**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10–Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarter ended September 30,2004**

 

**Commission File Number: 001–32033**

 

**TNS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                | ** ** | **36–4430020**                     |
|-------------------------------------------------------------|------------|-----------------------------------------|
| (State or jurisdiction of incorporation or  organization)   |       | (I.R.S. Employer Identification Number) |
|                                                        |       |                                    |
| **11480 Commerce Park Drive,  Suite 600  Reston, VA 20191** |
| (Address of principal executive offices)                    |

 

| **(703) 453–8300**                               |
|------------------------------------------------------------|
| (Registrant’s telephone number, including area  code) |

 

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirement for the past90 days.   ý Yes    o No

 

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

 

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

 

| **Shares Outstanding as of  November 1, 2004**       |
|------------------------------------------------------|
| 27,986,193 Shares of  Common Stock, $0.001 par value |

 

 

----

 

**TNS, INC.**

 

**INDEX**

 
| ** **   | ** **                | ** **                                                                                                             | ** ** | ** ** |
|--------------|---------------------------|------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **Part I:**  | **FINANCIAL INFORMATION** |                                                                                                                   |       |
|         |                      |                                                                                                                   |       |       |
|         | Item 1.              | Condensed  Consolidated Financial Statements (Unaudited)                                                               |       |       |
|         |                      | Condensed  Consolidated Balance Sheets as of December 31, 2003 and September 30,  2004                       |       |       |
|         |                      | Condensed  Consolidated Statements of Operations for the three and nine months ended September 30,  2003 and 2004 |       |       |
|         |                      | Condensed  Consolidated Statements of Cash Flows for the nine months ended September 30,  2003 and 2004           |       |       |
|         |                      | 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 4.              | Other Information                                                                                                      |       |       |
|         | Item 6.              | Exhibits                                                                                                               |       |       |
|              |                           |                                                                                                                        |            |            |  |

 

 

----

**PART I—FINANCIAL INFORMATION**

 

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

 

**TNS, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(dollars in thousands, exceptshare and per share data)**

 
| ** **                                                                                                                                                                                                                            | ** ** | **December 31, 2003** | ** ** | **September 30, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                            | ** ** | ** **                 | ** ** | **(unaudited)**             | ** ** |
| **ASSETS**                                                                                                                                                                                                                            |       |                       |       |                        |       |
| Current assets:                                                                                                                                                                                                                       |       |                       |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                             |       | $                          | 11,074     |                        | $          | 12,966 |   |
| Accounts receivable, net of allowance for doubtful accounts of $4,313  and $4,628, respectively                                                                                                                                       |       | 41,490                     |       | 47,537                      |       |
| Other current assets                                                                                                                                                                                                                  |       | 7,457                      |       | 10,683                      |       |
| Total current assets                                                                                                                                                                                                                  |       | 60,021                     |       | 71,186                      |       |
| Property and equipment, net                                                                                                                                                                                                           |       | 45,745                     |       | 47,649                      |       |
| Identifiable intangible assets, net                                                                                                                                                                                                   |       | 223,919                    |       | 212,613                     |       |
| Goodwill                                                                                                                                                                                                                              |       | 4,453                      |       | 4,453                       |       |
| Other assets                                                                                                                                                                                                                          |       | 8,221                      |       | 14,919                      |       |
| Total assets                                                                                                                                                                                                                          |       | $                          | 342,359    |                        | $          | 350,820 |   |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY**                                                                                                                                                                               |       |                       |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                  |       |                       |       |                        |       |
| Current portion of long–term debt                                                                                                                                                                                                |       | $                          | 28,731     |                        | $          | 11,750 |   |
| Accounts payable, accrued expenses and other current liabilities                                                                                                                                                                      |       | 42,072                     |       | 44,105                      |       |
| Deferred revenue                                                                                                                                                                                                                      |       | 7,320                      |       | 9,927                       |       |
| Total current liabilities                                                                                                                                                                                                             |       | 78,123                     |       | 65,782                      |       |
| Long–term debt, net of current portion                                                                                                                                                                                           |       | 121,664                    |       | 66,510                      |       |
| Other liabilities                                                                                                                                                                                                                     |       | 3,614                      |       | 4,470                       |       |
| Total liabilities                                                                                                                                                                                                                     |       | 203,401                    |       | 136,762                     |       |
| Commitments and contingencies                                                                                                                                                                                                         |       |                       |       |                        |       |
| Class A redeemable convertible preferred stock, $0.01 par value;  5,000,000 shares authorized; 134,846 shares issued and outstanding as of December 31,  2003, and no shares issued or outstanding as of September 30, 2004 |       | 176,470                    |       | —                      |       |
| Stockholders’ (deficit) equity:                                                                                                                                                                                                  |       |                       |       |                        |       |
| Common stock, $0.001 par value; 130,000,000 shares authorized;  12,373,370 and 26,783,312 shares issued and outstanding, respectively                                                                                                 |       | 12                         |       | 27                          |       |
| Additional paid–in capital                                                                                                                                                                                                       |       | 2,277                      |       | 259,374                     |       |
| Accumulated deficit                                                                                                                                                                                                                   |       | (38,889                    | )          | (39,762                     | )          |
| Deferred stock compensation                                                                                                                                                                                                           |       | (173                       | )          | (5,142                      | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                  |       | (739                       | )          | (439                        | )          |
| Total stockholders’ (deficit) equity                                                                                                                                                                                             |       | (37,512                    | )          | 214,058                     |       |
| Total liabilities and stockholders’ (deficit) equity                                                                                                                                                                             |       | $                          | 342,359    |                        | $          | 350,820 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

 

 

2

----

 

**TNS, INC.**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS (UNAUDITED)**

**(dollars in thousands, exceptshare and per share data)**

 
| ** **                                                                             | ** ** | **Three months ended**

**September 30,** | ** ** | **Nine months ended**

**September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                             | ** ** | **2003**                                       | ** ** | **2004**                                      | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues                                                                               |       | $                                              | 57,245     |                                          | $          | 64,584 |   | $ | 161,996 |   | $ | 185,680 |   |
| Operating expenses:                                                                    |       |                                           |       |                                          |       |   |   |   |   |
| Cost of network services, exclusive of the items shown separately  below               |       | 29,715                                         |       | 31,344                                        |       | 87,128 |   | 91,170 |   |
| Engineering and development                                                            |       | 2,416                                          |       | 3,748                                         |       | 8,385 |   | 10,680 |   |
| Selling, general, and administrative                                                   |       | 8,902                                          |       | 12,690                                        |       | 27,528 |   | 36,515 |   |
| Depreciation and amortization of property and equipment                                |       | 4,926                                          |       | 4,989                                         |       | 14,533 |   | 14,746 |   |
| Amortization of intangible assets                                                      |       | 6,285                                          |       | 6,151                                         |       | 18,856 |   | 20,855 |   |
| Total operating expenses                                                               |       | 52,244                                         |       | 58,922                                        |       | 156,430 |   | 173,966 |   |
| Income from operations                                                                 |       | 5,001                                          |       | 5,662                                         |       | 5,566 |   | 11,714 |   |
| Interest expense                                                                       |       | (2,794                                         | )          | (1,035                                        | )          | (8,615 | ) | (6,472 | ) |
| Interest income                                                                        |       | 34                                             |       | 130                                           |       | 111 |   | 216 |   |
| Other income, net                                                                      |       | 175                                            |       | 389                                           |       | 1,556 |   | 221 |   |
| Income (loss) before income taxes and equity in net loss of  unconsolidated affiliates |       | 2,416                                          |       | 5,146                                         |       | (1,382 | ) | 5,679 |   |
| Income tax provision                                                                   |       | (927                                           | )          | (1,714                                        | )          | (578 | ) | (2,344 | ) |
| Equity in net loss of unconsolidated affiliate                                         |       | (24                                            | )          | (682                                          | )          | (24 | ) | (780 | ) |
| Net income (loss)                                                                      |       | 1,465                                          |       | 2,750                                         |       | (1,984 | ) | 2,555 |   |
| Dividends on preferred stock                                                           |       | (3,827                                         | )          | —                                        |       | (11,111 | ) | (3,428 | ) |
| Net (loss) income attributable to common stockholders                                  |       | $                                              | (2,362     | )                                             | $          | 2,750 |   | $ | (13,095 | ) | $ | (873 | ) |
| Basic net (loss) income per common share                                               |       | $                                              | (0.19      | )                                             | $          | 0.10 |   | $ | (1.06 | ) | $ | (0.04 | ) |
| Diluted net (loss) income per common share                                             |       | $                                              | (0.19      | )                                             | $          | 0.10 |   | $ | (1.06 | ) | $ | (0.04 | ) |
| Basic weighted average common shares outstanding                                       |       | 12,373,369                                     |       | 26,781,393                                    |       | 12,373,334 |   | 22,836,485 |   |
| Diluted weighted average common shares outstanding                                     |       | 12,373,369                                     |       | 27,210,963                                    |       | 12,373,334 |   | 22,836,485 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

 

 

3

----

 

