**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

** **

**FORM 10-Q/A(Amendment No. 1)**

 

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGEACT OF 1934**

** **

**For the quarter ended March 31,2006**

** **

** **

**Commission File Number:001-32033**

** **

** **

**TNS, INC.**

(Exact name of registrant as specified in its charter)

 

 

| **DELAWARE**                                               |   | **36-4430020**                           |
|------------------------------------------------------------|--------|------------------------------------------|
| (State or  jurisdiction of incorporation or organization)  |   | (I.R.S. Employer  Identification Number) |
|                                                       |   |                                     |
| **11480  Commerce 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) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirement for the past 90 days. ý Yes    o No

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.

Large accelerated filer   o                                  Acceleratedfiler   x           Non-accelerated filer   o

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

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

 
| **Shares Outstanding as of  April 1, 2006**     |
|------------------------------------------------------|
| 24,088,008  Shares of Common Stock, $0.001 par value |

 

 

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** **

**TNS, INC.**

**INDEX**

| **EXPLANATORY NOTE**                    |   | 3            |
|-----------------------------------------|--------|--------------|
| ** **                              |   |         |
| **Part I:  FINANCIAL INFORMATION** |   | 4            |
|                                    |   |         |   |   |   |   |
|                                    |   | Item 1. |   | Condensed Consolidated Financial Statements  (Unaudited) |   | 4 |
|                                    |   |         |   | Condensed Consolidated Balance Sheets as of  December 31, 2005 and March 31, 2006 |   | 4 |
|                                    |   |         |   | Condensed Consolidated Statements of Operations for  the three months ended March 31, 2005 and 2006 |   | 5 |
|                                    |   |         |   | Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 2005 and 2006 |   | 6 |
|                                    |   |         |   | Notes to Condensed Consolidated Financial Statements |   | 7 |
|                                    |   | Item 2. |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |   | 16 |
|                                    |   | Item 3. |   | Quantitative and Qualitative Disclosures About Market  Risk |   | 22 |
|                                    |   | Item 4. |   | Controls and Procedures |   | 23 |
|                                    |   |         |   |   |   |   |
| **Part II:  OTHER INFORMATION**    |   | 24           |
|                                    |   |         |   |   |   |   |
|                                    |   | Item 1. |   | Legal  Proceedings |   | 24 |
|                                    |   | Item 2. |   | Changes in Securities, Use of Proceeds and Issuer  Purchases of Equity Securities |   | 24 |
|                                    |   | Item 3. |   | Default Upon Senior Securities |   | 24 |
|                                    |   | Item 4. |   | Submission of Matters to a Vote of Security Holders |   | 24 |
|                                    |   | Item 5. |   | Other  Information |   | 24 |
|                                    |   | Item 6. |   | Exhibits |   | 24 |

 

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EXPLANATORY NOTE

 

TNS, Inc. (“Registrant”) isfiling this Amendment No. 1 on Form 10-Q/A to its Quarterly Report on Form 10-Qfor the fiscal quarter ended March 31, 2006 (“Original Filing”) solely for thepurpose of amending and re-filing Exhibits 31.1 and 31.2 of the Original Filingto conform such officer certifications to the current requirements set forth inItem 601(b)(31) of Regulation S-K of the Securities and Exchange Act of 1934,as amended.  In the Original Filing, theRegistrant inadvertently omitted the required language concerning theRegistrant’s internal control over financial reporting.  As requested by the Securities and ExchangeCommission, this Amendment No. 1 sets forth the Original Filing in itsentirety, as amended.   No othermodifications or changes have been made to the Original Filing other than correcting a typographical errorcontained in Exhibit 32.1.

 

This Amendment No. 1 doesnot reflect events occurring after the filing of the Original Filing and doesnot modify or update the disclosure in the Original Filing.

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**PART I—FINANCIALINFORMATION**

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

**TNS, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(dollars in thousands, except share and per share data)**
| ** **                                                                                                                                                                                               | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                                               | ** ** | ** **                  | ** ** | **(unaudited)**          | ** ** |
| **ASSETS**                                                                                                                                                                                               | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Current assets:                                                                                                                                                                                          |       |                        |       |                     |       |
| Cash and cash equivalents                                                                                                                                                                                |       | $                           | 26,628     |                     | $          | 18,123 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $5,260 and $5,793, respectively                                                                                                     |       | 48,773                      |       | 53,234                   |       |
| Prepaid expenses                                                                                                                                                                                         |       | 4,407                       |       | 4,207                    |       |
| Deferred tax assets                                                                                                                                                                                      |       | 5,236                       |       | 2,898                    |       |
| Other current assets                                                                                                                                                                                     |       | 5,813                       |       | 7,331                    |       |
| Total current assets                                                                                                                                                                                     |       | 90,857                      |       | 85,793                   |       |
| Property and  equipment, net                                                                                                                                                                             |       | 52,448                      |       | 53,483                   |       |
| Identifiable  intangible assets, net                                                                                                                                                                     |       | 187,233                     |       | 200,684                  |       |
| Goodwill                                                                                                                                                                                                 |       | 5,160                       |       | 6,228                    |       |
| Other assets                                                                                                                                                                                             |       | 16,486                      |       | 18,616                   |       |
| Total assets                                                                                                                                                                                             |       | $                           | 352,184    |                     | $          | 364,804 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                           |       |                        |       |                     |       |
| Current liabilities:                                                                                                                                                                                     |       |                        |       |                     |       |
| Current portion of long-term debt                                                                                                                                                                        |       | $                           | —     |                     | $          | 413 |   |
| Accounts payable, accrued expenses and other current  liabilities                                                                                                                                        |       | 46,933                      |       | 49,623                   |       |
| Deferred revenue                                                                                                                                                                                         |       | 10,810                      |       | 13,227                   |       |
| Total current liabilities                                                                                                                                                                                |       | 57,743                      |       | 63,263                   |       |
| Long-term debt,  net of current portion                                                                                                                                                                  |       | 113,448                     |       | 119,035                  |       |
| Other  liabilities                                                                                                                                                                                       |       | 3,147                       |       | 3,555                    |       |
| Total liabilities                                                                                                                                                                                        |       | 174,338                     |       | 185,853                  |       |
| Commitments  and contingencies                                                                                                                                                                           |       |                        |       |                     |       |
| Stockholders’ equity:                                                                                                                                                                               |       |                        |       |                     |       |
| Common stock, $0.001 par value; 130,000,000 shares  authorized; 23,998,715 shares issued and 23,971,001 shares outstanding and  24,115,963 shares issued and 24,088,008 shares outstanding, respectively |       | 24                          |       | 24                       |       |
| Treasury stock, 27,714 shares and 27,955  shares, respectively                                                                                                                                           |       | (517                        | )          | (522                     | )          |
| Additional paid-in capital                                                                                                                                                                               |       | 217,434                     |       | 211,756                  |       |
| Accumulated deficit                                                                                                                                                                                      |       | (31,567                     | )          | (32,034                  | )          |
| Deferred stock compensation                                                                                                                                                                              |       | (7,150                      | )          | —                   |       |
| Accumulated other comprehensive loss                                                                                                                                                                     |       | (378                        | )          | (273                     | )          |
| Total stockholders’ equity                                                                                                                                                                          |       | 177,846                     |       | 178,951                  |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                         |       | $                           | 352,184    |                     | $          | 364,804 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

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**TNS, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)(dollars in thousands, except share and per share data)**
| ** **                                                                                                                              | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Revenues                                                                                                                                |       | $                                                | 63,132     |   | $ | 65,908 |   |
| Operating expenses:                                                                                                                     |       |                                             |       |   |   |
| Cost of network services, exclusive of the items  shown separately below                                                                |       | 30,230                                           |       | 33,057 |   |
| Engineering and development                                                                                                             |       | 3,906                                            |       | 4,535 |   |
| Selling, general, and administrative                                                                                                    |       | 13,094                                           |       | 16,126 |   |
| Depreciation and amortization of property and  equipment                                                                                |       | 4,863                                            |       | 5,027 |   |
| Amortization of intangible assets                                                                                                       |       | 6,265                                            |       | 4,931 |   |
| Total operating expenses                                                                                                                |       | 58,358                                           |       | 63,676 |   |
| Income from  operations                                                                                                                 |       | 4,774                                            |       | 2,232 |   |
| Interest expense                                                                                                                        |       | (811                                             | )          | (2,032 | ) |
| Interest income                                                                                                                         |       | 116                                              |       | 118 |   |
| Other (expense)  income, net                                                                                                            |       | (304                                             | )          | 190 |   |
| Income before  income taxes, equity in net loss of unconsolidated affiliates and cumulative  effect of a change in accounting principle |       | 3,775                                            |       | 508 |   |
| Income tax  (provision) benefit                                                                                                         |       | (1,905                                           | )          | 15 |   |
| Equity in net  loss of unconsolidated affiliates                                                                                        |       | (416                                             | )          | (1,074 | ) |
| Income (loss)  from continuing operations before cumulative effect of a change in accounting  principle                                 |       | 1,454                                            |       | (551 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                            |       | —                                           |       | 84 |   |
| Net income  (loss)                                                                                                                      |       | 1,454                                            |       | (467 | ) |
| Basic net income  (loss) per common share                                                                                               |       | $                                                | 0.05       |   | $ | (0.02 | ) |
| Diluted net  income (loss) per common share                                                                                             |       | $                                                | 0.05       |   | $ | (0.02 | ) |
| Basic weighted  average common shares outstanding                                                                                       |       | 28,007,946                                       |       | 23,990,356 |   |
| Diluted weighted  average common shares outstanding                                                                                     |       | 28,384,837                                       |       | 23,990,356 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

