**UNITEDSTATESSECURITIES 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**

**Forthe quarter ended June 30, 2006**

**CommissionFile Number: 001-32033**

**TNS, INC.**

(Exact name of registrantas specified in its charter)

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

 

**11480Commerce Park Drive, Suite 600Reston, VA 20191**

(Addressof principal executive offices)

**(703) 453-8300**

(Registrant’stelephone number, including area code)

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementfor the past 90 days.  x Yes  o No

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act.
| Large accelerated filer   o | Accelerated filer    x | Non-accelerated filer   o |
|--------------------------------------------|----------------------------------|-------------------------------------|

 

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

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

| **Shares Outstanding as of July  1, 2006**           |
|------------------------------------------------------|
| 24,100,487  Shares of Common Stock, $0.001 par value |

 

 

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**TNS, INC.**

**INDEX**
| **Part I: FINANCIAL  INFORMATION** | ** **   | ** ** |
|-----------------------------------------|--------------|------------|
|                                    |         |       |
|                                    | Item 1. |       | Condensed  Consolidated Financial Statements (Unaudited) |   |   |
|                                    |         |       | Condensed  Consolidated Balance Sheets as of December 31, 2005 and June 30, 2006 |   |   |
|                                    |         |       | Condensed  Consolidated Statements of Operations for the three and six months ended June 30,  2005 and 2006 |   |   |
|                                    |         |       | Condensed  Consolidated Statements of Cash Flows for the six months ended June 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—FINANCIALINFORMATION**

**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** | ** ** | **June 30,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                                                          | ** ** | ** **                  | ** ** | **(unaudited)**         | ** ** |
| **ASSETS**                                                                                                                                                                                                          | ** ** | ** **                  | ** ** | ** **              | ** ** |
| Current assets:                                                                                                                                                                                                     |       |                        |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                                                          |       | $                           | 26,628     |                    | $          | 21,188 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $5,260 and $5,984,  respectively                                                                                                                    |       | 48,773                      |       | 57,566                  |       |
| Prepaid expenses                                                                                                                                                                                                    |       | 4,407                       |       | 4,883                   |       |
| Deferred tax  assets                                                                                                                                                                                                |       | 5,236                       |       | 3,542                   |       |
| Other current  assets                                                                                                                                                                                               |       | 5,813                       |       | 7,450                   |       |
| Total current  assets                                                                                                                                                                                               |       | 90,857                      |       | 94,629                  |       |
| Property and equipment,  net                                                                                                                                                                                        |       | 52,448                      |       | 55,508                  |       |
| Identifiable intangible  assets, net                                                                                                                                                                                |       | 187,233                     |       | 194,049                 |       |
| Goodwill                                                                                                                                                                                                            |       | 5,160                       |       | 8,468                   |       |
| Other assets                                                                                                                                                                                                        |       | 16,486                      |       | 19,068                  |       |
| Total assets                                                                                                                                                                                                        |       | $                           | 352,184    |                    | $          | 371,722 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                      |       |                        |       |                    |       |
| Current liabilities:                                                                                                                                                                                                |       |                        |       |                    |       |
| Current portion  of long-term debt                                                                                                                                                                                  |       | $                           | —     |                    | $          | 825 |   |
| Accounts  payable, accrued expenses and other current liabilities                                                                                                                                                   |       | 46,933                      |       | 53,311                  |       |
| Deferred revenue                                                                                                                                                                                                    |       | 10,810                      |       | 14,050                  |       |
| Total current  liabilities                                                                                                                                                                                          |       | 57,743                      |       | 68,186                  |       |
| Long-term debt, net of  current portion                                                                                                                                                                             |       | 113,448                     |       | 118,623                 |       |
| Other liabilities                                                                                                                                                                                                   |       | 3,147                       |       | 3,611                   |       |
| Total  liabilities                                                                                                                                                                                                  |       | 174,338                     |       | 190,420                 |       |
| 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 24,129,152 shares issued and 24,100,487 shares  outstanding, respectively |       | 24                          |       | 24                      |       |
| Treasury stock,  27,714 shares and 28,665 shares, respectively                                                                                                                                                      |       | (517                        | )          | (536                    | )          |
| Additional  paid-in capital                                                                                                                                                                                         |       | 217,434                     |       | 213,776                 |       |
| Accumulated  deficit                                                                                                                                                                                                |       | (31,567                     | )          | (32,964                 | )          |
| Deferred stock  compensation                                                                                                                                                                                        |       | (7,150                      | )          | —                  |       |
| Accumulated  other comprehensive (loss) income                                                                                                                                                                      |       | (378                        | )          | 1,002                   |       |
| Total  stockholders’ equity                                                                                                                                                                                    |       | 177,846                     |       | 181,302                 |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                    |       | $                           | 352,184    |                    | $          | 371,722 |   |

 

See accompanying notes to condensed consolidatedfinancial 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  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                                                                                       |       | $                                               | 65,354     |                                          | $          | 72,660 |   | $ | 128,486 |   | $ | 138,568 |   |
| Operating  expenses:                                                                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Cost of network services, exclusive of the items  shown separately below                                                                       |       | 30,966                                          |       | 37,127                                        |       | 61,196 |   | 70,184 |   |
| Engineering and development                                                                                                                    |       | 4,034                                           |       | 5,501                                         |       | 7,940 |   | 10,036 |   |
| Selling, general, and administrative                                                                                                           |       | 12,957                                          |       | 17,992                                        |       | 26,051 |   | 34,118 |   |
| Depreciation and amortization of property and  equipment                                                                                       |       | 4,964                                           |       | 5,346                                         |       | 9,827 |   | 10,373 |   |
| Amortization of intangible assets                                                                                                              |       | 7,249                                           |       | 5,346                                         |       | 13,514 |   | 10,276 |   |
| Total operating expenses                                                                                                                       |       | 60,170                                          |       | 71,312                                        |       | 118,528 |   | 134,987 |   |
| Income from  operations                                                                                                                        |       | 5,184                                           |       | 1,348                                         |       | 9,958 |   | 3,581 |   |
| Interest expense                                                                                                                               |       | (3,228                                          | )          | (2,288                                        | )          | (4,039 | ) | (4,319 | ) |
| Interest income                                                                                                                                |       | 134                                             |       | 147                                           |       | 250 |   | 265 |   |
| Other (expense)  income, net                                                                                                                   |       | (194                                            | )          | 331                                           |       | (498 | ) | 521 |   |
| Income (loss)  before income taxes, equity in net loss of unconsolidated affiliates and  cumulative effect of a change in accounting principle |       | 1,896                                           |       | (462                                          | )          | 5,671 |   | 48 |   |
| Income tax  (provision) benefit                                                                                                                |       | (929                                            | )          | 456                                           |       | (2,834 | ) | 469 |   |
| Equity in net  loss of unconsolidated affiliates                                                                                               |       | (716                                            | )          | (924                                          | )          | (1,132 | ) | (1,998 | ) |
| Income (loss)  before cumulative effect of a change in accounting principle                                                                    |       | 251                                             |       | (930                                          | )          | 1,705 |   | (1,481 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                                   |       | —                                          |       | —                                        |       | — |   | 84 |   |
| Net income  (loss)                                                                                                                             |       | $                                               | 251        |                                          | $          | (930 | ) | $ | 1,705 |   | $ | (1,397 | ) |
| Basic net income  (loss) per common share:                                                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss) before cumulative effect of a change  in accounting principle                                                                    |       | $                                               | 0.01       |                                          | $          | (0.04 | ) | $ | 0.07 |   | $ | (0.06 | ) |
| Cumulative effect of a change in accounting  principle, net of tax provision                                                                   |       | —                                          |       | —                                        |       | — |   | — |   |
| Net income (loss)                                                                                                                              |       | $                                               | 0.01       |                                          | $          | (0.04 | ) | $ | 0.07 |   | $ | (0.06 | ) |
| Diluted net  income (loss) per common share:                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Income (loss) before cumulative effect of a change  in accounting principle                                                                    |       | $                                               | 0.01       |                                          | $          | (0.04 | ) | $ | 0.06 |   | $ | (0.06 | ) |
| Cumulative effect of a change in accounting  principle, net of tax provision                                                                   |       | —                                          |       | —                                        |       | — |   | — |   |
| Net income (loss)                                                                                                                              |       | $                                               | 0.01       |                                          | $          | (0.04 | ) | $ | 0.06 |   | $ | (0.06 | ) |
| Basic weighted  average common shares outstanding                                                                                              |       | 24,157,435                                      |       | 24,093,752                                    |       | 26,072,053 |   | 24,042,340 |   |
| Diluted weighted  average common shares outstanding                                                                                            |       | 24,529,448                                      |       | 24,093,752                                    |       | 26,445,417 |   | 24,042,340 |   |

 

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)**
| ** **                                                                                | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                          | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                    |       |                                              |       |   |   |
| Net income  (loss)                                                                        |       | $                                                 | 1,705      |   | $ | (1,397 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                              |       |   |   |
| Non-cash and working capital items                                                        |       | 21,279                                            |       | 21,643 |   |
| Net cash provided by operating activities:                                                |       | 22,984                                            |       | 20,246 |   |
| Cash flows from  investing activities:                                                    |       |                                              |       |   |   |
| Purchases of property and equipment                                                       |       | (10,211                                           | )          | (11,857 | ) |
| Cash paid for business acquisitions, net of cash  acquired                                |       | (3,501                                            | )          | (19,804 | ) |
| Investments in unconsolidated affiliates                                                  |       | (2,802                                            | )          | — |   |
| Net cash used in investing activities:                                                    |       | (16,514                                           | )          | (31,661 | ) |
| Cash flows from  financing activities:                                                    |       |                                              |       |   |   |
| Proceeds from issuance of long-term debt                                                  |       | 167,915                                           |       | 6,000 |   |
| Repayment of long-term debt                                                               |       | (54,328                                           | )          | — |   |
| Payment of long-term debt financing costs                                                 |       | (2,802                                            | )          | (225 | ) |
| Proceeds from stock option exercises, inclusive of  tax benefit                           |       | 436                                               |       | 342 |   |
| Purchase of treasury stock                                                                |       | (468                                              | )          | (19 | ) |
| Purchase of common stock, inclusive of fees of $996                                       |       | (116,869                                          | )          | — |   |
| Net cash (used in) provided by financing activities:                                      |       | (6,116                                            | )          | 6,098 |   |
| Effect of  exchange rates on cash and cash equivalents                                    |       | (453                                              | )          | (123 | ) |
| Net decrease in  cash and cash equivalents                                                |       | (99                                               | )          | (5,440 | ) |
| Cash and cash  equivalents, beginning of period                                           |       | 19,788                                            |       | 26,628 |   |
| Cash and cash  equivalents, end of period                                                 |       | $                                                 | 19,689     |   | $ | 21,188 |   |
| Supplemental  disclosures of cash flow information:                                       |       |                                              |       |   |   |
| Cash paid for interest                                                                    |       | $                                                 | 969        |   | $ | 2,110 |   |
| Cash paid for  income taxes                                                               |       | $                                                 | 3,009      |   | $ | 4,460 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

5

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**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

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

TNS, Inc. (TNS or the Company) is a Delawarecorporation. TNS is a leading provider of business-critical datacommunications services to processors of credit card, debit card and automatedteller machine (ATM) transactions. TNS is also a leading provider of callsignaling and database access services to the domestic telecommunicationsindustry and of secure data and voice network services to the global financialservices industry. TNS’ data communication services enable secure and reliabletransmission of time-sensitive, transaction-related information criticalto its customers’ operations. The Company’s customers outsource their datacommunication requirements to TNS because of the Company’s expertise,comprehensive customer support, and cost-effective services. TNS providesservices to customers in the United States and increasingly to customers in 27countries, including Canada and countries in Europe, Latin America and theAsia-Pacific region.