**TNS, INC.**

**CONDENDSED CONSOLIDATED STATEMENTSOF CASH FLOWS (UNAUDITED)**

**(dollars in thousands)**

 
| ** **                                                                       | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                       | ** ** | **2003**                                 | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                            |       |                                     |       |   |   |
| Net (loss) income                                                                |       | $                                        | (1,984     | ) | $ | 2,555 |   |
| Adjustments to reconcile net loss to net cash provided by operating  activities: |       |                                     |       |   |   |
| Depreciation and amortization of property and equipment                          |       | 14,533                                   |       | 14,746 |   |
| Amortization of intangible assets                                                |       | 18,856                                   |       | 20,855 |   |
| Deferred income tax benefit                                                      |       | (523                                     | )          | (3,333 | ) |
| Loss (gain) on disposal of property and equipment                                |       | 29                                       |       | (235 | ) |
| Amortization and write–off of deferred financing costs                      |       | 1,516                                    |       | 2,919 |   |
| Equity in net loss of unconsolidated affiliate                                   |       | 24                                       |       | 780 |   |
| Stock compensation                                                               |       | 74                                       |       | 798 |   |
| Changes in operating assets and liabilities, net of effect of  acquisitions:     |       |                                     |       |   |   |
| Accounts receivable, net                                                         |       | 2,888                                    |       | (6,047 | ) |
| Other current and noncurrent assets                                              |       | (5,739                                   | )          | (4,076 | ) |
| Accounts payable, accrued expenses and other current and noncurrent  liabilities |       | (2,833                                   | )          | 2,660 |   |
| Deferred revenue                                                                 |       | 3,138                                    |       | 2,357 |   |
| Net cash provided by operating activities:                                       |       | 29,979                                   |       | 33,979 |   |
| Cash flows from investing activities:                                            |       |                                     |       |   |   |
| Purchases of property and equipment                                              |       | (11,121                                  | )          | (16,396 | ) |
| Purchase of Synapse assets from USWD                                             |       | —                                   |       | (6,077 | ) |
| Purchase of vending assets from USWD                                             |       | —                                   |       | (3,748 | ) |
| Investments in unconsolidated affiliates                                         |       | (100                                     | )          | (3,600 | ) |
| Purchase of Openet S.r.l., net of cash acquired                                  |       | (1,985                                   | )          | — |   |
| Net cash used in investing activities:                                           |       | (13,206                                  | )          | (29,821 | ) |
| Cash flows from financing activities:                                            |       |                                     |       |   |   |
| Proceeds from issuance of long–term debt, net of financing costs of  $1,979 |       | —                                   |       | 84,531 |   |
| Repayment of long–term debt                                                 |       | (12,963                                  | )          | (158,646 | ) |
| Payment of refinancing costs                                                     |       | (588                                     | )          | — |   |
| Payment of dividends on preferred stock                                          |       | —                                   |       | (173 | ) |
| Proceeds from stock option exercises                                             |       | 14                                       |       | 101 |   |
| Proceeds from issuance of common stock, net                                      |       | —                                   |       | 71,516 |   |
| Net cash used in financing activities:                                           |       | (13,537                                  | )          | (2,671 | ) |
| Effect of exchange rates on cash and cash equivalents                            |       | (1,093                                   | )          | 405 |   |
| Net increase in cash and cash equivalents                                        |       | 2,143                                    |       | 1,892 |   |
| Cash and cash equivalents, beginning of period                                   |       | 5,984                                    |       | 11,074 |   |
| Cash and cash equivalents, end of period                                         |       | $                                        | 8,127      |   | $ | 12,966 |   |
| Supplemental disclosures of cash flow information:                               |       |                                     |       |   |   |
| Cash paid for interest                                                           |       | $                                        | 7,465      |   | $ | 4,244 |   |
| Cash paid for income taxes                                                       |       | $                                        | 1,137      |   | $ | 3,121 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

 

 

4

----

 

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

 

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

 

TNS, Inc. (TNS or the Company, formerly TNSHoldings, Inc.) is a Delaware corporation. On October 30, 2003, theCompany changed its name to TNS, Inc.

 

TNS is a leading provider of business–criticaldata communications services to processors of credit card, debit card andautomated teller machine (ATM) transactions. TNS is also a leading provider ofcall signaling 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 critical to itscustomers’ 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 internationalcustomers in 12 countries, including Canada and countries in Europe and theAsia–Pacific region.

 

The Company provides its services through itsmultiple data networks, each designed specifically for transactionapplications. These networks support a variety of widely acceptedcommunications protocols, are designed to be scalable and are accessible bymultiple methods, including dial–up, dedicated, wireless and Internetconnections.

 

The Company has four business divisions:(1) the point–of–sale/point–of–service (POS) division, which provides datacommunications services to payment processors in the U.S. and Canada,(2) the telecommunication services division (TSD), which provides callsignaling services and database access services targeting primarily thetelecommunications industry, (3) the financial services division (FSD),which provides, primarily to the financial services community, data networkingservices 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.

 

On March 15, 2004, the Company declared a 1–for–7.84reverse stock split. Accordingly, all share and per share amounts have beenretroactively adjusted to give effect to this event.

 

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 the Securitiesand Exchange Commission (SEC). Certain information and note disclosuresnormally included in the annual financial statements, required by GAAP, havebeen condensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationpresented not misleading.

 

In the 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 nine months ended September 30, 2004 are notnecessarily indicative of the results to be expected for any subsequent interimperiod or for the fiscal year. It is suggested that these unaudited condensedconsolidated financial statements be read in conjunction with the Company’sprospectus filed with the SEC on September 28, 2004 (File No. 333–118301),which includes consolidated financial statements and the notes thereto for theyear ended December 31, 2003.

 

**Use of Estimates**

 

The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of certain assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements.Significant estimates affecting the consolidated financial statements includemanagement’s judgments regarding the allowance for doubtful accounts, reservesfor excess and obsolete inventories, future cash flows from long–lived assets,and accrued expenses for probable losses. Actual results could differ fromthose estimates.

 

5

----

 

**Revenue Recognition**

 

The Company recognizes revenue when persuasiveevidence of an agreement exists, the terms are fixed and determinable, servicesare performed, and collection is probable. Cash received in advance of revenuerecognition is recorded as deferred revenue. POS services revenue is derivedprimarily from per transaction fees paid by the Company’s customers for thetransmission of transaction data, through the Company’s networks, betweenpayment processors and POS or ATM terminals. TSD revenue is derived primarily fromfixed monthly fees for call signaling services and per query fees charged fordatabase access and validation services. FSD revenue is derived primarily frommonthly recurring fees based on the number of customer connections to andthrough the Company’s networks. Incentives granted to new customers or uponcontract renewals are deferred and recognized ratably as a reduction of revenueover the contract period to the extent that the incentives are recoverableagainst the customer’s minimum purchase commitments under the contract. Inaddition, the Company receives installation fees related to the configurationof the customers’ systems. Revenue from installation fees is deferred andrecognized ratably over the customer’s contractual service period, generallythree years.

 

**Cost of Network Services**

 

Cost of network services is comprised primarily oftelecommunications charges, which include data transmission and database accesscharges, leased digital capacity charges, circuit installation charges andactivation charges. The cost of data transmission is based on a contract ortariff rate per minute of usage in addition to a prescribed rate pertransaction for certain vendors. The costs of database access, circuits,installation and activation charges are based on fixed fee contracts with localexchange carriers and interexchange carriers. The cost of network services alsoincludes salaries, equipment maintenance and other costs related to the ongoingoperation of the Company’s data networks. These costs are expensed by theCompany as incurred. Direct costs of installations are deferred and amortizedover three years. The Company records its accrual for telecommunication chargesbased upon network services utilized at historical invoiced rates. Depreciationexpense on our network equipment and amortization of developed technology areexcluded from our cost of network services and included in depreciation andamortization of property and equipment and amortization of intangible assets inour condensed consolidated statement of operations.

 

**Stock Based Compensation**

 

In February 2004, the Board of Directors ofthe Company adopted the TNS, Inc. 2004 Long–Term Incentive Plan (the Plan)and the Company’s stockholders approved the Plan in March 2004. The Planreserves 1,586,384 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 determined atthe date of grant, generally in equal monthly installments over four years. Theoptions expire 10 years from the date of grant. Restricted stock awardsand performance shares granted under the Plan are subject to a vesting perioddetermined at the date of grant, generally in equal annual installments overfour years. As of September 30, 2004, the Company granted 314,250 sharesof restricted stock and recorded approximately $5.1 million of deferredcompensation related to these shares of restricted stock. The deferredcompensation is being amortized over the four–year vesting period of the sharesof restricted stock. For the three and nine months ended September 30,2004, the Company recorded compensation expense of approximately $356,000 and$780,000 respectively, related to these shares of restricted stock.

 

The Company continues to account for employeestock options or similar equity instruments to employees under the intrinsicvalue method prescribed by APB Opinion No. 25, “Accounting for StockIssued to Employees.” Under the intrinsic value method, compensation cost isthe excess, if any, of the fair value of the stock at the grant date or othermeasurement date over the amount an employee must pay to acquire the stock.SFAS No. 123, “Accounting for Stock–Based Compensation” defines a fairvalue method of accounting for employee stock options or similar equityinstruments. Under the fair value method, compensation cost is measured at thegrant date based on the value of the award and is recognized over the serviceperiod. SFAS No. 123 allows an entity to continue to use the intrinsicvalue method. However, entities electing to account for employee stock optionsor similar instruments pursuant to APB Opinion No. 25 must make pro formadisclosures of net income, as if the fair value method of accounting had been applied.

 

 

6

----

 

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

 
| ** **                                                                                                                                        | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **2003**                                  | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net (loss) income attributable to common stockholders, as reported                                                                                |       | $                                         | (2,362     | )                                        | $          | 2,750 |   | $ | (13,095 | ) | $ | (873 | ) |
| Add: Stock–based employee compensation expense included in reported  net loss, net of related tax effects                                    |       | 12                                        |       | 216                                      |       | 44 |   | 479 |   |
| Deduct: Total stock–based employee compensation expense determined  under fair value based method for all awards, net of related tax effects |       | (164                                      | )          | (696                                     | )          | (490 | ) | (1,612 | ) |
| Pro forma net (loss) income attributable to common stockholders                                                                                   |       | $                                         | (2,514     | )                                        | $          | 2,270 |   | $ | (13,541 | ) | $ | (2,006 | ) |
| Basic and diluted net (loss) income per common share, as reported                                                                                 |       | $                                         | (0.19      | )                                        | $          | 0.10 |   | $ | (1.06 | ) | $ | (0.04 | ) |
| Pro forma basic and diluted net (loss) income per common share                                                                                    |       | $                                         | (0.20      | )                                        | $          | 0.08 |   | $ | (1.09 | ) | $ | (0.09 | ) |

 

**2.             Offeringsof Common Stock**

 

In March 2004, the Company completed itsinitial public offering (IPO) issuing 4,420,000 common shares at $18.00 pershare, which generated proceeds, net of offering costs, of approximately$71.5 million. The net proceeds of the IPO were used to repay a portion ofthe Company’s long–term debt outstanding under its previous senior securedcredit facility.

 

Upon the completion of the IPO, all of theoutstanding shares of the Company’s Class A redeemable convertiblepreferred stock (Class A Preferred Stock), including accrued and unpaiddividends, was converted into 9,984,711 shares of common stock.

 

On October 1, 2004, the Company completed a follow–onoffering of common stock issuing 1,084,744 common shares at $20.00 per share,which generated proceeds, net of offering costs, of approximately $19.0million.  On November 1, 2004, inconnection with the follow–on offering, the underwriters exercised a portion oftheir over–allotment option and the Company issued an additional 118,232 sharesof common stock at $20.00 per share, which generated proceeds, net of offeringcosts of approximately $2.3 million.  Thenet proceeds from the follow–on offering were used to repay a portion of theCompany’s long–term debt outstanding under its existing credit facility.