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**TNS, INC.CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)(dollars in thousands)**
| ** **                                                                                 | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                             | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                     |       |                                                 |       |   |   |
| Net income  (loss)                                                                         |       | $                                                    | 1,454      |   | $ | (467 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by  operating activities: |       |                                                 |       |   |   |
| Non-cash and working capital items                                                         |       | 13,691                                               |       | 10,459 |   |
| Net cash  provided by operating activities:                                                |       | 15,145                                               |       | 9,992 |   |
| Cash flows from  investing activities:                                                     |       |                                                 |       |   |   |
| Purchases of property and equipment                                                        |       | (4,136                                               | )          | (5,093 | ) |
| Cash paid for business acquisitions, net of cash  acquired                                 |       | —                                               |       | (19,628 | ) |
| Investments in unconsolidated affiliates                                                   |       | (2,802                                               | )          | — |   |
| Net cash used in  investing activities:                                                    |       | (6,938                                               | )          | (24,721 | ) |
| Cash flows from  financing activities:                                                     |       |                                                 |       |   |   |
| Borrowings under amended and restated senior secured  credit facility                      |       | —                                               |       | 6,000 |   |
| Repayment of long-term debt                                                                |       | (3,000                                               | )          | — |   |
| Payment of long-term debt financing costs                                                  |       | (75                                                  | )          | — |   |
| Proceeds from stock option exercises, inclusive of tax benefit                             |       | 14                                                   |       | 176 |   |
| Purchase of treasury stock                                                                 |       | (462                                                 | )          | (5 | ) |
| Net cash (used  in) provided by financing activities:                                      |       | (3,523                                               | )          | 6,171 |   |
| Effect of  exchange rates on cash and cash equivalents                                     |       | 89                                                   |       | 53 |   |
| Net increase  (decrease) in cash and cash equivalents                                      |       | 4,773                                                |       | (8,505 | ) |
| Cash and cash  equivalents, beginning of period                                            |       | 19,788                                               |       | 26,628 |   |
| Cash and cash  equivalents, end of period                                                  |       | $                                                    | 24,561     |   | $ | 18,123 |   |
| Supplemental  disclosures of cash flow information:                                        |       |                                                 |       |   |   |
| Cash paid for interest                                                                     |       | $                                                    | 682        |   | $ | 21 |   |
| Cash paid for  income taxes                                                                |       | $                                                    | 913        |   | $ | 3,467 |   |

 

See accompanying notes to condensed consolidatedfinancial statements (unaudited).

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

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

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

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

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

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

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

**Stock Repurchase and Offerings of Common Stock**

On May 4, 2005, theCompany purchased and retired 6,263,435 shares of its common stock, pursuant toa modified Dutch auction tender offer, for $18.50 per share plus expenses ofapproximately $1.0 million. Of the shares tendered, 6 million shareswere tendered by the Company’sthen controlling stockholder, GTCR GolderRauner L.L.C. and its affiliated investment funds (“GTCR”).

On September 21, 2005, the Company completed afollow-on offering of common stock issuing 1,200,000common shares at $23.25 per share, which generated proceeds, net of offeringcosts, of approximately $26.1 million. On September 21, 2005, inconnection with the following-on offering, the underwriters exercised theirover-allotment option and the Companyissued an additional 900,000 shares of common stock at $23.25 per share, which generatedproceeds net of offering costs of approximately $20.0 million. The net proceeds from thefollow-on offering were used torepay a portion of the Company’s long-term debt outstanding under its existingcredit-facility.

**Use of Estimates**

The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of certain assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements. Significantestimates affecting the consolidated financial statements include management’sjudgments regarding the allowance for doubtful accounts,future cash flows from long-lived assets, accrued expenses for probable lossesand estimates related to the fair value of our employee stock options,including volatility, expected term and estimates of forfeitures in future periods.Actual results could differ from those estimates.

**Revenue Recognition**

The Company recognizes revenue when persuasiveevidence of an agreement exists, the terms are fixed or determinable, servicesare performed, and collection is probable. Cash received in advance of revenuerecognition is recorded as deferred revenue. POS services revenue is derivedprimarily from the transmission of transaction data through our networksbetween payment processors and POS or ATM terminals. Telecommunication servicesrevenue is derived primarily from fixed monthly recurring fees for our callsignaling services and per query fees charged for our database access andvalidation services. Financial services revenue is derived primarily frommonthly recurring fees based on the number of customer connections to andthrough our networks. Customer incentives granted to new customers or uponcontract renewals are deferred and recognized ratably as a reduction of revenueover the contract period to the extent that the incentives are recoverable againstthe customer’s minimum purchase commitments under

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the contract. Inaddition, the Company receives installation fees related to the configurationof the customer’s systems. Revenue from installation fees are deferred andrecognized ratably over the customer’s contractual service period, generallythree years. The Company performs periodic evaluations of our customer base andestablishes allowances for estimated credit losses.

**Cost of Network Services**

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

**Stock-Based Compensation**

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R,“Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method. SFAS 123Rrequires all stock-based compensation to employees be measured at fair valueand expensed over the requisite service period and also requires an estimate offorfeitures when calculating compensation expense. The Company recognizescompensation cost on awards with graded vesting on a straight-line basis overthe requisite service period for the entire award. In accordance with theCompany’s chosen method of adoption, results for prior periods have not been restated. Share-based expenses for all non-vested awards as ofJanuary 1, 2006, will be recognized based on the grant date fair valueestimated in accordance with the provisions of SFAS 123 and in accordancewith SFAS 123R for all awards granted after January 1, 2006. Priorto the adoption of SFAS 123R, the Company followed Accounting Principles Board(“APB”) Opinion No. 25, whichaccounts for share-based payments to employees using the intrinsic value methodand, as such, the Company generallyrecognized no compensation cost for employee stock options. Refer to Note 7 foradditional discussion regarding details of the Company’s stock-basedcompensation plans and the adoption of SFAS 123R.

**Income Taxes**

The Company accounts for income taxes in accordancewith SFAS 109, “Accounting for Income Taxes.” Under SFAS 109, deferred taxassets or liabilities are computed based upon the difference between financialstatement and income tax bases of assets and liabilities using the enacted marginaltax rate. The Company provides a valuation allowance on its net deferred taxassets when it is more likely than not that such assets will not be realized.Deferred income tax expense or benefits are based upon the changes in the assetor liability from period to period.

For the three months ended March 31, 2005 and 2006,the Company’s effective tax rate was approximately 50.4% and 3.0%,respectively. The Company’s tax rate fluctuates from the U.S. Federal statutorytax rate of 34.0% as a result of lower tax rates in certain internationaljurisdictions in which the Company has operations and losses in certainjurisdictions that cannot be used to offset income in other jurisdictions.

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

**Acquisition of CommsXL**

On January 6,2006, we completed the acquisition of two companies in the United Kingdom,CommsXL Services and CommsXL Limited (collectively, CommsXL). Pursuant to twoseparate purchase agreements, the Company paid approximately $11.7 million, including directacquisition costs of approximately $0.3 million for certain assetsrelated to CommsXL. We purchased these companies to advance our end-to-end POSservice offerings in the United Kingdom as well as to penetrate new verticalmarkets.

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

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

 

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The amounts allocated to the customer relationships,developed technology and to the non-compete agreements are being amortized on astraight-line basis over their estimated useful life of five years, five yearsand three years, respectively. Unaudited pro forma results of operations arenot provided because the historical operating results were not significant andpro forma results would not be significantly different from reported resultsfor the periods presented. The Company’s results of operations for the threemonths ended March 31, 2006 include the operating results of theseacquisitions from January 6, 2006.

**Acquisition of InfiniRoute Assets**

On February 28,2006, the Company acquired certain tangible and intangible assets from InfiniRoute Networks, Inc.for a purchase price of approximately $2.5 million. The assets acquired includethe right to provide TSD services under customer contracts, developedtechnology, certain fixed assets and a non-compete agreement. The Companypurchased these assets to advance its TSD service offerings to enable traditionaltelecommunications carriers and next-generation service providers tointerconnect directly over Internet Protocol (IP) packet networks, reducing thecost and complexity associated with these interconnections.

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

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

 

The amounts allocated to the customerrelationships, developed technology and to the non-compete agreements are beingamortized on a straight-line basis over their estimated useful lives of three years. Unaudited proforma results of operations are not provided because the historical operatingresults were not significant and pro forma results would not be significantlydifferent from reported results for the periods presented. The Company’sresults of operations for the three months ended March 31, 2006 includethe operating results of this acquisition from March 1, 2006.

**Acquisition of Sonic Assets**

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

The purchase price for the Sonic assets was allocated, on apreliminary basis, as follows (in thousands):

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

 

The amounts allocated to the customerrelationships, developed technology and to the non-compete agreements are beingamortized on a straight-line basis over their estimated useful life of fiveyears, five years and three years, respectively. Unaudited pro forma results ofoperations are not provided because the historical operating results were notsignificant and pro forma results would not be significantly different fromreported results for the periods presented. The Company’s results of operationsfor the three months ended March 31, 2006 include the operating results ofthisacquisition from March 1,2006.

**Way Systems Investment**

In August 2004, TNS made an investment in WAYSystems, Inc. (WAY), which provides mobile POS transaction infrastructureand solutions for mobile merchants. TNS purchased 5,952,381 shares or 38.5percent of WAY’s Series B convertible preferred stock for $2.5 million andbecame entitled to representation on WAY’s board of directors. As of 

9

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December 31,2004, TNS owned 18.1 percent of WAY’s total outstanding shares. In March 2005,TNS made an additional investment of $0.8 million to purchase 1,910,401 sharesof WAY’s Series B convertible preferred stock for an additional 1.9percent of WAY’s outstanding shares. In July 2005, TNS made anadditional investment of $0.7 million in exchange for a convertible notebearing interest at a rate of 8 percent per annum and due January 1, 2009.In September 2005, TNS exercised its right on the convertible note toconvert the outstanding principal and accrued interest of approximately $0.8million to 1,185,085 shares of WAY’s Series C convertible preferred stockand made an additional investment of $1.1 million to purchase 1,676,429 sharesof WAY’s Series C convertible preferred stock. The Company owned 17.0percent of Way’s outstanding shares as of March 31, 2006. TheCompany is accounting for its investment under the equity method of accountingas the Company has significant influence over the financing and operatingactivities of WAY through its representation on the board of directors. Due totiming of the receipt of WAY’s financial statements, the Company is accountingfor the income or loss in this equity method investment on a one-month lag. For the three months endedMarch 31, 2005 and 2006, the Company recognized a net loss in the equityof an unconsolidated affiliate relatedto its investment in WAY  of approximately $0.3 million and$0.5 million, respectively.

