented below (in thousands):

|                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **     | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:      |       |                                                 |       |                                                |       |   |   |   |   |
| POS            |       | $                                                    | 21,109     |                                                | $          | 21,726 |   | $ | 66,380 |   | $ | 61,940 |   |
| TSD            |       | 11,864                                               |       | 15,503                                              |       | 33,114 |   | 47,057 |   |
| FSD            |       | 8,032                                                |       | 8,828                                               |       | 23,074 |   | 25,830 |   |
| ISD            |       | 23,831                                               |       | 27,130                                              |       | 70,753 |   | 76,928 |   |
| Total revenues |       | $                                                    | 64,836     |                                                | $          | 73,187 |   | $ | 193,321 |   | $ | 211,755 |   |

 

EBITDA beforestock compensation expense for North American and ISD operations is reflectedbelow (in thousands):
| ** **                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| EBITDA before stock  compensation expense:     |       |                                                 |       |                                                |       |   |   |   |   |
| North America                                  |       | $                                                    | 8,552      |                                                | $          | 1,721 |   | $ | 27,008 |   | $ | 14,010 |   |
| ISD                                            |       | 9,356                                                |       | 10,282                                              |       | 25,232 |   | 25,512 |   |
| Total EBITDA before stock compensation expense |       | $                                                    | 17,908     |                                                | $          | 12,003 |   | $ | 52,240 |   | $ | 39,522 |   |

 

EBITDA beforestock compensation expense differs from income (loss) before income taxes,equity in net loss of unconsolidated affiliates and cumulative effect of achange in accounting principle reported in the condensed consolidatedstatements of operations as follows (in thousands):
| ** **                                                                                                                                                           | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| EBITDA before stock  compensation expense                                                                                                                            |       | $                                                    | 17,908     |                                                | $          | 12,003 |   | $ | 52,240 |   | $ | 39,522 |   |
| Reconciling items:                                                                                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Depreciation and  amortization of property and equipment and intangible assets                                                                                       |       | (8,790                                               | )          | (11,033                                             | )          | (32,130 | ) | (31,682 | ) |
| Stock compensation  expense                                                                                                                                          |       | (755                                                 | )          | (2,512                                              | )          | (1,789 | ) | (5,802 | ) |
| Interest expense                                                                                                                                                     |       | (2,997                                               | )          | (2,466                                              | )          | (7,036 | ) | (6,785 | ) |
| Interest income and  other (expense) income, net                                                                                                                     |       | 150                                                  |       | 831                                                 |       | (99 | ) | 1,617 |   |
| Income (loss) before income taxes, equity in net loss of  unconsolidated affiliates and cumulative effect of a change in accounting  principle, net of tax provision |       | $                                                    | 5,516      |                                                | $          | (3,177 | ) | $ | 11,186 |   | $ | (3,130 | ) |

 

14

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Goodwill and identifiableintangible assets, net are located in the following reporting segments (inthousands):

|                                                        | ** ** | **December 31,  2005** | ** ** | **September 30,  2006** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| POS                                                    |       | $                           | 134,887    |                         | $          | 132,158 |   |
| TSD                                                    |       | 4,479                       |       | 5,172                        |       |
| FSD                                                    |       | 25,272                      |       | 23,719                       |       |
| ISD                                                    |       | 27,755                      |       | 47,957                       |       |
| Total goodwill and identifiable intangible assets, net |       | $                           | 192,393    |                         | $          | 209,006 |   |

 

**GeographicInformation**

The Company sellsits services through foreign subsidiaries in Australia, Austria, Bermuda,Canada, Colombia, France, Germany, Ireland, Italy, Japan, Malaysia, Mexico, theNetherlands, New Zealand, Poland, Romania, South Korea, Spain, Sweden, Thailandand the United Kingdom. Information regarding revenues and long-lived tangibleassets attributable to each geographic region is stated below.

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

|                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **     | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:      |       |                                                 |       |                                                |       |   |   |   |   |
| North America  |       | $                                                    | 41,005     |                                                | $          | 46,057 |   | $ | 122,568 |   | $ | 134,826 |   |
| Europe         |       | 21,110                                               |       | 24,162                                              |       | 62,603 |   | 68,148 |   |
| Asia-Pacific   |       | 2,721                                                |       | 2,968                                               |       | 8,150 |   | 8,781 |   |
| Total revenues |       | $                                                    | 64,836     |                                                | $          | 73,187 |   | $ | 193,321 |   | $ | 211,755 |   |

 

Revenues from theCompany’s subsidiaries in the United Kingdom were $13.8 million and $42.4million for the three and nine months ended September 30, 2005,respectively.  Revenues from the Company’s subsidiaries in the UnitedKingdom were $15.3 million and $43.2 million for the three and nine monthsended September 30, 2006, respectively.

The Company’slong-lived assets including goodwill and identifiable intangible assets, netwere located as follows (in thousands):

|                         | ** ** | **December 31,  2005** | ** ** | **September 30,  2006** | ** ** |
|-------------------------|------------|-----------------------------|------------|------------------------------|------------|
| North America           |       | $                           | 219,163    |                         | $          | 221,524 |   |
| Europe                  |       | 37,717                      |       | 58,018                       |       |
| Asia-Pacific            |       | 4,447                       |       | 4,149                        |       |
| Total long-lived assets |       | $                           | 261,327    |                         | $          | 283,691 |   |

 

**7.****                                        Stock-BasedCompensation**

As discussed inNote 1, effective January 1, 2006, the Company adopted SFAS 123R using themodified prospective transition method. The following table sets forth totalstock-based compensation expense recognized in the condensed consolidatedstatement of operations related to stock options and restricted stock units (inthousands except per share amounts):
| ** **                                                                                                                                         | ** ** | **Three months  ended  September 30, 2006** | ** ** | **Nine months  ended  September 30, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Loss before income  taxes, equity in net loss of unconsolidated affiliates and cumulative effect  of a change in accounting principle, as reported |       | $                                                          | (2,512     | )                                                         | $          | (5,802 | ) |
| Income tax benefit from  stock-based compensation expense                                                                                          |       | 1,005                                                      |       | 2,321                                                     |       |
| Loss from continuing  operations before cumulative effect of a change in accounting principle                                                      |       | (1,507                                                     | )          | (3,481                                                    | )          |
| Cumulative effect of a  change in accounting principle, net of tax provision                                                                       |       | —                                                     |       | 84                                                        |       |
| Net loss                                                                                                                                           |       | $                                                          | (1,507     | )                                                         | $          | (3,397 | ) |
| Earnings per share:                                                                                                                                |       |                                                       |       |                                                      |       |
| Basic                                                                                                                                              |       | $                                                          | (0.06      | )                                                         | $          | (0.14 | ) |
| Diluted                                                                                                                                            |       | $                                                          | (0.06      | )                                                         | $          | (0.14 | ) |

 

15

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Prior to theadoption of SFAS 123R, the Company did not make estimates for forfeitures andrecognized compensation cost assuming all awards would vest and reversedrecognized compensation cost for forfeited awards when the awards were actuallyforfeited. Upon adoption of SFAS 123R on January 1, 2006, the Companyrecorded a cumulative effect of a change in accounting principle, net of tax,of approximately $0.1 million related to estimated forfeitures of unvestedrestricted stock awards for which stock-based compensation was recorded in theCompany’s financial statements prior to January 1, 2006. During the threeand nine months ended September 30, 2006, the Company capitalized approximately$0.1 million and $0.3 million, respectively, of stock-based compensation costsfor employees working on capitalized software development projects.

As permitted bySFAS 123, during 2005 the Company followed APB Opinion No. 25 under whichshare-based payments to employees were accounted for using the intrinsic valuemethod and, as such, generally recognized no compensation cost for employee stockoptions. The Company’s pro forma information for the three and nine monthsended September 30, 2005 under SFAS 123, which reflects compensation expenseequal to the fair value of the options and restricted stock awards recognizedover their requisite service period, is as follows (in thousands, except pershare amounts):
| ** **                                                                                                                                    | ** ** | **Three months  ended  September 30, 2005** | ** ** | **Nine months  ended  September 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net income, as reported                                                                                                                       |       | $                                                          | 2,634      |                                                      | $          | 4,338 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                  |       | 453                                                        |       | 1,073                                                     |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (928                                                       | )          | (2,465                                                    | )          |
| Pro forma net income                                                                                                                          |       | $                                                          | 2,159      |                                                      | $          | 2,946 |   |
| Basic net income per  common share, as reported                                                                                               |       | $                                                          | 0.12       |                                                      | $          | 0.18 |   |
| Diluted net income per  common share, as reported                                                                                             |       | $                                                          | 0.12       |                                                      | $          | 0.17 |   |
| Pro forma basic and diluted net income per common share                                                                                       |       | $                                                          | 0.10       |                                                      | $          | 0.12 |   |

 

Detailsof the Company’s stock-based compensation plans are discussed below.

***Stock-Based Compensation Plans***

During 2001, theBoard of Directors of the Company adopted the TNS Holdings, Inc. 2001Founders’ Stock Option Plan (the 2001 Plan) whereby employees, nonemployeedirectors, and certain other individuals are granted the opportunity to acquirean equity interest in the Company. Either incentive stock options ornonqualified options may be granted under the 2001 Plan. Options granted underthe 2001 Plan have an exercise price equal to or greater than the estimatedfair value of the underlying common stock at the date of grant and becomeexercisable based on a vesting schedule determined at the date of grant,generally over four years. The options expire 10 years from the date of grant.