 

**3.             Acquisitionsand Long–term Investment**

 

**Acquisitions of Synapse and VendingAssets**

 

On May 21, 2004, the Company purchased twogroups of tangible and intangible assets from the bankrupt U.S. WirelessData, Inc. (USWD). Pursuant to two separate asset purchase agreements, theCompany, with the approval of the bankruptcy court, (a) paid approximately$6.1 million, including direct acquisition costs of approximately$0.1 million, for certain assets related to USWD’s Synapse platform, whichenables wireless POS terminals to initiate transactions for mobile and othermerchants and (b) paid approximately $3.7 million, including directacquisition costs of approximately $47,000, for USWD’s vending assets, whichsupport cashless transactions at vending machines. The Company purchased theseassets to advance the Company’s wireless capability to service existingcustomers as well as to penetrate new vertical markets.

 

The purchase price for the Synapse assets wasallocated as follows (in thousands):

 

| Property and equipment |   | $     | 214    |   |
|------------------------|--------|-------|--------|--------|
| Customer relationships |   | 4,095 |   |
| Developed technology   |   | 1,438 |   |
| Trade name             |   | 345   |   |
| Other liabilities      |   | (15   | )      |
| Net assets acquired    |   | $     | 6,077  |   |
|                        |        |       |        |        |  |

 

 

7

----

 

The purchase price for the vending assets wasallocated as follows (in thousands):

 

| Property and equipment |   | $     | 82     |   |
|------------------------|--------|-------|--------|--------|
| Customer relationship  |   | 831   |   |
| Developed technology   |   | 2,292 |   |
| Trade name             |   | 548   |   |
| Other liabilities      |   | (5    | )      |
| Net assets acquired    |   | $     | 3,748  |   |

 

The amounts allocated to the Synapse and vendingintangible assets are being amortized over their estimated useful lives of fiveyears. Unaudited pro forma results of operations are not provided because thehistorical operating results were not significant and pro forma results wouldnot be significantly different from reported results for the periods presented.The Company’s results of operations for the nine months ended September 30,2004 include the operating results of these acquisitions from May 21, 2004through September 30, 2004.

 

**Long–term Investments**

 

In April 2003, TNS made an investment in acompany that provides wireless Internet access to recreational vehicle parks.TNS purchased 3.2 percent of the company’s common shares for$0.1 million and obtained representation on the company’s board ofdirectors. In July 2003, TNS entered into an agreement to provide servicesto the company and, as consideration, received stock valued at$0.3 million for an additional 7.9 percent of the company’s commonshares. In May 2004, TNS’ investment in common shares was converted into13.1 percent of the company’s Series A preferred shares. InMay 2004, TNS also made an additional $0.1 million investment topurchase 3.7 percent of the company’s Series A preferred shares andthe company exercised its right under the existing services agreement toreceive additional services from TNS valued at $0.3 million in exchangefor 9.4 percent of the company’s Series A preferred shares. As of September 30,2004, TNS owned 26.2 percent of the company’s Series A preferredshares and 20.9 percent of the company’s total outstanding shares. TheCompany accounted for its investment under the equity method ofaccounting.  During the three monthsended September 30, 2004, TNS wrote–down the remaining investmentvalue.  For the three and nine monthsended September 30, 2004, the Company recognized a net loss in the equityof an unconsolidated affiliate of approximately $588,000 and $686,000,respectively.

 

In August 2004, TNS made an investment in acompany that provides mobile POS transaction infrastructure and solutions formobile merchants. TNS purchased 5,952,381 shares or 38.5 percent of the company’sSeries B convertible preferred stock for $2.5 million and obtainedrepresentation on the company’s board of directors. As of September 30,2004, TNS owned 20.2 percent of the company’s total outstanding shares.  TNS is accounting for its investment underthe equity method of accounting. For the three and nine months ended September 30,2004, the Company recognized a net loss in the equity of an unconsolidatedaffiliate of approximately $94,000.

 

In September 2004, TNS made an investment isa company that provides order–routingsystems and integrated electronic trading solutions to financial softwarecompanies and end–clients.  TNS purchased94,429 common shares or 8.4% of the company’s totaloutstanding shares for $1.0 million and obtained representation on the company’sboard of directors.  TNS is accountingfor its investment under the equity method of accounting. Due to timing of thereceipt of the company’s financial statements, TNS is accounting for the incomeor loss in this equity method investment on a one–month lag.  As a result, for the three and nine monthsended September 30, 2004, the Company recognized no income or loss in theequity of an unconsolidated affiliate,

 

8

----

 

**4.             Long–termDebt**

 

Debt consists of the following (in thousands):

 

| ** **                | ** ** | **December 31,**

** 2003** | ** ** | **September 30,**

**2004** | ** ** |
|---------------------------|------------|---------------------------------------|------------|----------------------------------|------------|
| Prior Term A Loan         |       | $                                     | 10,314     |                             | $          | — |   |
| Prior Term B Loan         |       | 140,081                               |       | —                           |       |
| Term Loan                 |       | —                                |       | 56,750                           |       |
| Revolving Credit Facility |       | —                                |       | 21,510                           |       |
|                      |       | 150,395                               |       | 78,260                           |       |
| Less: Current portion     |       | (28,731                               | )          | (11,750                          | )          |
| Long–term portion    |       | $                                     | 121,664    |                             | $          | 66,510 |   |
|                           |            |                                       |            |                                  |            |  |  |  |

 

In October and November 2004, the Company used thenet proceeds from its follow–on offering to repay the outstanding borrowingsunder the Company’s Revolving Credit Facility. As of November 1, 2004, total debt outstanding is $56.8 million.

 

On March 19, 2004, the Company entered into asenior secured credit facility (the Credit Facility) to replace its priorcredit facility. The Credit Facility consists of a $65.0 million term loan(Term Loan) and a revolving credit facility of $30.0 million (RevolvingCredit Facility). The Credit Facility matures March 19, 2009. Payments onthe Term Loan are due in quarterly installments over the five–year term,beginning on March 31, 2004. As of September 30, 2004 total remainingpayments on the Term Loan are as follows (in thousands):

 

| Three months ending  December 31, 2004 |   | $      | 2,750  |   |
|----------------------------------------|--------|--------|--------|--------|
| 2005                                   |   | 12,000 |   |
| 2006                                   |   | 13,000 |   |
| 2007                                   |   | 14,000 |   |
| 2008                                   |   | 15,000 |   |
|                                   |   | $      | 56,750 |   |

 

For the period through June 30, 2004,borrowings on the Revolving Credit Facility and the Term Loan bore interest ata rate of 2.50 percent over the LIBOR rate.  For the period from July 1, 2004 through September 30,2004, borrowings on the Revolving Credit Facility and the Term Loan boreinterest at a rate of 2.25 percent over the LIBOR rate (4.14 percent as ofSeptember 30, 2004). Thereafter, if the Company achieves a leverage ratioof less than one, the borrowings on the Revolving Credit Facility and the TermLoan generally will bear interest at a rate, at the Company’s option, of either0.75 percent over the lender’s base rate or 2.0 percent over theLIBOR rate. If the Company achieves a leverage ratio of less than 1.5 but morethan or equal to one, the borrowings on the Revolving Credit Facility and theTerm Loan generally will bear interest at a rate, at the Company’s option, ofeither 1.0 percent over the lender’s base rate or 2.25 percent overthe LIBOR rate. If the Company achieves a leverage ratio of less than 2.2 butmore than or equal to 1.5, the borrowings on the Revolving Credit Facility andthe Term Loan generally will bear interest at a rate, at the Company’s option,of either 1.25 percent over the lender’s base rate or 2.5 percentover the LIBOR rate. The Company’s leverage ratio as of September 30, 2004was 1.3 to 1.0. The Revolving Credit Facility is subject to an annualcommitment fee in an amount equal to 0.5 percent per annum multiplied bythe amount of funds available for borrowing under the Revolving CreditFacility. Interest payments on the Credit Facility are due monthly, bimonthly,or quarterly at the Company’s option.

 

The terms of the Credit Facility require theCompany to comply with financial and nonfinancial covenants, includingmaintaining certain leverage, interest and fixed charge coverage ratios at theend of each fiscal quarter. As of September 30, 2004, the Company wasrequired to maintain a leverage ratio of less than 2.2 to 1.0, an interestcoverage ratio of greater than 5.0 to 1.0 and a fixed charge ratio of greaterthan 1.5 to 1.0. Certain of the financial covenants will become morerestrictive over the term of the Credit Facility. The Credit Facility alsocontains nonfinancial covenants that restrict some of the Company’s corporateactivities, including the Company’s ability to dispose of assets, incuradditional debt, pay dividends, create liens, make investments, make capitalexpenditures and engage in specified transactions with affiliates. The Company’sfuture results of operations and its ability to comply with the covenants couldbe adversely impacted by increases in the general level of interest rates sincethe interest on a majority of the Company’s debt is variable. Noncompliancewith any of the financial or nonfinancial covenants without cure or waiverwould constitute an event of default under the 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 and

 

 

9

----

 

interest outstanding, and a termination of the RevolvingCredit Facility. The 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 Credit Facility as of September 30,2004.

 

In connection with the closing of the CreditFacility, the Company incurred approximately $2.0 million in financingcosts. These financing costs were deferred and are being amortized using theeffective interest method over the life of the Credit Facility. In connectionwith the termination of the prior credit facility in March 2004, theCompany wrote–off approximately $2.0 million in unamortized deferredfinancing costs related to the prior credit facility. Such write–off has beenincluded in interest expense in the accompanying condensed consolidatedstatement of operations for the nine months ended September 30, 2004.

 

**5.             ComprehensiveIncome (Loss)**

 

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

 

| ** **                                   | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                   | ** ** | **2003**                                  | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income (loss)                            |       | $                                         | 1,465      |                                     | $          | 2,750 |   | $ | (1,984 | ) | $ | 2,555 |   |
| Change in market value of interest rate swap |       | —                                    |       | —                                   |       | (381 | ) | — |   |
| Foreign currency translation adjustments     |       | (228                                      | )          | 269                                      |       | 487 |   | 299 |   |
| Total comprehensive income (loss)            |       | $                                         | 1,237      |                                     | $          | 3,019 |   | $ | (1,878 | ) | $ | 2,854 |   |

 

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

 

Statement of Financial Accounting Standards (SFAS)No. 128, Earnings Per Share, requires the presentation of basic anddiluted earnings per share. Basic earnings (loss) per common share is computedby dividing income (loss) attributable to common stockholders by the weightedaverage number of common shares outstanding for the period. The dilutedearnings (loss) per common share data is computed using the weighted averagenumber of common shares outstanding plus the dilutive effect of common stockequivalents, unless the common stock equivalents are anti–dilutive. For theperiod prior to the IPO, the effect of the Class A Preferred Stockconverting into shares of common stock was not included in the computation ofdiluted net loss per common share as the effect would be anti–dilutive. Inaddition, options to purchase 318,414 and 1,195,054 shares of common stock thatwere outstanding as of September 30, 2003 and 2004, respectively, wereexcluded from the computation of diluted net loss per common share for the ninemonths ended September 30, 2003 and 2004 and the three months ended September 30,2003 as their effect would be anti–dilutive. The treasury stock effect of314,250 shares of unvested common stock held by executives and employees as of September 30,2004 was not included in the computation of diluted net loss per common share forthe nine months ended September 30, 2004 as the effect would be anti–dilutive.