Summarized financial information for the Company’sinvestment in WAY is as follows (in thousands):

|                         | ** ** | **December 31, 2005** | ** ** | **March 31, 2006** | ** ** |
|-------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **              | ** ** | ** **                      | ** ** | **(unaudited)**              | ** ** |
| Current assets          |       | $                               | 12,473     |                         | $          | 9,124 |   |
| Non-current assets      |       | 743                             |       | 765                          |       |
| Current liabilities     |       | 1,956                           |       | 1,625                        |       |
| Non-current liabilities |       | —                |       | —                       |       |
|                         |            |                                 |            |                              |            |  |  |

 

|                              | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|
| ** **                   | ** ** | **2005**                                             | ** ** | **2006** | ** ** |
| ** **                   | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)** | ** ** |
| Revenue                      |       | $                                                    | 383        |   | $ | 1,467 |   |
| Gross profit                 |       | 114                                                  |       | 413 |   |
| Net loss                     |       | (1,565                                               | )          | (2,910 | ) |
| Company's equity in net loss |       | (290                                                 | )          | (535 | ) |
|                              |            |                                                      |            |  |  |  |  |

 

**IPCommerce Investment**

In January 2005, TNSmade an investment in IP Commerce, a company that provides operating softwareto facilitate the authorization of IP-based retail payment transactions. TNSpurchased 2,368,545 Series A preferred shares or 39.9 percent of IPCommerce’s total outstanding shares for $2.0 million and became entitled torepresentation on IP Commerce’s board of directors. In September 2005, theCompany made an additional investment of $0.9 million in exchange for aconvertible note bearing interest at a rate of 8 percent per annum which ispayable on demand, no earlier than February 1, 2007. In March 2006,the Company exercised its right on the convertible note toconvert the outstanding principal and accrued interest ofapproximately $0.9 million to 675,901 shares of IP Commerce’s Series Bconvertible preferred stock. The Company owned 29.5 percent of IP Commerce’soutstanding shares as of March 31, 2006. The Company is accounting for its investmentunder the equity method of accounting. Due to timing of the receipt of IPCommerce’s financial statements, the Company is accounting for the income orloss in this equity method investment on a one-month lag. For the three monthsended March 31, 2005 and 2006, the Company recognized a net loss in theequity of an unconsolidated affiliate relatedto its investment in IP Commerce of approximately $0.1million and $0.5 million, respectively.

Summarized financial information for the Company’sinvestment in IP Commerce is as follows (in thousands):

|                         | ** ** | **December 31, 2005** | ** ** | **March 31, 2006** | ** ** |
|-------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **              | ** ** | **(unaudited)**                 | ** ** | ** **                   | ** ** |
| Current assets          |       | $                               | 1,426      |                         | $          | 4,259 |   |
| Non-current assets      |       | 274                             |       | 249                          |       |
| Current liabilities     |       | 258                             |       | 509                          |       |
| Non-current liabilities |       | 2,596                           |       | —                       |       |
|                         |            |                                 |            |                              |            |  |  |

 

|                              | ** ** | **Three months ended March 31** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** |
| ** **                   | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)** | ** ** |
| Revenue                      |       | $                                                   | 49         |   | $ | — |   |
| Gross profit                 |       | 49                                                  |       | — |   |
| Net loss                     |       | (491                                                | )          | (1,437 | ) |
| Company's equity in net loss |       | (67                                                 | )          | (531 | ) |
|                              |            |                                                     |            |  |  |  |  |

 

10

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**3.****                                      Long-termDebt**

On May 4, 2005, theCompany entered into an amended and restated senior secured credit facility(the May 4, 2005 Credit Facility) to finance the stock repurchase and toreplace its prior senior secured credit facility (March 19, 2004 CreditFacility). The May 4, 2005 Credit Facility consists of a$165.0 million Term B Loan (Term B Loan) and a revolving credit facilityof $30.0 million (New Revolving Credit Facility), under which there were$6.0 million of borrowings as of March 31, 2006. The May 4, 2005Credit Facility matures May 4, 2012. Payments on the Term B Loan are duein quarterly installments over the seven-year term, which began on June 1, 2005,with the remainder payable on May 4, 2012. Voluntary prepayments on theterm loan are first applied pro-rata to the scheduled quarterly installmentsdue within the next succeeding twelve-month period until paid in full and thenapplied to the term loan in inverse order of maturity. As of March 31,2006 total remaining payments on the Term Loan are as follows (in thousands):

| Nine months ending  December 31, 2006 |   | $       | —  |   |
|--------------------------------------------|--------|---------|---------|--------|
| 2007                                       |   | 1,650   |    |
| 2008                                       |   | 1,650   |    |
| 2009                                       |   | 1,650   |    |
| 2010                                       |   | 1,650   |    |
| Thereafter                                 |   | 112,848 |    |
|                                       |   | $       | 119,448 |   |

 

For the three monthsended March 31, 2006, borrowings on the New Revolving Credit Facility andthe Term B Loan bore interest at a rate of 1.75 percent over theLIBOR rate (6.64 percent as of March 31, 2006). Thereafter, if the Companyattains a leverage ratio of more than 1.75, the borrowings on the New RevolvingCredit Facility and the Term B Loan generally will bear interest at a rate, atthe Company’s option, of either 1.0 percent over the lender’s base rate or2.0 percent over the LIBOR rate. The Company’s leverage ratio as of March 31,2006 was 1.89 to 1.0. The New Revolving Credit Facility is subject to an annualnon-use commitment fee in an amount equal to 0.375 percent or 0.5 percentper annum, depending on the Company’s leverage ratio, multiplied by the amountof funds available for borrowing under the New Revolving Credit Facility.Interest payments on the May 4, 2005 Credit Facility are due monthly,bimonthly, or quarterly at the Company’s option.

The terms of the May 4, 2005 Credit Facilityrequire the Company to comply with financial and nonfinancial covenants,including maintaining certain leverage, interest and fixed charge coverageratios at the end of each fiscal quarter. As of March 31, 2006, theCompany was required to maintain a leverage ratio of less than 2.7 to 1.0, aninterest coverage ratio of greater than 4.0 to 1.0 and a fixed charge ratio ofgreater than 2.5 to 1.0. Certain of the financial covenants will become morerestrictive over the term of the May 4, 2005 Credit Facility. The May 4,2005 Credit Facility also contains nonfinancial covenants that restrict some ofthe Company’s corporate activities, including the Company’s ability to disposeof assets, incur additional debt, pay dividends, create liens, makeinvestments, make capital expenditures and engage in specified transactionswith affiliates. The Company’s future results of operations and its ability tocomply with the covenants could be adversely impacted by increases in thegeneral level of interest rates since the interest on a majority of the Company’sdebt is variable. Noncompliance with any of the financial or nonfinancialcovenants without cure or waiver would constitute an event of default under theMay 4, 2005 Credit Facility. An event of default resulting from a breachof a financial or nonfinancial covenant may result, at the option of thelenders, in an acceleration of the principal and interest outstanding, and atermination of the May 4, 2005 Revolving Credit Facility. The May 4,2005 Credit Facility also contains other customary events of default (subject tospecified grace periods), including defaults based on events of bankruptcy andinsolvency, nonpayment of principal, interest or fees when due, breach ofspecified covenants, change in control and material inaccuracy ofrepresentations and warranties. The Company was in compliance with thefinancial and nonfinancial covenants of the May 4, 2005 Credit Facility asof March 31, 2006.

In connection with theclosing of the May 4, 2005 Credit Facility, the Company incurredapproximately $2.7 million in financing costs. These financing costs weredeferred and are being amortized using the effective interest method over thelife of the May 4, 2005 Credit Facility.

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

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

|                                           | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Net income  (loss)                        |       | $                                                | 1,454      |   | $ | (467 | ) |
| Foreign currency  translation (loss) gain |       | (811                                             | )          | 105 |   |
| Total comprehensive  income (loss)        |       | $                                                | 643        |   | $ | (362 | ) |

 

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

SFAS No. 128, “Earnings Per Share”, requires thepresentation of basic and diluted earnings per share. Basic earnings (loss) percommon share is computed by dividing income (loss) attributable to commonstockholders by the weighted average number of common shares outstanding forthe period. The diluted earnings (loss) per common share data is computed usingthe weighted average number of common shares outstanding plus the dilutiveeffect of common stock equivalents, unless the common stock equivalents are anti-dilutive.During the three months ended March 31, 2006 the treasury stock effect of optionsto purchase 1,465,776 shares of common stock and 349,687 restricted stock unitswere not included in the computation of diluted income  (loss) per common share as their effectwould have been anti-dilutive.