InFebruary 2004, the Board of Directors of the Company adopted theTNS, Inc. 2004 Long-Term Incentive Plan (the Plan) and the Company’sstockholders approved the Plan in March 2004. The Plan reserves 3,847,384shares of common stock for grants of incentive stock options, nonqualifiedstock 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 thanthe fair market value of the underlying common stock at the date of grant andbecome exercisable based on a vesting schedule determined at the date ofgrant, generally in equal monthly installments over four years. The optionsexpire 10 years from the date of grant. Restricted stock awards andperformance shares granted under the Plan are subject to a vesting perioddetermined at the date of grant, generally in equal annual installments overfour years.

***Stock Options***

The fair value forstock options granted during the periods were estimated at the grant date usinga Black-Scholes option pricing model with the following weighted averageassumptions:
| ** **              | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **2005 (a)**                                   | ** ** | **2006** | ** ** |
| Expected life           |       | 4 years                                        |       | 5 years |   |
| Risk-free interest rate |       | 3.0%                                                |       | 4.9% |   |
| Volatility              |       | 50%                                                 |       | 49% |   |
| Dividend yield          |       | 0.0%                                                |       | 0.0% |   |

----

(a)             Assumptionsused to calculate pro forma expense under SFAS 123 discussed above.

16

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* *

*Expectedvolatility* — The expected volatility is based on the resultsof a study of similar guideline companies in the Company’s peer group.Historical volatility was not used as the Company does not have sufficienthistorical information to develop reasonable expectations about futurevolatility.

*Expecteddividend yield* — The dividend yield is based on actualdividends expected to be paid over the expected term of the option. The Companyhas not and has no plans to issue dividends.

*Expectedterm* — The expected term is based on the results of a studyperformed of guideline companies in the Company’s peer group. The Company, atthis point, does not have sufficient historical information to developreasonable expectations about future exercise patterns. The Company accountsfor stock options with graded vesting as a single award with the expected term equalto the average of the expected term of the component vesting tranches andrecognizes the related compensation cost on a straight-line basis over thevesting period of the award.

*Risk-freeinterest rate* — The risk-free rate for stock options grantedduring the period is determined by using U.S. treasury rates of the same periodas the expected option term of each option.

A summary oftime-vested option activity under the Plan as of September 30, 2006, andchanges during the nine months then ended, is presented below (in thousands,except share and per share amounts):
| ** **                              | ** ** | **Number of  shares** | ** ** | **Weighted-  average  exercise price** | ** ** | **Weighted-  average  remaining  contractual term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding,  January 1, 2006      |       | 1,488,570                  |       | $                                           | 19.78      |                                                     |       |                                |       |   |
| Granted                                 |       | 467,495                    |       | 20.69                                       |       |                                                     |       |                                |       |
| Exercised                               |       | (16,758                    | )          | 19.13                                       |       |                                                     |       |                                |       |
| Canceled                                |       | (114,770                   | )          | 19.79                                       |       |                                                     |       |                                |       |
| Outstanding at  September 30, 2006 |       | 1,824,537                  |       | $                                           | 20.02      |                                                     | 8 years    |                                | $          | 468 |   |
| Exercisable at September 30, 2006       |       | 880,384                    |       | $                                           | 19.84      |                                                     | 7 years    |                                | $          | 164 |   |

 

The weightedaverage grant date fair value of options granted during the nine months endedSeptember 30, 2006 was $10.44. The total intrinsic value of stock optionsexercised during the nine months ended September 30, 2006 was approximately$25,000. As of September 30, 2006, there was a total of $8.2 million ofdeferred compensation cost related to time-vested stock options, which isexpected to be recognized over a weighted average period of approximately threeyears.

During the ninemonths ended September 30, 2006 the Company received approximately $0.3 millionin cash proceeds related to the exercise of stock options. In addition theCompany realized total tax benefits from stock option exercises ofapproximately $6,000 for the nine months ended September 30, 2006, respectively,which were recorded as additions to additional paid-in capital in the condensedconsolidated balance sheets. The adoption of SFAS 123R also resulted inreflecting the excess tax benefit from the exercise of stock based compensationawards in cash flows from financing activities.

***Performance-Based Stock Options***

Performance-basedstock options are tied to the Company’s annual performance againstpre-established internal budget targets for revenues and EBITDA before stockcompensation expense.  Under the Company’s long-term incentive program,the actual payout under these awards may vary from zero to 200% of an employee’starget payout, based upon the Company’s actual performance over the fiscalyear.  The fair value for stock options granted during the period wasestimated at the grant date using the Black Schole’s option pricing model asdescribed above.  Compensation cost is based on the expected payout levelthat will be achieved and is adjusted in subsequent periods as changes in theestimates occur until the performance criteria have been satisfied.

Asummary of performance-based stock options outstanding as of September 30,2006, and changes during the nine months then ended is presented below:
| ** **                                 | ** ** | **Number of  shares** | ** ** | **Weighted-  average  exercise price** | ** ** | **Weighted-  average  remaining  contractual term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|--------------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding,  January 1, 2006         |       | —                     |       | $                                           | —     |                                                     |       |                                |       |   |
| Granted(1)                                 |       | 330,250                    |       | 20.56                                       |       |                                                     |       |                                |       |
| Exercised                                  |       | —                     |       | —                                      |       |                                                     |       |                                |       |
| Canceled                                   |       | —                     |       | —                                      |       |                                                     |       |                                |       |
| Outstanding at September 30,  2006(1) |       | 330,250                    |       | $                                           | 20.56      |                                                     | 10 years   |                                | $          | — |   |
| Exercisable at  September 30, 2006         |       | —                     |       | —                                      |       | —                                                   |       | $                                   | —     |   |
| Expected to vest at September 30, 2006     |       | 76,821                     |       | $                                           | 20.56      |                                                     | 10 years   |                                | $          | — |   |

----

(1)             Basedon 100% of the target payout

17

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The weightedaverage grant date fair value of performance-based options granted during thenine months ended September 30, 2006 was $9.16.  The Company recognizedexpense of $0.5 million and $0.6 million related to such options during thethree and nine months ended September 30, 2006, respectively.  As of September 30, 2006, there was a totalof $0.1 million of deferred compensation cost related to performance-basedoptions expected to vest, which is expected to be recognized over a weightedaverage period of approximately three months.

***Time-Vested Restricted Stock Units***

A summary of thestatus of the Company’s time-vested restricted stock units as of September 30,2006, and changes during the nine months then ended is presented below:
| ** **                          | ** ** | **Number of  shares** | ** ** | **Weighted-average  grant-date  fair value** | ** ** |
|-------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Non-vested at  January 1, 2006 |       | 439,316                    |       | $                                                 | 20.52      |   |
| Granted                             |       | 175,999                    |       | 20.47                                             |       |
| Vested                              |       | (123,666                   | )          | 20.10                                             |       |
| Forfeited                           |       | (43,781                    | )          | 20.86                                             |       |
| Non-vested at September 30, 2006    |       | 447,868                    |       | $                                                 | 20.58      |   |

 

The total fair valueof shares vested (measured as of the vesting date) during the nine months endedSeptember 30, 2006 was $2.5 million. As of September 30, 2006, there was $6.1million of deferred compensation cost related to restricted stock units, whichis expected to be recognized over a weighted average period of approximatelythree years.

***Performance-Based Restricted Stock Units***

Performance-basedrestricted stock units are tied to the Company’s annual performance againstpre-established internal budget targets for revenues and EBITDA before stockcompensation expense.  Under the Company’s long-term incentive program,the actual payout under these awards may vary from zero to 200% of an employee’starget payout, based upon the Company’s actual performance over the fiscalyear.  The fair value is based on the market price of the Company’s stockon the date of grant.  Compensation cost is based on the expected payoutlevel that will be achieved and is adjusted in subsequent periods as changes inthe estimates occur until the performance criteria have been satisfied.

A summary ofperformance-based restricted stock units outstanding as of September 30, 2006,and changes during the nine months then ended is presented below:
| ** **                             | ** ** | **Number of  shares** | ** ** | **Weighted-average  grant-date  fair value** | ** ** |
|----------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Balance at  January 1, 2006       |       | —                     |       | $                                                 | —     |   |
| Granted(1)                             |       | 113,029                    |       | 20.56                                             |       |
| Vested                                 |       | —                     |       | —                                            |       |
| Forfeited                              |       | —                     |       | —                                            |       |
| Balance at September  30, 2006(1)      |       | 113,029                    |       | $                                                 | 20.56      |   |
| Expected to vest at September 30, 2006 |       | 26,262                     |       | $                                                 | 20.56      |   |

----

(1)             Basedon 100% of the target payout

The Companyrecognized expense of $0.4 million and $0.5 million related to such restrictedstock units during the three and nine months ended September 30, 2006,respectively.  As of September 30, 2006,there was approximately $0.1 million of deferred compensation cost related toperformance-based restricted stock units expected to vest, which is expected tobe recognized over a weighted average period of approximately three months.

18

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** **

**8.****                                           RestructuringCosts**

In August2006, the Company implemented a plan to reduce its cost structure and improveoperating efficiencies by reducing its workforce and implementing productivityimprovement initiatives and expense reduction measures (2006 RestructuringPlan). In connection with the 2006 Restructuring Plan, the Company incurredapproximately $3.7 million associated with its workforce reduction, of which$3.6 million is included in selling, general and administrative expense and isassociated with the Company’s North American operations and $0.1 million isincluded in cost of network services and is associated with the internationalservices division in the accompanying condensed consolidated statement of operationsfor the three and nine months ended September 30, 2006.