 

10

----

 

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

 
| ** **                                            | ** ** | **Three months ended**

** September 30,** | ** ** | **Nine months ended**

** September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2003**                                             | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income (loss)                                     |       | $                                                    | 1,465      |                                                | $          | 2,750 |   | $ | (1,984 | ) | $ | 2,555 |   |
| Dividends on preferred stock                          |       | (3,827                                               | )          | —                                              |       | (11,111 | ) | (3,428 | ) |
| Net (loss) income attributable to common stockholders |       | $                                                    | (2,362     | )                                                   | $          | 2,750 |   | $ | (13,095 | ) | $ | (873 | ) |
| Weighted average common share calculation:            |       |                                                 |       |                                                |       |   |   |   |   |
| Basic weighted average common shares outstanding      |       | 12,373,369                                           |       | 26,781,393                                          |       | 12,373,334 |   | 22,836,485 |   |
| Conversion of Class A Preferred Stock                 |       | —                                               |       | —                                              |       | — |   | — |   |
| Treasury stock effect of unvested common stock        |       | —                                               |       | 318,995                                             |       | — |   | — |   |
| Treasury stock effect of options                      |       | —                                               |       | 110,575                                             |       | — |   | — |   |
| Diluted weighted average common shares outstanding    |       | 12,373,369                                           |       | 27,210,963                                          |       | 12,373,334 |   | 22,836,485 |   |
| Net (loss) income per common share:                   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic (loss) income per common share                  |       | $                                                    | (0.19      | )                                                   | $          | 0.10 |   | $ | (1.06 | ) | $ | (0.04 | ) |
| Diluted (loss) income per common share                |       | $                                                    | (0.19      | )                                                   | $          | 0.10 |   | $ | (1.06 | ) | $ | (0.04 | ) |

 

The pro forma net income (loss) per common shareis computed using the pro forma net income (loss) attributable to commonstockholders and the pro forma weighted average common shares outstandingduring the period. The pro forma weighted average common shares outstandingassume the conversion of the Class A Preferred Stock plus accrued andunpaid dividends into common stock at the IPO price of $18.00 per share as ifthe conversion had occurred at the beginning of each period presented.

 
| ** **                                                      | ** ** | **Three months ended**

** September 30,** | ** ** | **Nine months ended**

**September 30,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                      | ** ** | **2003**                                             | ** ** | **2004**                                      | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income (loss)                                               |       | $                                                    | 1,465      |                                          | $          | 2,750 |   | $ | (1,984 | ) | $ | 2,555 |   |
| Dividends on preferred stock                                    |       | —                                               |       | —                                        |       | — |   | — |   |
| Pro forma net (loss) income attributable to common stockholders |       | $                                                    | 1,465      |                                          | $          | 2,750 |   | $ | (1,984 | ) | $ | 2,555 |   |
| Weighted average common share calculation:                      |       |                                                 |       |                                          |       |   |   |   |   |
| Basic weighted average common shares outstanding                |       | 12,373,369                                           |       | 26,781,393                                    |       | 12,373,334 |   | 22,836,485 |   |
| Conversion of Class A Preferred Stock                           |       | 9,584,508                                            |       | —                                        |       | 9,584,508 |   | 2,733,042 |   |
| Pro forma basic weighted average common shares outstanding      |       | 21,957,877                                           |       | 26,781,393                                    |       | 21,757,842 |   | 25,569,527 |   |
| Treasury stock effect of unvested common stock                  |       | —                                               |       | 318,995                                       |       | — |   | 224,707 |   |
| Treasury stock effect of options                                |       | —                                               |       | 110,575                                       |       | — |   | 84,580 |   |
| Pro forma diluted weighted average common shares outstanding    |       | 21,957,877                                           |       | 27,210,963                                    |       | 21,757,842 |   | 25,878,814 |   |
| Pro forma net income (loss) per common share:                   |       |                                                 |       |                                          |       |   |   |   |   |
| Pro forma basic income (loss) per common share                  |       | $                                                    | 0.07       |                                          | $          | 0.10 |   | $ | (0.09 | ) | $ | 0.10 |   |
| Pro forma diluted income (loss) per common share                |       | $                                                    | 0.07       |                                          | $          | 0.10 |   | $ | (0.09 | ) | $ | 0.10 |   |

 

 

**7.             SegmentInformation**

 

The Company’s reportable segments are strategicbusiness units that offer different products and services. The Companyclassifies its business into four segments: POS, TSD, FSD and ISD. However, theCompany’s management only evaluates revenues for these four segments. Asignificant portion of the Company’s North American operating expenses areshared between the POS, TSD and FSD segments, and therefore, managementanalyzes operating results for these three segments on a combined basis.

 

Management evaluates the North American and ISDperformance on EBITDA before stock compensation expense because operating expensesare distinguishable between North American and ISD operations. The Companydefines EBITDA

 

 

11

----

 

before stock compensation expense as income fromoperations before depreciation, amortization and stock compensation expense.EBITDA before stock compensation expense is not a generally accepted accountingprinciple measure, but rather a measure employed by management to viewoperating results adjusted for major noncash items. The Company’s definition ofEBITDA before stock compensation expense may not be comparable to similarlytitled measures used by other entities. Assets are not segregated betweenreportable segments, and management does not use asset information by segmentsto evaluate segment performance. As such, no information is presented related tofixed assets by reportable segment and capital expenditures for each segment.

 

Revenue for the Company’s four business units ispresented below (in thousands):

 
| ** **     | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **     | ** ** | **2003**                                  | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues:      |       |                                      |       |                                     |       |   |   |   |   |
| POS            |       | $                                         | 31,588     |                                     | $          | 28,901 |   | $ | 92,078 |   | $ | 86,372 |   |
| TSD            |       | 7,664                                     |       | 8,595                                    |       | 21,713 |   | 25,446 |   |
| FSD            |       | 5,161                                     |       | 6,469                                    |       | 15,072 |   | 18,627 |   |
| ISD            |       | 12,832                                    |       | 20,619                                   |       | 33,133 |   | 55,235 |   |
| Total revenues |       | $                                         | 57,245     |                                     | $          | 64,584 |   | $ | 161,996 |   | $ | 185,680 |   |
|                |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |  |

 

EBITDA before stockcompensation expense for North American and ISD operations is reflected below(in thousands):

 
| ** **                                     | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                     | ** ** | **2003**                                   | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| EBITDA before stock compensation expense:      |       |                                       |       |                                      |       |   |   |   |   |
| North America                                  |       | $                                          | 13,046     |                                      | $          | 10,501 |   | $ | 33,926 |   | $ | 31,618 |   |
| ISD                                            |       | 3,186                                      |       | 6,661                                     |       | 5,103 |   | 16,495 |   |
| Total EBITDA before stock compensation expense |       | $                                          | 16,232     |                                      | $          | 17,162 |   | $ | 39,029 |   | $ | 48,113 |   |

 

EBITDA before stockcompensation expense differs from (loss) income before income taxes and equityin net loss of unconsolidated affiliate reported in the condensed consolidatedstatements of operations as follows (in thousands):

 
| ** **                                                                            | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                            | ** ** | **2003**                                   | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| EBITDA before stock compensation expense                                              |       | $                                          | 16,232     |                                      | $          | 17,162 |   | $ | 39,029 |   | $ | 48,113 |   |
| Reconciling items:                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Depreciation and amortization of property and equipment and  intangible assets        |       | (11,211                                    | )          | (11,140                                   | )          | (33,389 | ) | (35,601 | ) |
| Stock compensation                                                                    |       | (20                                        | )          | (360                                      | )          | (74 | ) | (798 | ) |
| Interest expense                                                                      |       | (2,794                                     | )          | (1,035                                    | )          | (8,615 | ) | (6,472 | ) |
| Interest and other income, net                                                        |       | 209                                        |       | 519                                       |       | 1,667 |   | 437 |   |
| Income (loss) before income taxes and equity in net loss of  unconsolidated affiliate |       | $                                          | 2,416      |                                      | $          | 5,146 |   | $ | (1,382 | ) | $ | 5,679 |   |

 

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

 
| ** **                           | ** ** | **December 31,**

**2003** | ** ** | **September 30,**

**2004** | ** ** |
|--------------------------------------|------------|----------------------------|------------|----------------------------------|------------|
| POS                                  |       | $                          | 160,271    |                             | $          | 152,980 |   |
| TSD                                  |       | 3,305                      |       | 3,179                            |       |
| FSD                                  |       | 30,503                     |       | 28,947                           |       |
| ISD                                  |       | 34,293                     |       | 31,960                           |       |
| Total goodwill and intangible assets |       | $                          | 228,372    |                             | $          | 217,066 |   |

 

12

----

 

**Geographic Information**

 

The Company sells its services through foreignsubsidiaries in the United Kingdom, Australia, Canada, France, Germany,Ireland, Italy, Japan, New Zealand, Spain, Sweden and The Netherlands.Information regarding revenues and long–lived tangible assets attributable toeach geographic region is stated below.