The Company provides its services through its multipledata networks, each designed specifically for transaction applications. Thesenetworks support a variety of widely accepted communications protocols, aredesigned to be scalable and are accessible by multiple methods, includingdial-up, dedicated, wireless and Internet connections.

The Company has four business divisions: (1) thepoint-of-sale/point-of-service (POS) division, which provides data communicationsservices to payment processors in the U.S. and Canada, (2) thetelecommunication services division (TSD), which provides call signalingservices and database access services targeting primarily thetelecommunications industry, (3) the financial services division (FSD),which provides data and voice communications services to the financial servicescommunity in support of the Financial Information eXchange (FIX) messagingprotocol and other transaction-oriented trading applications, and (4) theinternational services division (ISD), which markets the Company’s POS andfinancial services in countries outside of the United States and Canada.

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with United Statesgenerally accepted accounting principles (GAAP) for interim financialinformation and in conjunction with the rules and regulations of theSecurities and Exchange Commission (SEC). Certain information and notedisclosures normally included in the annual financial statements, required byGAAP, have been condensed or omitted pursuant to those rules andregulations, although the Company believes that the disclosures made areadequate to make the information presented not misleading.

In the opinion of management, the accompanyingunaudited condensed consolidated financial statements reflect all necessaryadjustments (all of which are of a normal and recurring nature) that arenecessary for fair presentation for the periods presented. The results ofoperations for the three and six months ended June 30, 2006 are not necessarilyindicative of the results to be expected for any subsequent interim period orfor the fiscal year. It is suggested that these unaudited condensedconsolidated financial statements be read in conjunction with the Company’sannual report on Form 10-K dated March 16, 2006 and amended July 21,2006 as filed with the SEC, which includes consolidated financial statementsand the notes thereto for the year ended December 31, 2005.

*Stock Repurchaseand Offerings of Common Stock*

On May 5, 2005, the Company purchased and retired6,263,435 shares of its common stock, pursuant to a modified Dutch auctiontender offer, for $18.50 per share plus expenses of approximately$1.0 million. Of the shares tendered, 6 million shares were tenderedby the Company’s then controlling stockholder, 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 of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of certain assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements. Significantestimates affecting the consolidated financial statements include management’sjudgments regarding the allowance for doubtful accounts, future cash flows fromlong-lived assets, accrued expenses for probable losses and estimates relatedto the fair value of employee stock options, including volatility, expectedterm and estimates of forfeitures in future periods. Actual results coulddiffer from those estimates.

**Revenue Recognition**

The Company recognizes revenue when persuasiveevidence of an agreement exists, the terms are fixed or determinable, servicesare performed, and collection is probable. Cash received in advance of revenuerecognition is recorded as deferred revenue. POS services revenue is derivedprimarily from the transmission of transaction data through the Company’snetworks between payment processors and POS or ATM terminals. Telecommunicationservices revenue is derived primarily from fixed monthly recurring fees for theCompany’s call signaling services and per query fees charged for the Company’sdatabase access and validation services. Financial services revenue is derivedprimarily from monthly recurring fees based on the number of customerconnections to and through the Company’s networks. Customer incentives grantedto new customers or upon contract renewals are deferred and recognized ratablyas a reduction of revenue over the contract period to the extent that theincentives are recoverable against the customer’s minimum purchase commitmentsunder the contract. In addition, the Company receives installation fees relatedto the configuration of the customer’s systems. Revenue from installation feesare deferred and recognized ratably over the customer’s contractual serviceperiod, generally three years. The Company performs periodic evaluations of itscustomer base and establishes allowances for estimated credit losses.

**Cost of Network Services**

Cost of network servicesis comprised primarily of telecommunications charges, which include datatransmission 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-Based Compensation**

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123R, “Share-Based Payment” (“SFAS 123R”), using the modifiedprospective transition method. SFAS 123R requires all stock-based compensationto employees be measured at fair value and expensed over the requisite serviceperiod and also requires an estimate of forfeitures when calculatingcompensation expense. The Company recognizes compensation cost on awards withgraded vesting on a straight-line basis over the requisite service period forthe entire award. In accordance with the Company’s chosen method of adoption,results for prior periods have not been restated. Share-based expenses for allnon-vested awards outstanding as of January 1, 2006, are being recognizedbased on the grant date fair value estimated in accordance with the provisionsof SFAS No. 123 “Accounting for Stock-Based Compensation” and inaccordance with SFAS 123R for all awards granted or modified afterJanuary 1, 2006. Prior to the adoption of SFAS 123R, the Company followedAccounting Principles Board (“APB”) Opinion No. 25, which accounts forshare-based payments to employees using the intrinsic value method and, assuch, the Company generally recognized no compensation cost for employee stockoptions. Refer to Note 7 for additional discussion regarding details of theCompany’s stock-based compensation plans and the adoption of SFAS 123R.

7

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**Identifiable Intangible Assets**

Amortization of intangible assets is recorded on a straight-linebasis over their expected useful lives. The Company evaluates the useful livesassigned to intangible assets on a regular basis.

Developed technology represents the Company’s proprietaryknowledge, including processes and procedures, used to configure its networks.Network equipment and software, both purchased and internally developed, arecomponents used to build the networks and are separately identified assetsclassified within property and equipment.

For purposes of measuring and recognizing impairment of long-livedassets, including intangibles, the Company assesses whether separate cash flowscan be attributed to the individual asset.  For the customer relationshipintangible assets, the Company recognizes and measures impairment upon thesignificant loss of revenue from a customer. Included in amortization of intangiblesexpense for the three and six months ended June 30, 2005 and for the three andsix months ended June 30, 2006 is approximately $3.1 million and $0.1 million,respectively, in accelerated amortization on a portion of the Company’scustomer relationship assets in connection with the loss of certain customersduring those respective periods.  The Company has experienced revenue andtransaction volume declines with a major customer during 2005 and 2006. The customer relationship intangible asset assigned to this customer isapproximately $23.1 million as of June 30, 2006.  The Company assessed therecoverability of this customer relationship intangible asset based uponundiscounted anticipated future cash flows and concluded that no impairmentexisted as of June 30, 2006.

**Income Taxes**

The Companyaccounts for income taxes in accordance with SFAS 109, “Accounting for IncomeTaxes.” Under SFAS 109, deferred tax assets or liabilities are computed basedupon the difference between financial statement and income tax bases of assetsand liabilities using the enacted marginal tax rate. The Company provides avaluation allowance on its net deferred tax assets when it is more likely thannot that such assets will not be realized. Deferred income tax expense orbenefits are based upon the changes in the asset or liability from period toperiod.

For the three and sixmonths ended June 30, 2005, the Company’s effective tax rate was approximately78.7% and 62.4%, respectively. For the three and six months ended June 30, 2006the Company’s effective tax rate was approximately 32.9% and 24.1%,respectively.  The Company’s tax ratefluctuates from the U.S. Federal statutory tax rate of 34.0% as a result of lossesin certain international jurisdictions and losses on equity method investmentsfor which a valuation allowance has been established on the deferred tax assetscreated by such net losses. In addition, the majority of the Company’soperations in foreign countries that are generating pre-tax income aregenerally taxed at rates less than 34.0%.

**New Accounting Pronouncements**

In June 2006, the FinancialAccounting Standards Board (FASB) issued FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109” (“FIN 48”). This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. It alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. This interpretationis effective for fiscal years beginning after December 15, 2006, but earlieradoption is permitted. The Company is currently evaluating the effect that theadoption of FIN 48 will have on its results of operations and financialposition.

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

**Acquisition of Connet-Ro**

On December 13, 2005, the Company completed the acquisitionof a Romanian company, SC Connet-Ro SRL (Connet-Ro) for a purchase price of$1.4 million, including direct acquisition costs of approximately $0.1 million.The Company 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 anadditional payment of $0.2 million based upon the results of operations ofConnet-Ro.  This contingent considerationhas been allocated to the customer relationship intangible asset.

The purchase price was allocated, on a preliminary basis, asfollows (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 amounts allocated to the customer relationship and to thenon-compete agreements are being amortized on a straight-line basis over theirestimated useful life of five years and three years, respectively.

 

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**Acquisition ofCommsXL**

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, including 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.

Thepurchase price for 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 six months ended June 30, 2006include the operating results of these acquisitions from January 6, 2006.

**Acquisitionof InfiniRoute Assets**

OnFebruary 28, 2006, the Company acquired certain tangible and intangibleassets from InfiniRoute Networks, Inc. for a purchase price ofapproximately $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 complexity associatedwith these interconnections.

The purchase price for 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 amounts allocated to the customerrelationships, developed technology and to the non-compete agreements are beingamortized on a straight-line basis over their estimated useful lives of threeyears. 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 six months ended June 30, 2006include the operating results of this acquisition from March 1, 2006.

**Acquisition of Sonic Assets**

On March 13, 2006, the Company acquiredcertain tangible and intangible assets from Sonic Global PTY Ltd. and all ofthe capital stock of a subsidiary of Sonic Global PTY Ltd. for a purchase priceof approximately $6.0 million, plus direct acquisition costs of approximately$0.1 million. The assets acquired include the right to provide POS servicesunder customer contracts, developed technology, certain fixed assets andnon-compete agreements. The Company purchased these assets to enhance its’end-to-end POS service offerings.

 

9

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The purchase price forthe 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 amounts allocated to the customerrelationships, developed technology and to the non-compete agreements are beingamortized on a straight-line basis over their estimated useful life of fiveyears, five 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 six months ended June 30, 2006 include the operating results of thisacquisition from March 1, 2006.

**Way Systems Investment**

In August 2004, the Company made aninvestment in WAY Systems, Inc. (WAY), which provides mobile POStransaction infrastructure and solutions for mobile merchants. The Companypurchased 5,952,381 shares or 38.5 percent of WAY’s Series B convertiblepreferred stock for $2.5 million and became entitled to representation on WAY’sboard of directors. In March 2005, the Company made an additionalinvestment of $0.8 million to purchase 1,910,401 shares of WAY’s Series Bconvertible preferred stock for an additional 1.9 percent of WAY’s outstandingshares. In July 2005, the Company made an additional investment of $0.7million in exchange for a convertible note bearing interest at a rate of 8percent per annum and due January 1, 2009. In September 2005, theCompany exercised its right on the convertible note to convert the outstandingprincipal and accrued interest of approximately $0.8 million to 1,185,085shares 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. The Company owned 17.1 percent ofWay’s total outstanding shares as of June 30, 2006. The Company is accountingfor its investment under the equity method of accounting as the Company hassignificant influence over the financing and operating activities of WAYthrough its representation on the WAY board of directors. Due to timing of thereceipt of WAY’s financial statements, the Company is accounting for the incomeor loss in this equity method investment on a one-month lag. 

