**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

** **

**FORM 10-Q**

 

 

**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**

| **Part I: FINANCIAL  INFORMATION** |   | 3            |
|-----------------------------------------|--------|--------------|
|                                    |   |         |   |   |   |   |
|                                    |   | Item 1. |   | Condensed Consolidated Financial Statements  (Unaudited) |   | 3 |
|                                    |   |         |   | Condensed Consolidated Balance Sheets as of  December 31, 2005 and March 31, 2006 |   | 3 |
|                                    |   |         |   | Condensed Consolidated Statements of Operations for  the three months ended March 31, 2005 and 2006 |   | 4 |
|                                    |   |         |   | Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 2005 and 2006 |   | 5 |
|                                    |   |         |   | Notes to Condensed Consolidated Financial Statements |   | 6 |
|                                    |   | Item 2. |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |   | 15 |
|                                    |   | Item 3. |   | Quantitative and Qualitative Disclosures About Market  Risk |   | 21 |
|                                    |   | Item 4. |   | Controls  and Procedures |   | 22 |
|                                    |   |         |   |   |   |   |
| **Part II:  OTHER INFORMATION**    |   | 23           |
|                                    |   |         |   |   |   |   |
|                                    |   | Item 1. |   | Legal Proceedings |   | 23 |
|                                    |   | Item 2. |   | Changes in Securities, Use of Proceeds and Issuer  Purchases of Equity Securities |   | 23 |
|                                    |   | Item 3. |   | Default Upon Senior Securities |   | 23 |
|                                    |   | Item 4. |   | Submission of Matters to a Vote of Security Holders |   | 23 |
|                                    |   | Item 5. |   | Other Information |   | 23 |
|                                    |   | Item 6. |   | Exhibits |   | 23 |

 

2

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**PART I—FINANCIALINFORMATION**

**Item 1. CondensedConsolidated 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.CONDENSED CONSOLIDATED 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).

5

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

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

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

The Company provides its services through its multipledata networks, each designed specifically for transaction applications. Thesenetworks support a variety of widely accepted communications protocols, aredesigned to be scalable and are accessible by multiple methods, 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 Repurchaseand Offerings of Common Stock**

On May 4, 2005, the Company purchased and retired6,263,435 shares of its common stock, pursuant to a modified Dutch auction tenderoffer, for $18.50 per share plus expenses of approximately $1.0 million.Of the shares tendered, 6 million shares were tendered by the Company’sthen controlling stockholder, GTCR Golder Rauner L.L.C. and its affiliatedinvestment funds (“GTCR”).

On September 21, 2005, the Company completed afollow-on offering of common stock issuing 1,200,000 common shares at $23.25 pershare, which generated proceeds, net of offering costs, of approximately$26.1 million. On September 21, 2005, in connection with thefollowing-on offering, the underwriters exercised their over-allotment optionand the Company issued an additional 900,000 shares of common stock at$23.25 per share, which generated proceeds net of offering costs ofapproximately $20.0 million. The net proceeds from the follow-on offeringwere used to repay a portion of the Company’s long-term debt outstanding underits existing credit-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 fromlong-lived assets, accrued expenses for probable losses and estimates relatedto the fair value of our employee stock options, including volatility, expectedterm and estimates of forfeitures in future periods. Actual results coulddiffer from those estimates.

**Revenue Recognition**

The Company recognizes revenue when persuasiveevidence of an agreement exists, the terms are fixed or determinable, servicesare performed, and collection is probable. Cash received in advance of revenuerecognition is recorded as deferred revenue. POS services revenue is derivedprimarily from the transmission of transaction data through 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

6

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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 123R requires all stock-based compensation to employees be measured atfair value and expensed over the requisite service period and also requires anestimate of forfeitures when calculating compensation expense. The Companyrecognizes compensation cost on awards with graded vesting on a straight-linebasis over the requisite service period for the entire award. In accordancewith the Company’s chosen method of adoption, results for prior periods havenot 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. Prior tothe adoption of SFAS 123R, the Company followed Accounting Principles Board (“APB”)Opinion No. 25, which accounts for share-based payments to employees usingthe intrinsic value method and, as such, the Company generally recognized nocompensation cost for employee stock options. Refer to Note 7 for additionaldiscussion regarding details of the Company’s stock-based compensation plansand the adoption of SFAS 123R.

