**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**Forthe quarter ended September 30, 2005**

 

**CommissionFile Number: 001–32033**

 

**TNS, INC.**

(Exact name of registrant asspecified 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) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities 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 past90 days.   ý Yes    o No

 

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

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes  ýNo

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of Common Stock, as of the latest practicabledate.

 

SharesOutstanding as of October 1, 2005

**23,967,892Shares of Common Stock, $0.001 par value**

 

 

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**TNS, INC.INDEX**

 
| **Part I:**  | **FINANCIAL INFORMATION** |                                                                                                                  |
|-------------------|---------------------------|-----------------------------------------------------------------------------------------------------------------------|
|              |                      |                                                                                                                  |   |
|              | Item 1.              | Condensed Consolidated Financial Statements (Unaudited)                                                               |   |
|              |                      | Condensed Consolidated Balance Sheets as of December 31, 2004  and September 30, 2005                       |   |
|              |                      | Condensed Consolidated Statements of Operations for the three and  nine months ended September 30, 2004 and 2005 |   |
|              |                      | Condensed Consolidated Statements of Cash Flows for the nine months  ended September 30, 2004 and 2005           |   |
|              |                      | Notes to Condensed Consolidated Financial Statements                                                                  |   |
|              | Item 2.              | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                           |   |
|              | Item 3.              | Quantitative and Qualitative Disclosures  About Market Risk                                                           |   |
|              | Item 4.              | Controls and Procedures                                                                                               |   |
|              |                      |                                                                                                                  |   |
| **Part II:** | **OTHER INFORMATION**     |                                                                                                                  |
|              |                      |                                                                                                                  |   |
|              | Item 1.              | Legal Proceedings                                                                                                     |   |
|              | Item 2.              | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities                                     |   |
|              | Item 3.              | Default Upon Senior Securities                                                                                        |   |
|              | Item 4.              | Submission of Matters to a Vote of Security  Holders                                                                  |   |
|              | Item 5.              | Other Information                                                                                                     |   |
|              | Item 6.              | Exhibits                                                                                                              |   |

 

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**PART I—FINANCIAL INFORMATION**

 

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

 

**TNS, INC.CONDENSED CONSOLIDATEDBALANCE SHEETS(dollars in thousands, except share and per share data)**

 
| ** **                                                                                                                                                                      | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                      | ** ** | ** **                  | ** ** | **(unaudited)**              | ** ** |
| **ASSETS**                                                                                                                                                                      | ** ** | ** **                  | ** ** | ** **                   | ** ** |
| Current assets:                                                                                                                                                                 |       |                        |       |                         |       |
| Cash and  cash equivalents                                                                                                                                                      |       | $                           | 19,788     |                         | $          | 24,564 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $4,756 and $5,021,  respectively                                                                                |       | 47,896                      |       | 47,970                       |       |
| Current  deferred tax asset                                                                                                                                                     |       | 1,167                       |       | 6,049                        |       |
| Prepaid  expenses                                                                                                                                                               |       | 3,279                       |       | 5,197                        |       |
| Other  current assets                                                                                                                                                           |       | 4,903                       |       | 7,928                        |       |
| Total  current assets                                                                                                                                                           |       | 77,033                      |       | 91,708                       |       |
| Property and equipment, net                                                                                                                                                     |       | 50,587                      |       | 49,109                       |       |
| Identifiable intangible assets, net                                                                                                                                             |       | 205,208                     |       | 191,049                      |       |
| Goodwill                                                                                                                                                                        |       | 5,386                       |       | 5,255                        |       |
| Other assets                                                                                                                                                                    |       | 18,198                      |       | 15,945                       |       |
| Total assets                                                                                                                                                                    |       | $                           | 356,412    |                         | $          | 353,066 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |                        |       |                         |       |
| Current liabilities:                                                                                                                                                            |       |                        |       |                         |       |
| Current  portion of long-term debt                                                                                                                                              |       | $                           | 9,000      |                         | $          | 1,650 |   |
| Accounts  payable, accrued expenses and other current liabilities                                                                                                               |       | 43,528                      |       | 44,100                       |       |
| Deferred  revenue                                                                                                                                                               |       | 14,419                      |       | 10,571                       |       |
| Total  current liabilities                                                                                                                                                      |       | 66,947                      |       | 56,321                       |       |
| Long-term debt, net of current portion                                                                                                                                          |       | 42,000                      |       | 117,525                      |       |
| Other liabilities                                                                                                                                                               |       | 4,967                       |       | 2,952                        |       |
| Total  liabilities                                                                                                                                                              |       | 113,914                     |       | 176,798                      |       |
| Commitments and contingencies                                                                                                                                                   |       |                        |       |                         |       |
| Stockholders’ equity:                                                                                                                                                      |       |                        |       |                         |       |
| Common stock  $0.001 par value; 130,000,000 shares authorized; 27,996,053 shares issued and  outstanding and 23,995,385 shares issued and 23,967,892 outstanding,  respectively |       | 28                          |       | 24                           |       |
| Treasury  stock                                                                                                                                                                 |       | —                      |       | (511                         | )          |
| Additional  paid-in capital                                                                                                                                                     |       | 281,766                     |       | 217,212                      |       |
| Accumulated  deficit                                                                                                                                                            |       | (37,333                     | )          | (32,995                      | )          |
| Deferred  stock compensation                                                                                                                                                    |       | (4,766                      | )          | (7,668                       | )          |
| Accumulated  other comprehensive income                                                                                                                                         |       | 2,803                       |       | 206                          |       |
| Total  stockholders’ equity                                                                                                                                                |       | 242,498                     |       | 176,268                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                                |       | $                           | 356,412    |                         | $          | 353,066 |   |