11

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

 
| ** **                                                                                                  | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Net income  (loss) from continuing operations before cumulative effect of a change in  accounting principle |       | $                                                | 1,454      |   | $ | (551 | ) |
| Cumulative  effect of a change in accounting principle, net of tax                                          |       | —                                           |       | 84 |   |
| Net income  (loss)                                                                                          |       | $                                                | 1,454      |   | $ | (467 | ) |
| Weighted average common  share calculation:                                                                 |       |                                             |       |   |   |
| Basic weighted average common shares outstanding                                                            |       | 28,007,946                                       |       | 23,990,356 |   |
| Treasury stock effect of unvested restricted stock units                                                    |       | 311,181                                          |       | — |   |
| Treasury stock effect of options                                                                            |       | 65,710                                           |       | — |   |
| Diluted weighted average common shares outstanding                                                          |       | 28,384,837                                       |       | 23,990,356 |   |
| Net income (loss) per  common share:                                                                        |       |                                             |       |   |   |
| Basic income (loss) per common share                                                                        |       | $                                                | 0.05       |   | $ | (0.02 | ) |
| Diluted income  (loss) per common share                                                                     |       | $                                                | 0.05       |   | $ | (0.02 | ) |

 

**6.****                                      SegmentInformation**

The Company’s reportablesegments are strategic business units that offer different products andservices. The Company classifies its business into four segments: POS, TSD, FSDand ISD. However, the Company’s management only evaluates revenues for thesefour segments. A significant portion of the Company’s North American operatingexpenses are shared between the POS, TSD and FSD segments, and therefore,management analyzes operating results for these three segments on a combinedbasis.

Management evaluates theNorth American and ISD performance on EBITDA before stock compensation expensebecause operating expenses are distinguishable between North American and ISDoperations. The Company defines EBITDA before stock compensation expense asincome from operations before depreciation, amortization and stock compensationexpense. EBITDA before stock compensation expense is not a generally acceptedaccounting principle measure, but rather a measure employed by management toview operating results adjusted for major noncash items. The Company’sdefinition of EBITDA before stock compensation expense may not be comparable tosimilarly titled measures used by other entities. Assets are not segregatedbetween reportable segments, and management does not use asset information bysegments to evaluate segment performance. As such, no information is presentedrelated to fixed assets by reportable segment and capital expenditures for eachsegment.

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

 

|                | ** ** | **Three months ended  March 31,** | ** ** |
|----------------|------------|--------------------------------------------------|------------|
| ** **     | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Revenues:      |       |                                             |       |   |   |
| POS            |       | $                                                | 23,159     |   | $ | 18,792 |   |
| TSD            |       | 10,037                                           |       | 14,829 |   |
| FSD            |       | 7,307                                            |       | 8,373 |   |
| ISD            |       | 22,629                                           |       | 23,914 |   |
| Total revenues |       | $                                                | 63,132     |   | $ | 65,908 |   |

 

EBITDA before stock compensation expense for the North American and ISDoperations is reflected below (in thousands):

|                                                 | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| EBITDA before stock  compensation expense:      |       |                                             |       |   |   |
| North America                                   |       | $                                                | 9,195      |   | $ | 6,901 |   |
| ISD                                             |       | 7,197                                            |       | 6,725 |   |
| Total EBITDA before  stock compensation expense |       | $                                                | 16,392     |   | $ | 13,626 |   |

 

12

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EBITDA before stock compensation expense differs from(loss) income before income taxes and equity in net loss of unconsolidatedaffiliate reported in the condensed consolidated statements of operations asfollows (in thousands):

 

|                                                                                                                                                                | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                                                     | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| EBITDA before  stock compensation expense                                                                                                                      |       | $                                                | 16,392     |   | $ | 13,626 |   |
| Reconciling  items:                                                                                                                                            |       |                                             |       |   |   |
| Depreciation and  amortization of property and equipment and intangible assets                                                                                 |       | (11,128                                          | )          | (9,958 | ) |
| Stock  compensation expense                                                                                                                                    |       | (490                                             | )          | (1,436 | ) |
| Interest expense                                                                                                                                               |       | (811                                             | )          | (2,032 | ) |
| Interest income and other (expense)  income, net                                                                                                               |       | (188                                             | )          | 308 |   |
| Income before income  taxes, equity in net loss of unconsolidated affiliates and cumulative effect of a  change in accounting principle, net  of tax provision |       | $                                                | 3,775      |   | $ | 508 |   |

 

Goodwill and identifiable intangible assets, net arelocated in the following reporting segments (in thousands):

 

|                                                         | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| POS                                                     |       | $                           | 134,887    |                     | $          | 138,336 |   |
| TSD                                                     |       | 4,479                       |       | 5,780                    |       |
| FSD                                                     |       | 25,272                      |       | 24,771                   |       |
| ISD                                                     |       | 27,755                      |       | 38,025                   |       |
| Total goodwill and  identifiable intangible assets, net |       | $                           | 192,393    |                     | $          | 206,912 |   |

 

**Geographic Information**

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

The Company’s revenues were generated in the followinggeographic regions (in thousands):

 

|                | ** ** | **Three months ended  March 31,** | ** ** |
|----------------|------------|--------------------------------------------------|------------|
| ** **     | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Revenues:      |       |                                             |       |   |   |
| North America  |       | $                                                | 40,503     |   | $ | 41,994 |   |
| Europe         |       | 19,853                                           |       | 21,179 |   |
| Asia-Pacific   |       | 2,776                                            |       | 2,735 |   |
| Total revenues |       | $                                                | 63,132     |   | $ | 65,908 |   |

 

Revenues from the Company’s subsidiaries in the United Kingdomwere $13.8 millionand $13.7 million for the three months ended March 31, 2005 and 2006,respectively.

The Company’s long-lived assets including goodwill andidentifiable intangible assets, net were located as follows (in thousands):

 

|                         | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** |
|-------------------------|------------|-----------------------------|------------|--------------------------|------------|
| North America           |       | $                           | 219,163    |                     | $          | 227,342 |   |
| Europe                  |       | 37,717                      |       | 47,407                   |       |
| Asia-Pacific            |       | 4,447                       |       | 4,262                    |       |
| Total long-lived assets |       | $                           | 261,327    |                     | $          | 279,011 |   |

 

13

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**7.             Stock-BasedCompensation**

As discussed in Note 1, effective January 1, 2006, theCompany adopted SFAS 123R using the modified prospective transition method. Thefollowing table sets forth total stock based compensation expense recognized inthe condensed consolidated statement of operations resulting from stock optionsand non-vested restricted stock units (in thousands except per share amounts):

|                                                                                                                                                      | ** ** | **Three months ended   March 31, 2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| Income before  income taxes, equity in net loss of unconsolidated affiliates and cumulative  effect of a change in accounting principle, as reported |       | $                                                                | (1,436     | ) |
| Income tax  benefit from stock based compensation expense                                                                                            |       | 574                                                              |       |
| Income from  continuing operations before cumulative effect of a change in accounting  principle                                                     |       | (862                                                             | )          |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                                         |       | 84                                                               |       |
| Net loss                                                                                                                                             |       | $                                                                | (778       | ) |
| Earnings per share:                                                                                                                                  |       |                                                             |       |
| Basic                                                                                                                                                |       | $                                                                | (0.03      | ) |
| Diluted                                                                                                                                              |       | $                                                                | (0.03      | ) |

 

Prior to the adoption of SFAS 123R, the Company didnot make estimates for forfeitures and recognized compensation cost assumingall awards would vest and reversed recognized compensation cost for forfeitedawards when the awards were actually forfeited. Upon adoption of SFAS 123R onJanuary 1, 2006, the Company recorded a cumulative effect of a change inaccounting principle, net of tax,of approximately $0.1 million related to estimated forfeitures of unvestedrestricted stock awards for which stock basedcompensation was recorded in the Company’s financial statements prior toJanuary 1, 2006. Duringthe three months ended March 31, 2006, the Company capitalizedapproximately $81,000 of stock basedcompensation costs for employees working on capitalized software development projects.

As permitted by SFAS 123 “Accounting for Stock-BasedCompensation (“SFAS 123”), during 2005 the Company followed APB OpinionNo. 25 under which share-based payments to employees are accounted forusing the intrinsic value method and, as such, generally recognized no compensationcost for employee stock options. The Company’s pro forma information for the three months ended March 31,2005 under SFAS 123, which reflects compensation expense equal to the fairvalue of the options and restricted stock awards recognized over their requisite service period, is asfollows (in thousands, except per share amounts):

|                                                                                                                                               | ** ** | **Three months  ended  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Net income, as  reported                                                                                                                      |       | $                                                      | 1,454      |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related tax  effects                                  |       | 294                                                    |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (731                                                   | )          |
| Pro forma net  income                                                                                                                         |       | $                                                      | 1,017      |   |
| Basic and  diluted net income per  common share, as reported                                                                                  |       | $                                                      | 0.05       |   |
| Pro forma basic and  diluted net income per  common share                                                                                     |       | $                                                      | 0.04       |   |

 

Details of the Company’s stock-based compensation plans are discussedbelow.

***Stock Options***

During 2001, the Board ofDirectors of the Company adopted the TNS Holdings, Inc. 2001 Founders’Stock Option Plan (the 2001 Plan)whereby employees, nonemployee directors, and certain other individuals aregranted the opportunity to acquire an equity interest in the Company. Eitherincentive stock options or nonqualified options may be granted under the 2001Plan. Options granted under the 2001 Plan have an exercise price equal to orgreater than the estimated fair value of the underlying common stock at thedate of grant andbecome exercisable based on a vesting schedule determined at the date of grant,generally over four years. The options expire 10 years from the date ofgrant.

In February 2004, the Board of Directors of theCompany adopted the TNS, Inc. 2004 Long-Term Incentive Plan (the Plan) and theCompany’s stockholders approved the Plan in March 2004. The Plan reserves3,847,384 shares of common stock for grants of incentive stock options,nonqualified stock options, restricted stock awards and performance shares toemployees, non-employee directors and consultants performing services for theCompany. Options granted under the Plan have an exercise price equal to orgreater than the fair market value of the underlying common stock at the dateof grant and become exercisable based on a vesting schedule determined at thedate of grant, generally in equal monthly installments over four years. Theoptions expire 10 years from the date of grant. Restricted stock awards andperformance shares granted under the Plan are subject to a vesting perioddetermined at the date of grant, generally in equal annual installments overfour years.