A summary ofthe liability for the 2006 Restructuring Plan is as follows (in thousands):

| Balance as of January 1,  2006               |   | $     | — |   |
|----------------------------------------------|--------|-------|--------|--------|
| Severance and benefits                       |   | 3,706 |   |
| Total restructuring  costs                   |   | 3,706 |   |
| Cash paid (1)                                |   | (184  | )      |
| Remaining liability as of September 30, 2006 |   | $     | 3,522  |   |

----

(1)             Represents amountspaid during the three and nine months ended September 30, 2006

The aboveseverance and benefits charges are based on estimates that are subject tochange.  The remaining cash expendituresrelating to workforce reductions are expected to be paid through 2008. As ofSeptember 30, 2006, $1.7 million of the total $3.5 million accrual forworkforce reductions was classified as accounts payable, accrued expenses andother liabilities and the remaining $1.8 million was classified as otherliabilities in the accompanying condensed consolidated balance sheet.

The Companyanticipates recording additional charges related to the workforce reductionduring the next quarter.  In addition,the Company anticipates incurring additional charges associated with expensereduction measures. The total amount and timing of these charges will dependupon the nature, timing, and extent of these future actions.

**9.****                                           Litigationand Claims**

The Company isperiodically involved in disputes arising from normal business activities. Inthe opinion of management, resolution of these matters will not have a materialadverse effect upon the financial position or future operating results of theCompany, and adequate provision for any potential losses has been made in theaccompanying consolidated financial statements.

On August 26,2002, an action was filed in the Superior Court of the State of Delaware bypersons alleging that the Company breached an agreement to purchase anunrelated entity. On February 28, 2005, the court denied the Company’smotion for summary judgment. After considering the defense costs, potentialdamages should the plaintiffs prevail, and continued diversion of managementresources, the Company determined in March 2005 that a settlement waswarranted. In April 2005, the Company paid $3.25 million in cash to theplaintiffs and received the dismissal of all claims, with prejudice, by theplaintiffs, thereby settling this dispute. This $3.25 million settlement isincluded in selling, general and administrative expenses in the accompanyingcondensed consolidated statement of operations for the nine months endedSeptember 30, 2005.

Certainstates in which the Company operates assess sales taxes on certain servicesprovided by the Company. The Company believes it has no liability because itscustomer contracts contain terms that stipulate the customer, not the Company,is responsible for any sales tax liability. In jurisdictions where the customermay be liable for sales taxes, the Company either includes sales tax on itsinvoice or has obtained an exemption certificate from the customer. Certainstates have audited the Company from 1996 to early 2001 and originally proposed$6.7 million in assessments on the basis that sales taxes are owed. InMarch 2005, the Company received verbal notification from a state salestax auditor that one of the states was likely to reduce its proposed assessmentby $4.4 million. In April 2005, the Company received written confirmationfrom that state’s Department of Revenue that the state’s assessment would bereduced by $4.3 million.  Based on this written confirmation, the Companyreduced its liability for this matter by $4.3 million during the first quarterof 2005.  In July 2005, the Company entered into an agreement with thatstate’s Department of Revenue to settle the outstanding liability for $0.8million and concurrently entered into an agreement with a customer to reimbursethe Company for $0.5 million of the settlement amount.  Based onthese final executed settlements, the Company reduced its net liability forthis matter by $1.5 million during the three months ended June 30, 2005. This$1.5 million and $5.8 million reduction in the liability, respectively, isincluded in selling, general and administrative expenses in the accompanyingcondensed consolidated statements of operations for the nine months endedSeptember 30, 2005. Both the Company and the customers involved are vigorouslydefending the remaining proposed assessments by the sales tax authorities. Inthe opinion of management, resolution of these matters will not have a materialadverse effect upon the financial position or future operating results of theCompany. Included in net income in the accompanying condensed consolidatedstatement of operations for the nine months ended September 30, 2005 is a net$1.5 million benefit, or $0.06 per share, related to the legal settlement andreduced state sales tax assessment described above.

The Company andJohn J. McDonnell, Jr., the Company’s former Chief Executive Officer, and HenryH. Graham, Jr., the Company’s Chief Executive Officer, are defendants in aputative class action lawsuit filed in connection with the Company’s publicoffering of common stock in September 2005 (“Secondary Offering”).  TheCement Masons and Plasterers Joint Pension Trust, purportedly on behalf ofitself and others similarly situated, filed the putative class action lawsuitcaptioned*Cement Masons & PlasterersJoint Pension Trust v. TNS, Inc., et al.,*  Case No. 1:06 CV 363, CMH/BRP, on April 4,2006 in the United States District Court for the Eastern District ofVirginia.  Plaintiff claims that the Registration Statement filed inconnection with the Secondary Offering negligently failed to disclose that (1)TNS’ agreement with the Pepsi Bottling Group, Inc. (“Pepsi”) to providecashless vending to Pepsi had been delayed beyond August 7, 2005; (2) TNS wasgenerating less revenues and income than it had anticipated from its contractwith the Royal Bank of Scotland (“RBS”), because RBS purportedly had overstatedthe number of transactions that TNS would be responsible for processing forRBS; and (3) TNS’ International Services Division was experiencing decliningrevenues during that time period because of unfavorable foreign exchangerates.  TNS filed a motion to dismiss the lawsuit on July 14, 2006.

19

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The Plaintiff filed itsmemorandum in opposition to TNS’ motion to dismiss on August 4, 2006, and TNSfiled its reply memorandum on August 18, 2006. The Court denied the motion to dismiss on September 12, 2006, and  has since ordered the parties to conductdiscovery in the case.  This action is inthe preliminary phase of discovery; thus the timing and course of thelitigation are not predictable, and, as a result, management cannot estimate arange of possible loss and has therefore not recognized a liability for thisexpense.  However, TNS intends to take appropriate steps to defend againstthe lawsuit, the outcome of which could have a material adverse affect on thefinancial condition or future operating results of TNS. During the nine monthsended September 30, 2006, the Company accrued legal costs of approximately $0.5million, representing management’s estimate of the probable legal costs todefend itself in this matter. These legal costs are included in selling,general and administrative expense in the accompanying condensed consolidatedstatement of operations for the nine months ended September 30, 2006.

The Company andthe members of its Board of Directors also are defendants in a putativeshareholder class action lawsuit that seeks to enjoin the non-binding proposalannounced on March 13, 2006 from senior management of the Company to acquire alloutstanding shares of the Company.  Paul Schwartz, purportedly on behalfof himself and others similarly situated, filed the lawsuit captioned*Schwartz v. TNS, Inc., et al.,*  C.A. No. 2000-N, on March 13, 2006 inDelaware Chancery Court for New Castle County.  The plaintiff alleges thatinjunctive relief is necessary because the Company and the members of the Boardof Directors allegedly breached their fiduciary duties to TNS shareholders byallegedly causing the Company to negotiate for the sale of TNS at an unfairprice, depriving TNS’ public shareholders of the maximum value to which theypurportedly are entitled.  The plaintiff further alleges that members ofthe Board of Directors also breached their fiduciary duties by allegedly nottaking adequate measures to ensure that the interests of TNS’ publicshareholders are properly protected, as the terms of the proposed transactionallegedly are grossly unfair to the shareholders.  On April 3, 2006, theplaintiff and the defendants entered into a letter agreement that provides thedefendants with an open-ended extension of time to answer or otherwise respondto the plaintiff’s complaint, and holds discovery and other matters in the casein abeyance pending an agreement on a management buy-out proposal or other formof transaction.  On May 1, 2006, the Special Committee of the Board ofDirectors announced that it had rejected the non-binding proposal from seniormanagement that prompted the filing of this lawsuit.  On August 7, 2006, the Special Committee furtherannounced that it had ended the process of actively seeking strategicalternatives for the Company.  On October18, 2006, an amended Schedule 13D was filed with the SEC to report thedissolution of the proposed management buying group.  In the opinion of TNS’ current management andthe Board of Directors, the likelihood of a transaction remains remote, andthis lawsuit likely will continue to be held in abeyance and eventuallydismissed. However, this action remains on the Court’s docket and the ultimatetiming and conclusion of the litigation is not certain.  Consequently, management cannot estimate arange of possible loss at this juncture.  TNS intends to take appropriateactions to defend against the lawsuit, the outcome of which could have a materialadverse affect on the financial condition or future operating results ofTNS.  No amounts have been accrued related to this case in the condensedconsolidated financial statements for the nine months ended September 30, 2006,as management cannot yet estimate the future legal costs to defend against thislawsuit or potential damages, if any, that will be incurred.

20

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

You should readthe following discussion of the financial condition and results of operationsof TNS, Inc. in conjunction with the consolidated financial statements andthe related notes included in our annual report on Form 10-K datedMarch 16, 2006 and amended July 21, 2006, as filed with the SEC, andavailable directly from the SEC at www.sec.gov and the condensed consolidatedfinancial statements and the related notes of TNS, Inc., includedelsewhere in this quarterly report.