**Income Taxes**

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

For the three monthsended March 31, 2005 and 2006, the Company’s effective tax rate wasapproximately 50.4% and 3.0%, respectively. The Company’s tax rate fluctuatesfrom the U.S. Federal statutory tax rate of 34.0% as a result of lower taxrates in certain international jurisdictions in which the Company hasoperations and losses in certain jurisdictions that cannot be used to offsetincome 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 direct acquisition costs of approximately $0.3 million for certainassets related to CommsXL. We purchased these companies to advance ourend-to-end POS service offerings in the United Kingdom as well as to penetratenew vertical markets.

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 |   |

 

7

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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 fromInfiniRoute Networks, Inc. for a purchase price of approximately $2.5million. The assets acquired include the right to provide TSD services undercustomer contracts, developed technology, certain fixed assets and anon-compete agreement. The Company purchased these assets to advance its TSDservice offerings to enable traditional telecommunications carriers andnext-generation service providers to interconnect directly over InternetProtocol (IP) packet networks, reducing the cost and complexity associated withthese interconnections.

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

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

 

The amounts allocated to the customerrelationships, developed technology and to the non-compete agreements are beingamortized on a straight-line basis over their estimated useful lives of threeyears. Unaudited pro forma results of operations are not provided because thehistorical operating results were not significant and pro forma results wouldnot be significantly different from reported results for the periods presented.The Company’s results of operations for the three months ended March 31,2006 include the 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 stock of a subsidiary of Sonic GlobalPTY Ltd. for a purchase price of approximately $6.0 million, plus directacquisition costs of approximately $0.1 million. The assets acquired includethe right to provide POS services under customer contracts, developedtechnology, certain fixed assets and non-compete agreements. The Companypurchased 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 ofthis acquisition 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 

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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 related to its investment in WAY ofapproximately $0.3 million and $0.5 million, respectively.

Summarized financialinformation for the Company’s investment 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 to convert theoutstanding principal and accrued interest of approximately $0.9 million to675,901 shares of IP Commerce’s Series B convertible preferred stock. TheCompany owned 29.5 percent of IP Commerce’s outstanding shares as of March 31,2006. The Company isaccounting for its investment under the equity method of accounting. Due totiming of the receipt of IP Commerce’s financial statements, the Company isaccounting for the income or loss in this equity method investment on aone-month lag. For the three months ended March 31, 2005 and 2006, theCompany recognized a net loss in the equity of an unconsolidated affiliate relatedto its investment in IP Commerce of approximately $0.1 million and $0.5million, respectively.

Summarized financialinformation for the Company’s investment in IP Commerce is as follows (inthousands):

|                         | ** ** | **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 | ) |
|                               |            |                                                     |            |  |  |  |  |

 

9

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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 onthe term loan are first applied pro-rata to the scheduled quarterlyinstallments due within the next succeeding twelve-month period until paid infull and then applied to the term loan in inverse order of maturity. As of 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 shareas their effect would have been anti-dilutive.

10

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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 NorthAmerican and ISD operations 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 |   |

 

11

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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 UnitedKingdom were $13.8 million and $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 |   |

 

12

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

##### As discussed inNote 1, effective January 1, 2006, the Company adopted SFAS 123R using themodified prospective transition method. The following table sets forth totalstock based compensation expense recognized in the condensed consolidatedstatement of operations resulting from stock options and non-vested restrictedstock 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 on January 1,2006, the Company recorded a cumulative effect of a change in accountingprinciple, net of tax, of approximately $0.1 million related to estimatedforfeitures of unvested restricted stock awards for which stock basedcompensation was recorded in the Company’s financial statements prior toJanuary 1, 2006. During the three months ended March 31, 2006, theCompany capitalized approximately $81,000 of stock based compensation costs foremployees working on capitalized software development projects.

##### As permitted bySFAS 123 “Accounting for Stock-Based Compensation (“SFAS 123”), during 2005 theCompany followed APB Opinion No. 25 under which share-based payments toemployees are accounted for using the intrinsic value method and, as such,generally recognized no compensation cost for employee stock options. TheCompany’s pro forma information for the three months ended March 31, 2005under SFAS 123, which reflects compensation expense equal to the fair value ofthe options and restricted stock awards recognized over their requisite serviceperiod, is as follows (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 compensationplans are discussed below.

***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, andcertain other individuals are granted the opportunity to acquire an equityinterest in the Company. Either incentive stock options or nonqualified optionsmay be granted under the 2001 Plan. Options granted under the 2001 Plan have anexercise price equal to or greater than the estimated fair value of the underlyingcommon stock at the date of grant and become exercisable based on a vestingschedule determined at the date of grant, generally over four years. Theoptions expire 10 years from the date of grant.