14

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The fair value for stock options granted during theperiod was estimated at the grant date using a Black-Scholes option pricingmodel with the following weighted average assumptions:

|                          | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **2005 (a)**                                | ** ** | **2006** | ** ** |
| Expected life            |       | 4 years                                          |       | 4 years |   |
| Risk-free  interest rate |       | 3.0%                                             |       | 4.6% |   |
| Volatility               |       | 50%                                              |       | 50% |   |
| Dividend yield           |       | 0.0%                                             |       | 0.0% |   |

----

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

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

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

*Expected term* — The expected term is basedon the results of a study performed ofguideline companies in the Company’s peer group. The Company, at this point,does not have sufficient historical information to develop reasonableexpectations about future exercise patterns. The Company accounts for stockoptions with graded vesting as a single award with the expected term equal tothe average of the expected term of the component vesting tranches andrecognizes the related compensation cost on a straight-line basis over thevesting period of the award.

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

A summary of option activity under the Plan as of March 31,2006, and changes during the three months then ended is presented below (inthousands, except share and per share amounts):
| ** **                          | ** ** | **Number of  shares** | ** ** | **Weighted-  average  exercise price** | ** ** | **Weighted-  average  remaining   contractual term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding,  January 1, 2006  |       | 1,488,570                  |       | $                                           | 19.78      |                                                           |       |                                |       |   |
| Granted                             |       | 8,800                      |       | 18.72                                       |       |                                                           |       |                                |       |
| Exercised                           |       | (6,619                     | )          | 19.36                                       |       |                                                           |       |                                |       |
| Canceled                            |       | (24,975                    | )          | 20.48                                       |       |                                                           |       |                                |       |
| Outstanding at  March 31, 2006 |       | 1,465,776                  |       | $                                           | 19.76      |                                                           | 8 years    |                                | $          | 2,606 |   |
| Exercisable at  March 31, 2006 |       | 714,255                    |       | $                                           | 19.71      |                                                           | 7 years    |                                | $          | 1,350 |   |

The weighted average grant date fair value ofoptions granted during the three months ended March 31, 2005 and 2006 was$9.51 and $8.21, respectively. The total intrinsic value ofstock options exercised during the three months ended March 31, 2005 and2006 was approximately $1,000 and $7,000, respectively. As of March 31,2006, there was a total of $6.2 million of total unrecognizedcompensation cost related to non-vested stock options which is expected to berecognized over a weighted average period of approximately twoyears.

TheCompany received approximately $3,000 and $0.1 million in cash proceeds relatedto the exercise of stock options during the three months ended March 31,2005 and 2006, respectively. In addition the Company realized total taxbenefits from stock option exercises of $0 and $3,000 forthe three months ended March 31, 2005 and 2006, respectively, which wererecorded as additions to additional paid-in capital inthe condensed consolidated balance sheets. The adoption of SFAS 123R alsoresulted in reflecting the excess tax benefit from the exercise of stock basedcompensation awards in cash flows from financing activities.

***Restricted Stock Units***

A summary of the status of the Company’s non-vestedrestricted stock units as of March 31, 2006, and changes during the threemonths then ended is presented below (in thousands, except share and per shareamounts):

|                                     | ** ** | **Number of  shares** | ** ** | **Weighted-average  grant-date  fair value** | ** ** |
|-------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Non-vested at  January 1, 2006 |       | 439,316                    |       | $                                                 | 20.52      |   |
| Granted                             |       | 22,350                     |       | 18.72                                             |       |
| Vested                              |       | (110,629                   | )          | 19.95                                             |       |
| Forfeited                           |       | (1,350                     | )          | 22.00                                             |       |
| Non-vested  March 31, 2006     |       | 349,687                    |       | $                                                 | 20.58      |   |

Thetotal fair value of shares vested (measured as of the vesting date) during thethree months ended March 31, 2005 and 2006 was $1.2 million and $2.3 million,respectively. As of March 31, 2006, there was $6.7 million of totalunrecognized compensation cost related to restricted stock unitswhich is expected to be recognized over a weighted average period ofapproximately three years.

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**8.             Litigationand Claims**

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

On August 26, 2002, an action was filed in theSuperior Court of the State of Delaware by persons alleging that the Companybreached an agreement to purchase an unrelated entity. On February 28,2005, the court denied the Company’s motion for summary judgement. Afterconsidering the defense costs, potential damages should the plaintiffs prevail,and continued diversion of management resources, the Company determined in March 2005that a settlement was warranted. In April 2005, the Company paid $3.25 millionin cash to the plaintiffs and received the dismissal of all claims, withprejudice, by the plaintiffs, thereby settling this dispute. This $3.25 millionsettlement is included in selling, general and administrative expenses in theaccompanying condensed consolidated statement of operations for the threemonths ended March 31, 2005.

Certain states in which the Company operates assesssales taxes on certain services provided by the Company. The Company believesit has no liability because its customer contracts contain terms that stipulatethe customer, not the Company, is responsible for any sales tax liability. Injurisdictions where the customer may be liable for sales taxes, the Companyeither includes sales tax on its invoice or has obtained an exemptioncertificate from the customer. Certain states have audited the Company from1996 to early 2001 and originally proposed $6.7 million in assessments on thebasis that sales taxes are owed. In March 2005, the Company receivedverbal notification from a state sales tax auditor that one of the states waslikely to reduce its proposed assessment by $4.4 million. In April 2005,the Company received written confirmation from that state’s Department ofRevenue that the state’s assessment would be reduced. Based in part on thiswritten confirmation, the Company reduced its liability for this matter by $4.2million. This $4.2 million reduction in theliability is included in selling, general and administrative expenses in theaccompanying condensed consolidated statement of operations for the threemonths ended March 31, 2005. Both the Company and the customers involvedare vigorously defending the remaining proposed assessments by the sales taxauthorities. In the opinion of management, resolution of these matters will nothave a material adverse effect upon the financial position or future operatingresults of the Company.

Included in net income in the accompanying condensedconsolidated statement of operations for the three months ended March 31,2005 is a net $0.6 million benefit, or $0.02 per share, related to the legalsettlement and reduced state sales tax assessment.

The Company and John J.McDonnell, Jr., the Company’s Chief Executive Officer, and Henry H. Graham, Jr., the Company’s Chief Financial Officer, are defendants in a putative class action lawsuitfiled in connection with the Company’s publicoffering of common stock inSeptember 2005 (“Secondary Offering”).  The CementMasons and Plasterers Joint Pension Trust, purportedly on behalf of itself andothers similarly situated, filed the putative class action lawsuit captioned *Cement Masons & Plasterers Joint Pension Trust v. TNS, Inc., et al.,*Case No. 1:06 CV 363, CMH/BRP, on April 4, 2006 in the United States DistrictCourt for the Eastern District of Virginia. Plaintiff claims that the Registration Statement filed in connectionwith the Secondary Offering negligently failed to disclose that (1) TNS’agreement with the Pepsi Bottling Group, Inc. (“Pepsi”) to provide cashlessvending to Pepsi had been delayed beyond August 7, 2005; (2) TNS was generatingless revenues and income than it had anticipated from its contract with theRoyal Bank of Scotland (“RBS”), because RBS purportedly had overstated thenumber of transactions that TNS would be responsible for processing for RBS;and (3) TNS’ International Services Division was experiencingdeclining revenues during that time period because of unfavorable foreign  exchange rates.  This action is in the preliminary phase; thusthe timing and course of the litigation are not predictable, and, as a result, management cannot estimate a range of possibleloss.  However, TNS intends to takeappropriate steps to defend against the lawsuit, the outcome of which couldhave a material adverse affect on the financial condition or future operatingresults of TNS. During the three months ended March 31, 2006, the Companyaccrued legal costs of approximately $0.5 million to defend itself in thismatter. These legal costs are included in selling, general and administrativeexpense in the accompanying condensed consolidated statement of operations forthe three months ended March 31, 2006.

The Company and the membersof its Board of Directors also are defendants in a putative shareholder classaction lawsuit that seeks to enjoin the non-binding proposal announced on March 13, 2006 from senior managementof the Company to acquire all outstanding shares of the Company.  Paul Schwartz,purportedly on behalf of himself and others similarly situated, filed thelawsuit captioned *Schwartz v. TNS, Inc., et al.,*C.A. No. 2000-N, on March 13, 2006 in Delaware Chancery Court for New CastleCounty.  The plaintiff alleges thatinjunctive relief is necessary because the Company and the members of the Boardof Directors allegedly breached their fiduciary duties to TNS shareholders byallegedly causing the Company to negotiate for the sale of TNS at an unfairprice, depriving TNS' public shareholders of the maximum value to which theypurportedly are entitled.  The plaintifffurther alleges that members of the Board of Directors also breached theirfiduciary duties by allegedly not taking adequate measures to ensure that theinterests of TNS' public shareholders are properly protected, as the terms ofthe proposed transaction allegedly are grossly unfair to the shareholders.  On April 3, 2006, the plaintiff and thedefendants entered into a letter agreement that provides the defendants with anopen-ended extension of time to answer or otherwise respond to the plaintiff'scomplaint, and holds discovery and other matters in the case in abeyancepending an agreement on a management buy-out proposal or other form oftransaction.  This action is in thepreliminary phase; thus the timing and course of the litigation are notpredictable, and, as aresult, management cannotestimate a range of possible loss. However, TNS intends to take appropriate actions to defend against thelawsuit, the outcome of which could have a material adverse affect on thefinancial condition or future operating results of TNS.  No amountshave been accrued related to this case in  thecondensed consolidated financial statements for the three months endedMarch 31, 2006, as management cannot yet estimate the future legal costs, if any, that will be incurred to defend against thislawsuit.