There arestatements made herein which may not address historical facts and, therefore,could be interpreted to be forward-looking statements within the meaning of ThePrivate Securities Litigation Reform Act of 1995. These forward-lookingstatements are based on current expectations, forecasts and assumptions thatare subject to risks and uncertainties that could cause actual results todiffer materially from those set forth in, or implied by, the forward-lookingstatements. The Company has attempted, whenever possible, to identify theseforward-looking statements using words such as “may,” “will,” “should,” “projects,”“estimates,” “expects,” “plans,” “intends,” “anticipates,” “believes,” andvariations of these words and similar expressions. Similarly, statements hereinthat describe the Company’s business strategy, prospects, opportunities,outlook, objectives, plans, intentions or goals are also forward-lookingstatements. Actual results may differ materially from those indicated by suchforward-looking statements as a result of various important factors, including:the Company’s reliance upon a small number of customers for a significantportion of its revenue; competitive factors such as pricing pressures; ourcustomer’s ability to direct their data communications from the Company’snetworks to other networks; the Company’s ability to grow its businessdomestically and internationally by generating greater transaction volumes,acquiring new customers or developing new service offerings; fluctuations inthe Company’s quarterly results because of the seasonal nature of the businessand other factors outside of the Company’s control; the Company’s ability toidentify, execute or effectively integrate acquisitions; the Company’s abilityto adapt to changing technology; additional costs related to compliance withthe Sarbanes-Oxley Act of 2002, any revised New York Stock Exchange listingstandards, SEC rule changes or other corporate governance issues; andother risk factors described in the Company’s annual report on Form 10-Kdated March 16, 2006 and amended July 21, 2006, as filed with the SEC. Inaddition, the statements in this quarterly report are made as of the date ofthis filing. The Company expects that subsequent events or developments willcause its views to change. The Company undertakes no obligation to update anyof the forward-looking statements made herein, whether as a result of newinformation, future events, changes in expectations or otherwise. Theseforward-looking statements should not be relied upon as representing theCompany’s views as of any date subsequent to the date of this filing. Theforward-looking statements in this document are intended to be subject to thesafe harbor protection provided by Sections 27A of the Securities Act and 21Eof the Exchange Act.

**Overview**

We are a leadingprovider of business-critical data communications services to processors ofcredit card, debit card and ATM transactions. We are also a leading provider ofsecure data and voice network services to the global financial servicesindustry. We operate one of four unaffiliated Signaling System No. 7networks in the United States capable of providing services nationwide, and weutilize this network to provide call signaling and database access services tothe domestic telecommunications industry. Our data communications servicesenable secure and reliable transmission of time-sensitive, transaction-relatedinformation critical to our customers’ operations. Our customers outsourcetheir data communications requirements to us because of our substantialexpertise, comprehensive customer support and cost-effective services. Weprovide services to customers in the United States and increasingly to internationalcustomers in 27 countries, including Canada and countries in Europe, LatinAmerica and the Asia-Pacific region.

We provideservices through our 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:

·                       ***POS services***. Weprovide fast, secure and reliable data communications services primarily topayment processors in the United States and Canada. POS services revenue isderived primarily from per transaction fees paid by our customers for thetransmission of transaction data through our networks between paymentprocessors and POS or ATM terminals.

·                       ***International services***.We are one of the leading providers of data communications services to the POSindustry in the United Kingdom. Our international services division alsoprovides services in Australia, Austria, Bermuda, Colombia, France, Germany,Ireland, Italy, Japan, Malaysia, Mexico, the Netherlands, New Zealand,Poland, Romania, South Korea, Spain, Sweden and Thailand through subsidiarieslocated in these countries. Additionally, through these internationalsubsidiaries, we also provide services to customers located in Belgium,Finland, Gibraltar, Hong Kong, Norway and Singapore.  Our international services division generatesrevenues primarily from our POS and financial services offerings abroad.

·                       ***Telecommunication services***.We provide call signaling services that enable telecommunications carriers toestablish and terminate telephone calls placed by their subscribers. We alsoprovide database access services that enable our customers to provideintelligent network services, such as caller identification and local numberportability, and credit card, calling card, third-party billing and collectcalling. Our telecommunication services division generates revenues primarilyfrom fixed monthly fees charged for our call signaling services and per-queryfees charged for our database access and validation services.

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·                       ***Financial services.***We provide fast, secure and reliable private data networking services thatenable seamless communications and facilitate electronic trading amongcommercial banks, mutual funds, pension funds, broker-dealers, alternativetrading systems, electronic communications networks, securities and commoditiesexchanges and other market participants. Our networks support multiplecommunications protocols including the Financial Information eXchange, or FIX,protocol. Our financial services division generates revenues from monthlyrecurring fees based on the number of customer connections to and through ournetworks.

Our mostsignificant expense is cost of network services, which is comprised primarilyof telecommunications charges, including data transmission and database access,leased digital capacity charges, circuit installation charges and activationcharges. The cost of data transmission is based on a contract or tariff rateper minute of usage in addition to a prescribed rate per transaction for somevendors. The costs of database access, circuits, installation charges andactivation charges are based on fixed fee contracts with local exchangecarriers and interexchange carriers. The cost of network services also includessalaries, equipment maintenance and other costs related to the ongoingoperation of our data networks. Depreciation expense on our network equipmentand amortization of developed technology are excluded from our cost of networkservices and included in depreciation and amortization of property andequipment and amortization of intangible assets in our consolidated statementsof operations.

Our engineeringand development expenses include salaries and other costs related to productdevelopment, engineering, hardware maintenance and materials. The majority ofthese costs are expensed as incurred, including costs related to the developmentof internal use software in the preliminary project, the post-implementationand operation stages. Development costs we incur during the softwareapplication development stage are capitalized and amortized over the estimateduseful life of the developed software.

Our selling,general and administrative expenses include costs related to sales, marketing,administrative and management personnel, as well as external legal, accountingand consulting services.

In connection withthe completion of our tender offer, as described below, on May 4, 2005, weentered into an amended and restated senior secured credit facility, whichconsists of two amended and restated facilities: a senior term loan facility inan aggregate principal amount of $165 million and a senior revolving creditfacility in an aggregate principal amount of $30 million. Pursuant to theamended and restated senior secured credit facility, certain term lendersholding loans under our 2004 senior secured credit facility exchanged $48million of old term loans for term loans under the amended term facility and$117 million of additional term loans were made to us to finance the purchaseof shares of our common stock, including fees and expenses incurred therewith,in connection with the tender offer. The amended and restated senior securedcredit facility may also be used for general corporate purposes.

On May 5,2005, we completed a modified Dutch auction tender offer, purchasing andretiring 6,263,435 shares of our outstanding common stock at a price of $18.50per share net to each seller in cash, for an aggregate purchase price of $116.9million. The 6,263,435 shares tendered include 6,000,000 shares tendered by ourthen controlling stockholder, GTCR.

OnSeptember 21, 2005, we completed a follow-on offering of common stockissuing 1,200,000 common shares at $23.25 per share, which generated proceeds,net of offering costs, of approximately $26.1 million. On September 21,2005, in connection with the follow-on offering, the underwriters exercised theirover-allotment option and we issued an additional 900,000 shares of commonstock at $23.25 per share, which generated proceeds, net of offering costs, ofapproximately $20.0 million. The net proceeds from the follow-on offering wereused to repay a portion of our long-term debt outstanding under our amended andrestated senior secured credit facility.

**RestructuringCosts**

In August 2006, weimplemented a plan to reduce our cost structure and improve operatingefficiencies by reducing our workforce and implementing productivityimprovement initiatives and expense reduction measures.  In connection with this restructuring plan,we incurred approximately $3.7 million associated with our workforce reduction,of which $3.6 million is included in selling, general and administrativeexpense and is associated with our North American operations and $0.1 millionis included in cost of network services and is associated with ourinternational services division in the accompanying condensed consolidatedstatement of operations for the three and nine months ended September 30, 2006.  

We anticipaterecording additional charges related to the workforce reduction during the nextquarter.  In addition, we anticipateincurring additional charges associated with expense reduction measures. Thetotal amount and timing of these charges will depend upon the nature, timing,and extent of these future actions.  Weanticipate the cost savings associated with this restructuring plan to have asignificant favorable impact on our 2007 operating results.

**Long-termInvestments**

In August 2004, wemade an investment in WAY Systems, Inc. (WAY), which provides mobile POStransaction infrastructure and solutions for mobile merchants. We purchased5,952,381 shares or 38.5 percent of WAY’s Series B convertible preferred stockfor $2.5 million and became entitled to representation on WAY’s board ofdirectors. In March 2005, we made an additional investment of $0.8 million topurchase 1,910,401 shares of WAY’s Series B convertible preferred stock for anadditional 1.9 percent of WAY’s outstanding shares. In July 2005, we made anadditional investment of $0.7 million in exchange for a convertible notebearing interest at a rate of 8 percent per annum and due January 1, 2009. InSeptember 2005, we exercised our right on the convertible note to convert theoutstanding principal and accrued interest of approximately $0.8 million to1,185,085 shares of WAY’s Series C convertible preferred stock and made anadditional investment of $1.1 million to purchase 1,676,429 shares of WAY’sSeries C convertible preferred stock. We owned 17.1 percent of WAY’s totaloutstanding shares as of September 30, 2006. We are accounting for ourinvestment under the equity method of accounting as we have significantinfluence over the financing and

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operating activities ofWAY through our representation on WAY’s board of directors. Due to timing ofthe receipt of WAY’s financial statements, we are accounting for the income orloss in this equity method investment on a one-month lag. For the three andnine months ended September 30, 2006, we recognized a net loss in the equity ofan unconsolidated affiliate related to our investment in WAY of approximately$0.5 million and $1.5 million, respectively.  For the three and ninemonths ended September 30, 2005, we recognized a net loss in the equity of anunconsolidated affiliate related to our investment in WAY of approximately $0.4million and $1.0 million, respectively.