Summarized financialinformation for WAY is as follows (in thousands):
|                         | ** ** | **December 31,  2005** | ** ** | **June 30, 2006** | ** ** |
|-------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | ** **                  | ** ** | **(unaudited)**             | ** ** |
| Current assets          |       | $                           | 12,473     |                        | $          | 7,393 |   |
| Non-current  assets     |       | 743                         |       | 869                         |       |
| Current  liabilities    |       | 1,956                       |       | 2,869                       |       |
| Non-current liabilities |       | —            |       | —                      |       |
|                         |            |                             |            |                             |            |  |  |

 
|                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)**                                   | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenue                            |       | $                                                   | 1,033      |                                              | $          | 2,126 |   | $ | 1,423 |   | $ | 3,593 |   |
| Gross profit                       |       | 372                                                 |       | 707                                               |       | 490 |   | 1,120 |   |
| Net loss                           |       | (1,618                                              | )          | (2,902                                            | )          | (3,157 | ) | (5,813 | ) |
| Company’s equity in net  loss |       | (332                                                | )          | (518                                              | )          | (635 | ) | (1,053 | ) |
|                                    |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

10

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**IP Commerce Investment**

In January 2005, theCompany made an investment in IP Commerce, a company that provides operatingsoftware to facilitate the authorization of IP-based retail paymenttransactions. The Company purchased 2,368,545 Series A preferred shares or39.9 percent of IP Commerce’s total outstanding shares for $2.0 million andbecame entitled to representation on IP Commerce’s board of directors. InSeptember 2005, the Company made an additional investment of $0.9 millionin exchange for a convertible note bearing interest at a rate of 8 percent perannum which was payable on demand, no earlier than February 1, 2007. InMarch 2006, the Company exercised its right on the convertible note toconvert the outstanding principal and accrued interest of approximately $0.9million to 675,901 shares of IP Commerce’s Series B convertible preferredstock. The Company owned 29.4 percent of IP Commerce’s total outstanding sharesas of June 30, 2006. TheCompany is accounting for its investment under the equity method of accounting.Due to timing of the receipt of IP Commerce’s financial statements, the Companyis accounting for the income or loss in this equity method investment on aone-month lag. 

Summarized financialinformation for IP Commerce is as follows (in thousands):
|                         | ** ** | **December 31, 2005** | ** ** | **June 30, 2006** | ** ** |
|-------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | ** **                      | ** ** | **(unaudited)**             | ** ** |
| Current assets          |       | $                               | 1,426      |                        | $          | 4,443 |   |
| Non-current  assets     |       | 274                             |       | 300                         |       |
| Current  liabilities    |       | 258                             |       | 659                         |       |
| Non-current liabilities |       | 2,596                           |       | —                      |       |
|                         |            |                                 |            |                             |            |  |  |

 
|                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)**                                   | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenue                            |       | $                                                   | 149        |                                              | $          | — |   | $ | 198 |   | $ | — |   |
| Gross profit                       |       | 149                                                 |       | —                                            |       | 198 |   | — |   |
| Net loss                           |       | (830                                                | )          | (1,418                                            | )          | (1,321 | ) | (2,855 | ) |
| Company’s equity in net  loss |       | (340                                                | )          | (407                                              | )          | (407 | ) | (938 | ) |
|                                    |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

**3.             Long-termDebt**

On May 4, 2005, theCompany entered into an amended and restated senior secured credit facility(the May 4, 2005 Credit Facility) to finance the stock repurchase and toreplace its prior senior secured credit facility (March 19, 2004 CreditFacility). 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$6.0 million of borrowings as of June 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 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 June 30, 2006total remaining payments on the Term B Loan are as follows (in thousands):
| Six months ending  December 31, 2006 |   | $       | —  |   |
|-------------------------------------------|--------|---------|---------|--------|
| 2007                                      |   | 1,650   |    |
| 2008                                      |   | 1,650   |    |
| 2009                                      |   | 1,650   |    |
| 2010                                      |   | 1,650   |    |
| Thereafter                                |   | 112,848 |    |
|                                      |   | $       | 119,448 |   |

 

For the three monthsended June 30, 2006, borrowings onthe New Revolving Credit Facility and the Term B Loan bore interest at arate of 2.0 percent over the LIBOR rate (7.4 percent as of June 30, 2006).Thereafter, if the Company achieves a leverage ratio of less than 1.75, theborrowings on the New Revolving Credit Facility and the Term B Loan generallywill bear interest at a rate, at the Company’s option, of either0.75 percent over the lender’s base rate or 1.75 percent over theLIBOR rate. The Company’s leverage ratio as of June 30, 2006 was1.95 to 1.0. The New Revolving Credit Facility is subject to an annual non-usecommitment fee in an amount equal to 0.375 percent or 0.5 percent perannum, depending on the Company’s leverage ratio, multiplied by the amount offunds available for borrowing under the New Revolving Credit Facility. Interestpayments on the May 4, 2005 Credit Facility are due monthly, bimonthly,quarterly, semi-annually or annually at the Company’s option.

11

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The terms of the May 4, 2005 Credit Facilityrequire the Company to comply with financial and nonfinancial covenants,including maintaining certain leverage, interest and fixed charge coverageratios at the end of each fiscal quarter. As of June 30, 2006, the Company wasrequired to maintain a leverage ratio of less than 2.55 to 1.0, an interestcoverage ratio of greater than 4.0 to 1.0 and a fixed charge ratio of greaterthan 2.5 to 1.0. Certain of the financial covenants will become morerestrictive over the term of the May 4, 2005 Credit Facility. TheMay 4, 2005 Credit Facility also contains nonfinancial covenants thatrestrict some of the 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 June 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 six months ended June 30, 2005.

**4.             Comprehensive Income (Loss)**

The components of comprehensive income (loss), net oftax effect are as follows (in thousands):
|                                           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income  (loss)                        |       | $                                               | 251        |                                          | $          | (930 | ) | $ | 1,705 |   | $ | (1,397 | ) |
| Foreign currency  translation adjustments |       | (1,360                                          | )          | 1,276                                         |       | (2,171 | ) | 1,380 |   |
| Total comprehensive  (loss) income        |       | $                                               | (1,109     | )                                             | $          | 346 |   | $ | (466 | ) | $ | (17 | ) |

 

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

SFAS No. 128, “Earnings Per Share”, requires thepresentation of basic and diluted earnings per share. Basic earnings (loss) percommon share is computed by dividing income (loss) attributable to commonstockholders by the weighted average number of common shares outstanding forthe period. The diluted earnings (loss) per common share data is computed usingthe weighted average number of common shares outstanding plus the dilutiveeffect of common stock equivalents, unless the common stock equivalents areanti-dilutive. During the three and six months ended June 30, 2006, thetreasury stock effect of options to purchase 1,890,484 shares of common stockand 489,423 restricted stock units were not included in the computation ofdiluted loss per common share as their effect would have been anti-dilutive.

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

12

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| ** **                                                                                                  | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income (loss) from  continuing operations before cumulative effect of a change in accounting  principle |       | $                                               | 251        |                                          | $          | (930 | ) | $ | 1,705 |   | $ | (1,481 | ) |
| Cumulative effect of a  change in accounting principle, net of tax                                          |       | —                                          |       | —                                        |       | — |   | 84 |   |
| Net income (loss)                                                                                           |       | $                                               | 251        |                                          | $          | (930 | ) | $ | 1,705 |   | $ | (1,397 | ) |
| Weighted average common  share calculation:                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Basic weighted  average common shares outstanding                                                           |       | 24,157,435                                      |       | 24,093,752                                    |       | 26,072,053 |   | 24,042,340 |   |
| Treasury stock  effect of unvested restricted stock units                                                   |       | 280,985                                         |       | —                                        |       | 296,020 |   | — |   |
| Treasury stock  effect of options                                                                           |       | 91,028                                          |       | —                                        |       | 77,344 |   | — |   |
| Diluted weighted  average common shares outstanding                                                         |       | 24,529,448                                      |       | 24,093,752                                    |       | 26,445,417 |   | 24,042,340 |   |
| Net income (loss) per  common share:                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Basic income  (loss) per common share                                                                       |       | $                                               | 0.01       |                                          | $          | (0.04 | ) | $ | 0.07 |   | $ | (0.06 | ) |
| Diluted income (loss)  per common share                                                                     |       | $                                               | 0.01       |                                          | $          | (0.04 | ) | $ | 0.06 |   | $ | (0.06 | ) |

 

**6.             SegmentInformation**

The Company’s reportable segmentsare strategic business units that offer different products and services. TheCompany classifies its business into four segments: POS, TSD, FSD and ISD.However, the Company’s management only evaluates revenues for these foursegments. 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 evaluates theNorth American and ISD performance on EBITDA before stock compensation expensebecause operating expenses are distinguishable between North American and ISDoperations. The Company defines EBITDA before stock compensation expense asincome from operations before depreciation, amortization and stock compensationexpense. EBITDA before stock compensation expense is not a generally acceptedaccounting principle measure, but rather a measure employed by management toview operating results adjusted for significant noncash items. The Company’sdefinition of EBITDA before stock compensation expense may not be comparable tosimilarly titled measures used by other entities. Assets are not segregatedbetween reportable segments, and management does not use asset information bysegments to evaluate segment performance. As such, no information is presentedrelated to fixed assets by reportable segment and capital expenditures for eachsegment.

Revenue for the Company’s four business units ispresented below (in thousands):
|                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:      |       |                                            |       |                                          |       |   |   |   |   |
| POS            |       | $                                               | 22,113     |                                          | $          | 21,422 |   | $ | 45,272 |   | $ | 40,214 |   |
| TSD            |       | 11,213                                          |       | 16,725                                        |       | 21,250 |   | 31,554 |   |
| FSD            |       | 7,735                                           |       | 8,629                                         |       | 15,042 |   | 17,001 |   |
| ISD            |       | 24,293                                          |       | 25,884                                        |       | 46,922 |   | 49,799 |   |
| Total revenues |       | $                                               | 65,354     |                                          | $          | 72,660 |   | $ | 128,486 |   | $ | 138,568 |   |

 

EBITDA before stock compensationexpense for North American and ISD operations is reflected below (inthousands):

 
|                                                 | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                            |       |                                            |       |                                          |       |   |   |   |   |
| EBITDA before  stock compensation expense:      |       |                                            |       |                                          |       |   |   |   |   |
| North America                                   |       | $                                               | 9,261      |                                          | $          | 5,687 |   | $ | 18,456 |   | $ | 12,290 |   |
| ISD                                             |       | 8,680                                           |       | 8,207                                         |       | 15,877 |   | 15,229 |   |
| Total EBITDA before  stock compensation expense |       | $                                               | 17,941     |                                          | $          | 13,894 |   | $ | 34,333 |   | $ | 27,519 |   |

 

 

13

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EBITDA beforestock compensation expense differs from (loss) income before income taxes andequity in net loss of unconsolidated affiliate reported in the condensedconsolidated statements of operations as follows (in thousands):
|                                                                                                                                                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| EBITDA before stock  compensation expense                                                                                                                     |       | $                                               | 17,941     |                                          | $          | 13,894 |   | $ | 34,333 |   | $ | 27,519 |   |
| Reconciling items:                                                                                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Depreciation and  amortization of property and equipment and intangible assets                                                                                |       | (12,213                                         | )          | (10,692                                       | )          | (23,341 | ) | (20,649 | ) |
| Stock compensation  expense                                                                                                                                   |       | (544                                            | )          | (1,854                                        | )          | (1,034 | ) | (3,289 | ) |
| Interest expense                                                                                                                                              |       | (3,228                                          | )          | (2,288                                        | )          | (4,039 | ) | (4,319 | ) |
| Interest income and  other (expense) income, net                                                                                                              |       | (60                                             | )          | 478                                           |       | (248 | ) | 786 |   |
| Income before income taxes, equity in net loss of unconsolidated  affiliates and cumulative effect of a change in accounting principle, net of  tax provision |       | $                                               | 1,896      |                                          | $          | (462 | ) | $ | 5,671 |   | $ | 48 |   |

 

Goodwill and identifiable intangible assets, net are located in thefollowing reporting segments (in thousands):

 
|                                                         | ** ** | **December 31,  2005** | ** ** | **June 30,  2006** | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| POS                                                     |       | $                           | 134,887    |                    | $          | 135,233 |   |
| TSD                                                     |       | 4,479                       |       | 5,454                   |       |
| FSD                                                     |       | 25,272                      |       | 24,259                  |       |
| ISD                                                     |       | 27,755                      |       | 37,571                  |       |
| Total goodwill and  identifiable intangible assets, net |       | $                           | 192,393    |                    | $          | 202,517 |   |

 

**Geographic Information**

The Company sells itsservices through foreign subsidiaries in Australia, Austria, Bermuda, Canada,Colombia, France, Germany, Ireland, Italy, Japan, Malaysia, the Netherlands,New Zealand, Poland, Romania, South Korea, Spain, Sweden, Thailand and theUnited Kingdom. Information regarding revenues and long-lived tangible assetsattributable to each geographic region is stated below.