In February 2004, the Board of Directors of the Companyadopted 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 atthe date of grant, generally in equal monthly installments over four years. Theoptions expire 10 years from the date of grant. Restricted stock awardsand performance shares granted under the Plan are subject to a vesting perioddetermined at the date of grant, generally in equal annual installments overfour years.

13

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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 of similar guideline companies in the Company’s peer group. Historicalvolatility was not used as the Company does not have sufficient historicalinformation to develop reasonable expectations about future volatility.

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

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

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 |   |

Theweighted average grant date fair value of options granted during the threemonths ended March 31, 2005 and 2006 was $9.51 and $8.21, respectively. Thetotal intrinsic value of stock options exercised during the three months ended March 31,2005 and 2006 was approximately $1,000 and $7,000, respectively. As of March 31,2006, there was a total of $6.2 million of total unrecognized compensation costrelated to non-vested stock options which is expected to be recognized over aweighted average period of approximately two years.

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 for the three monthsended March 31, 2005 and 2006, respectively, which were recorded as additionsto additional paid-in capital in the condensed consolidated balance sheets. Theadoption of SFAS 123R also resulted in reflecting the excess tax benefit fromthe exercise of stock based compensation awards in cash flows from financingactivities.

***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 $2.3million, respectively. As of March 31, 2006, there was $6.7 million oftotal unrecognized compensation cost related to restricted stock units which isexpected to be recognized over a weighted average period of approximately threeyears.

14

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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 $3.25million in cash to the plaintiffs and received the dismissal of all claims,with prejudice, by the plaintiffs, thereby settling this dispute. This $3.25million settlement is included in selling, general and administrative expensesin the accompanying condensed consolidated statement of operations for thethree months 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 the liability is included in selling,general and administrative expenses in the accompanying condensed consolidatedstatement of operations for the three months ended March 31, 2005. Boththe Company and the customers involved are vigorously defending the remainingproposed assessments by the sales tax authorities. In the opinion ofmanagement, resolution of these matters will not have a material adverse effectupon the financial position or future operating results 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’sChief Executive Officer, and Henry H. Graham, Jr., the Company’s ChiefFinancial Officer, are defendants in a putative class action lawsuit filed inconnection with the Company’s public offering of common stock in September 2005(“Secondary Offering”).  The CementMasons and Plasterers Joint Pension Trust, purportedly on behalf of itself andothers similarly situated, filed the putative class action lawsuit captioned *Cement Masons & Plasterers Joint Pension Trust v. TNS, Inc., etal.,* Case No. 1:06 CV 363, CMH/BRP, on April 4, 2006 in the UnitedStates District Court for the Eastern District of Virginia.  Plaintiff claims that the RegistrationStatement filed in connection with the Secondary Offering negligently failed todisclose that (1) TNS’ agreement with the Pepsi Bottling Group, Inc. (“Pepsi”)to provide cashless vending to Pepsi had been delayed beyond August 7, 2005;(2) TNS was generating less revenues and income than it had anticipated fromits contract with the Royal Bank of Scotland (“RBS”), because RBS purportedlyhad overstated the number of transactions that TNS would be responsible forprocessing for RBS; and (3) TNS’ International Services Division wasexperiencing declining revenues during that time period because of unfavorableforeign exchange rates.  This action isin the preliminary phase; thus the timing and course of the litigation are notpredictable, 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 members of its Board of Directorsalso are defendants in a putative shareholder class action lawsuit that seeksto 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 ofhimself and others similarly situated, filed the lawsuit captioned *Schwartz v. TNS, Inc., et al.,* C.A. No. 2000-N, on March 13,2006 in Delaware Chancery Court for New Castle County.  The plaintiff alleges that injunctive reliefis necessary because the Company and the members of the Board of Directorsallegedly breached their fiduciary duties to TNS shareholders by allegedlycausing the Company to negotiate for the sale of TNS at an unfair price,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 a result, management cannot estimate a range of possibleloss.  However, TNS intends to takeappropriate actions to defend against the lawsuit, the outcome of which couldhave a material adverse affect on the financial condition or future operatingresults of TNS.  No amounts have beenaccrued related to this case in the condensed consolidated financial statementsfor the three months ended March 31, 2006, as management cannot yetestimate the future legal costs, if any, that will be incurred to defendagainst this lawsuit.

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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 and countries in Europe, Latin America andthe Asia-Pacific region.

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

Wegenerate revenues through four business divisions:

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

·                     ***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 through subsidiaries located in thesecountries. Additionally, through these international subsidiaries, we alsoprovide services to customers located in Belgium, Finland, Gibraltar, HongKong, 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 amongcommercial banks, mutual funds, pension funds, broker-dealers, alternativetrading systems, electronic communications networks, securities and commoditiesexchanges and other market participants. Our networks support multiplecommunications protocols including the Financial Information eXchange, or FIX,protocol. Our financial services division generates revenues from monthlyrecurring fees based on the number of customer connections to and through ournetworks.