InJanuary 2005, we made an investment in IP Commerce, a company that isdeveloping operating software to facilitate the authorization of IP-basedretail payment transactions. We purchased 2,368,545 Series A preferredshares or 39.9 percent of IP Commerce’s total outstanding shares for $2.0million and became entitled to representation on IP Commerce’s board ofdirectors. In September 2005, the Company made an additional investment of$0.9 million in exchange for a convertible note bearing interest at a rate of 8percent per annum which is payable on demand, no earlier than February 1,2007. In March 2006, we exercised our right on the convertible note to convertthe outstanding principal and accrued interest of approximately $0.9 million to675,901 shares of IP Commerce’s Series B convertible preferred stock. Weowned approximately 27.2 percent of IP Commerce’s total outstanding shares asof September 30, 2006. We are accounting for this investment under the equitymethod of accounting. Due to timing of the receipt of IP Commerce’s financialstatements, we are accounting for the income or loss in this equity methodinvestment on a one-month lag. For the three and nine months ended September30, 2006, we recognized a net loss in the equity of an unconsolidated affiliaterelated to our investment in IP Commerce of approximately $0.4 million and $1.3million, respectively. For the three and nine months ended September 30, 2005,we recognized a net loss in the equity of an unconsolidated affiliate relatedto our investment in IP Commerce of approximately $0.4 million and $0.8million, respectively.

**Resultsof Operations**

The followingtable sets forth, for the periods indicated, selected statement of operationsdata (dollars in thousands):
| ** **                                                                                                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                                                                                       |       | $                                                    | 64,836     |                                                | $          | 73,187 |   | $ | 193,321 |   | $ | 211,755 |   |
| Operating  expenses:                                                                                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of network  services, exclusive of the items shown separately below                                                                       |       | 30,074                                               |       | 37,442                                              |       | 91,270 |   | 107,627 |   |
| Engineering and  development                                                                                                                   |       | 3,813                                                |       | 5,269                                               |       | 11,753 |   | 15,305 |   |
| Selling,  general, and administrative                                                                                                          |       | 13,796                                               |       | 20,985                                              |       | 39,847 |   | 55,103 |   |
| Depreciation and  amortization of property and equipment                                                                                       |       | 4,541                                                |       | 5,574                                               |       | 14,367 |   | 15,947 |   |
| Amortization of  intangible assets                                                                                                             |       | 4,249                                                |       | 5,459                                               |       | 17,763 |   | 15,735 |   |
| Total operating expenses                                                                                                                       |       | 56,473                                               |       | 74,729                                              |       | 175,000 |   | 209,717 |   |
| Income (loss)  from operations                                                                                                                 |       | 8,363                                                |       | (1,542                                              | )          | 18,321 |   | 2,038 |   |
| Interest expense                                                                                                                               |       | (2,997                                               | )          | (2,466                                              | )          | (7,036 | ) | (6,785 | ) |
| Interest income  and other (expense) income, net                                                                                               |       | 150                                                  |       | 831                                                 |       | (99 | ) | 1,617 |   |
| Income (loss)  before income taxes, equity in net loss of unconsolidated affiliates and  cumulative effect of a change in accounting principle |       | 5,516                                                |       | (3,177                                              | )          | 11,186 |   | (3,130 | ) |
| Income tax  (provision) benefit                                                                                                                |       | (2,085                                               | )          | 2,240                                               |       | (4,919 | ) | 2,711 |   |
| Equity in net  loss of unconsolidated affiliates                                                                                               |       | (797                                                 | )          | (904                                                | )          | (1,929 | ) | (2,902 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                                   |       | —                                               |       | —                                              |       | — |   | 84 |   |
| Net income  (loss)                                                                                                                             |       | $                                                    | 2,634      |                                                | $          | (1,841 | ) | $ | 4,338 |   | $ | (3,237 | ) |

 

**Threemonths ended September 30, 2006 compared to the three months ended September30, 2005**

***Revenues.*** Total revenues increased$8.4 million, or 12.9%, to $73.2 million for the three months ended September30, 2006, from $64.8 million for the three months ended September 30, 2005. Wegenerate revenues through four business divisions.

***POS division.*** Revenues from the POSdivision increased $0.6 million, or 2.9%, to $21.7 million for the three monthsended September 30, 2006, from $21.1 million for the three months endedSeptember 30, 2005. Included in POS revenues for the three months endedSeptember 30, 2006 was approximately $0.6 million of revenues from regulatorycharges that we pass-through to our customers. POS transaction volumesincreased 11.2% to 1.6 billion transactions for the three months endedSeptember 30, 2006, from 1.4 billion transactions for the three months endedSeptember 30, 2005. We have negotiated contract renewals with some of our POScustomers, and in several instances we agreed to pricing discounts in exchangefor maintaining or increasing their minimum transaction or revenue commitments.As a result, it is likely our revenue per transaction will continue to decreaseand, depending upon the number of transactions we transport, our POS revenuesmay decrease.

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***International services division.***Revenues from the international services division increased $3.3 million, or13.8%, to $27.1 million for the three months ended September 30, 2006, from$23.8 million for the three months ended September 30, 2005. The increase wasprimarily due to additional revenues generated from our POS customers in CentralEurope and the United Kingdom, and to a lesser extent, the favorable impact offoreign exchange and revenues we have generated in countries we have recentlyentered through acquisition or otherwise, primarily in Eastern Europe and theAsia-Pacific region. Revenues from our United Kingdom subsidiaries increased$1.5 million, or 10.7%, to $15.3 million for the three months endedSeptember 30, 2006, from $13.8 million for the three months ended September 30,2005. The increase was primarily due to revenue generated from our new POSservice offerings from recent acquisitions and to a lesser extent the favorableimpact of foreign exchange.

Future revenue growth in the internationalservices division depends on a number of factors including the success of ourPOS and FSD products in countries we have recently entered, the success of ournew product offerings and the successful integration of our recent acquisitions,including our recent acquisition of JPG Telecom, SAS.

***Telecommunication services division.***Revenues from the telecommunication services division increased$3.6 million, or 30.7%, to $15.5 million for the three months endedSeptember 30, 2006, from $11.9 million for the three months ended September 30,2005. Included in telecommunications services division revenues for the threemonths ended September 30, 2006 and 2005 were approximately $1.4 million and$0.1 million, respectively, of revenues from regulatory charges that wepass-through to our customers. Excluding the increase in pass-through revenues,the growth in revenues was primarily due to increased usage of our databaseaccess and call signaling services from new and existing customers.

***Financial services division.*** Revenuesfrom the financial services division increased $0.8 million, or 9.9%, to $8.8million for the three months ended September 30, 2006, from $8.0 million forthe three months ended September 30, 2005. The increase in revenues was due tothe growth in the number of customer connections, both physical and logical, toand through our networks.

Future revenuegrowth in the financial services division depends on a number of factorsincluding the number of connections to and through our networks as well as thesuccess of our new product offerings.  Wehave begun to see an increased demand from our customers for larger bandwidth connectionsto our network and while these connections do draw greater revenue per physicalendpoint, they do require longer sales and installation lead times.  

***Cost of network services.*** Cost ofnetwork services increased $7.4 million, or 24.5%, to $37.4 million for thethree months ended September 30, 2006, from $30.1 million for the three monthsended September 30, 2005. Cost of network services were 51.2% of revenues forthe three months ended September 30, 2006, compared to 46.4% of revenues forthe three months ended September 30, 2005. The increase in cost of networkservices resulted primarily from higher usage charges from ourtelecommunications services and international services divisions and to alesser extent an increase in regulatory charges that we pass through to ourcustomers. Gross profit represented 48.8% of total revenues for the threemonths ended September 30, 2006, compared to 53.6% for the three months endedSeptember 30, 2005.  Excluding the incremental $1.9 million of pass-throughrevenues in the POS and telecommunications services divisions, our gross marginwould have been 50.1% for the three months ended September 30, 2006.  Thedecrease in gross profit as a percentage of total revenues resulted primarilyfrom increased contribution of our telecommunication services division, ourlowest gross margin division, and to a lesser extent a decline in the grossmargin of our POS division as a result of declines in our average revenue pertransaction, partially offset by increased contribution from our internationalservices and financial services divisions, our highest gross margin divisions.

Future cost ofnetwork services depends on a number of factors including total transaction andquery volume, the relative growth and contribution to total transaction volumeof each of our customers, the success of our new service offerings, the timingand extent of our network expansion and the timing and extent of any networkcost increases or reductions. In addition, any significant loss or significantreduction in transaction or query volumes could lead to a decline in grossmargin since significant portions of our network costs are fixed costs.

***Engineering and development expense.***Engineering and development expense increased $1.5 million, or 38.2%, to $5.3million for the three months ended September 30, 2006, from $3.8 million forthe three months ended September 30, 2005. Engineering and development expenserepresented 7.2% of revenues for the three months ended September 30, 2006 and5.9% of revenues for the three months ended September 30, 2005. Engineering anddevelopment expense increased primarily from an increase in engineering  and development expenses required to supportour international expansion and new product offerings in the telecommunicationsservices and POS divisions and to a lesser extent from an increase instock-based compensation expense of approximately $0.4 million, primarily as aresult of the adoption of SFAS 123R on January 1, 2006.

***Selling, general and administrative expense.***Selling, general and administrative expense increased $7.2 million, or 52.1%,to $21.0 million for the three months ended September 30, 2006, from $13.8million for the three months ended September 30, 2005. Selling, general andadministrative expense represented 28.7% of revenues for the three months endedSeptember 30, 2006, compared to 21.3% of revenues for the three months endedSeptember 30, 2005. Included in selling, general and administrative expensesfor the three months ended September 30, 2006 is $3.6 million in severanceexpense associated with a corporate restructuring event and approximately $0.7million of fees related to the special committee of our board ofdirectors.   Included in selling,general, and administrative expenses for the three months ended September 30,2005 is a $0.7 million benefit from the favorable settlement of certain salestax liabilities. Excluding these items, selling, general and administrativeexpense increased primarily from the expenses required to support our revenuegrowth, mainly within the international services division as well as newproduct offerings in our POS and telecommunications services divisions and to alesser extent from an increase in stock-based compensation expense, primarilyas a result of the adoption of SFAS 123R on January 1, 2006.