The Company’s revenues were generated in the followinggeographic regions (in thousands):
|                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:      |       |                                            |       |                                          |       |   |   |   |   |
| North America  |       | $                                               | 41,061     |                                          | $          | 46,776 |   | $ | 81,564 |   | $ | 88,770 |   |
| Europe         |       | 21,640                                          |       | 22,807                                        |       | 41,493 |   | 43,986 |   |
| Asia-Pacific   |       | 2,653                                           |       | 3,077                                         |       | 5,429 |   | 5,812 |   |
| Total revenues |       | $                                               | 65,354     |                                          | $          | 72,660 |   | $ | 128,486 |   | $ | 138,568 |   |

 

Revenues from the Company’s subsidiaries in the UnitedKingdom were $14.8 million and $28.6 million for the three and six months endedJune 30, 2005, respectively.  Revenuesfrom the Company’s subsidiaries in the United Kingdom were $14.2 million and$27.9 million for the three and six months ended June 30, 2006, respectively.

TheCompany’s long-lived assets including goodwill and identifiable intangibleassets, net were located as follows (in thousands):

14

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|                         | ** ** | **December 31,  2005** | ** ** | **June 30,  2006** | ** ** |
|-------------------------|------------|-----------------------------|------------|-------------------------|------------|
| North America           |       | $                           | 219,163    |                    | $          | 225,159 |   |
| Europe                  |       | 37,717                      |       | 47,615                  |       |
| Asia-Pacific            |       | 4,447                       |       | 4,319                   |       |
| Total long-lived assets |       | $                           | 261,327    |                    | $          | 277,093 |   |

 

**7.**                                           Stock-Based Compensation

##### 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  June 30, 2006** | ** ** | **Six months  ended  June 30, 2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Income (loss) before  income taxes, equity in net loss of unconsolidated affiliates and cumulative  effect of a change in accounting principle, as reported |       | $                                                     | (1,854     | )                                                   | $          | (3,289 | ) |
| Income tax benefit from  stock-based compensation expense                                                                                                   |       | 742                                                   |       | 1,316                                               |       |
| Income from continuing  operations before cumulative effect of a change in accounting principle                                                             |       | (1,112                                                | )          | (1,973                                              | )          |
| Cumulative effect of a  change in accounting principle, net of tax provision                                                                                |       | —                                                |       | 84                                                  |       |
| Net loss                                                                                                                                                    |       | $                                                     | (1,112     | )                                                   | $          | (1,889 | ) |
| Earnings per share:                                                                                                                                         |       |                                                  |       |                                                |       |
| Basic                                                                                                                                                       |       | $                                                     | (0.05      | )                                                   | $          | (0.08 | ) |
| Diluted                                                                                                                                                     |       | $                                                     | (0.05      | )                                                   | $          | (0.08 | ) |

 

Prior to the adoption of SFAS 123R, the Company didnot make estimates for forfeitures and recognized compensation cost assumingall awards would vest and reversed recognized compensation cost for forfeitedawards when the awards were actually forfeited. Upon adoption of SFAS 123R onJanuary 1, 2006, the Company recorded a cumulative effect of a change inaccounting principle, net of tax, of approximately $0.1 million related toestimated forfeitures of unvested restricted stock awards for which stock-basedcompensation was recorded in the Company’s financial statements prior toJanuary 1, 2006. During the three and six months ended June 30, 2006, theCompany capitalized approximately $0.1 million and $0.2 million, respectively,of stock-based compensation costs for employees working on capitalized softwaredevelopment projects.

As permitted by SFAS 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 employeestock options. The Company’s pro forma information for the three and six monthsended June 30, 2005 under SFAS 123, which reflects compensation expense equalto the fair value of the options and restricted stock awards recognized overtheir requisite service period, is as follows (in thousands, except per shareamounts):
|                                                                                                                                               | ** ** | **Three months  ended  June 30, 2005** | ** ** | **Six months  ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Net income, as  reported                                                                                                                      |       | $                                                     | 251        |                                                | $          | 1,705 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                  |       | 326                                                   |       | 620                                                 |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (806                                                  | )          | (1,537                                              | )          |
| Pro forma net  (loss) income                                                                                                                  |       | $                                                     | (229       | )                                                   | $          | 788 |   |
| Basic net income  per common share, as reported                                                                                               |       | $                                                     | 0.01       |                                                | $          | 0.07 |   |
| Diluted net  income per common share, as reported                                                                                             |       | $                                                     | 0.01       |                                                | $          | 0.06 |   |
| Pro forma basic and  diluted net (loss) income per common share                                                                               |       | $                                                     | (0.01      | )                                                   | $          | 0.03 |   |

15

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Details of theCompany’s stock-based compensation plans are discussed below.

***Stock-Based Compensation Plans***

During 2001, the Board ofDirectors of the Company adopted the TNS Holdings, Inc. 2001 Founders’Stock Option Plan (the 2001 Plan) whereby employees, nonemployee directors, andcertain other individuals are granted the opportunity to acquire an equityinterest in the Company. Either incentive stock options or nonqualified optionsmay be granted under the 2001 Plan. Options granted under the 2001 Plan have anexercise price equal to or greater than the estimated fair value of theunderlying common stock at the date of grant and become exercisable based on avesting schedule determined at the date of grant, generally over four years.The options expire 10 years from the date of grant.

In February 2004, the Board of Directors of theCompany adopted the TNS, Inc. 2004 Long-Term Incentive Plan (the Plan) andthe Company’s stockholders approved the Plan in March 2004. The Planreserves 3,847,384 shares of common stock for grants of incentive stockoptions, nonqualified stock options, restricted stock awards and performanceshares to employees, non-employee directors and consultants performing servicesfor the Company. Options granted under the Plan have an exercise price equal toor greater than the fair market value of the underlying common stock at thedate of grant and become exercisable based on a vesting schedule determinedat the date of grant, generally in equal monthly installments over four years.The options expire 10 years from the date of grant. Restricted stockawards and performance shares granted under the Plan are subject to a vestingperiod determined at the date of grant, generally in equal annual installmentsover four years.

***Stock Options***

The fair value for stock options granted during theperiods were estimated at the grant date using a Black-Scholes option pricingmodel with the following weighted average assumptions:
|                          | ** ** | **Six months ended  June 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 | % |

 

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(a)          Assumptions used tocalculate pro forma expense under SFAS 123 discussed above.

*Expected volatility*— The expected volatility is based on theresults of 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.

*Expected dividend yield* — The dividendyield is based on actual dividends expected to be paid over the expected term ofthe option. The Company has not and has no plans to issue dividends.

*Expected term* — The expected term is basedon the results of a study performed of guideline companies in the Company’speer group. The Company, at this point, does not have sufficient historicalinformation to develop reasonable expectations about future exercise patterns.The Company accounts for stock options with graded vesting as a single awardwith the expected term equal to the average of the expected term of thecomponent vesting tranches and recognizes the related compensation cost on astraight-line basis over the vesting period of the award.

*Risk-free interest rate* — The risk-freerate for stock options granted during the period is determined by using U.S.treasury rates of the same period as the expected option term of each option.

16

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Asummary of time-vested option activity under the Plan as of June 30, 2006, andchanges during the six 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                           |       | (48,823                    | )          | 20.33                                       |       |                                                           |       |                                |       |
| Outstanding at  June 30, 2006 |       | 1,890,484                  |       | $                                           | 20.00      |                                                           | 8 years    |                                | $          | 1,435 |   |
| Exercisable at June 30, 2006       |       | 805,095                    |       | $                                           | 19.76      |                                                           | 7 years    |                                | $          | 847 |   |

Theweighted average grant date fair value of options granted during the six monthsended June 30, 2006 was $10.44. The total intrinsic value of stock optionsexercised during the six months ended June 30, 2006 was approximately $25,000.As of June 30, 2006, there was a total of $9.4 million of deferred compensationcost related to time-vested stock options, which is expected to be recognizedover a weighted average period of approximately three years.

During the three and six months ended June 30, 2006the Company received approximately $0.2 million and $0.3 million in cashproceeds related to the exercise of stock options, respectively. In additionthe Company realized total tax benefits from stock option exercises of approximately$6,000 for the six months ended June 30, 2006, respectively, which wererecorded 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-based stock options are tied to theCompany’s annual performance against pre-established internal budget targets forrevenues and EBITDA before stock compensation expense.  Under the Company’s long-term incentiveprogram, the actual payout under these awards may vary from zero to 200% of anemployee’s target payout, based upon the Company’s actual performance over thefiscal year.  The fair value for stockoptions granted during the period was estimated at the grant date using theBlack Schole’s option pricing model as described above.  Compensation cost initially recognizedassumes the target payout level will be achieved and is adjusted for subsequentchanges in the expected outcome of performance-related conditions until thevesting date.

A summary of performance-based stock optionsoutstanding as of June 30, 2006, and changes during the six months then endedis 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    |       | —                     |       | $                                           | —     |                                                           |       |                                |       |   |
| Granted(1)                            |       | 330,250                    |       | 20.56                                       |       |                                                           |       |                                |       |
| Exercised                             |       | —                     |       | —                                      |       |                                                           |       |                                |       |
| Canceled                              |       | —                     |       | —                                      |       |                                                           |       |                                |       |
| Outstanding at  June 30, 2006(1) |       | 330,250                    |       | $                                           | 20.56      |                                                           | 10 years   |                                | $          | 43 |   |
| Exercisable at June 30,  2006         |       | —                     |       | —                                      |       | —                                                         |       | $                                   | —     |   |
| Expected to vest at June 30, 2006     |       | 103,446                    |       | $                                           | 20.56      |                                                           | 10 years   |                                | $          | 13 |   |

 

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(1)             Based on 100% of thetarget payout

The weighted average grant date fair value ofperformance-based options granted during the six months ended June 30, 2006 was$9.16.  As of June 30, 2006, there was atotal of $0.9 million of deferred compensation cost related toperformance-based options expected to vest, which is expected to be recognizedover a weighted average period of approximately four years.