 

The Company’s revenues were generated in thefollowing geographic regions (in thousands):

 
| ** **        | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **        | ** ** | **2003**                                  | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues:         |       |                                      |       |                                     |       |   |   |   |   |
| North America     |       | $                                         | 44,413     |                                     | $          | 43,965 |   | $ | 128,863 |   | $ | 130,445 |   |
| Europe            |       | 11,456                                    |       | 16,955                                   |       | 30,716 |   | 47,655 |   |
| Asia–Pacific |       | 1,376                                     |       | 3,664                                    |       | 2,417 |   | 7,580 |   |
| Total revenues    |       | $                                         | 57,245     |                                     | $          | 64,584 |   | $ | 161,996 |   | $ | 185,680 |   |
|                   |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |  |  |

 

The Company’s long–lived tangible assets includinggoodwill and intangible assets were located as follows (in thousands):

 
| ** **                   | ** ** | **December 31,**

**2003** | ** ** | **September 30,**

**2004** | ** ** |
|------------------------------|------------|----------------------------|------------|----------------------------------|------------|
| North America                |       | $                          | 232,393    |                             | $          | 232,117 |   |
| Europe                       |       | 45,057                     |       | 42,381                           |       |
| Asia–Pacific            |       | 4,888                      |       | 5,136                            |       |
| Total long–lived assets |       | $                          | 282,338    |                             | $          | 279,634 |   |

 

**9.             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.

 

On August 26, 2002, an action was filed inthe Superior Court of the State of Delaware by persons alleging that theCompany breached an agreement to purchase an unrelated entity. The plaintiffsare seeking unspecified damages. Management intends to vigorously contest thisaction, although no assurance can be given as to the outcome of this lawsuit.Management cannot estimate a range of possible loss. Management believes thatit will prevail in this matter and that its loss will be limited to legaldefense costs.

 

Certain states in which the Company operatesassess sales taxes on certain services provided by the Company. The Companybelieves it has no liability because its customer contracts contain terms thatstipulate the customer, not the Company, is responsible for any sales taxliability. In jurisdictions where the customer may be liable for sales taxes,the Company either includes sales tax on its invoice or has obtained anexemption certificate from the customer. Certain states have audited theCompany from 1996 to early 2001 and have proposed $6.7 million inassessments on the basis that sales taxes are owed. Both the Company and thecustomers involved are vigorously defending any proposed assessments by thesales tax authorities. In the opinion of management, resolution of thesematters will not have a material adverse effect upon the financial position orfuture operating results of the Company.

 

 

13

----

** **

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

 

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 prospectus (File No. 333–118301) filed with the SEC on September 28,2004 and available directly from the SEC at www.sec.gov and the condensedconsolidated financial statements and the related notes of TNS, Inc.,included elsewhere in this quarterly report.

 

There are statements made herein which may notaddress historical 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 also forward–lookingstatements. Actual results may differ materially from those indicated by suchforward–looking statements as a result of various important factors, including:the Company’s reliance upon a small number of customers for a significantportion of its revenue; competitive factors such as pricing pressures; ourcustomer’s ability to direct their data communications from the Company’snetworks to other networks; the Company’s ability to grow its businessdomestically and internationally by generating greater transaction volumes,acquiring new customers or developing new service offerings; fluctuations inthe Company’s quarterly results because of the seasonal nature of the businessand other factors outside of the Company’s control; the Company’s ability toidentify, execute or effectively integrate future 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; andother risk factors described in the Company’s prospectus filed with the SEC on September 28,2004. In addition, the statements in this quarterly report are made as of thedate of this filing. The Company expects that subsequent events or developmentswill cause its views to change. The Company undertakes no obligation to updateany of the forward–looking statements made herein, whether as a result of newinformation, future events, changes in expectations or otherwise. These forward–lookingstatements should not be relied upon as representing the Company’s views as ofany date subsequent to the date of this filing. The forward–lookingstatements in this document are intended to be subject to the safe harborprotection provided by Sections 27A of the Securities Act and 21E of theExchange Act.

 

**Overview**

 

We are a leading provider of business–criticaldata communications services to processors of credit card, debit card and ATMtransactions. We are also a leading provider of secure data and voice networkservices to the global financial services industry. We operate one of fourunaffiliated Signaling System No. 7 networks in the United States capableof providing services nationwide, and we utilize this network to provide callsignaling and database access services to the domestic telecommunicationsindustry. Our data communications services enable secure and reliabletransmission of time–sensitive, transaction–related information critical to ourcustomers’ operations. Our customers outsource their data communicationsrequirements to us because of our substantial expertise, comprehensive customersupport and cost–effective services. We provide services to customers in theUnited States and increasingly to international customers in 12 countries,including Canada and countries in Europe and the Asia–Pacific region.

 

We provide our services through multiple datanetworks, each designed specifically for transaction applications. Our networkssupport a variety of widely accepted communications protocols and are designedto be scalable and accessible by multiple methods, including dial–up,dedicated, wireless and Internet connections.

 

We generate revenues through four businessdivisions:

 

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

 

•                  ***International services***.We are one of the leading providers of data communications services to the POSindustry in the United Kingdom. We also provide our services in Australia,France, Germany, Ireland, Italy, Japan, The 

 

 

14

----

 

                        Netherlands,New Zealand, Spain and Sweden. Our international services division generatesrevenues from our POS and financial services offerings abroad.

 

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

 

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

 

Our most significant expense is cost of networkservices, which is comprised primarily of telecommunications charges, includingdata transmission and database access, leased digital capacity charges, circuitinstallation charges and activation charges. The cost of data transmission isbased on a contract or tariff rate per minute of usage in addition to aprescribed rate per transaction for some vendors. The costs of database access,circuits, installation charges and activation charges are based on fixed feecontracts with local exchange carriers and interexchange carriers. The cost ofnetwork services also includes salaries, equipment maintenance and other costsrelated to the ongoing operation of our data networks. Depreciation expense onour network equipment and amortization of developed technology are excludedfrom our cost of network services and included in depreciation and amortizationof property and equipment and amortization of intangible assets in ourcondensed consolidated statement of operations.

 

Our engineering and development expenses includesalaries and other costs related to product development, engineering andmaterials. The majority of these costs are expensed as incurred, includingcosts related to the development of internal use software in the preliminaryproject, the post–implementation and operation stages. Development costs weincur during the software application development stage are capitalized andamortized over the estimated useful life of the developed software.

 

Our selling, general and administrative expensesinclude costs related to sales, marketing, administrative and managementpersonnel, as well as outside legal, accounting and consulting services. Webelieve that selling, general and administrative expenses as a percentage ofrevenues will remain constant or increase to support expansion of theinternational services division, as well as from the additional costs of beinga publicly traded company, including the legal, audit, insurance and board ofdirectors compensation costs needed to establish and maintain compliance withthe Sarbanes–Oxley Act of 2002.

 

In March 2004, we completed our initialpublic offering (IPO) of common stock issuing 4,420,000 common shares at $18.00per share, which generated proceeds, net of offering costs, of approximately$71.5 million. The net proceeds of the IPO were used to repay a portion ofthe outstanding debt under our then–existing senior secured credit facility. Concurrentwith the closing of the IPO, we entered into a new senior secured creditfacility and used the net proceeds from borrowings to repay the remaining debtoutstanding under our then–existing senior secured credit facility. Inconnection with the termination of our previous senior secured credit facility,we recognized a charge of approximately $2.0 million related to the write–offof unamortized deferred financing costs. Such write–off was included ininterest expense in the accompanying condensed consolidated statement ofoperations for the nine months ended September 30, 2004.

 

Upon the completion of the IPO, all of theoutstanding shares of our Class A redeemable convertible preferred stock,including accrued and unpaid dividends, converted at $18.00 per share into9,984,712 shares of common stock.

 

On October 1, 2004, we completed a follow–onoffering of common stock issuing 1,084,744 common shares at $20.00 per share,which generated proceeds, net of offering costs, of approximately $19.0 million.  On November 1, 2004, in connection with thefollow–on offering, the underwriters exercised a portion of their over–allotmentoption and we issued an additional 118,232 common shares at $20.00 per share,which generated proceeds, net of offering costs of approximately $2.3million.  The net proceeds from thefollow–on offering were used to repay a portion of our long–term debtoutstanding under our existing credit facility.

 

15

----

 

**Acquisitions and Long–term Investments**

 

On May 21, 2004, we purchased two groups oftangible and intangible assets from the bankrupt U.S. Wireless Data, Inc.(USWD). Pursuant to two separate asset purchase agreements, the Company, withthe approval of the bankruptcy court, (a) paid approximately$6.1 million, including direct acquisition costs of approximately$0.1 million, for certain assets related to USWD’s Synapse platform, whichenables wireless POS terminals to initiate transactions for mobile and othermerchants and (b) paid approximately $3.7 million, including directacquisition costs of approximately $47,000, for USWD’s vending assets, whichsupport cashless transactions at vending machines. We purchased these assets toadvance our wireless capability to service existing customers as well as topenetrate new vertical markets. We accounted for the acquisitions of theSynapse and vending assets under the purchase method with the totalconsideration allocated to the fair value of the assets acquired andliabilities assumed, including identifiable intangibles of $5.9 millionrelated to the Synapse assets and $3.7 million related to the vendingassets. Our consolidated results of operations for the nine months ended September 30,2004 include the operating results of these acquisitions from May 21, 2004through September 30, 2004.

 

In April 2003, we made an investment inLinkSpot Networks, Inc., a company that provides wireless Internet access torecreational vehicle parks. We purchased 3.2 percent of the company’scommon shares for $0.1 million and obtained representation on the company’sboard of directors. In July 2003, we entered into an agreement to provideservices to the company and, as consideration, received stock valued at$0.3 million for an additional 7.9 percent of the company’s commonshares. In May 2004, our investment in common shares was converted into13.1 percent of the company’s Series A preferred shares. InMay 2004, we also made an additional $0.1 million investment topurchase 3.7 percent of the company’s Series A preferred shares andthe company exercised its right under the existing services agreement toreceive additional services from us valued at $0.3 million in exchange for9.4 percent of the company’s Series A preferred shares. As of September 30,2004, we owned 26.2 percent of the company’s Series A preferredshares and 20.9 percent of the company’s total outstanding shares. Weaccounted for this investment under the equity method of accounting. During thethree months ended September 30, 2004, we wrote–down the remaininginvestment value.  For the three and ninemonths ended September 30, 2004, we recognized a net loss in the equity ofan unconsolidated affiliate of approximately $588,000 and $686,000,respectively.

 

In August 2004, we made an investment in WAYSystems, Inc., a company that provides mobile POS transaction infrastructureand solutions for mobile merchants. We purchased 5,952,381 shares or 38.5percent of the company’s Series B convertible preferred stock for$2.5 million and obtained representation on the company’s board ofdirectors. As of September 30, 2004, we owned 20.2 percent of the company’stotal outstanding shares.  We areaccounting for our investment under the equity method of accounting. For thethree and nine months ended September 30, 2004, we recognized a net lossin the equity of an unconsolidated affiliate of approximately $94,000.