***Depreciation and amortization of property and equipment.***Depreciation and amortization of property and equipment increased $1.0 million,or 22.8%, to $5.6 million for the three months ended September 30, 2006, from$4.5 million for the three months ended September 30, 2005. Depreciationexpense increased primarily due to an increase in capital expenditures tosupport our revenue growth. Depreciation and amortization of property andequipment represented 7.6% of revenues for the three months ended September 30,2006, compared to 7.0% of revenues for the three months ended September 30,2005.

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***Amortization of intangible assets.***Amortization of intangible assets increased $1.2 million, or 28.5%, to$5.5 million for the three months ended September 30, 2006, from $4.2million for the three months ended September 30, 2005. The amortization ofintangible assets for the three months ended September 30, 2006 and 2005relates solely to the intangible assets resulting from acquisitions. Theincrease was primarily attributable to the additional amortization resultingfrom acquisitions completed during 2005 and 2006. For purposes of measuring andrecognizing impairment of long-lived assets including intangibles, we assesswhether separate cash flows can be attributed to the individual asset. For ourcustomer relationship intangible assets, we recognize and measure impairmentupon the significant loss of revenue from a customer. Based upon our contractwith one of our major customers, we believe that revenues and relatedtransaction volumes from this customer may continue to decline in 2006 andthereafter. The intangible asset value attributable to this customerrelationship was approximately $22.7 million as of September 30, 2006. Weassessed the recoverability of this customer relationship asset based uponundiscounted anticipated future cash flows and concluded no impairment existedas of September 30, 2006.

***Interest expense.*** Interest expensedecreased $0.5 million to $2.5 million for the three months ended September 30,2006 from $3.0 million for the three months ended September 30, 2005. Includedin interest expense for the three months ended September 30, 2005 is theaccelerated amortization of approximately $0.6 million of deferred financingcosts in connection with the early repayment of amounts outstanding under ouramended and restated senior secured credit facility with the net proceeds fromour follow-on offering in September 2005.

***Interest and other income (expense), net.***Interest and other income (expense), net was $0.8 million for the three monthsended September 30, 2006 compared to $0.1 million for the three months endedSeptember 30, 2005. Included in other income (expense), net for the threemonths ended September 30, 2006 is a gain on foreign currency transactions ofapproximately $0.7 million due to fluctuations in the value of the U.S. dollaras compared with foreign currencies, predominately, the euro, the British poundand the Australian dollar, versus a loss on foreign currency translation of$19,000 for the three months ended September 30, 2005.

***Income tax benefit (provision).*** Forthe three months ended September 30, 2006, our income tax benefit was $2.2million compared to an income tax provision of $2.1 million for the threemonths ended September 30, 2005. Our effective tax rate for the three monthsended September 30, 2006 and 2005 is 54.9% and 44.2%, respectively, versus theU.S. Federal statutory tax rate of 34.0%, due primarily to losses in certainjurisdictions and our equity method investments that are not being benefitedand to a lesser extent lower tax rates in certain international jurisdictionsin which we have operations.

***Equity in net loss of unconsolidated affiliates.***For the three months ended September 30, 2006, our equity in net loss ofunconsolidated affiliates was $0.9 million compared to $0.8 million for thethree months ended September 30, 2005. The increase was due to additionallosses recorded on our equity method investments, primarily relating to ourinvestments in Way Systems, Inc. and IP Commerce, Inc. As ofSeptember 30, 2006, we had $3.2 million of long-term investments inunconsolidated affiliates, and we expect to incur additional losses on theseinvestments in 2006, and we may continue to incur losses on them thereafter.

**Ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005**

***Revenues.***  Total revenuesincreased $18.4 million, or 9.5%, to $211.8 million for the nine months endedSeptember 30, 2006, from $193.3 million for the nine months ended September 30,2005. We generate revenues through four operating divisions.

***POS division.***  Revenues from thePOS division decreased $4.4 million, or 6.7%, to $61.9 million for the ninemonths ended September 30, 2006, from $66.4 million for the nine months endedSeptember 30, 2005. The $4.4 million decrease in POS revenues resultedprimarily from a decline in the average revenue per transaction as a result ofrecent pricing discounts given to some of our larger POS customers. Included in POS revenues for the nine months ended September 30, 2006 wasapproximately $0.6 million of revenues from regulatory charges that we passthrough to our customers. POS transaction volumes increased 0.9% to 4.5 billiontransactions for the nine months ended September 30, 2006, from 4.4 billiontransactions for the nine months ended September 30, 2005. We have negotiatedcontract renewals with some of our POS customers, and in several instances weagreed to pricing discounts in exchange for maintaining or increasing theirminimum transaction or revenue commitments. As a result, it is likely ourrevenue per transaction will decrease and, depending upon the number oftransactions we transport, our POS revenues may decrease.

***International services division.*** Revenues from the international services division increased $6.2 million, or8.7%, to $76.9 million for the nine months ended September 30, 2006, from $70.8million for the nine months ended September 30, 2005. The increase wasprimarily due to additional revenues generated from our POS and FSD customersin Ireland, the United Kingdom and Central Europe, and to a lesser extent, revenuecontribution from countries we have recently entered through acquisition orotherwise, primarily in Eastern Europe and the Asia-Pacific Region. Theseincreases were partially offset by the unfavorable impact of foreign exchange. Revenuesfrom our United Kingdom subsidiaries increased $0.7 million, or 1.7%, to$43.2 million for the nine months ended September 30, 2006, from $42.4million for the nine months ended September 30, 2005. The increase wasprimarily due to the revenues generated from our new POS service offerings fromour recent acquisitions which, were partially offset by the loss of revenuefrom a customer that was transferred to one of our Irish subsidiaries and theunfavorable impact of foreign exchange.

Future revenue growth in the internationalservices division depends on a number of factors including the success of ourPOS and FSD products in countries we have recently entered, the success of ournew product offerings and the successful integration of our recent acquisitions,including our recent acquisition of JPG Telecom, SAS.

***Telecommunication services division.*** Revenues from the telecommunication services division increased$13.9 million, or 42.1%, to $47.1 million for the nine months endedSeptember 30, 2006, from $33.1 million for the nine months ended September 30,2005. Included in telecommunications services revenues for the nine monthsended September 30, 2006 and 2005 were approximately $5.1 million and $0.3million, respectively, of revenues from regulatory charges that we pass-throughto our customers. Excluding the increase in pass-through revenues, the growthin revenues was primarily due to increased usage of our database access andcall signaling services from new and existing customers.

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*** ***

***Financial services division.*** Revenues from the financial services division increased $2.8 million, or 11.9%,to $25.8 million for the nine months ended September 30, 2006, from $23.1million for the nine months ended September 30, 2005. The increase in revenueswas due to the growth in the number of customer connections, both physical and logical,to and through our networks.

Future revenuegrowth in the financial services division depends on a number of factorsincluding the number of connections to and through our networks as well as thesuccess of our new product offerings.  Wehave begun to see an increased demand from our customers for larger bandwidthconnections to our network and while these connections do draw greater revenueper physical endpoint, they do require longer sales and installation leadtimes.  

***Cost of network services.***  Costof network services increased $16.4 million, or 17.9%, to $107.6 million forthe nine months ended September 30, 2006, from $91.3 million for the ninemonths ended September 30, 2005. Cost of network services were 50.8% ofrevenues for the nine months ended September 30, 2006, compared to 47.2% ofrevenues for the nine months ended September 30, 2005. The increase in cost ofnetwork services resulted primarily from higher usage charges from ourtelecommunications services and international services divisions as well as anincrease in regulatory charges in our telecommunications services and POSdivisions that we pass through to our customers. Gross profit represented 49.2%of total revenues for the nine months ended September 30, 2006, compared to 52.8%for the nine months ended September 30, 2005.  Excluding the incremental$5.4 million of pass-through revenues in the POS division andtelecommunications services division, our gross margin would have been 50.4%for the nine months ended September 30, 2006.  The decrease in grossprofit as a percentage of total revenues resulted primarily from increasedcontribution of our telecommunication services division, our lowest grossmargin division, and to a lesser extent a decline in the gross margin of ourPOS division as a result of declines in our average revenue per transaction,partially offset by increased contribution from our international services andfinancial services divisions, our highest gross margin divisions.

Future cost ofnetwork services depends on a number of factors including total transaction andquery volume, the relative growth and contribution to total transaction volumeof each of our customers, the success of our new service offerings, the timingand extent of our network expansion and the timing and extent of any networkcost increases or reductions. In addition, any significant loss or significantreduction in transaction or query volumes could lead to a decline in grossmargin since significant portions of our network costs are fixed costs.

***Engineering and development expense.*** Engineering and development expense increased $3.6 million, or 30.2%, to$15.3 million for the nine months ended September 30, 2006, from $11.8million for the nine months ended September 30, 2005. Engineering anddevelopment expense represented 7.2% of revenues for the nine months endedSeptember 30, 2006 and 6.1% of revenues for the nine months ended September 30,2005. Engineering and development expense increased primarily from an increasein engineering expenses required to support our international expansion and newproduct offerings in our TSD and POS division and to a lesser extent from anincrease in stock-based compensation expense of approximately $0.8 million,primarily as a result of the adoption of SFAS 123R on January 1, 2006 andapproximately $0.2 million of severance expense.