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***Time-VestedRestricted Stock Units***

Asummary of the status of the Company’s time-vested restricted stock units as ofJune 30, 2006, and changes

during the six monthsthen ended is presented below (in thousands, except share and per shareamounts):
|                                     | ** ** | **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                              |       | (113,679                   | )          | 19.98                                             |       |
| Forfeited                           |       | (12,213                    | )          | 21.28                                             |       |
| Non-vested at June 30, 2006         |       | 489,423                    |       | $                                                 | 20.61      |   |

The total fair value of shares vested(measured as of the vesting date) during the six months ended June 30, 2006 was$2.3 million. As of June 30, 2006, there was $8.6 million of deferredcompensation cost related to restricted stock units, which is expected to berecognized over a weighted average period of approximately three years.

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

Performance-based restricted stock units are tied tothe Company’s annual performance against pre-established internal budgettargets for revenues and EBITDA before stock compensation 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 themarket price of the Company’s stock on the date of grant.  Compensation cost initially recognizedassumes the target payout level will be achieved and is adjusted for subsequentchanges in the expected outcome of performance-related conditions until thevesting date.

A summary of performance-based restricted stock unitsoutstanding as of June 30, 2006, and changes during the six months then endedis presented below (in thousands, except share and per share amounts):
|                                   | ** ** | **Number of  shares** | ** ** | **Weighted-average  grant-date  fair value** | ** ** |
|-----------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Balance at  January 1, 2006  |       | —                     |       | $                                                 | —     |   |
| Granted(1)                        |       | 113,029                    |       | 20.56                                             |       |
| Vested                            |       | —                     |       | —                                            |       |
| Forfeited                         |       | —                     |       | —                                            |       |
| Balance at June 30,  2006(1)      |       | 113,029                    |       | $                                                 | 20.56      |   |
| Expected to vest at June 30, 2006 |       | 35,398                     |       | $                                                 | 20.56      |   |

 

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(1)             Based on 100% of thetarget payout

As of June 30, 2006, there was approximately $0.7million of deferred compensation cost related to performance-based restrictedstock units expected to vest, which is expected to be recognized over aweighted average period of approximately four years.

**8.             Litigationand Claims**

The Company is periodically involved in disputesarising from normal business activities. In the opinion of management,resolution of these matters will not have a material adverse effect upon thefinancial position or future operating results of the Company, and adequateprovision for any potential losses has been made in the accompanyingconsolidated financial statements.

OnAugust 26, 2002, an action was filed in the Superior Court of the State ofDelaware by persons alleging that the Company breached an agreement to purchasean unrelated entity. On February 28, 2005, the court denied the Company’smotion for summary judgement. 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 six months ended June30, 2005.

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Certain states in whichthe Company operates assess sales taxes on certain services provided by theCompany. The Company believes it has no liability because its customercontracts contain terms that stipulate the customer, not the Company, isresponsible 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 three and six months endedJune 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 three months ended June 30, 2005 is a $0.9million benefit, or $0.04 per share, related to the state sales tax settlement,net of related tax provision described above. Included in net income in the accompanying condensed consolidatedstatement of operations for the six months ended June 30, 2005 is a net $1.5million benefit, or $0.06 per share, related to the legal settlement andreduced state sales tax assessment described above.

 

The Company and John J. McDonnell, Jr., the Company’sChief Executive Officer, and Henry H. Graham, Jr., the Company’s ChiefFinancial Officer, are defendants in a putative class action lawsuit filed inconnection with the Company’s public offering of common stock in September 2005(“Secondary Offering”).  The CementMasons and Plasterers Joint Pension Trust, purportedly on behalf of itself andothers similarly situated, filed the putative class action lawsuit captioned *Cement Masons & Plasterers Joint Pension Trust v. TNS, Inc., etal.,* Case No. 1:06 CV 363, CMH/BRP, on April 4, 2006 in the UnitedStates District Court for the Eastern District of Virginia.  Plaintiff claims that the RegistrationStatement filed in connection with the Secondary Offering negligently failed todisclose that (1) TNS’ agreement with the Pepsi Bottling Group, Inc. (“Pepsi”)to provide cashless vending to Pepsi had been delayed beyond August 7, 2005; (2)TNS was generating less revenues and income than it had anticipated from itscontract with the Royal Bank of Scotland (“RBS”), because RBS purportedly hadoverstated the number of transactions that TNS would be responsible forprocessing for RBS; and (3) TNS’ International Services Division wasexperiencing declining revenues during that time period because of unfavorableforeign exchange rates.  TNS filed amotion to dismiss the lawsuit on July 14, 2006. The Plaintiff filed itsmemorundum in oposition to TNS’ motion to dismiss on August 4, 2006. The Courthas yet to rule on the motion to dismiss. This action is in the preliminary phase; thus the timing and course ofthe litigation are not predictable, and, as a result, management cannotestimate a range of possible loss and has therefore not recognized a liabilityfor this expense.  However, TNS intendsto take appropriate steps to defend against the lawsuit, the outcome of whichcould have a material adverse affect on the financial condition or futureoperating results of TNS. During the six months ended June 30, 2006, theCompany accrued legal costs of approximately $0.5 million, representingmanagement’s estimate of the probable legal costs to defend itself in thismatter. These legal costs are included in selling, general and administrativeexpense in the accompanying condensed consolidated statement of operations forthe six months ended June 30, 2006.

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TheCompany and the members of its Board of Directors also are defendants in aputative shareholder class action lawsuit that seeks to enjoin the non-bindingproposal announced on March 13, 2006 from senior management of the Company toacquire all outstanding shares of the Company. Paul Schwartz, purportedly on behalf of himself and others similarlysituated, filed the lawsuit captioned *Schwartz v. TNS, Inc., etal.,* C.A. No. 2000-N, on March 13, 2006 in Delaware Chancery Courtfor New Castle County.  The plaintiffalleges that injunctive relief is necessary because the Company and the membersof the Board of Directors allegedly breached their fiduciary duties to TNSshareholders by allegedly causing the Company to negotiate for the sale of TNSat an unfair price, depriving TNS’ public shareholders of the maximum value towhich they purportedly are entitled.  Theplaintiff further alleges that members of the Board of Directors also breachedtheir fiduciary duties by allegedly not taking adequate measures to ensure thatthe interests of TNS’ public shareholders are properly protected, as the termsof the proposed transaction allegedly are grossly unfair to theshareholders.  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.  This action is in the preliminaryphase; thus the timing and course of the litigation are not predictable, and,as a result, management cannot estimate a range of possible loss.  However, TNS intends to take appropriateactions to defend against the lawsuit, the outcome of which could have amaterial adverse affect on the financial condition or future operating resultsof TNS.  No amounts have been accruedrelated to this case in the condensed consolidated financial statements for thesix months ended June 30, 2006, as management cannot yet estimate the futurelegal costs to defend against this lawsuit or potential damages, if any, thatwill be incurred.

 

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**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

You should read the following discussion of thefinancial condition and results of operations of TNS, Inc. in conjunctionwith the consolidated financial statements and the related notes included inour annual report on Form 10-K dated March 16, 2006 and amendedJuly 21, 2006, as filed with the SEC, and available directly from the SEC atwww.sec.gov and the condensed consolidated financial statements and the relatednotes of TNS, Inc., included elsewhere in this quarterly report.

There are statements made herein which may not addresshistorical facts and, therefore, could be interpreted to be forward-lookingstatements within the meaning of The Private Securities Litigation Reform Actof 1995. These forward-looking statements are based on current expectations,forecasts and assumptions that are subject to risks and uncertainties thatcould cause actual results to differ materially from those set forth in, orimplied by, the forward-looking statements. The Company has attempted, wheneverpossible, to identify these forward-looking statements using words such as “may,”“will,” “should,” “projects,” “estimates,” “expects,” “plans,” “intends,” “anticipates,”“believes,” and variations of these words and similar expressions. Similarly,statements herein that describe the Company’s business strategy, prospects,opportunities, outlook, objectives, plans, intentions or goals are alsoforward-looking statements. Actual results may differ materially from thoseindicated by such forward-looking statements as a result of various importantfactors, including: the Company’s reliance upon a small number of customers fora significant portion of its revenue; competitive factors such as pricingpressures; our customer’s ability to direct their data communications from theCompany’s networks to other networks; the Company’s ability to grow itsbusiness domestically and internationally by generating greater transactionvolumes, acquiring new customers or developing new service offerings;fluctuations in the Company’s quarterly results because of the seasonal natureof the business and other factors outside of the Company’s control; the Company’sability to identify, execute or effectively integrate acquisitions; the Company’sability to adapt to changing technology; additional costs related to compliancewith the Sarbanes-Oxley Act of 2002, any revised New York Stock Exchangelisting standards, SEC rule changes or other corporate governance issues;and other 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 leading providerof business-critical data communications services to processors of creditcard, debit card and ATM transactions. We are also a leading provider of securedata and voice network services to the global financial services industry. Weoperate one of four unaffiliated Signaling System No. 7 networks in theUnited States capable of providing services nationwide, and we utilize thisnetwork to provide call signaling and database access services to the domestictelecommunications industry. Our data communications services enable secure andreliable transmission of time-sensitive, transaction-related informationcritical to our customers’ operations. Our customers outsource their datacommunications requirements to us because of our substantial expertise,comprehensive customer support and cost-effective services. We provide servicesto customers in the United States and increasingly to international customersin 27 countries, including Canada and countries in Europe, Latin America andthe Asia-Pacific region.

We provide servicesthrough our multiple data networks, each designed specifically for transactionapplications. Our networks support a variety of widely accepted communicationsprotocols and are designed to be scalable and accessible by multiple methods,including dial-up, dedicated, wireless and Internet connections.

Wegenerate revenues 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.

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·                     ***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, the Netherlands, New Zealand, Poland,Romania, South Korea, Spain, Sweden and Thailand through subsidiaries locatedin these countries. Additionally, through these international subsidiaries, wealso provide services to customers located in Belgium, Finland, Gibraltar, HongKong, Mexico, Norway and Singapore. 

Our international services division generates revenues primarily fromour 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 collect calling.Our telecommunication services division generates revenues primarily from fixedmonthly fees charged for our call signaling services and per-query fees chargedfor our database access and validation services. 

·                     ***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 monthly recurringfees based on the number of customer connections to and through our networks.

Our most significantexpense is cost of network services, which is comprised primarily oftelecommunications 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 engineering anddevelopment 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 thedevelopment of internal use software in the preliminary project, thepost-implementation and operation stages. Development costs we incur during thesoftware application development stage are capitalized and amortized over theestimated useful life of the developed software.

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

In connection with thecompletion 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 Dutchauction tender offer, purchasing and retiring 6,263,435 shares of ouroutstanding common stock at a price of $18.50 per share net to each seller incash, for an aggregate purchase price of $116.9 million. The 6,263,435 sharestendered include 6,000,000 shares tendered by our then controlling stockholder,GTCR.

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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 exercisedtheir over-allotment option and we issued an additional 900,000 shares ofcommon stock at $23.25 per share, which generated proceeds, net of offeringcosts, of approximately $20.0 million. The net proceeds from the follow-onoffering were used to repay a portion of our long-term debt outstanding underour amended and restated senior secured credit facility.