 

In September 2004, we made an investment inAK Jenson Group, Limited, a company that provides order–routing systems and integrated electronictrading solutions to financial software companies and end–clients.  We purchased 94,429 common shares or 8.4% ofthe company’s total outstanding shares for$1.0 million and obtained representation on the company’s board of directors.  We are accounting for our investment underthe equity method of accounting. Due to timing of the receipt of the company’sfinancial statements, we are accounting for the income or loss in this equitymethod investment on a one–month lag.  Asa result, for the three and nine months ended September 30, 2004, werecognized no income or loss in the equity of an unconsolidated affiliate.

 

16

----

 

**Results of Operations**

 

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

 
| ** **                                                                            | ** ** | **Three months ended**

**September 30,** | ** ** | **Nine months ended**

**September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                            | ** ** | **2003**                                       | ** ** | **2004**                                      | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues                                                                              |       | $                                              | 57,245     |                                          | $          | 64,584 |   | $ | 161,996 |   | $ | 185,680 |   |
| Operating expenses:                                                                   |       |                                           |       |                                          |       |   |   |   |   |
| Cost of network services, exclusive of the items shown separately  below              |       | 29,715                                         |       | 31,344                                        |       | 87,128 |   | 91,170 |   |
| Engineering and development                                                           |       | 2,416                                          |       | 3,748                                         |       | 8,385 |   | 10,680 |   |
| Selling, general, and administrative                                                  |       | 8,902                                          |       | 12,690                                        |       | 27,528 |   | 36,515 |   |
| Depreciation and amortization of property and equipment                               |       | 4,926                                          |       | 4,989                                         |       | 14,533 |   | 14,746 |   |
| Amortization of intangible assets                                                     |       | 6,285                                          |       | 6,151                                         |       | 18,856 |   | 20,855 |   |
| Total operating expenses                                                              |       | 52,244                                         |       | 58,922                                        |       | 156,430 |   | 173,966 |   |
| Income from operations                                                                |       | 5,001                                          |       | 5,662                                         |       | 5,566 |   | 11,714 |   |
| Interest expense                                                                      |       | (2,794                                         | )          | (1,035                                        | )          | (8,615 | ) | (6,472 | ) |
| Interest and other income, net                                                        |       | 209                                            |       | 519                                           |       | 1,667 |   | 437 |   |
| Income (loss) before income taxes and equity in net loss of  unconsolidated affiliate |       | 2,416                                          |       | 5,146                                         |       | (1,382 | ) | 5,679 |   |
| Income tax provision                                                                  |       | (927                                           | )          | (1,714                                        | )          | (578 | ) | (2,344 | ) |
| Equity in net loss of unconsolidated affiliate                                        |       | (24                                            | )          | (682                                          | )          | (24 | ) | (780 | ) |
| Net income (loss)                                                                     |       | $                                              | 1,465      |                                          | $          | 2,750 |   | $ | (1,984 | ) | $ | 2,555 |   |
|                                                                                       |            |                                                |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Three monthsended September 30, 2004 compared to the three months ended September 30,2003***

 

***Revenues.***  Total revenues increased$7.3 million, or 12.8%, to $64.6 million for the three months ended September 30,2004, from $57.2 million for the three months ended September 30,2003. We generate revenues through four operating divisions.

 

***POS division.***  Revenues from the POS divisiondecreased $2.7 million, or 8.5%, to $28.9 million for the threemonths ended September 30, 2004, from $31.6 million for the threemonths ended September 30, 2003. The $2.7 million decrease in POSrevenues resulted from a decline in transaction volumes primarily from ourlargest customer and to a lesser extent as a result of negotiated pricereductions upon renewal of certain contracts. POS transaction volumes decreased10.9% to 1.8 billion transactions for the three months ended September 30,2004, from 2.0 billion transactions for the three months ended September 30,2003. In 2004 we negotiated contract renewals with some of our POS customers,and we agreed to pricing discounts in exchange for maintaining or increasingtheir minimum transaction or revenue commitments.  As a result, it is likely our revenue pertransaction will decrease and, depending upon the number of transactions wetransport, our POS revenues may continue to decrease. In addition, based uponthe current status of negotiations, we believe that revenues and relatedtransaction volumes from our largest customer will continue to decline in thefourth quarter of 2004 and may decline further thereafter.

 

***Internationalservices division.***  Revenues from the international servicesdivision increased $7.8 million, or 60.7%, to $20.6 million for thethree months ended September 30, 2004, from $12.8 million for thethree months ended September 30, 2003. The increase was primarily due toadditional revenues generated from our POS customers in the U.K., Australia,France, Spain and Italy and to a lesser extent we benefited from favorableforeign exchange.  Included in revenuesand cost of sales for the three months ended September 30, 2004 is $1.4million associated with the sale of equipment in Australia.  Revenues from our U.K. subsidiary increased$3.2 million, or 38.2%, to $11.6 million for the three months ended September 30,2004, from $8.4 million for the three months ended September 30,2003.

 

***Telecommunicationservices division.***  Revenues from the telecommunication servicesdivision increased $0.9 million, or 12.2%, to $8.6 million for thethree months ended September 30, 2004, from $7.7 million for thethree months ended September 30, 2003. The growth in revenues was primarilydue to increased usage of our call signaling services.

 

***Financialservices division.***  Revenues from the financial services divisionincreased $1.3 million, or 25.3%, to $6.5 million for the threemonths ended September 30, 2004, from $5.2 million for the threemonths ended September 30, 2003. The increase in revenues was due to thegrowth in the number of customer connections to and through our networks.

 

17

----

 

***Cost of networkservices.***  Cost of network services increased$1.6 million, or 5.5%, to $31.3 million for the three months ended September 30,2004, from $29.7 million for the three months ended September 30,2003. Cost of network services were 48.5% of revenues for the three monthsended September 30, 2004, compared to 51.9% of revenues for the threemonths ended September 30, 2003. The increase in cost of network servicesresulted primarily from higher usage charges from our TSD, FSD and ISDservices, offset primarily by a decrease in usage–based vendortelecommunications charges in our POS division, and to a lesser extent, lowerusage charges from decreased POS transactions. Included in revenues and cost ofsales for the three months ended September 30, 2004 is $1.4 millionassociated with the sale of equipment in Australia.   Gross profit represented 51.5% of totalrevenues for the three months ended September 30, 2004, compared to 48.1%for the three months ended September 30, 2003. The increase in grossprofit as a percentage of total revenues resulted primarily from increasedcontribution of our financial services division and international servicesdivision, and to a lesser extent the decrease in usage–based vendortelecommunications charges.

 

Future cost of network services depends on anumber of factors including total transaction and query volume, the relativegrowth and contribution to total transaction volume of each of our customers,the success of our new service offerings, the timing and extent of our networkexpansion and the timing and extent of any network cost reductions. In addition,any significant loss or significant reduction in transaction volumes could leadto a decline in gross margin since significant portions of our network costsare fixed costs.

 

***Engineering anddevelopment expense.***  Engineering and development expense increased$1.3 million, or 55.1%, to $3.7 million for the three months ended September 30,2004, from $2.4 million for the three months ended September 30,2003. Engineering and development expense represented 5.8% of revenues for thethree months ended September 30, 2004 and 4.2% for the three months ended September 30,2003. Engineering and development expense increased primarily from an increasein engineering expenses required to support our international expansion.

 

***Selling,general and administrative expense.***  Selling, general and administrative expenseincreased $3.8 million, or 42.5%, to $12.7 million for the threemonths ended September 30, 2004, from $8.9 million for the threemonths ended September 30, 2003. Selling, general and administrativeexpense represented 19.7% of revenues for the three months ended September 30,2004, compared to 15.6% of revenues for the three months ended September 30,2003. Selling, general and administrative expense increased primarily from theexpenses required to support our revenue growth, mainly within theinternational services division, and to a lesser extent, the incremental costsnecessary to operate as a public company and stock compensation expense.

 

***Depreciationand amortization of property and equipment.***  Depreciation and amortization of property andequipment increased $0.1 million to $5.0 million for the three monthsended September 30, 2004, from $4.9 million for the three monthsended September 30, 2003. Depreciation and amortization of property andequipment represented 7.7% of revenues for the three months ended September 30,2004, compared to 8.6% of revenues for the three months ended September 30,2003.

 

***Amortization ofintangible assets.***  Amortization of intangible assets decreased$0.1 million, or 2.1%, to $6.2 million for the three months ended September 30,2004, from $6.3 million for the three months ended September 30,2003. The amortization of intangible assets for the three months ended September 30,2004 and 2003 relates solely to the intangible assets resulting fromacquisitions. For purposes of measuring and recognizing impairment of long–livedassets including intangibles, we assess whether separate cash flows can beattributed to the individual asset. For our customer relationship intangible assets,we recognize and measure impairment upon the termination or loss of a customerthat results in a loss of revenue. Based upon the current status of contractnegotiations with our largest customer, we believe that revenues and relatedtransaction volumes from this customer will continue to decline in the fourthquarter of 2004 and may decline further thereafter. The intangible asset valueattributable to this customer relationship is approximately $25.5 millionas of September 30, 2004. We will continue to assess the recoverability ofthis customer relationship asset based upon anticipated future cash flows.

 

***Interestexpense.***  Interest expense decreased $1.8 millionto $1.0 million for the three months ended September 30, 2004, from$2.8 million for the three months ended September 30, 2003. Thisdecrease was primarily due to the repayment of a portion of our term debt withthe net proceeds from our initial public offering on March 16, 2004.

 

***Interest andother income, net.***  Interest and other income, net increased$0.3 million to $0.5 million for the three months ended September 30,2004 compared to $0.2 million for the three months ended September 30,2003. Included in other income, net for the three months ended September 30,2004 and 2003 is a gain on foreign currency translation of $ 0.2 milliondue to fluctuations in the value of the U.S. dollar as compared with foreigncurrencies, predominately, the euro, the British pound 

 

18

----

 

and the Australian dollar.   Also included in other income, net for thethree months ended September 30, 2004 is a $0.2 million gain on the saleof property and equipment, versus a loss of $33,000 for the three months ended September 30,2003.

 

***Income taxprovision.***  For the three months ended September 30,2004, our income tax provision was $1.7 million compared to $0.9 millionfor the three months ended September 30, 2003.  Our effective tax rate for the three monthsended September 30, 2004 is 33.3% versus the U.S. federal statutory taxrate of 35.0%, due primarily to the fact that the statutory rate in certain ofour international jurisdictions is lower than the U.S. federal rate, partiallyoffset by the fact that we have losses from certain of our internationalsubsidiaries that cannot be used to offset income in other jurisdictions.