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of 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 annual report on Form 10-K filed with the SEC on March 16,2006 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 not addresshistorical facts and, therefore, could be interpreted to be forward-lookingstatements within the meaning of The Private Securities Litigation Reform Actof 1995. These forward-looking statements are based on current expectations,forecasts and assumptions that are subject to risks and uncertainties thatcould cause actual results to differ materially from those set forth in, orimplied by, the forward-looking statements. The Company has attempted, wheneverpossible, to identify these forward-looking statements using words such as “may,”“will,” “should,” “projects,” “estimates,” “expects,” “plans,” “intends,” “anticipates,”“believes,” and variations of these words and similar expressions. Similarly,statements herein that describe the Company’s business strategy, prospects,opportunities, outlook, objectives, plans, intentions or goals are 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;and other risk factors described in the Company’s annual report on Form 10-Kfiled with the SEC on March 16, 2006. In addition, the statements in thisquarterly report are made as of the date of this filing. The Company expectsthat subsequent events or developments will cause its views to change. TheCompany undertakes no obligation to update any of the forward-lookingstatements made herein, whether as a result of new information, future events,changes in expectations or otherwise. These forward-looking statements shouldnot be relied upon as representing the Company’s views as of any datesubsequent to the date of this filing. The forward-looking statements in thisdocument are intended to be subject to the safe harbor protection provided bySections 27A of the Securities Act and 21E of the Exchange Act.

**Overview**

We are a leading providerof business-critical data communications services to processors of creditcard, debit card and ATM transactions. We are also a leading provider of securedata and voice network services to the global financial services industry. Weoperate one of four unaffiliated Signaling System No. 7 networks in theUnited States capable of providing services nationwide, and we utilize thisnetwork to provide call signaling and database access services to the domestictelecommunications industry. Our data communications services enable secure andreliable transmission of time-sensitive, transaction-related informationcritical to our customers’ operations. Our customers outsource their datacommunications requirements to us because of our substantial expertise,comprehensive customer support and cost-effective services. We provide servicesto customers in the United States and increasingly to international customersin 27 countries, including Canada andcountries in Europe, Latin America and the Asia-Pacific region.

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

Wegenerate revenues through four business divisions:

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

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

Our international services division generates revenues primarily fromour POS and financial services offerings abroad.

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

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·                     ***Financial services.***We provide fast, secure and reliable private data networking services thatenable seamless communications and facilitate electronic trading among commercialbanks, mutual funds, pension funds, broker-dealers, alternative tradingsystems, 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 significantexpense is cost of network services, which is comprised primarily oftelecommunications charges, including data transmission and database access,leased digital capacity charges, circuit installation charges and activationcharges. The cost of data transmission is based on a contract or tariff rateper minute of usage in addition to a prescribed rate per transaction for somevendors. The costs of database access, circuits, installation charges andactivation charges are based on fixed fee contracts with local exchangecarriers and interexchange carriers. The cost of network services also includessalaries, equipment maintenance and other costs related to the ongoingoperation of our data networks. Depreciation expense on our network equipmentand amortization of developed technology are excluded from our cost of networkservices and included in depreciation and amortization of property andequipment and amortization of intangible assets in our consolidated statementsof operations.

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

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

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

On May 5, 2005, wecompleted a modified Dutch auction tender offer, purchasing and retiring6,263,435 shares of our outstanding common stock at a price of $18.50 per sharenet to each seller in cash, for an aggregate purchase price of $116.9 million.The 6,263,435 shares tendered include 6,000,000 shares tendered by our thencontrolling stockholder, GTCR.

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

**Long-term Investments**

In August 2004, wemade an investment in WAY Systems, Inc. (WAY), which provides mobile POStransaction infrastructure and solutions for mobile merchants. We purchased5,952,381 shares or 38.5 percent of WAY’s Series B convertible preferredstock for $2.5 million and became entitled to representation on WAY’s board ofdirectors. In March 2005,we made an additional investment of $0.8 million to purchase 1,910,401 sharesof WAY’s Series B convertible preferred stock for an additional 1.9percent of WAY’s outstanding shares. In July 2005, we made an additionalinvestment of $0.7 million in exchange for a convertible note bearing interestat a rate of 8 percent per annum and due January 1, 2009. In September 2005,we exercised our right on the convertible note toconvert the outstanding principal and accrued interest of approximately $0.8million to 1,185,085 shares of WAY’s Series C convertible preferred stockand made an additional investment of $1.1 million to purchase 1,676,429 sharesof WAY’s Series C convertible preferred stock. We owned 17.0 percent ofWay’s outstanding shares as of March 31, 2006. We are accounting for ourinvestment under the equity method of accounting as the Company has significantinfluence over the financing and operating activities of WAY through itsrepresentation on the board of directors. Due to timing of the receipt of WAY’sfinancial statements, TNS is accounting for the income or loss in this equitymethod investment on a one-month lag. For the three months ended March 31,2005 and 2006, werecognized a net loss in the equity of an unconsolidated affiliate related to our investment in WAYof approximately $0.3 million and $0.5 million, respectively.

In January 2005, wemade an investment in IP Commerce, a company that provides operating softwareto facilitate the authorization of IP-based retail payment transactions. We purchased2,368,545 Series A preferred shares or 39.9 percent of IP Commerce’s totaloutstanding shares for $2.0 million and became entitled to representation on IPCommerce’s board of directors. In September 2005, the Company made anadditional investment of $0.9 million in exchange for a convertible notebearing interest at a rate of 8 percent per annum which is payable on demand,no earlier than February 1, 2007. In September 2005, we exercised ourright on the convertible note toconvert the outstanding principal and accrued interest of approximately $0.9million to 675,901 shares of IP Commerce’s Series B convertible preferredstock. We owned approximately 29.5 percent of IP Commerce’s outstanding shares as of March 31, 2006. We areaccounting for this investment under the equity method of accounting. Due totiming of the receipt of IP Commerce’s financial statements, TNS is accountingfor the income or loss in this equity method investment on a one-month lag. Forthe three months ended March 31, 2005 and 2006, we recognized a net lossin the equity of an unconsolidated affiliate relatedto our investment in IP Commerceof approximately $0.1 million and $0.5 million, respectively.

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**Results of Operations**

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

 
| ** **                                                                                                                              | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Revenues                                                                                                                                |       | $                                                | 63,132     |   | $ | 65,908 |   |
| Operating expenses:                                                                                                                     |       |                                             |       |   |   |
| Cost of network  services, exclusive of the items shown separately below                                                                |       | 30,230                                           |       | 33,057 |   |
| Engineering and  development                                                                                                            |       | 3,906                                            |       | 4,535 |   |
| Selling,  general, and administrative                                                                                                   |       | 13,094                                           |       | 16,126 |   |
| Depreciation and  amortization of property and equipment                                                                                |       | 4,863                                            |       | 5,027 |   |
| Amortization of  intangible assets                                                                                                      |       | 6,265                                            |       | 4,931 |   |
| Total operating expenses                                                                                                                |       | 58,358                                           |       | 63,676 |   |
| Income from  operations                                                                                                                 |       | 4,774                                            |       | 2,232 |   |
| Interest expense                                                                                                                        |       | (811                                             | )          | (2,032 | ) |
| Interest income and other (expense)  income, net                                                                                        |       | (188                                             | )          | 308 |   |
| Income before  income taxes, equity in net loss of unconsolidated affiliates and cumulative  effect of a change in accounting principle |       | 3,775                                            |       | 508 |   |
| Income tax  (provision) benefit                                                                                                         |       | (1,905                                           | )          | 15 |   |
| Equity in net  loss of unconsolidated affiliates                                                                                        |       | (416                                             | )          | (1,074 | ) |
| Cumulative  effect of a change in accounting principle, net of tax provision                                                            |       | —                                           |       | 84 |   |
| Net income (loss)                                                                                                                       |       | $                                                | 1,454      |   | $ | (467 | ) |

 

**Three months ended March 31, 2006 compared to the threemonths ended March 31, 2005**

***Revenues.***Totalrevenues increased $2.8 million, or 4.4%, to $65.9 million for the three monthsended March 31, 2006, from $63.1 million for the three months ended March 31,2005. We generate revenues through four operating divisions.

***POS division.***Revenuesfrom the POS division decreased $4.4 million, or 18.9%, to $18.8 million forthe three months ended March 31, 2006, from $23.2 million for the threemonths ended March 31, 2005. The $4.4 million decrease in POS revenuesresulted from a decline in transaction volumes and to a lesser extent adecrease in revenue per transaction as a result of negotiated price reductionsupon renewal of certain contracts. POS transaction volumes decreased 13.5% to1.3 billion transactions for the three months ended March 31, 2006, from1.5 billion transactions for the three months ended March 31, 2005. Wehave negotiated contract renewals with some of our POS customers, and inseveral instances we agreed to pricing discounts in exchange for maintaining orincreasing their minimum transaction or revenue commitments. As a result, it islikely our revenue per transaction will decrease and, depending upon the numberof transactions we transport, our POS revenues may continue to decrease.

***Internationalservices division.***Revenues from the internationalservices division increased $1.3 million, or 5.7%, to $23.9 million for thethree months ended March 31, 2006, from $22.6 million for the three monthsended March 31, 2005. The increase was primarily due to additionalrevenues generated from our POS customers in the U.K., Australia, France, Spainand Ireland which was partially offset by the unfavorable impact of foreignexchange. Revenues from our U.K. subsidiaries decreased $0.1 million, or 0.9%,to $13.7 million for the three months ended March 31, 2006, from $13.8million for the three months ended March 31, 2005. Excluding the negativeimpact of foreign exchange rates, revenues from our U.K. subsidiaries wouldhave increased $1.0 million, or 7.0%.

***Telecommunicationservices division.***Revenues from the telecommunicationservices division increased $4.8 million, or 47.7%, to $14.8 million for thethree months ended March 31, 2006, from $10.0 million for the three monthsended March 31, 2005. Included in telecommunications services revenues forthe three months ended March 31, 2006 and 2005 were approximately $1.3million and $0.1 million, respectively, of pass-through revenues. Excluding theincrease in pass-through revenues the growth in revenues was primarily due toincreased usage of our call signaling services and database access servicesfrom new and existing customers.