**Long-term Investments**

In August 2004, we made an investment in WAYSystems, Inc. (WAY), which provides mobile POS transaction infrastructure andsolutions for mobile merchants. We purchased 5,952,381 shares or 38.5 percentof WAY’s Series B convertible preferred stock for $2.5 million and becameentitled to representation on WAY’s board of directors. In March 2005, we madean additional investment of $0.8 million to purchase 1,910,401 shares of WAY’sSeries B convertible preferred stock for an additional 1.9 percent of WAY’soutstanding shares. In July 2005, we made an additional investment of $0.7million in exchange for a convertible note bearing interest at a rate of 8percent per annum and due January 1, 2009. In September 2005, we exercised ourright on the convertible note to convert the outstanding principal and accruedinterest of approximately $0.8 million to 1,185,085 shares of WAY’s Series Cconvertible preferred stock and made an additional investment of $1.1 millionto purchase 1,676,429 shares of WAY’s Series C convertible preferred stock. Weowned 17.1 percent of WAY’s total outstanding shares as of June 30, 2006. Weare accounting for our investment under the equity method of accounting as wehave significant influence over the financing and operating activities of WAYthrough its representation on WAY’s board of directors. Due to timing of thereceipt of WAY’s financial statements, we are accounting for the income or lossin this equity method investment on a one-month lag. For the three and sixmonths ended June 30,2006, we recognized a net loss in the equity of anunconsolidated affiliate related to our investment in WAY of approximately $0.5million and $1.1 million, respectively. For the three and six months ended June 30,2005, we recognized a netloss in the equity of an unconsolidated affiliate related to our investment inWAY of approximately $0.3 million and $0.6 million, respectively.

In January 2005, we made an investment in IPCommerce, a company that provides operating software to facilitate theauthorization of IP-based retail payment transactions. We purchased 2,368,545Series A preferred shares or 39.9 percent of IP Commerce’s totaloutstanding shares for $2.0 million and became entitled to representation on IPCommerce’s board of directors. In September 2005, the Company made anadditional investment of $0.9 million in exchange for a convertible notebearing interest at a rate of 8 percent per annum which is payable on demand,no earlier than February 1, 2007. In March 2006, we exercised our right onthe convertible note to convert the outstanding principal and accrued interestof approximately $0.9 million to 675,901 shares of IP Commerce’s Series Bconvertible preferred stock. We owned approximately 29.4 percent of IP Commerce’stotal outstanding shares as of June 30, 2006. We are accounting for thisinvestment under the equity method of accounting. Due to timing of the receiptof IP Commerce’s financial statements, we are accounting for the income or lossin this equity method investment on a one-month lag. For the three and sixmonths ended June 30, 2006, we recognized a net loss in the equity of anunconsolidated affiliate related to our investment in IP Commerce ofapproximately $0.4 million and $0.9 million, respectively. For the three andsix months ended June 30, 2005, we recognized a net loss in the equity of anunconsolidated affiliate related to our investment in IP Commerce ofapproximately $0.3 million and $0.4 million, respectively.

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**Resultsof Operations**

The following table sets forth, for the periodsindicated, selected statement of operations data (dollars in thousands):
| ** **                                                                                                                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                                                                                |       | $                                               | 65,354     |                                          | $          | 72,660 |   | $ | 128,486 |   | $ | 138,568 |   |
| Operating  expenses:                                                                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Cost of network  services, exclusive of the items shown separately below                                                                |       | 30,966                                          |       | 37,127                                        |       | 61,196 |   | 70,184 |   |
| Engineering and  development                                                                                                            |       | 4,034                                           |       | 5,501                                         |       | 7,940 |   | 10,036 |   |
| Selling,  general, and administrative                                                                                                   |       | 12,957                                          |       | 17,992                                        |       | 26,051 |   | 34,118 |   |
| Depreciation and  amortization of property and equipment                                                                                |       | 4,964                                           |       | 5,346                                         |       | 9,827 |   | 10,373 |   |
| Amortization of  intangible assets                                                                                                      |       | 7,249                                           |       | 5,346                                         |       | 13,514 |   | 10,276 |   |
| Total operating expenses                                                                                                                |       | 60,170                                          |       | 71,312                                        |       | 118,528 |   | 134,987 |   |
| Income from  operations                                                                                                                 |       | 5,184                                           |       | 1,348                                         |       | 9,958 |   | 3,581 |   |
| Interest expense                                                                                                                        |       | (3,228                                          | )          | (2,288                                        | )          | (4,039 | ) | (4,319 | ) |
| Interest income  and other (expense) income, net                                                                                        |       | (60                                             | )          | 478                                           |       | (248 | ) | 786 |   |
| Income before  income taxes, equity in net loss of unconsolidated affiliates and cumulative  effect of a change in accounting principle |       | 1,896                                           |       | (462                                          | )          | 5,671 |   | 48 |   |
| Income tax  (provision) benefit                                                                                                         |       | (929                                            | )          | 456                                           |       | (2,834 | ) | 469 |   |
| Equity in net  loss of unconsolidated affiliates                                                                                        |       | (716                                            | )          | (924                                          | )          | (1,132 | ) | (1,998 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                            |       | —                                          |       | —                                        |       | — |   | 84 |   |
| Net income (loss)                                                                                                                       |       | 251                                             |       | (930                                          | )          | 1,705 |   | (1,397 | ) |
|                                                                                                                                         |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

**Three months ended June 30, 2006 compared to the three monthsended June 30, 2005**

***Revenues.***Total revenues increased$7.3 million, or 11.2%, to $72.7 million for the three months ended June 30,2006, from $65.4 million for the three months ended June 30, 2005. We generaterevenues through four business divisions.

***POS division.***Revenues from the POSdivision decreased $0.7 million, or 3.1%, to $21.4 million for the three monthsended June 30, 2006, from $22.1 million for the three months ended June 30, 2005.The $0.7 million decrease in POS revenues resulted from a decline in revenueper transaction, partially offset by an increase in transaction volumes. POStransaction volumes increased 6.0% to 1.6 billion transactions for the threemonths ended June 30, 2006, from 1.5 billion transactions for the three monthsended June 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.

***Internationalservices division.***Revenues from the internationalservices division increased $1.6 million, or 6.6%, to $25.9 million for thethree months ended June 30, 2006, from $24.3 million for the three months endedJune 30, 2005. The increase was primarily due to additional revenues generatedfrom our POS customers in Central Europe and Australia, which were partiallyoffset by the unfavorable impact of foreign exchange. Revenues from our U.K.subsidiaries decreased $0.6 million, or 4.1%, to $14.2 million for thethree months ended June 30, 2006, from $14.8 million for the three months endedJune 30, 2005. Revenues from our Irish subsidiaries increased $0.7 million, or48.0%, to $2.1 million for the three months ended June 30, 2006, from $1.4million for the three months ended June 30, 2005. The decrease and increase inrevenues in the U.K. and Ireland, respectively, is primarily attributable tothe transfer of a customer contract from a U.K. subsidiary to an Irishsubsidiary.

***Telecommunicationservices division.***Revenues from the telecommunicationservices division increased $5.5 million, or 49.2%, to $16.7 million forthe three months ended June 30, 2006, from $11.2 million for the three monthsended June 30, 2005. Included in telecommunications services division revenuesfor the three months ended June 30, 2006 and 2005 were approximately $2.4million and $0.1 million, respectively, of pass-through revenues. Excluding theincrease in pass-through revenues, the growth in revenues was primarily due toincreased usage of our database access and call signaling services from new andexisting customers.

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***Financial services division.***Revenuesfrom the financial services division increased $0.9 million, or 11.6%, to $8.6million for the three months ended June 30, 2006, from $7.7 million for thethree months ended June 30, 2005. The increase in revenues was due to thegrowth in the number of customer connections, both physical and logical, to andthrough our networks.

***Cost of networkservices.***Cost of network services increased $6.2million, or 19.9%, to $37.1 million for the three months ended June 30, 2006,from $31.0 million for the three months ended June 30, 2005. Cost of networkservices were 51.1% of revenues for the three months ended June 30, 2006,compared to 47.4% of revenues for the three months ended June 30, 2005. Theincrease in cost of network services resulted primarily from higher usagecharges from our TSD, FSD and ISD services. Gross profit represented 48.9% oftotal revenues for the three months ended June 30, 2006, compared to 52.6% forthe three months ended June 30, 2005. Excluding the incremental $2.3 million of pass-through revenues in thetelecommunications services division, our gross margin would have been 50.5%for the three months ended June 30, 2006. The decrease in gross profit as a percentage of total revenues resultedprimarily from increased contribution of our telecommunication servicesdivision, our lowest gross margin division.

Future cost of network services depends on a number offactors including total transaction and query volume, the relative growth andcontribution to total transaction volume of each of our customers, the successof our new service offerings, the timing and extent of our network expansionand the timing and extent of any network cost reductions or increases. Inaddition, any significant loss or significant reduction in transaction volumescould lead to a decline in gross margin since significant portions of ournetwork costs are fixed costs.

***Engineering anddevelopment expense.***Engineering and development expenseincreased $1.5 million, or 36.4%, to $5.5 million for the three months endedJune 30, 2006, from $4.0 million for the three months ended June 30, 2005.Engineering and development expense represented 7.6% of revenues for the threemonths ended June 30, 2006 and 6.2% of revenues for the three months ended June30, 2005. Engineering and development expense increased primarily from anincrease in engineering expenses required to support our international expansionand new product offerings in the TSD and POS division and to a lesser extent froman increase in stock-based compensation expense of approximately $0.4 million,primarily as a result of the adoption of SFAS 123R on January 1, 2006 andapproximately $0.2 million of severance expense.

***Selling, generaland administrative expense.***Selling, general andadministrative expense increased $5.0 million, or 38.9%, to $18.0 million forthe three months ended June 30, 2006, from $13.0 million for the three monthsended June 30, 2005. Selling, general and administrative expense represented24.8% of revenues for the three months ended June 30, 2006, compared to 19.8%of revenues for the three months ended June 30, 2005. Included in selling,general and administrative expenses for the three months ended June 30, 2006 isa $0.5 million charge for legal expenses incurred by the special committee ofthe board of directors. Included in selling, general, and administrativeexpenses for the three months ended June 30, 2005 is a $1.5 million benefitfrom a state sales tax liability settlement and approximately $0.3 million ofseverance expense. 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 TSD and POS divisions and to a lesser extent from anincrease in stock-based compensation expense primarily as a result of theadoption of SFAS 123R on January 1, 2006.

***Depreciation andamortization of property and equipment.***Depreciation andamortization of property and equipment increased $0.4 million, or 7.7%, to $5.3million for the three months ended June 30, 2006, from $5.0 million for the threemonths ended June 30, 2005. Depreciation expense increased primarily due to anincrease in capital expenditures to support our revenue growth. Depreciationand amortization of property and equipment represented 7.4% of revenues for thethree months ended June 30, 2006, compared to 7.6% of revenues for the threemonths ended June 30, 2005.

***Amortization ofintangible assets.***Amortization of intangible assetsdecreased $1.9 million, or 26.3%, to $5.3 million for the three monthsended June 30, 2006, from $7.2 million for the three months ended June 30,2005. The amortization of intangible assets for the three months ended June 30,2006 and 2005 relates solely to the intangible assets resulting fromacquisitions. Included in amortization of intangibles expense for the threemonths ended June 30, 2006 and 2005 is approximately $0.1 million and $3.1million, respectively, in accelerated amortization on a portion of our customerrelationship assets in connection with the loss of certain customers duringthose respective periods.  Excluding these items, the increase wasprimarily attributable to the additional amortization resulting fromacquisitions 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 $23.1 million as of June 30, 2006. Weassessed the recoverability of this customer relationship asset based uponundiscounted anticipated future cash flows and concluded no impairment existedas of June 30, 2006.