 

***Nine monthsended September 30, 2004 compared to the nine months ended September 30,2003***

 

***Revenues.***  Total revenues increased$23.7 million, or 14.6%, to $185.7 million for the nine months ended September 30,2004, from $162.0 million for the nine months ended September 30,2003. We generate revenues through four operating divisions.

 

***POS division.***  Revenues from the POS divisiondecreased $5.7 million, or 6.2%, to $86.4 million for the nine monthsended September 30, 2004, from $92.1 million for the nine monthsended September 30, 2003. The $5.7 million decrease in POS revenuesresulted from a decline in transaction volumes primarily from our largestcustomer and to a lesser extent a decrease in revenue per transaction as aresult of negotiated price reductions upon renewal of certain contracts. POStransaction volumes decreased 5.9% to 5.6 billion transactions for thenine months ended September 30, 2004, from 5.9 billion transactionsfor the nine months ended September 30, 2003. In 2004 we negotiatedcontract renewals with some of our POS customers, and we agreed to pricingdiscounts in exchange for maintaining or increasing their minimum transactionor revenue commitments. As a result, it is likely our revenue per transactionwill decrease and, depending upon the number of transactions we transport, ourPOS revenues may continue to decrease. In addition, based upon the current status of negotiations, we believethat revenues and related transaction volumes from our largest customer willcontinue to decline in the fourth quarter of 2004 and may decline furtherthereafter.

 

***Internationalservices division.***  Revenues from the international servicesdivision increased $22.1 million, or 66.7%, to $55.2 million for thenine months ended September 30, 2004, from $33.1 million for the ninemonths ended September 30, 2003. The increase was primarily due toadditional revenues generated from our POS customers in the U.K., Australia,France, Spain and Italy and to a lesser extent we benefited from favorableforeign exchange. Included in revenues and cost of sales for the nine monthsended September 30, 2004 is $1.4 million associated with the sale ofequipment in Australia.   Revenues fromour U.K. subsidiary increased $10.2 million, or 43.6%, to $33.7 millionfor the nine months ended September 30, 2004, from $23.5 million forthe nine months ended September 30, 2003.

 

***Telecommunicationservices division.***  Revenues from the telecommunication servicesdivision increased $3.7 million, or 17.2%, to $25.4 million for thenine months ended September 30, 2004, from $21.7 million for the ninemonths ended September 30, 2003. The growth in revenues was primarily dueto increased usage of our call signaling services.

 

***Financialservices division.***  Revenues from the financial services divisionincreased $3.5 million, or 23.6%, to $18.6 million for the ninemonths ended September 30, 2004, from $15.1 million for the ninemonths ended September 30, 2003. The increase in revenues was due to thegrowth in the number of customer connections to and through our networks.

 

***Cost of networkservices.***  Cost of network services increased$4.0 million, or 4.6%, to $91.2 million for the nine months ended September 30,2004, from $87.1 million for the nine months ended September 30,2003. Cost of network services were 49.1% of revenues for the nine months endedSeptember 30, 2004, compared to 53.8% of revenues for the nine monthsended September 30, 2003. The increase in cost of network servicesresulted primarily from higher usage charges from our TSD, FSD and ISDservices, offset primarily by a decrease in usage–based vendortelecommunications charges in our POS division, and to a lesser extent, lowerusage charges from decreased POS transactions. Included in revenues and cost of sales for the nine months ended September 30,2004 is $1.4 million associated with the sale of equipment in Australia.  Gross profit represented 50.9% of totalrevenues for the nine months ended September 30, 2004, compared to 46.2%for the nine months ended September 30, 2003. The increase in gross profitas a percentage of total revenues resulted primarily from increasedcontribution of our financial services division and international servicesdivision, and to a lesser extent the decrease in usage–based vendortelecommunications charges.

 

Future cost of network services depends on anumber of factors including total transaction and query volume, the relativegrowth and contribution to total transaction volume of each of our customers,the success of our new service offerings, the 

 

19

----

 

timing and extent of our network expansion and the timingand extent of any network cost reductions. In addition, any significant loss orsignificant reduction in transaction volumes could lead to a decline in grossmargin since significant portions of our network costs are fixed costs.

 

***Engineering anddevelopment expense.***  Engineering and development expense increased$2.3 million, or 27.4%, to $10.7 million for the nine months ended September 30,2004, from $8.4 million for the nine months ended September 30, 2003.Engineering and development expense represented 5.8% of revenues for the ninemonths ended September 30, 2004 and 5.9% of revenues for the nine monthsended September 30, 2003. Engineering and development expense increasedprimarily from an increase in engineering expenses required to support ourinternational expansion.

 

***Selling,general and administrative expense.***  Selling, general and administrative expenseincreased $9.0 million, or 32.6%, to $36.5 million for the ninemonths ended September 30, 2004, from $27.5 million for the nine monthsended September 30, 2003. Selling, general and administrative expenserepresented 19.7% of revenues for the nine months ended September 30,2004, compared to 18.6% of revenues for the nine months ended September 30,2003. Selling, general and administrative expense increased primarily from theexpenses required to support our revenue growth, mainly within theinternational services division, and to a lesser extent, the incremental costsnecessary to operate as a public company.

 

***Depreciationand amortization of property and equipment.***  Depreciation and amortization of property andequipment increased $0.2 million to $14.7 million for the nine monthsended September 30, 2004, from $14.5 million for the nine monthsended September 30, 2003. Depreciation and amortization of property andequipment represented 7.9% of revenues for the nine months ended September 30,2004, compared to 9.0% of revenues for the nine months ended September 30,2003.

 

***Amortization ofintangible assets.***  Amortization of intangible assets increased$2.0 million, or 10.6%, to $20.9 million for the nine months ended September 30,2004, from $18.9 million for the nine months ended September 30,2003. The amortization of intangible assets for the nine months ended September 30,2004 and 2003 relates solely to the intangible assets resulting fromacquisitions. The increase was attributable to the accelerated amortization ofa portion of our customer relationship intangible asset in connection with theloss of two POS customers during the first quarter of 2004. For purposes ofmeasuring and recognizing impairment of long–lived assets includingintangibles, we assess whether separate cash flows can be attributed to theindividual asset. For our customer relationship intangible assets, we recognizeand measure impairment upon the termination or loss of a customer that resultsin a loss of revenue. Based upon the current status of contract negotiationswith our largest customer, we believe that revenues and related transactionvolumes from this customer will continue to decline in the fourth quarter of2004 and may decline further thereafter. The intangible asset valueattributable to this customer relationship is approximately $25.5 millionas of September 30, 2004. We will continue to assess the recoverability ofthis customer relationship asset based upon anticipated future cash flows.

 

***Interestexpense.***  Interest expense decreased $2.1 millionto $6.5 million for the nine months ended September 30, 2004, from$8.6 million for the nine months ended September 30, 2003. Thisdecrease was primarily due to the repayment of a portion of our term debt withthe net proceeds from our initial public offering on March 16, 2004,partially offset by the write–off on March 19, 2004 of $2.0 millionof deferred financing costs in connection with the termination of our previoussenior secured credit facility.

 

***Interest andother income, net.***  Interest and other income, net was $0.4 millionfor the nine months ended September 30, 2004 compared to $1.7 millionfor the nine months ended September 30, 2003. Included in other income,net for the nine months ended September 30, 2004 is a loss on foreigncurrency translation of $4,000 due to fluctuations in the value of the U.S.dollar as compared with foreign currencies, predominately, the euro, theBritish pound and the Australian dollar, versus a gain on foreign currencytranslation of $1.0 million for the nine months ended September 30,2003.  Also included in other income, netfor the nine months ended September 30, 2004 is a $0.2 million gain on thesale of property and equipment, versus a loss of $29,000 for the nine monthsended September 30, 2003.  Includedin interest and other income, net for the nine months ended September 30,2003 was a gain of $0.6 million on the sale of our equity methodinvestment in a related entity.

 

***Income taxprovision.***  For the nine months ended September 30,2004, our income tax provision was $2.3 million compared to $0.6 millionfor the nine months ended September 30, 2003.  Our effective tax rate for the nine monthsended September 30, 2004 is 41.3% versus the U.S. federal statutory taxrate of 35.0%, due primarily to the fact that we have losses from certain ofour international subsidiaries that cannot be used to offset income in otherjurisdictions.

 

20

----

 

**Seasonality**

 

Credit card and debit card transactions accountfor a major percentage of the transaction volume processed by our customers.The volume of these transactions on our networks generally is greater in thethird and fourth quarter vacation and holiday seasons than during the rest ofthe year. Consequently, revenues and earnings from credit card and debit cardtransactions in the first quarter generally are lower than revenues andearnings from credit card and debit card transactions in the third and fourthquarters of the immediately preceding year. We expect that our operatingresults in the foreseeable future will be significantly affected by seasonaltrends in the credit card and debit card transaction market.

 

**Liquidity and Capital Resources**

 

Our primary liquidity and capital resource needsare to finance the costs of our operations, to make capital expenditures and toservice our debt. The proceeds from our initial public offering inMarch 2004, along with the proceeds from borrowings under our new seniorsecured credit facility, were used to repay the amounts outstanding under ourprevious senior secured credit facility. Based upon our current level ofoperations, we expect that our cash flow from operations, together with theamounts we are able to borrow under our existing credit facility, will beadequate to meet our anticipated needs for the foreseeable future. Although wehave no specific plans to do so, to the extent we decide to pursue one or moresignificant strategic acquisitions, we will likely need to incur additionaldebt or sell additional equity to finance those acquisitions.

 

Our operations provided us cash of$34.0 million for the nine months ended September 30, 2004, which wasattributable to net income of $2.6 million, depreciation, amortization andother non–cash charges of $36.5 million and a decrease in working capitalof $5.1 million. Our operations provided us cash of $30.0 million forthe nine months ended September 30, 2003, which was attributable to a netloss of $2.0 million, depreciation, amortization and other non–cashcharges of $34.5 million and a decrease in working capital of$2.5 million.