***Selling, general and administrative expense.*** Selling, general and administrative expense increased $15.3 million, or 38.3%,to $55.1 million for the nine months ended September 30, 2006, from $39.8million for the nine months ended September 30, 2005. Selling, general andadministrative expense represented 26.0% of revenues for the nine months endedSeptember 30, 2006, compared to 20.6% of revenues for the nine months endedSeptember 30, 2005. Included in selling, general and administrative expensesfor the nine months ended September 30, 2006 is a charge for severance ofapproximately $3.7 million primarily associated with a corporate restructuringevent, a charge for expenses incurred by the special committee of our board ofdirectors of approximately $1.4 million and a charge related to other legalcosts of approximately $0.5 million. Included in selling, general andadministrative expenses for the nine months ended September 30, 2005 is acharge related to a legal settlement of approximately $3.3 million, a benefitfrom a reduced state sales tax liability assessment of approximately $5.8million and a benefit from the favorable settlement of certain sales taxliabilities of approximately $0.7 million. Excluding these items, selling,general and administrative expense increased primarily from the expensesrequired to support our revenue growth, mainly within the internationalservices division as well as new product offerings in our TSD and POSdivisions, and to a lesser extent, from an increase in stock-based compensationexpense primarily as a result of the adoption of SFAS 123R on January 1, 2006.

***Depreciation and amortization of property and equipment.*** Depreciation and amortization of property and equipment increased $1.6 millionto $15.9 million for the nine months ended September 30, 2006, from $14.4million for the nine months ended September 30, 2005. Depreciation expenseincreased primarily due to an increase in capital expenditures to support ourrevenue growth.  Depreciation and amortization of property and equipmentrepresented 7.5% of revenues for the nine months ended September 30, 2006,compared to 7.4% of revenues for the nine months ended September 30, 2005.

***Amortization of intangible assets.*** Amortization of intangible assets decreased $2.0 million, or 11.4%, to $15.7million for the nine months ended September 30, 2006, from $17.8 million forthe nine months ended September 30, 2005. The amortization of intangible assetsfor the nine months ended September 30, 2006 and 2005 relates solely to theintangible assets resulting from acquisitions. In the nine months endedSeptember 30, 2006 and 2005, we accelerated amortization on a portion of ourcustomer relationship intangible assets in connection with the loss of certaincustomers by $0.1 million and $3.1 million, respectively.  Excluding theseitems, amortization of intangible assets increased primarily as a result of ourrecent business acquisitions.  For purposesof measuring and recognizing impairment of long-lived assets includingintangibles, we assess whether separate cash flows can be attributed to theindividual asset. For our customer relationship intangible assets, we recognizeand measure impairment upon the termination or loss of a customer that resultsin a loss of revenue.  Based on the outcome of our contract negotiationswith one of our major customers, we believe that revenues and relatedtransaction volumes from this customer may continue to decline in 2006 andthereafter.  The intangible asset value attributable to this customerrelationship is approximately $22.7 million as of September 30, 2006.  Weassessed the recoverability of this customer relationship asset based uponanticipated future cash flows and concluded that no impairment existed as ofSeptember 30, 2006.

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***Interest expense.***  Interestexpense decreased $0.2 million to $6.8 million for the nine months endedSeptember 30, 2006, from $7.0 million for the nine months ended September30, 2005. Included in interest expense for the nine months ended September 30,2005 is approximately $1.7 million related to the acceleration of deferredfinancing costs in connection with the early repayment of long-term debt.  Excluding this item, interest expenseincreased primarily due to increases in interest rates and to a lesser extentan increase in our weighted average debt outstanding.

***Interest and other income (expense), net.*** Interest and other income (expense), net was $1.6 million for the nine monthsended September 30, 2006 compared to expense of $0.1 million for the ninemonths ended September 30, 2005. Included in other income (expense), net forthe nine months ended September 30, 2006 is a gain on foreign currencytransactions of approximately $1.2 million due to fluctuations in the value ofthe U.S. dollar as compared with foreign currencies, predominately, the euro,the British pound and the Australian dollar, versus a loss on foreign currencytranslation of $0.6 million for the nine months ended September 30, 2005.

***Income tax benefit (provision).*** For the nine months ended September 30, 2006, our income tax benefit was $2.7million compared to a provision of $4.9 million for the nine months endedSeptember 30, 2005. Our effective tax rate for the nine months ended September30, 2006 is 44.9% and 53.1%, respectively, versus the U.S. Federal statutorytax rate of 34.0%, due primarily to lower tax rates in certain internationaljurisdictions in which we have operations and losses in certain jurisdictionsand our equity method investments that are not being benefited.

***Equity in net loss of unconsolidated affiliates.*** For the nine months ended September 30, 2006, our equity in net loss ofunconsolidated affiliates was $2.9 million compared to $1.9 million for thenine months ended September 30, 2005. The increase was due to additional lossesrecorded on our equity method investments, primarily relating to ourinvestments in Way Systems, Inc. and IP Commerce, Inc. As ofSeptember 30, 2006, we had $3.2 million of long-term investments inunconsolidated affiliates, and we expect to incur additional losses on theseinvestments in 2006, and we may continue to incur losses on them thereafter.

**Seasonality**

Credit card anddebit card transactions account for a major percentage of the transactionvolume processed by our customers. The volume of these transactions on ournetworks generally is greater in the third and fourth quarter vacation andholiday seasons than during the rest of the year. Consequently, revenues andearnings from credit card and debit card transactions in the first and secondquarter generally are lower than revenues and earnings from credit card anddebit card transactions in the third and fourth quarters of the immediatelypreceding year. We expect that our operating results in the foreseeable futurewill be significantly affected by seasonal trends in the credit card and debitcard transaction market.

**Liquidityand Capital Resources**

Our primaryliquidity and capital resource needs are to finance the costs of ouroperations, to make capital expenditures and to service our debt. Theborrowings under our amended and restated senior secured credit facility wereused to finance the stock repurchase on May 5, 2005, as well as to repaythe amounts outstanding under our 2004 senior secured credit facility. Based upon our current level of operations, we expect that our cash flow fromoperations, together with the amounts we are able to borrow under our amendedand restated senior secured credit facility, will be adequate to meet ouranticipated needs for the foreseeable future. Although we have no specificplans to do so, to the extent we decide to pursue one or more significantstrategic acquisitions, we will likely need to incur additional debt or selladditional equity to finance those acquisitions.

Our operationsprovided us cash of $24.8 million for the nine months ended September 30,2006, which was attributable to a net loss of $3.2 million, depreciation,amortization and other non-cash charges of $39.6 million and a decrease inworking capital of $11.6 million. Our operations provided us cash of$33.5 million for the nine months ended September 30, 2005, which wasattributable to net income of $4.3 million, depreciation, amortization andother non-cash charges of $40.7 million and a decrease in working capitalof $11.6 million.

We used cash of$46.1 million in investing activities for the nine months ended September30, 2006, which includes cash paid for business acquisitions of $27.8 millionand capital expenditures of $18.3 million. We used cash of$23.7 million in investing activities for the nine months ended September30, 2005, which includes capital expenditures of $14.1 million. Inaddition, we made investments for $2.6 million in WAY and $2.9 million in IPCommerce, and we made business acquisitions of $4.1 million.

Wegenerated cash of $8.1 million from financing activities for the nine monthsended September 30, 2006, which includes $8.0 million of borrowings underour amended and restated senior secured credit facility, the proceeds of whichwere used to partially finance business acquisitions. We used cash of $4.4million for financing activities for the nine months ended September 30, 2005,which includes borrowings under our amended and restated senior secure creditfacility, net of financing costs, of $165.2 million that were used to financethe purchase and retirement of 6,263,435 shares of our common stock at a priceof $18.50 per share plus expenses for approximately $116.9 million and to repay$48.0 million of long-term debt under our March 19, 2004 credit facility. We used the net proceeds from our follow-on offering in September 2005 ofapproximately $46.1 million to repay $45.0 million of long-term debt under ouramended and restated senior secure credit facility.  In addition we made long-termdebt repayments of $3.7 million on our amended and restated senior securedcredit facility and an additional $3.0 million on our 2004 senior securedcredit facility.

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*** ***

***Amended and Restated Senior Secured Credit Facility***

On May 4,2005, we entered into an amended and restated senior secured credit facility tofinance the stock repurchase and to replace our 2004 senior secured creditfacility. The amended and restated senior secured credit facility consists of a$165.0 million term loan and a revolving credit facility of$30.0 million, under which there were $8.0 million of borrowings as ofSeptember 30, 2006. The amended and restated senior secured credit facilitymatures May 4, 2012. Payments on the term loan are due in quarterlyinstallments over the seven-year term, beginning on September 1, 2005,with the remainder payable on May 4, 2012. Voluntary prepayments on theterm loan are first applied pro-rata to the scheduled quarterly installmentsdue within the next succeeding twelve-month period until paid in full and thenapplied to the term loan in inverse order of maturity.

As of September30, 2006, total remaining payments on the Term Loan are as follows (inthousands):

| Three months ending  December 31, 2006 |   | $       | —  |   |
|---------------------------------------------|--------|---------|---------|--------|
| 2007                                        |   | 1,650   |    |
| 2008                                        |   | 1,650   |    |
| 2009                                        |   | 1,650   |    |
| 2010                                        |   | 1,650   |    |
| Thereafter                                  |   | 114,848 |    |
|                                        |   | $       | 121,448 |   |

 

For the periodthrough September 30, 2006, borrowings on the New Revolving Credit Facility andthe term loan bore interest at a rate of 2.0 percent over the LIBORrate (7.4 percent as of September 30, 2006). Thereafter, if we attain aleverage ratio of less than 1.75, the borrowings on the revolving creditfacility and the term loan generally will bear interest at a rate, at ouroption, of either 0.75 percent over the lender’s base rate or1.75 percent over the LIBOR rate. Our leverage ratio as of September 30,2006 was 2.0 to 1.0. The revolving credit facility is subject to an annualnon-use commitment fee in an amount equal to 0.375 percent or 0.5 percentper annum, depending on our leverage ratio, multiplied by the amount of fundsavailable for borrowing under the revolving credit facility. Interest paymentson the May 4, 2005 Credit Facility are due monthly, bimonthly, quarterly,semi-annual or annual at our option.