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

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

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

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

On May 5, 2005, 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, we made an investment in WAYSystems, Inc. (WAY), which provides mobile POS transaction infrastructureand solutions for mobile merchants. We 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. 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 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, 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 accountingfor our investment under the equity method of accounting as the Company hassignificant influence over the financing and operating activities of WAYthrough its representation on the board of directors. Due to timing of thereceipt of WAY’s financial statements, TNS is accounting for the income or lossin this equity method investment on a one-month lag. For the three months ended March 31, 2005 and2006, we recognized a net loss in the equity of an unconsolidated affiliaterelated to our investment in WAY of approximately $0.3 million and $0.5million, 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. Wepurchased 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 September 2005,we exercised our right on the convertible note to convert the outstandingprincipal and accrued interest of approximately $0.9 million to 675,901 sharesof IP Commerce’s Series B convertible preferred stock. We ownedapproximately 29.5 percent of  IPCommerce’s outstanding shares as of March 31, 2006. We are accounting forthis investment under the equity method of accounting. Due to timing of thereceipt of IP Commerce’s financial statements, TNS is accounting for the incomeor loss in this equity method investment on a one-month lag. For the threemonths ended March 31, 2005 and 2006, we recognized a net loss in theequity of an unconsolidated affiliate related to 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. We havenegotiated contract renewals with some of our POS customers, and in severalinstances 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, andadministrative expenses for the three months ended March 31, 2005 is a$3.2 million charge related to a legal settlement and a $4.2 million benefitfrom 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 an increase in stock basedcompensation expense as a result of the adoption of SFAS 123R onJanuary 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 from acquisitions.The decrease was primarily attributable to certain of our intangible assetsbecoming fully amortized at the end of the first quarter of 2005 which waspartially 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 thesignificant loss of revenue from a customer. Based upon our contract with oneof our major customers, we believe that revenues and related transactionvolumes from this customer will continue to decline in 2006 and may declinefurther thereafter. The intangible asset value attributable to this customerrelationship was approximately $23.3 million as of March 31, 2006. Weassessed the recoverability of this customer relationship asset based uponundiscounted anticipated future cash flows and concluded no impairment existedas of March 31, 2006.

***Interest expense.***Interestexpense increased $1.2 million to $2.0 million for the three months ended March 31,2006, from $0.8 million for the three months ended March 31, 2005. Interestexpense increased primarily due to the additional borrowings under our amendedand restated senior 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 incometax provision of $1.9 million for the three months ended March 31, 2005.Our effective tax rate for the three months ended March 31, 2006 is 3.0%versus the U.S. federal statutory tax rate of 34.0%, due primarily to lower taxrates in certain 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 was due to additional losses recorded on our equity methodinvestments, primarily relating to our investments in Way Systems, Inc.and IP Commerce, Inc. As of March 31, 2006, we have $4.9 million of long-terminvestments in unconsolidated affiliates, and we expect to incur additionallosses on these investments in 2006 and we may continue to incur lossesthereafter.

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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 financingactivities for the three months ended March 31, 2006, which includes$6.0 million of borrowings under our amended and restated senior securedcredit facility, the proceeds of which were used to finance the stock and assetpurchase from Sonic. We used cash of $3.5 million for financing activitiesfor the three months ended March 31, 2005, which consisted primarily of$3.0 million of long-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 coverage ratio of greater than 4.0 to 1.0 and afixed charge ratio of greater than 2.5 to 1.0. Certain of the financialcovenants will become more restrictive over the term of the amended andrestated senior secured credit facility. The amended and restated seniorsecured credit facility also contains nonfinancial covenants that restrict someof our corporate activities, including our ability to dispose of assets, incuradditional debt, pay dividends, create liens, make investments, make capitalexpenditures and engage in specified transactions with affiliates. Our futureresults of operations and our ability to comply with the covenants could beadversely impacted by increases in the general level of interest rates sincethe interest on a majority of our debt is variable. Noncompliance with any ofthe financial or nonfinancial covenants without cure or waiver would constitutean event of default under the amended and restated senior secured creditfacility. An event of default resulting from a breach of a financial ornonfinancial covenant may result, at the option of the lenders, in anacceleration of the principal and interest outstanding, and a termination ofthe amended and restated senior secured revolving credit facility. The amendedand restated senior secured credit facility also contains other customaryevents of default (subject to specified grace periods), including defaultsbased on events of bankruptcy and insolvency, nonpayment of principal, interestor fees when due, breach of specified covenants, change in control and materialinaccuracy of representations and warranties. We were in compliance with thefinancial and nonfinancial covenants of the amended and restated senior securedcredit facility as of March 31, 2006.