***Financial servicesdivision.***Revenues from the financial services divisionincreased $1.1 million, or 14.6%, to $8.4 million for the three months ended March 31,2006, from $7.3 million for the three months ended March 31, 2005. Theincrease in revenues was due to the growth in the number of customerconnections to and through our networks.

***Cost of networkservices.***Cost of network services increased $2.8million, or 9.4%, to $33.1 million for the three months ended March 31,2006, from $30.2 million for the three months ended March 31, 2005. Costof network services were 50.2% of revenues for the three months ended March 31,2006, compared to 47.9% of revenues for the three months ended March 31,2005. The increase in cost of network services resulted primarily from higherusage charges from our TSD, FSD and ISD services, partially offset by lowerusage charges from decreased POS transactions. Gross profit represented 49.8%of total revenues for the three months ended March 31, 2006, compared to52.1% for the three months ended March 31, 2005. The decrease in grossprofit as a percentage of total revenues resulted primarily from increasedcontribution of our telecommunication services division and to a lesser extentthe decline in margin of our POS division as we transported fewer transactionsover our fixed cost network, partially offset by increased contribution fromour international and financial services divisions, our highest gross marginbusinesses.

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Future cost of network services depends on a number offactors including total transaction and query volume, the relative growth andcontribution to total transaction volume of each of our customers, the successof our new service offerings, the timing and extent of our network expansionand the timing and extent of any network cost reductions. In addition, anysignificant loss or significant reduction in transaction volumes could lead toa decline in gross margin since significant portions of our network costs arefixed costs.

***Engineering anddevelopment expense.***Engineering and development expenseincreased $0.6 million, or 16.1%, to $4.5 million for the three months ended March 31,2006, from $3.9 million for the three months ended March 31, 2005.Engineering and development expense represented 6.9% of revenues for the threemonths ended March 31, 2006 and 6.2% of revenues for the three monthsended March 31, 2005. Engineering and development expense increasedprimarily from an increase in engineering expenses required to support ourinternational expansion and new product offerings in our POS division.

***Selling, generaland administrative expense.***Selling, general andadministrative expense increased $3.0 million, or 23.2%, to $16.1 million forthe three months ended March 31, 2006, from $13.1 million for the threemonths ended March 31, 2005. Selling, general and administrative expenserepresented 24.5% of revenues for the three months ended March 31, 2006,compared to 20.7% of revenues for the three months ended March 31, 2005. Includedin selling, general and administrative expenses for the three months ended March 31,2006 is a $0.5 million charge related to litigation that arose during thequarter and a $0.2 million charge for legal expenses incurred by the specialcommittee of the board of directors.Included in selling, general, and administrative expenses for the three months ended March 31,2005 is a $3.2 million charge related to a legal settlement and a $4.2 millionbenefit from a reduced state sales tax liability assessment. Excluding these items, selling,general and administrative expense increased primarily from the expensesrequired to support our revenue growth, mainly within the internationalservices division and to a lesser extent anincrease in stock based compensation expense as a result of the adoption ofSFAS 123R on January 1, 2006.

***Depreciation andamortization of property and equipment.***Depreciation andamortization of property and equipment increased $0.2 million, or 3.4% to $5.0million for the three months ended March 31, 2006, from $4.9 million forthe three months ended March 31, 2005. Depreciation expense increasedprimarily due to an increase in capital expenditures to support the growth inour international services division. Depreciation and amortization of propertyand equipment represented 7.6% of revenues for the three months ended March 31,2006, compared to 7.7% of revenues for the three months ended March 31,2005.

***Amortization ofintangible assets.***Amortization of intangible assetsdecreased $1.3 million, or 21.3%, to $4.9 million for the three months ended March 31,2006, from $6.3 million for the three months ended March 31, 2005. Theamortization of intangible assets for the three months ended March 31,2006 and 2005 relates solely to the intangible assets resulting fromacquisitions. The decrease was primarily attributable to certain of our intangibleassets becoming fully amortized at the end of the first quarter of 2005 whichwas partially offset by the additional amortization resulting from acquisitionscompleted during 2005 and 2006. For purposes of measuring and recognizingimpairment of long-lived assets including intangibles, we assess whetherseparate cash flows can be attributed to the individual asset. For our customerrelationship intangible assets, we recognize and measure impairment upon the significantloss of revenue from a customer. Based upon our contract with one of our majorcustomers, we believe that revenues and related transaction volumes from thiscustomer will continue to decline in 2006 and may decline further thereafter.The intangible asset value attributable to this customer relationship wasapproximately $23.3 million as of March 31, 2006. We assessed therecoverability of this customer relationship asset based upon undiscountedanticipated future cash flows and concluded no impairment existed as of March 31,2006.

***Interest expense.***Interestexpense increased $1.2 million to $2.0million for the three months ended March 31, 2006, from $0.8 million forthe three months ended March 31, 2005. Interest expense increasedprimarily due to the additional borrowings under our amended and restatedsenior secured credit facility to finance the stock repurchase in May 2005.

***Interest and otherincome (expense), net.***Interest and other income(expense), net was $0.3 million for the three months ended March 31, 2006compared to expense of $0.2 million for the three months ended March 31,2005. Included in other income (expense), net for the three months ended March 31,2006 is a gain on foreign currency translation of approximately $0.2 milliondue to fluctuations in the value of the U.S. dollar as compared with foreigncurrencies, predominately, the euro, the British pound and the Australiandollar, versus a loss on foreign currency translation of $0.4 million for thethree months ended March 31, 2005.

***Income tax benefit(provision).***For the three months ended March 31,2006, our income tax benefit was approximately $15,000 compared to an income taxprovision of $1.9 million for the three months ended March 31, 2005. Oureffective tax rate for the three months ended March 31, 2006 is 3.0% versus the U.S. federalstatutory tax rate of 34.0%, due primarily to lower tax rates incertain of our international subsidiaries.

***Equity in net lossof unconsolidated affiliates.***For the three months ended March 31,2006, our equity in net loss of unconsolidated affiliates was $1.1 millioncompared to a loss of$0.4 million for the three months ended March 31, 2005. The increase wasdue to additional losses recorded on our equity method investments, primarilyrelating to our investments in Way Systems, Inc. and IP Commerce, Inc.As of March 31, 2006, we have $4.9 million of long-term investments inunconsolidated affiliates, and we expect to incur additional losses on theseinvestments in 2006 and we may continue to incur losses thereafter.

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**Seasonality**

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

**Liquidity and Capital Resources**

Our primaryliquidity and capital resource needs are to finance the costs of ouroperations, to make capital expenditures and to service our debt. Theborrowings under our amended and restated senior secured credit facility wereused to finance the stock repurchase on May 5, 2005, as well as to repaythe amounts outstanding under our 2004 senior secured credit facility. Theproceeds from our initial public offering in March 2004, along with theproceeds from borrowings under our 2004 senior secured credit facility, wereused to repay the amounts outstanding under our 2001 senior secured creditfacility. Based upon our current level of operations, we expect that our cashflow from operations, together with the amounts we are able to borrow under ouramended and restated senior secured credit facility, will be adequate to meetour anticipated needs for the foreseeable future. Although we have no specificplans to do so, to the extent we decide to pursue one or more significantstrategic acquisitions, we will likely need to incur additional debt or selladditional equity to finance those acquisitions.

Our operations provided us cash of $10.0 millionfor the three months ended March 31, 2006, which was attributable to a netloss of $0.5 million, depreciation, amortization and other non-cashcharges of $12.6 million and an increase in working capital of$2.1 million. Our operations provided us cash of $15.2 million forthe three months ended March 31, 2005, which was attributable to netincome of $1.5 million, depreciation, amortization and other non-cashcharges of $13.4 million and a decrease in working capital of$0.3 million.

We used cash of $24.7 million in investingactivities for the three months ended March 31, 2006, which includescapital expenditures of $5.1 million. In addition we completed theacquisition of CommsXL in the UK, InfiniRoute and Sonic. We used cash of$6.9 million in investing activities for the three months ended March 31,2005, which consisted of capital expenditures of $4.1 million. Inaddition, we made investments of $0.8 million in WAY Systems, Inc., acompany that provides mobile POS transaction infrastructure and solutions tomobile merchants, and $2.0 million in IP Commerce, a company that providesoperating software to facilitate the authorization of IP-based retail paymenttransactions.

We generated cash of $6.2 million from financing activities for thethree months ended March 31, 2006, which includes $6.0 million ofborrowings under our amended and restated senior secured credit facility, theproceeds of which were used to finance the stock and asset purchase from Sonic.We used cash of $3.5 million for financing activities for the three monthsended March 31, 2005, which consisted primarily of $3.0 million oflong-term debt repayments.

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

On May 4,2005, we entered into an amended and restated senior secured credit facility tofinance the stock repurchase and to replace our 2004 senior secured creditfacility. The amended and restated senior secured credit facility consists of a$165.0 million term loan and a revolving credit facility of $30.0 million,under which there were $6.0 million of borrowings as of March 31, 2006.The amended and restated senior secured credit facility matures May 4,2012. Payments on the term loan are due in quarterly installments over theseven-year term, beginning on June 1, 2005, with the remainder payable on May 4,2012. Voluntary prepayments on the term loan are first applied pro-rata to thescheduled quarterly installments due within the next succeeding twelve-monthperiod until paid in full and then applied to the term loan in inverse order ofmaturity.