The terms of theamended and restated senior secured credit facility require us to comply withfinancial and nonfinancial covenants, including maintaining certain leverage,interest and fixed charge coverage ratios at the end of each fiscal quarter. Asof September 30, 2006, we were required to maintain a leverage ratio of lessthan 2.4 to 1.0, an interest coverage ratio of greater than 4.0 to 1.0 and afixed charge ratio of greater than 2.5 to 1.0. Certain of the financialcovenants will become more restrictive over the term of the amended andrestated senior secured credit facility. The amended and restated seniorsecured credit facility also contains nonfinancial covenants that restrict someof our corporate activities, including our ability to dispose of assets, incuradditional debt, pay dividends, create liens, make investments, make capitalexpenditures and engage in specified transactions with affiliates. Our futureresults of operations and our ability to comply with the covenants could beadversely impacted by increases in the general level of interest rates sincethe interest on a majority of our debt is variable. Noncompliance with any ofthe financial or nonfinancial covenants without cure or waiver would constitutean event of default under the amended and restated senior secured creditfacility. An event of default resulting from a breach of a financial ornonfinancial covenant may result, at the option of the lenders, in anacceleration of the principal and interest outstanding, and a termination ofthe amended and restated senior secured revolving credit facility. The amendedand restated senior secured credit facility also contains other customaryevents of default (subject to specified grace periods), including defaultsbased on events of bankruptcy and insolvency, nonpayment of principal, interestor fees when due, breach of specified covenants, change in control and materialinaccuracy of representations and warranties. We were in compliance with thefinancial and nonfinancial covenants of the amended and restated senior securedcredit facility as of September 30, 2006.

**Adoption of SFAS 123R**

We adopted SFAS123R following the modified prospective transition method effective January 1,2006. SFAS 123R requires all share-based payments to employees to be recognizedin the income statement based on their respective grant date fair values overthe corresponding service periods and also requires an estimation offorfeitures when calculating compensation expense. The adoption of SFAS 123Rreduced income from operations by approximately $2.4 million and basic anddiluted earnings per share (“EPS”) by approximately $0.10 for the nine monthsended September 30, 2006. Stock-based compensation accounted for under SFAS123R is expected to reduce income from operations and earnings per share byapproximately $3.2 million and  $0.13, respectively, for the full year2006. The current compensation structure, or changes therein, as well as anysubsequent stock based compensation plan activity could result in an increasein the impact of SFAS 123R in 2006 and thereafter.

Prior to theadoption of SFAS 123R, we followed APB Opinion No. 25, “Accounting for StockIssued to Employees,” in its accounting for stock compensation and recordedstock-based compensation based on the intrinsic value method. Stockcompensation expense recognized in the nine months ended September 30, 2005reduced net income by approximately $1.1 million, related to restricted stockunits. Prior to the adoption of SFAS 123R, we did not make estimates forforfeitures and recognized compensation cost assuming all restricted stockawards would vest and reversed compensation cost for forfeited awards when theawards were actually forfeited.  Upon adoption of SFAS 123R, we recorded acumulative effect of a change in accounting principle, net of tax of

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approximately $0.1million related to estimated forfeitures of unvested restricted stockawards.  As of September 30, 2006, the total compensation cost related tounvested stock options and restricted stock units that has not yet beenrecognized was approximately $14.5 million, which we expect to recognize over aweighted average period of approximately 3 years.

Refer to Note 7 ofour Condensed Consolidated Financial Statements in Item 1 for a completediscussion of our stock-based compensation plans and the adoption of SFAS 123R.

**New Accounting Pronouncements**

In June 2006, theFinancial Accounting Standards Board issued FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN48). This interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. It also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. This interpretation iseffective for fiscal years beginning after December 15, 2006, but earlieradoption is permitted. We are currently evaluating the effect that the adoptionof FIN 48 will have on our results of operations and financial position.

In September 2006,the FASB issued SFAS No. 157 “Fair Value Measurements” (SFAS 157). SFAS 157provides a new single authoritative definition of fair value and providesenhanced guidance for measuring the fair value of assets and liabilities andrequires additional disclosures related to the extent to which companiesmeasure assets and liabilities at fair value, the information used to measurefair value, and the effect of fair value measurements on earnings. SFAS 157 iseffective as of January 1, 2008. We are currently assessing the impact, if any,of SFAS 157 on our consolidated financial statements.

In September 2006,the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans — an amendment of FASB Statements No. 87, 88,106, and 132(R)” (SFAS 158). SFAS 158 requires balance sheet recognition of theoverfunded or underfunded status of pension and postretirement benefit plans.Under SFAS 158, actuarial gains and losses, prior service costs or credits, andany remaining transition assets or obligations that have not been recognizedunder previous accounting standards must be recognized as a component of accumulatedother comprehensive income (loss) within stockholders’ equity, net of taxeffects, until they are amortized as a component of net periodic benefit cost.In addition, the measurement date and the date at which plan assets and thebenefit obligation are measured, are required to be the company’s fiscalyear-end. SFAS 158 is effective as of December 31, 2007, except for themeasurement date provisions, which are effective December 31, 2009. Theadoption of SFAS 158 is not expected to have a material impact on ourconsolidated financial statements.

In September 2006,the SEC released Staff Accounting Bulletin No. 108 “Considering the Effects ofPrior Year Misstatements When Quantifying Misstatements in Current YearFinancial Statements” (SAB 108). SAB 108 provides interpretative guidance onhow public companies quantify financial statement misstatements. There havebeen two common approaches used to quantify such errors. Under an incomestatement approach, the “roll-over” method, the error is quantified as theamount by which the current year income statement is misstated. Alternatively,under a balance sheet approach, the “iron curtain” method, the error isquantified as the cumulative amount by which the current year balance sheet ismisstated. In SAB 108, the SEC established an approach that requiresquantification of financial statement misstatements based on the effects of themisstatements on each of the company’s financial statements and the relatedfinancial statement disclosures. This model is commonly referred to as a “dualapproach” because it requires quantification of errors under both the roll-overand iron curtain methods. SAB 108 is effective as of January 1, 2007. Theadoption of SAB 108 is not expected to have a material impact on our consolidatedfinancial statements.

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** **

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

***Interest rates***

Our principalexposure to market risk relates to changes in interest rates. As of September30, 2006, we had $121.4 million outstanding under our amended and restatedsenior secured credit facility with interest rates tied to changes in thelender’s base rate or the LIBOR rate. Based upon the outstanding borrowings onSeptember 30, 2006 and assuming repayment of the Term Loan in accordance withscheduled maturities, each 1.0% increase in these rates could add an additional$1.2 million to our annual interest expense.

As of September30, 2006, we did not hold derivative financial or commodity instruments and allof our cash and cash equivalents were held in money market or commercialaccounts.

***Foreign currency risk***

Our earnings areaffected 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 have operationsin 21 countries outside of the U.S., including the United Kingdom, Australia,Austria, Bermuda, Canada, Colombia, France, Germany, Ireland, Italy, Japan,Malaysia, Mexico, the Netherlands, New Zealand, Poland, Romania, South Korea,Spain, Sweden and Thailand. We provide services in these countries usingnetworks deployed in each country. 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 nine monthsended September 30, 2006, we recorded a gain on foreign currency transactionsof approximately $1.2 million.

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** **

**Item4. Controls and Procedures**

The Companymaintains disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the Company’s reports under theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to the Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily was required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

**Evaluation**

The Companycarried out an evaluation, under the supervision, and with the participation,of the Company’s management, including the Company’s Chief Executive Officerand the Company’s Chief Financial Officer, of the effectiveness of the Company’sdisclosure controls and procedures as of September 30, 2006. Based on theforegoing, the Company’s Chief Executive Officer and principal financialofficers concluded that the Company’s disclosure controls and procedures wereeffective as of September 30, 2006.

There have been nosignificant changes during the quarter covered by this report in the Company’sinternal control over financial reporting or in other factors, including thedeparture of our former Chief Executive Officer, John J.McDonnell, Jr.

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**PART II—OTHER INFORMATION**

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

Informationregarding legal proceedings is contained in Note 9 to the CondensedConsolidated Financial Statements contained in this Report and is incorporatedherein by reference.

**Item 1A.****                Risk Factors**

There were nomaterial changes from the risk factors previously disclosed in “Item 1A. RiskFactors” included in our Annual Report on Form 10-K for the year ended December31, 2005.

**Item 2.****                   Unregistered Sales of Equity Securities and Use of Proceeds**

None.

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

None.

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

None.

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

None.

**Item 6.****                   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 |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                        |   | TNS, Inc. |
|------------------------|--------|----------------|
|                   |   | (Registrant)   |
|                   |   |           |   |   |
|                   |   |           |   |   |
| Date: November 9, 2006 |   | By:            |   | /s/ HENRY H. GRAHAM, JR. |
|                   |   |           |   | Henry H. Graham, Jr. |
|                   |   |           |   | Chief Executive Officer |
|                   |   |           |   |   |
| Date: November 9, 2006 |   | By:            |   | /s/ EDWARD C. O’BRIEN |
|                   |   |           |   | Edward C. O’Brien |
|                   |   |           |   | Executive Vice President, Chief Financial  Officer & Treasurer |

 

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