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***Interest expense.***Interest expensedecreased $0.9 million to $2.3 million for the three months ended June 30,2006, from $3.2 million for the three months ended June 30, 2005. Included ininterest expense for the six months ended June 30, 2005 is approximately $1.1million related to the write-off of deferred financing costs in connection withthe termination of our 2004 senior secured credit facility.  

***Interest and otherincome (expense), net.***Interest and other income(expense), net was $0.5 million for the three months ended June 30, 2006compared to expense of $60,000 for the three months ended June 30, 2005.Included in other income (expense), net for the three months ended June 30,2006 is a gain on foreign currency translation of approximately $0.3 milliondue to fluctuations in the value of the U.S. dollar as compared with foreigncurrencies, predominately, the euro, the British pound and the Australiandollar, versus a loss on foreign currency translation of $0.2 million for thethree months ended June 30, 2005.

***Income tax benefit(provision).***For the three months ended June 30, 2006,our income tax benefit was $0.5 million compared to an income tax provision of$0.9 million for the three months ended June 30, 2005. Our effective tax ratefor the three months ended June 30, 2006 is 32.9% versus the U.S. Federalstatutory tax rate of 34.0%, due primarily to lower tax rates in certaininternational jurisdictions in which we have operations and losses in certainjurisdictions and our equity method investments that are not being benefited.

*** Equity in net loss of unconsolidatedaffiliates.***For the three months ended June 30, 2006, ourequity in net loss of unconsolidated affiliates was $0.9 million compared to$0.7 million for the three months ended June 30, 2005. The increase was due toadditional losses recorded on our equity method investments, primarily relatingto our investments in Way Systems, Inc. and IP Commerce, Inc. As ofJune 30, 2006, we had $4.1 million of long-term investments in unconsolidatedaffiliates, and we expect to incur additional losses on these investments in2006, and we may continue to incur losses on them thereafter.

**Sixmonths ended June 30, 2006 compared to the six months ended June 30, 2005**

***Revenues.***  Total revenuesincreased $10.1 million, or 7.8%, to $138.6 million for the six months endedJune 30, 2006, from $128.5 million for the six months ended June 30, 2005. Wegenerate revenues through four operating divisions.

***POS division.***  Revenues from thePOS division decreased $5.1 million, or 11.2%, to $40.2 million for the sixmonths ended June 30, 2006, from $45.3 million for the six months ended June30, 2005. The $5.1 million decrease in POS revenues resulted primarily from adecline in the average revenue per transaction and to a lesser extent adecrease in transaction volumes.  POS transactionvolumes decreased 4.1% to 2.9 billion transactions for the six months endedJune 30, 2006, from 3.0 billion transactions for the six months ended June 30,2005. We have negotiated contract renewals with some of our POS customers, andin several instances we agreed to pricing discounts in exchange for maintainingor increasing their minimum transaction or revenue commitments. As a result, itis likely our revenue per transaction will decrease and, depending upon thenumber of transactions we transport, our POS revenues may decrease.

***International services division.*** Revenues from the international services division increased $2.9 million, or6.1%, to $49.8 million for the six months ended June 30, 2006, from $46.9million for the six months ended June 30, 2005. The increase was primarily dueto additional revenues generated from our POS customers in Ireland, CentralEurope and Australia which was partially offset by the unfavorable impact offoreign exchange. Revenues from our U.K. subsidiary decreased $0.7 million, or2.6%, to $27.9 million for the six months ended June 30, 2006, from $28.6million for the six months ended June 30, 2005. Excluding the negative impact of foreign exchange rates, revenues fromour U.K. subsidiaries would have increased $0.6 million, or 2.1%.

***Telecommunication services division.*** Revenues from the telecommunication services division increased $10.3 million,or 48.5%, to $31.6 million for the six months ended June 30, 2006, from $21.3million for the six months ended June 30, 2005. Included in telecommunicationsservices revenues for the six months ended June 30, 2006 and 2005 wereapproximately $3.7 million and $0.2 million, respectively, of pass-throughrevenues. Excluding the increase in pass-through revenues the growth inrevenues was primarily due to increased usage of our database access and callsignaling services from new and existing customers.

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***Financial services division.*** Revenues from the financial services division increased $2.0 million, or 13.0%,to $17.0 million for the six months ended June 30, 2006, from $15.0million for the six months ended June 30, 2005. The increase in revenues was dueto the growth in the number of customer connections, both physical and logical,to and through our networks.

***Cost of networkservices.***  Cost of network services increased $9.0million, or 14.7%, to $70.2 million for the six months ended June 30, 2006, from$61.2 million for the six months ended June 30, 2005. Cost of network serviceswere 50.6% of revenues for the six months ended June 30, 2006, compared to47.6% of revenues for the six months ended June 30, 2005. The increase in costof network services resulted primarily from higher usage charges from our TSD,FSD and ISD services partially offset by lower usage charges from decreased POStransactions. Gross profit represented 49.4% of total revenues for the sixmonths ended June 30, 2006, compared to 52.4% for the six months ended June 30,2005.  Excluding the incremental $3.5million of pass-through revenues in the telecommunications services division,our gross margin would have been 50.6% for the six months ended June 30,2006.  The decrease in gross profit as apercentage of total revenues resulted primarily from increased contribution ofour telecommunication services division, our lowest gross margin division.

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 reductions or increases. In addition, any significant loss or significantreduction in transaction volumes could lead to a decline in gross margin sincesignificant portions of our network costs are fixed costs.

***Engineering and development expense.*** Engineering and development expense increased $2.1 million, or 26.4%, to$10.0 million for the six months ended June 30, 2006, from $7.9 millionfor the six months ended June 30, 2005. Engineering and development expenserepresented 7.2% of revenues for the six months ended June 30, 2006 and 6.2% ofrevenues for the six months ended June 30, 2005. Engineering and developmentexpense increased primarily from an increase in engineering expenses requiredto support our international expansion and new product offerings in our TSD andPOS division and to a lesser extent from an increase in stock-basedcompensation expense of approximately $0.4 million, primarily as a result ofthe adoption of SFAS 123R on January 1, 2006 and approximately $0.2 million ofseverance expense.

***Selling, generaland administrative expense.***  Selling, general andadministrative expense increased $8.1 million, or 31.0%, to $34.1 millionfor the six months ended June 30, 2006, from $26.1 million for the six monthsended June 30, 2005. Selling, general and administrative expense represented24.6% of revenues for the six months ended June 30, 2006, compared to 20.3% ofrevenues for the six months ended June 30, 2005. Included in selling, generaland administrative expenses for the six months ended June 30, 2006 is a chargefor legal expenses incurred by the special committee of our board of directorsof approximately $0.6 million and a charge related to a reserve for litigationof approximately $0.5 million. Included in selling, general and administrativeexpenses for the six months ended June 30, 2005 is a charge related to a legalsettlement of approximately $3.3 million and a benefit from a reduced statesales tax liability assessment of approximately $5.8 million and severanceexpense of approximately $0.9 million. Excluding these items, selling, generaland administrative expense increased primarily from the expenses required tosupport our revenue growth, mainly within the international services divisionas well as new product offerings in our TSD and POS divisions, and to a lesserextent, from an increase in stock-based compensation expense primarily as aresult of the adoption of SFAS 123R on Jnuary 1, 2006. 

***Depreciation and amortization of property and equipment.*** Depreciation and amortization of property and equipment increased $0.5 millionto $10.4 million for the six months ended June 30, 2006, from $9.8 million forthe six months ended June 30, 2005. Depreciation expense increased primarilydue to an increase in capital expenditures to support our revenue growth.  Depreciation and amortization of property andequipment represented 7.5% of revenues for the six months ended June 30, 2006,compared to 7.7% of revenues for the six months ended June 30, 2005.

***Amortization of intangible assets.*** Amortization of intangible assets decreased $3.2 million, or 24.0%, to $10.3million for the six months ended June 30, 2006, from $13.5 million for the sixmonths ended June 30, 2005. The amortization of intangible assets for the sixmonths ended June 30, 2006 and 2005 relates solely to the intangible assetsresulting from acquisitions. In the six months ended June 30, 2006 and 2005, weaccelerated amortization on a portion of our customer relationship intangibleassets in connection with the loss of certain customers by $0.1 million and$3.1 million, respectively.  For purposes of measuring and recognizingimpairment of long-lived assets including intangibles, we assess whetherseparate cash flows can be attributed to the individual asset. For our customerrelationship intangible assets, we recognize and measure impairment upon thetermination or loss of a customer that results in a loss of revenue. Based on the outcome of our contract negotiations with one of our majorcustomers, we believe that revenues and related transaction volumes from thiscustomer may continue to decline in 2006 and thereafter.  The intangibleasset value attributable to this customer relationshipis approximately $23.1million as of June 30, 2006.  We assessed the recoverability of thiscustomer relationship asset based upon anticipated future cash flows andconcluded that no impairment existed as of June 30, 2006.

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*** ***

***Interest expense.***  Interestexpense increased $0.3 million to $4.3 million for the six months ended June30, 2006, from $4.0 million for the six months ended June 30, 2005.Included in interest expense for the six months ended June 30, 2005 isapproximately $1.1 million related to the write-off of deferred financing costsin connection with the termination of our 2004 senior secured creditfacility.  Excluding this item, interestexpense increased primarily from an increase in the level of our outstandingdebt and an increase in the market interest rates.

***Interest and other income (expense), net.*** Interest and other income (expense), net was $0.8 million for the six monthsended June 30, 2006 compared to expense of $0.2 million for the six monthsended June 30, 2005. Included in other income (expense), net for the six monthsended June 30, 2006 is a gain on foreign currency translation of approximately$0.5 million due to fluctuations in the value of the U.S. dollar as comparedwith foreign currencies, predominately, the euro, the British pound and theAustralian dollar, versus a loss on foreign currency translation of $0.6million for the six months ended June 30, 2005.

***Income tax benefit(provision).***  For the six months ended June 30,2006, our income tax benefit was $0.5 million compared to a provision of$2.8 million for the six months ended June 30, 2005. Our effective taxrate for the six months ended June 30, 2006 is 24.1% versus the U.S. Federalstatutory tax rate of 34.0%, due primarily to lower tax rates in certaininternational jurisdictions in which we have operations and losses in certainjurisdictions and our equity method investments that are not being benefited.

***Equity in net lossof unconsolidated affiliates.***  For the six monthsended June 30, 2006, our equity in net loss of unconsolidated affiliates was$2.0 million compared to $1.1 million for the six months ended June 30, 2005.The increase was due to additional losses recorded on our equity methodinvestments, primarily relating to our investments in Way Systems, Inc.and IP Commerce, Inc. As of June 30, 2006, we had $4.1 million oflong-term investments in unconsolidated affiliates, and we expect to incuradditional losses on these investments in 2006, and we may continue to incurlosses 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.

**Liquidity and Capital Resources**

Our primaryliquidity and capital resource needs are to finance the costs of ouroperations, to make capital expenditures and to service our debt. 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 from operations, together with the amounts we areable to borrow under our amended and restated senior secured credit facility,will be adequate to meet our anticipated needs for the foreseeable future.Although we have no specific plans to do so, to the extent we decide to pursueone or more significant strategic acquisitions, we will likely need to incuradditional debt or sell additional equity to finance those acquisitions.

Our operations provided us cash of $20.2 millionfor the six months ended June 30, 2006, which was attributable to a net loss of$1.4 million, depreciation, amortization and other non-cash charges of$25.4 million and an increase in working capital of $3.8 million. Ouroperations provided us cash of $23.0 million for the six months ended June30, 2005, which was attributable to net income of $1.7 million,depreciation, amortization and other non-cash charges of $27.0 million andan increase in working capital of $5.8 million. 