 

We used cash of $29.8 million in investingactivities for the nine months ended September 30, 2004, which includescapital expenditures of $16.4 million. In addition, we spent$6.1 million and $3.7 million, respectively to purchase the Synapseand vending assets from USWD to facilitate our objective to enhance our POSservices. We also made investments for $2.5 million in WAY Systems, Inc., acompany that provides mobile POS transaction infrastructure and solutions tomobile merchants, and $1.0 million in AK Jensen Group, Limited, a company thatprovides order–routingsystems and integrated electronic trading solutions to financial softwarecompanies and end–clients.  We used cash of $13.2 million ininvesting activities for the nine months ended September 30, 2003, whichconsisted primarily of capital expenditures of $11.1 million, and inaddition we spent $2.0 million in January 2003 to purchase theremaining 49.9% interest of Openet S.r.l., an Italian provider of POS services.Significant portions of our capital expenditures in each period were fornetwork equipment, third–party software and capitalized software developmentcosts we incurred to expand our network platforms and service our customerrequirements. Our remaining capital expenditures were for office equipment andleasehold improvements and for general corporate purposes. We currently have nosignificant capital spending or purchase commitments but expect to continue toengage in capital spending in the ordinary course of business.

 

We used cash of $2.7 million for financingactivities for the nine months ended September 30, 2004, which includes$8.2 million of long–term debt repayments on our new senior secured creditfacility and $150.4 million of long–term debt repayments under ourprevious senior secured credit facility with the net proceeds generated fromour IPO in March 2004 of $71.5 million and borrowings under our newcredit facility, net of financing costs, of $79.0 million. We alsoborrowed $5.5 million in May 2004 under our new credit facility, theproceeds of which were used to fund the acquisition of the Synapse assets fromUSWD. We used cash of $13.5 million for financing activities for the ninemonths ended September 30, 2003, which consisted primarily of$13.0 million of long–term debt repayments.

 

In October and November 2004, we used the netproceeds from our follow–on offering to repay the outstanding borrowings underour Revolving Credit Facility.  As ofNovember 1, 2004, total debt outstanding is $56.8 million.

 

21

----

 

***Senior SecuredCredit Facility***

 

On March 19, 2004, we entered into a newsenior secured credit facility (the Credit Facility) to replace our existingsenior secured credit facility. The Credit Facility consists of a$65.0 million term loan (Term Loan) and a revolving credit facility of $30.0 million(Revolving Credit Facility). The Credit Facility matures March 19, 2009.Payments on the Term Loan are due in quarterly installments over the five–yearterm, beginning on March 31, 2004.

 

As of September 30, 2004, total remainingpayments on the Term Loan are as follows (in thousands):

 
| Three months ending December 31, 2004 |   | $      | 2,750  |   |
|---------------------------------------|--------|--------|--------|--------|
| 2005                                  |   | 12,000 |   |
| 2006                                  |   | 13,000 |   |
| 2007                                  |   | 14,000 |   |
| 2008                                  |   | 15,000 |   |
|                                  |   | $      | 56,750 |   |
|                                       |        |        |        |        |  |

 

For the period through June 30, 2004,borrowings on the Revolving Credit Facility and the Term Loan generally boreinterest at a rate of 2.50 percent over the LIBOR rate.  For the period from July 1, 2004 through September 30,2004, borrowings on the Revolving Credit Facility and the Term Loan boreinterest at a rate of 2.25 percent over the LIBOR rate (4.14 percent as ofSeptember 30, 2004). Thereafter, if we achieve a leverage ratio of lessthan one, the borrowings on the Revolving Credit Facility and the Term Loanwill generally bear interest at a rate, at our option, of either 0.75 percentover the lender’s base rate or 2.0 percent over the LIBOR rate. If weachieve a leverage ratio of less than 1.5 but more than or equal to one, theborrowings on the Revolving Credit Facility and the Term Loan will generallybear interest at a rate, at our option, of either 1.0 percent over thelender’s base rate or 2.25 percent over the LIBOR rate. If we achieve aleverage ratio of less than 2.2 but more than or equal to 1.5, the borrowingson the Revolving Credit Facility and the Term Loan will generally bear interestat a rate, at our option, of either 1.25 percent over the lender’s baserate or 2.5 percent over the LIBOR rate. Our leverage ratio as of September 30,2004 was 1.3 to 1.0. The Revolving Credit Facility is subject to an annualcommitment fee in an amount equal to 0.5 percent per annum multiplied bythe amount of funds available for borrowing under the Revolving CreditFacility. Interest payments on the Credit Facility are due monthly, bimonthly,or quarterly at our option.

 

The terms of the Credit Facility require us tocomply with financial and nonfinancial covenants, including maintaining certainleverage, interest and fixed charge coverage ratios at the end of each fiscalquarter. As of September 30, 2004, we are required to maintain a leverageratio of less than 2.2 to 1.0, an interest coverage ratio of greater than 5.0to 1.0 and a fixed charge ratio of greater than 1.5 to 1.0. Certain of thefinancial covenants will become more restrictive over the term of the CreditFacility. The Credit Facility also contains nonfinancial covenants thatrestrict some of our corporate activities, including our ability to dispose ofassets, incur additional debt, pay dividends, create liens, make investments,make capital expenditures and engage in specified transactions with affiliates.Our future results of operations and our ability to comply with the covenantscould be adversely impacted by increases in the general level of interest ratessince the interest on a majority of our debt is variable. Noncompliance withany of the financial or nonfinancial covenants without cure or waiver wouldconstitute an event of default under the Credit Facility. An event of defaultresulting from a breach of a financial or nonfinancial covenant may result, atthe option of the lenders, in an acceleration of the principal and interestoutstanding, and a termination of the Revolving Credit Facility. The CreditFacility also contains other customary events of default, including defaultsbased on events of bankruptcy and insolvency, nonpayment of principal, interestor fees when due, subject to specified grace periods, breach of specifiedcovenants, change in control and material inaccuracy of representations andwarranties. We are in compliance with our financial and nonfinancial covenantsas of September 30, 2004.

 

In connection with the closing of the CreditFacility in March 2004, we incurred approximately $2.0 million infinancing costs. These financing costs were deferred and are being amortizedusing the effective interest method over the life of the Credit Facility. Inconnection with the termination of the prior credit facility, we wrote–offapproximately $2.0 million of unamortized deferred financing costs relatedto the prior credit facility. Such write–off has been included in interestexpense in the accompanying condensed consolidated statement of operations forthe nine months ended September 30, 2004.

 

In October and November 2004, we used the netproceeds from our follow–on offering to repay the outstanding borrowings underour Revolving Credit Facility.  As ofNovember 1, 2004, total debt outstanding is $56.8 million.

 

22

----

 

**Other Matters**

 

TheFinancial Accounting Standards Board has issued a proposed standard related toShare–Based Payments that, upon implementation, would adversely impact our netearnings and earnings per share, but would not be expected to impact our cashfrom operations. The proposed standard would require stock options and othershare–based payments made to employees to be accounted for as compensationexpense and recorded at fair value. While many technical issues are yet to beresolved, including the selection and use of an appropriate valuation model,information about the fair value of stock options under the Black–Scholes modeland its pro forma impact on our net earnings and earnings per share for thequarter and nine months ended September 30, 2004 (which may differ fromthe ultimate impact of the proposed new standard) can be found in Note 1 to thecondensed consolidated financial statements in this Form 10–Q.

 

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

 

***Interest rates***

 

Our principal exposure to market risk relates tochanges in interest rates. As of September 30, 2004, we had$78.3 million outstanding under our new senior secured credit facilitywith interest rates tied to changes in the lender’s base rate or the LIBORrate. Based upon the outstanding borrowings on September 30, 2004 andassuming repayment of the Term Loan in accordance with scheduled maturities,each 1.0% increase in these rates could add an additional $0.8 million toour annual interest expense.

 

As of September 30, 2004, we did not holdderivative financial or commodity instruments and all of our cash and cashequivalents were held in money market or commercial accounts.

 

***Foreigncurrency risk***

 

Our earnings are affected by fluctuations in thevalue of the U.S. dollar as compared with foreign currencies, predominately theeuro, the British pound and the Australian dollar due to our operations inEurope and Australia.

 

We provide services in 12 countries outside of theU.S., including the United Kingdom, Australia, Canada, France, Germany,Ireland, Italy, Japan, The Netherlands, New Zealand, Spain and Sweden. Wemanage foreign exchange risk through the structure of our business. In thesubstantial majority of our transactions, we receive payments denominated inthe U.S. dollar, British pound, euro or Australian dollar. Therefore, we do notrely on international currency markets to obtain and pay illiquid currencies.The foreign currency exposure that does exist is limited by the fact that themajority of transactions are paid according to our standard payment terms,which are generally short–term in nature. Our policy is not to speculate inforeign currencies, and we promptly buy and sell foreign currencies asnecessary to cover our net payables and receivables, which are denominated inforeign currencies. For the nine months ended September 30, 2004, werecorded a loss on foreign currency translation of approximately $4,000.

 

23

----

 

**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 Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms, and that such information is accumulated and communicated to theCompany’s management, including its Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management necessarily was required to applyits judgment in evaluating the cost–benefit relationship of possible controlsand 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 September 30, 2004. Based on the foregoing, the Company’sChief Executive Officer and principal financial officers concluded that theCompany’s disclosure controls and procedures were effective as of September 30,2004.

 

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

 

**Audit Committee Pre–Approval**

 

Our audit committee has resolved to pre–approveall audit and non–audit services to be performed for us by our independentauditors, Ernst & Young LLP. Non–audit services that have received pre–approvalinclude tax preparation and related tax consultation and advice, review andsupport for securities issuances and acquisition assistance.

##### ** **

##### **24**

##### ****

##### ** **

 

**PART II—OTHER INFORMATION**

 

**Item1.    Legal Proceedings**

 

We are party to various legal proceedings in thenormal course of business. Please see the description under the caption “LegalProceedings” in the prospectus filed with the Commission on September 28,2004 (File No. 333-118301).

 

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

 

None.

 

**Item 3.    Default Upon SeniorSecurities**

 

None.

 

**Item 4.    Submission of Mattersto a Vote of Security Holders**

 

None

 

**Item5.    Other Information**

 

None.

 

##### **Item 6.    Exhibits**

 

(31.1)      Certification—ChiefExecutive Officer

 

(31.2)      Certification—ChiefFinancial Officer

 

(32.1)      WrittenStatement of Chief Executive Officer and Chief Financial Officer

 

** **

**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: November 15, 2004 | By:                   | /s/ JOHN J. MCDONNELL,  JR.  |
|                         |                  | John J. McDonnell, Jr.Chairman and Chief  Executive Officer |
|                         |                  |   |
| Date: November 15, 2004 | By:                   | /s/ HENRY H. GRAHAM,  JR. |
|                         |                  | Henry H. Graham, Jr.Chief Financial Officer |

 

 

26

----