As of March 31, 2006, total remaining payments onthe Term Loan are as follows (in thousands):

| Nine months ending  December 31, 2006 |   | $       | —  |   |
|--------------------------------------------|--------|---------|---------|--------|
| 2007                                       |   | 1,650   |    |
| 2008                                       |   | 1,650   |    |
| 2009                                       |   | 1,650   |    |
| 2010                                       |   | 1,650   |    |
| Thereafter                                 |   | 112,848 |    |
|                                       |   | $       | 119,448 |   |

 

For the periodthrough March 31, 2006, borrowings on the revolving credit facility andthe term loan bore interest at a rate of 1.75 percent over the LIBOR rate(6.64 percent as of March 31, 2006). Thereafter, if we attain a leverageratio of more than 1.75, the borrowings on the revolving credit facility andthe term loan generally will bear interest at a rate, at our option, of either1.0 percent over the lender’s base rate or 2.0 percent over the LIBORrate. Our leverage ratio as of March 31, 2006 was 1.89 to 1.0. Therevolving credit facility is subject to an annual non-use commitment fee in anamount equal to 0.375 percent or 0.5 percent per annum, depending on ourleverage ratio, multiplied by the amount of funds available for borrowing underthe revolving credit facility. Interest payments on the amended and restatedsenior secured credit facility are due monthly, bimonthly, or quarterly at ouroption.

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The terms of theamended and restated senior secured credit facility require us to comply withfinancial and nonfinancial covenants, including maintaining certain leverage,interest and fixed charge coverage ratios at the end of each fiscal quarter. Asof March 31, 2006, we were required to maintain a leverage ratio of lessthan 2.7 to 1.0, an interest coverageratio of greater than 4.0 to 1.0 and a fixed charge ratio of greater than 2.5to 1.0. Certain of the financial covenants will become more restrictive overthe term of the amended and restated senior secured credit facility. Theamended and restated senior secured credit facility also contains nonfinancialcovenants that restrict some of our corporate activities, including our abilityto dispose of assets, incur additional debt, pay dividends, create liens, makeinvestments, make capital expenditures and engage in specified transactionswith affiliates. Our future results of operations and our ability to complywith the covenants could be adversely impacted by increases in the generallevel of interest rates since the interest on a majority of our debt isvariable. Noncompliance with any of the financial or nonfinancial covenantswithout cure or waiver would constitute an event of default under the amendedand restated senior secured credit facility. An event of default resulting froma breach of a financial or nonfinancial covenant may result, at the option ofthe lenders, in an acceleration of the principal and interest outstanding, anda termination of the amended and restated senior secured revolving creditfacility. The amended and restated senior secured credit facility also containsother customary events of default (subject to specified grace periods),including defaults based on events of bankruptcy and insolvency, nonpayment ofprincipal, interest or fees when due, breach of specified covenants, change incontrol and material inaccuracy of representations and warranties. We were incompliance with the financial and nonfinancial covenants of the amended andrestated senior secured credit facility as of March 31, 2006.

**Adoption of SFAS 123R**

We adopted SFAS 123R following the modifiedprospective transition method effective January 1, 2006. SFAS 123R requires allshare-based payments to employees to be recognized in the income statementbased on their respective grant date fair values over the corresponding serviceperiods and also requires an estimation of forfeitures when calculatingcompensation expense. The adoption of SFAS 123R reduced income from operations byapproximately $0.8 million and basic and diluted earnings per share (“EPS”) by$0.03 for the three months ended March 31, 2006. Stock-based compensationaccounted for under SFAS 123R is expected to reduce income from operations andearnings per share by approximately $3.2 million and  $0.14, respectively, for the full year 2006.The current compensation structure, or changes therein, as well as anysubsequent stock based compensation plan activity could result in an increasein the impact of SFAS 123R in 2006 and thereafter.

Prior to the adoption of SFAS 123R, we followed APBOpinion No. 25, “Accounting for Stock Issued to Employees,” in its accountingfor stock compensation and recorded stock based compensation based on theintrinsic value method. Stock compensation expense recognized in the threemonths ended March 31, 2005 reduced net income by approximately $0.3 million,related to restricted stock units.  Prior to the adoption of SFAS 123R, we did not make estimates forforfeitures and recognized compensation cost assuming all restricted stockawards would vest and reversed compensation cost for forfeited awards when theawards were actually forfeited.  Uponadoption of SFAS 123R, we recorded a cumulative effect of a change inaccounting principle, net of tax of approximately $0.1 million related toestimated forfeitures of unvested restricted stock awards.  As of March 31, 2006, the total compensationcost related to unvested stock options and restricted stock units that has notyet been recognized was approximately $12.9 million,which we expect to recognize over a weighted average period of approximately 3years.

Refer to Note 7 of our Condensed ConsolidatedFinancial Statements in Item 1 for a complete discussion of our stock-basedcompensation plans and the adoption of SFAS 123R. 

**Item 3. Quantitativeand Qualitative Disclosures About Market Risk**

***Interest rates***

Our principal exposure to market risk relates tochanges in interest rates. As of March 31, 2006, we had$119.4 million outstanding under our amended and restated senior securedcredit facility with interest rates tied to changes in the lender’s base rateor the LIBOR rate. Based upon the outstanding borrowings on March 31, 2006and assuming repayment of the Term Loan in accordance with scheduledmaturities, each 1.0% increase in these rates could add an additional$1.2 million to our annual interest expense.

As of March 31, 2006, we did not hold derivativefinancial or commodity instruments and all of our cash and cash equivalentswere held in money market or commercial accounts.

***Foreign currency risk***

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

We have operations in 19 countries outside of theU.S., including the United Kingdom, Australia, Austria, Bermuda, Canada,Colombia, France, Germany, Ireland, Italy, Japan, Malaysia, the Netherlands,New Zealand, Poland, Romania, South Korea, Spain and Sweden. We provideservices in these countries using networks deployed in each country. We manageforeign exchange risk through the structure of our business. In the substantialmajority of our transactions, we receive payments denominated in the U.S.dollar, British pound, euro or Australian dollar. Therefore, we do not rely oninternational currency markets to obtain and pay illiquid currencies. Theforeign 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 three months ended March 31, 2006, we recordeda gain on foreign currency translation of approximately $0.2 million.

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**Item 4. Controls and Procedures**

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

**Evaluation**

The Company carried out an evaluation, under thesupervision, and with the participation, of the Company’s management, includingthe Company’s Chief Executive Officer and the Company’s Chief FinancialOfficer, of the effectiveness of the Company’s disclosure controls andprocedures as of March 31, 2006. 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 March 31,2006.

There have been no significant changes during the three months ended March 31, 2006 covered by this report inthe Company’s internal control over financial reporting or in other factorsthat could significantly affect the internal control over financial reporting.

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**PART II—OTHERINFORMATION**

**Item 1.**                          LegalProceedings

Informationregarding legal proceedings is contained in Note 8 to the CondensedConsolidated Financial Statements contained in this Report and is incorporatedherein by reference.

**Item 1A.      RiskFactors**

There were no material changes from the riskfactors previously disclosed in “Item 1A. Risk Factors” included in our AnnualReport on Form 10-K for the year ended December 31, 2005, except that, at March31, 2006, the following additional risk factor has been added:

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

We have been named as adefendant in a number of securities class action and derivative lawsuits.  We are generally obliged, to the extentpermitted by law, to indemnify our current and former directors and officerswho are named as defendants in some of these lawsuits. Defending against existing and potentiallitigation may divert financial and management resources that would otherwisebe used to benefit our operations. Although we believe that we have meritoriousdefenses to the claims made in each and all of the litigation matters to whichwe have been named a party, and intend to contest each lawsuit vigorously, noassurances can be given that the results of these matters will be favorable tous. Regardless of the outcome, such litigation will result in significant legalexpenses. A materially adverse resolution of any of these lawsuits could have amaterial adverse affect on our business, financial position and results ofoperations.

**Item 2.**                          UnregisteredSales of Equity Securities and Use of Proceeds

None.

**Item 3.**                          DefaultUpon Senior Securities

None.

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

None

**Item 5.**                          Other Information

None.

**Item 6.**                          Exhibits
|        |   | (10.1) |   | Employment Agreement,  dated as of March 10, 2006, by and among the Registrant, Transaction  Network Services, Inc. and John J. McDonnell, Jr. |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.2) |   | Employment Agreement,  dated as of March 10, 2006, by and among the Registrant, Transaction  Network Services, Inc. and Brian J. Bates              |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.3) |   | Employment Agreement,  dated as of March 10, 2006, by and among the Registrant, Transaction  Network Services, Inc. and Henry H. Graham, Jr.        |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.4) |   | Employment Agreement,  dated as of March 10, 2006, by and among the Registrant, Transaction  Network Services, Inc. and John J. McDonnell III  |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.5) |   | Employment Agreement,  dated as of March 10, 2006, by and among the Registrant, Transaction  Network Services, Inc. and Matthew M. Mudd             |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.6) |   | Employment Agreement,  dated as of March 10, 2006, by and among the Registrant, Transaction  Network Services, Inc. and Edward J. O’Brien      |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.7) |   | Employment Agreement, dated  as of March 10, 2006, by and among the Registrant, Transaction Network  Services, Inc. and Michael Q. Keegan           |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (10.8) |   | Service Agreement, dated  May 9, 2006, by and between Transaction Network Services (UK) Limited  and Raymond Low                                              |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (31.1) |   | Certification—Chief Executive Officer                                                                                                                              |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (31.2) |   | Certification—Chief Financial Officer                                                                                                                              |
|   |   |   |   |                                                                                                                                                                    |
|   |   | (32.1) |   | Written Statement of Chief Executive Officer and  Chief Financial Officer                                                                                               |

 

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this Amendment No. 1 on Form 10-Q/A tobe signed on its behalf by the undersigned thereunto duly authorized.
|                     | TNS, Inc.  (Registrant) |
|---------------------|------------------------------|
|                |                         |   |
|                |                         |   |
| Date: July 21, 2006 | By:                          | /s/ JOHN J. MCDONNELL, JR. |
|                |                         | John J. McDonnell, Jr. Chairman and Chief Executive Officer |
|                |                         |   |
| Date: July 21, 2006 | By:                          | /s/ HENRY H. GRAHAM, JR. |
|                |                         | Henry H. Graham, Jr. Executive Vice President, Chief  Financial Officer & Treasurer |

 

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