**Adoption of SFAS 123R**

We adopted SFAS 123Rfollowing the modified prospective transition method effective January 1, 2006.SFAS 123R requires all share-based payments to employees to be recognized inthe income statement based on their respective grant date fair values over thecorresponding service periods and also requires an estimation of forfeitureswhen calculating compensation expense. The adoption of SFAS 123R reduced incomefrom operations by approximately $0.8 million and basic and diluted earningsper share (“EPS”) by $0.03 for the three months ended March 31, 2006.Stock-based compensation accounted for under SFAS 123R is expected to reduceincome from operations and earnings per share by approximately $3.2 millionand  $0.14, respectively, for the fullyear 2006. The current compensation structure, or changes therein, as well asany subsequent stock based compensation plan activity could result in an increasein the impact of SFAS 123R in 2006 and thereafter.

Prior to the adoption ofSFAS 123R, we followed APB Opinion No. 25, “Accounting for Stock Issued toEmployees,” in its accounting for stock compensation and recorded stock basedcompensation based on the intrinsic value method. Stock compensation expenserecognized in the three months ended March 31, 2005 reduced net income byapproximately $0.3 million, related to restricted stock units.   Prior to the adoption of SFAS 123R, we didnot make estimates for forfeitures and recognized compensation cost assumingall restricted stock awards would vest and reversed compensation cost forforfeited awards when the awards were actually forfeited.  Upon adoption of SFAS 123R, we recorded acumulative effect of a change in accounting principle, net of tax ofapproximately $0.1 million related to estimated forfeitures of unvestedrestricted stock awards.  As of March 31,2006, the total compensation cost related to unvested stock options andrestricted stock units that has not yet been recognized was approximately $12.9million, which we expect to recognize over a weighted average period ofapproximately 3 years.

Refer to Note 7 of ourCondensed Consolidated Financial Statements in Item 1 for a complete discussionof our stock-based compensation 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.

Wehave operations in 19 countries outside of the U.S., including the UnitedKingdom, Australia, Austria, Bermuda, Canada, Colombia, France, Germany,Ireland, Italy, Japan, Malaysia, the Netherlands, New Zealand, Poland, Romania,South Korea, Spain and Sweden. We provide services in these countries usingnetworks deployed in each country. We manage foreign exchange risk through thestructure of our business. In the substantial majority of our transactions, wereceive payments denominated in the U.S. dollar, British pound, euro orAustralian dollar. Therefore, we do not rely on international currency marketsto obtain and pay illiquid currencies. The foreign currency exposure that doesexist is limited by the fact that the majority of transactions are paidaccording to our standard payment terms, which are generally short-term innature. Our policy is not to speculate in foreign currencies, and we promptlybuy and sell foreign currencies as necessary to cover our net payables andreceivables, which are denominated in foreign currencies. For the three monthsended March 31, 2006, we recorded a gain on foreign currency translationof approximately $0.2 million.

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**Item 4. Controlsand Procedures**

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

**Evaluation**

The Company carried out an evaluation, under thesupervision, and with the participation, of the Company’s management, includingthe Company’s Chief Executive Officer and the Company’s Chief FinancialOfficer, of the effectiveness of the Company’s disclosure controls andprocedures as of 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 threemonths ended March 31, 2006 covered by this report in the Company’sinternal control over financial reporting or in other factors that couldsignificantly affect the internal control over financial reporting.

 

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**PART II—OTHERINFORMATION**

**Item 1.**                          LegalProceedings

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

**Item 1A.      Risk Factors**

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

***We face risksrelated to securities litigation that could have a material adverse effect onour business, financial position and results of operations.***

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

**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 report to be signedon its behalf by the undersigned thereunto duly authorized.
|                          | TNS, Inc.  (Registrant) |
|--------------------------|------------------------------|
|                     |                         |   |
|                     |                         |   |
| Date:  May 10, 2006 | By:                          | /s/ JOHN J. MCDONNELL, JR. |
|                     |                         | John J. McDonnell, Jr. Chairman and Chief Executive Officer |
|                     |                         |   |
| Date:  May 10, 2006 | By:                          | /s/ HENRY H. GRAHAM, JR. |
|                     |                         | Henry H. Graham, Jr. Executive Vice President, Chief  Financial Officer & Treasurer |

 

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