Weused cash of $31.7 million in investing activities for the six monthsended June 30, 2006, which includes capital expenditures of $11.9 million.In addition, we completed the acquisitions of CommsXL, InfiniRoute and Sonic. Weused cash of $16.5 million in investing activities for the six monthsended June 30, 2005, which includes capital expenditures of $10.1 million.In addition, we made investments for $0.8 million in WAY and $2.0 million in IPCommerce, and we purchased certain assets of FusionPoint for $3.5 million.

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 We generatedcash of $6.1 million from financing activities for the six months ended June30, 2006, which includes $6.0 million of borrowings under our amended andrestated senior secured credit facility, the proceeds of which were used tofinance the stock and asset purchase from Sonic. We used cash of $6.1 millionfor financing activities for the six months ended June 30, 2005, which includesborrowings under our amended and restated senior secure credit facility, net offinancing costs, of $165.2 million that were used to finance the purchase andretirement of 6,263,435 shares of our common stock at a price of $18.50 pershare plus expenses for approximately $116.9 million and to repay $48.0 millionof long-term debt under our March 19, 2004 credit facility.  In addition,we made long-term debt repayments of $3.3 million on our amended and restatedsenior secure credit facility and an additional $3.0 million on our March 19,2004 credit facility. 

***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 $6.0 million of borrowings as ofJune 30, 2006. The amended and restated senior secured credit facility maturesMay 4, 2012. Payments on the term loan are due in quarterly installmentsover the seven-year term, beginning on June 1, 2005, with the remainderpayable on May 4, 2012. Voluntary prepayments on the term loan are firstapplied pro-rata to the scheduled quarterly installments due within the nextsucceeding twelve-month period until paid in full and then applied to the termloan in inverse order of maturity.

As of June 30, 2006, total remaining payments on theTerm Loan are as follows (in thousands):
| Six months ending  December 31, 2006 |   | $       | —  |   |
|-------------------------------------------|--------|---------|---------|--------|
| 2007                                      |   | 1,650   |    |
| 2008                                      |   | 1,650   |    |
| 2009                                      |   | 1,650   |    |
| 2010                                      |   | 1,650   |    |
| Thereafter                                |   | 112,848 |    |
|                                      |   | $       | 119,448 |   |

 

For the period throughJune 30, 2006, borrowings on the New Revolving Credit Facility and theterm loan bore interest at a rate of 2.0 percent over the LIBOR rate(7.4 percent as of June 30, 2006). Thereafter, if we attain a leverage ratio ofless than 1.75, the borrowings on the revolving credit facility and the termloan generally will bear interest at a rate, at our option, of either0.75 percent over the lender’s base rate or 1.75 percent over theLIBOR rate. Our leverage ratio as of June 30, 2006 was 1.95 to 1.0. Therevolving credit facility is subject to an annual non-use commitment fee in anamount equal to 0.375 percent or 0.5 percent per annum, depending on ourleverage ratio, multiplied by the amount of funds available for borrowing underthe fevolving credit facility. Interest payments on the May 4, 2005 CreditFacility are due monthly, bimonthly, quarterly, semi-annual or annual at ouroption.

The terms of the amendedand restated senior secured credit facility require us to comply with financialand nonfinancial covenants, including maintaining certain leverage, interestand fixed charge coverage ratios at the end of each fiscal quarter. As of June30, 2006, we were required to maintain a leverage ratio of less than 2.55 to1.0, an interest coverage ratio of greater than 4.0 to 1.0 and a fixed chargeratio of greater than 2.5 to 1.0. Certain of the financial covenants willbecome more restrictive over the term of the amended and restated seniorsecured credit facility. The amended and restated senior secured creditfacility also contains nonfinancial covenants that restrict some of ourcorporate 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 June 30, 2006.

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**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 $1.9 million and basic anddiluted earnings per share (“EPS”) by approximately $0.05 for the six monthsended June 30, 2006. Stock-based compensation accounted for under SFAS 123R isexpected to reduce income from operations and earnings per share byapproximately $4.4 million and  $0.11,respectively, for the full year 2006. The current compensation structure, orchanges therein, as well as any subsequent stock based compensation planactivity could result in an increase in the impact of SFAS 123R in 2006 andthereafter.

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 six months ended June 30, 2005 reducednet income by approximately $0.6 million, related to restricted stock units.Prior to the adoption of SFAS 123R, we did not make estimates for forfeituresand recognized compensation cost assuming all restricted stock awards wouldvest and reversed compensation cost for forfeited awards when the awards wereactually forfeited.  Upon adoption ofSFAS 123R, we recorded a cumulative effect of a change in accounting principle,net of tax of approximately $0.1 million related to estimated forfeitures ofunvested restricted stock awards.  As ofJune 30, 2006, the total compensation cost related to unvested stock optionsand restricted stock units that has not yet been recognized was approximately$19.6 million, which we expect to recognize over a weighted average period ofapproximately 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 AccountingPronouncements**

In June 2006, theFinancial Accounting Standards Board issued FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109”(“FIN 48”). This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. It alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. This interpretationis effective 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.

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

***Interest rates***

Our principal exposure to market risk relates tochanges in interest rates. As of June 30, 2006, we had $119.4 millionoutstanding under our amended and restated senior secured credit facility withinterest rates tied to changes in the lender’s base rate or the LIBOR rate.Based upon the outstanding borrowings on June 30, 2006 and assuming repaymentof the Term Loan in accordance with scheduled maturities, each 1.0% increase inthese rates could add an additional $1.2 million to our annual interestexpense.

As of June 30, 2006, we did not hold derivativefinancial or commodity instruments and all of our cash and cash equivalentswere held in money market or commercial accounts.

***Foreign currency risk***

Our earnings are affected by fluctuations in the valueof the U.S. dollar as compared with foreign currencies, predominately the euro,the British pound and the Australian dollar due to our operations in Europe andAustralia.

We have operations in 20 countriesoutside of the U.S., including the United Kingdom, Australia, Austria, Bermuda,Canada, Colombia, France, Germany, Ireland, Italy, Japan, Malaysia, theNetherlands, New Zealand, Poland, Romania, South Korea, Spain, Sweden andThailand. We provide services in these countries using networks deployed ineach country. We manage foreign exchange risk through the structure of ourbusiness. In the substantial majority of our transactions, we receive paymentsdenominated in the U.S. dollar, British pound, euro or Australian dollar.Therefore, we do not rely on international currency markets to obtain and payilliquid currencies. The foreign currency exposure that does exist is limitedby the fact that the majority of transactions are paid according to ourstandard payment terms, which are generally short-term in nature. Our policy isnot to speculate in foreign currencies, and we promptly buy and sell foreigncurrencies as necessary to cover our net payables and receivables, which aredenominated in foreign currencies. For the six months ended June 30, 2006, werecorded a gain on foreign currency transactions of approximately $0.5 million.

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**Item 4. Controls and Procedures**

The Company maintains disclosure controls andprocedures that are designed to ensure that information required to bedisclosed in the Company’s reports under the Securities Exchange Act of 1934,as amended, is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to the Company’s management, including itsChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

**Evaluation**

The Company carried out an evaluation, under thesupervision, and with the participation, of the Company’s management, includingthe Company’s Chief Executive Officer and the Company’s Chief FinancialOfficer, of the effectiveness of the Company’s disclosure controls andprocedures as of June 30, 2006. Based on the foregoing, the Company’s ChiefExecutive Officer and principal financial officers concluded that the Company’sdisclosure controls and procedures were effective as of June 30, 2006.

Therehave been no significant changes during the quarter covered by this report inthe Company’s internal control over financial reporting or in other factorsthat could significantly affect the internal control over financial reporting.

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**PART II—OTHERINFORMATION**

**Item1.**                          LegalProceedings

Information regarding legal proceedings is containedin Note 8 to the Condensed Consolidated Financial Statements contained inthis Report and is incorporated herein by reference.

**Item1A.**                 RiskFactors

There were no materialchanges from the risk factors previously disclosed in “Item 1A. Risk Factors”included in our Annual Report on Form 10-K for the year ended December 31,2005, except that, at June 30, 2006, the following additional risk factor hasbeen added:

**We face risks related to securities litigation thatcould have a material adverse effect on our business, financial position andresults of operations.**

We have been named as a defendant in a number ofsecurities class action and derivative lawsuits.  We are generally obliged, to the extentpermitted by law, to indemnify our current and former directors and officerswho are named as defendants in some of these lawsuits. Defending againstexisting and potential litigation may divert financial and management resourcesthat would otherwise be used to benefit our operations. Although we believethat we have meritorious defenses to the claims made in each and all of thelitigation matters to which we have been named a party, and intend to contesteach lawsuit vigorously, no assurances can be given that the results of thesematters will be favorable to us. Regardless of the outcome, such litigationwill result in significant legal expenses. A materially adverse resolution ofany of these lawsuits could have a material adverse affect on our business,financial position and results of operations.

**Item2.**                          UnregisteredSales of Equity Securities and Use of Proceeds

None.

**Item3.**                          DefaultUpon Senior Securities

None.

**Item4.**                          Submissionof Matters to a Vote of Security Holders

The Annual Meeting of Stockholders was held on May 16,2006. The stockholders voted on the following matters as set forth in the proxystatement.

1. ELECTION OF DIRECTORS. The stockholders voted toelect five directors to a one-year term expiring at the annual meeting ofstockholders in 2007. The voting tabulation for each nominee was as follows:

 

| Director                | ** ** | ** ** | ** ** | **Votes in Favor** | ** ** | **Vote Withheld** | ** ** |
|-------------------------|------------|------------|------------|------------------------------|------------|------------------------|------------|
| John J.  McDonnell, Jr. |       | 19,239,291 |       | 97,490                       |       |
| John B. Benton          |       | 19,308,631 |       | 28,150                       |       |
| Stephen X.  Graham      |       | 19,308,631 |       | 28,150                       |       |
| John V. Sponyoe         |       | 19,308,531 |       | 28,250                       |       |
| Jay E. Ricks            |       | 19,308,631 |       | 28,150                       |       |

 

2. RATIFICATION OF INDEPENDENT ACCOUNTANTS. Thestockholders ratified the selection of Ernst & Young LLP as the Company'sindependent registered public accounting firm for the current fiscal year. Thevoting tabulation was as follows: 19,319,731 votes in favor of the ratification6,200 against the ratification; and 10,850 abstentions.

**Item5.**                          OtherInformation

None.

**Item6.**                          Exhibits
| (10.1) | Management Agreement, dated as of June 12, 2006, by  and between Transaction Network Services, Inc. and Heidi Goff. |
|--------|---------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                |
| (10.2) | 2006 Annual Incentive Plan                                                                                          |
|   |                                                                                                                |
| (10.3) | 2006 Executive Long-Term Incentive Plan                                                                             |
|   |                                                                                                                |
| (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 the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|                       | TNS, Inc.  (Registrant) |
|-----------------------|------------------------------|
|                  |                         |
|                  |                         |
| Date: August 9,  2006 | By:                          | /s/ JOHN J. MCDONNELL, JR. |
|                  |                         | John J. McDonnell, Jr.  Chairman and Chief Executive Officer |
|                  |                         |
| Date: August 9,  2006 | By:                          | /s/ HENRY H. GRAHAM, JR. |
|                  |                         | Henry H. Graham, Jr.  Executive Vice President, Chief Financial Officer &  Treasurer |

 

 

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