 

See accompanying notes tocondensed consolidated financial statements (unaudited).

 

2

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**TNS, INC.CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS (UNAUDITED)(dollars in thousands, except share and per share data)**

 
| ** **                                                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues                                                                        |       | $                                          | 64,584     |                                      | $          | 64,836 |   | $ | 185,680 |   | $ | 193,321 |   |
| Operating expenses:                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Cost of  network services, exclusive of the items shown separately below        |       | 31,344                                     |       | 30,074                                    |       | 91,170 |   | 91,270 |   |
| Engineering  and development                                                    |       | 3,748                                      |       | 3,813                                     |       | 10,680 |   | 11,753 |   |
| Selling,  general, and administrative                                           |       | 12,690                                     |       | 13,796                                    |       | 36,515 |   | 39,847 |   |
| Depreciation  and amortization of property and equipment                        |       | 4,989                                      |       | 4,541                                     |       | 14,746 |   | 14,367 |   |
| Amortization  of intangible assets                                              |       | 6,151                                      |       | 4,249                                     |       | 20,855 |   | 17,763 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Total  operating expenses                                                       |       | 58,922                                     |       | 56,473                                    |       | 173,966 |   | 175,000 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Income from operations                                                          |       | 5,662                                      |       | 8,363                                     |       | 11,714 |   | 18,321 |   |
| Interest expense                                                                |       | (1,035                                     | )          | (2,997                                    | )          | (6,472 | ) | (7,036 | ) |
| Interest income                                                                 |       | 130                                        |       | 172                                       |       | 216 |   | 422 |   |
| Other income (expense), net                                                     |       | 389                                        |       | (22                                       | )          | 221 |   | (521 | ) |
| Income  before income taxes and equity in net loss of unconsolidated affiliates |       | 5,146                                      |       | 5,516                                     |       | 5,679 |   | 11,186 |   |
| Income tax provision                                                            |       | (1,714                                     | )          | (2,085                                    | )          | (2,344 | ) | (4,919 | ) |
| Equity in net loss of unconsolidated  affiliates                                |       | (682                                       | )          | (797                                      | )          | (780 | ) | (1,929 | ) |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Net income                                                                      |       | 2,750                                      |       | 2,634                                     |       | 2,555 |   | 4,338 |   |
| Dividends on preferred stock                                                    |       | —                                     |       | —                                    |       | (3,428 | ) | — |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss) attributable to common  stockholders                          |       | $                                          | 2,750      |                                      | $          | 2,634 |   | $ | (873 | ) | $ | 4,338 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Basic net income (loss) per common share                                        |       | $                                          | 0.10       |                                      | $          | 0.12 |   | $ | (0.04 | ) | $ | 0.18 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Diluted net income (loss) per common share                                      |       | $                                          | 0.10       |                                      | $          | 0.12 |   | $ | (0.04 | ) | $ | 0.17 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Basic weighted average common shares  outstanding                               |       | 26,781,393                                 |       | 22,040,253                                |       | 22,836,485 |   | 24,703,641 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Diluted weighted average common shares  outstanding                             |       | 27,210,963                                 |       | 22,631,624                                |       | 22,836,485 |   | 25,110,688 |   |

 

See accompanying notes to condensedconsolidated financial statements (unaudited).

 

3

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**TNS, INC.CONDENDSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS (UNAUDITED)(dollars in thousands)**

 
| ** **                                                                                            | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2004**                                 | ** ** | **2005** | ** ** |
| Cash flows from operating activities:                                                                 |       |                                     |       |   |   |
| Net income                                                                                            |       | $                                        | 2,555      |   | $ | 4,338 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                    |       |                                     |       |   |   |
| Depreciation  and amortization of property and equipment                                              |       | 14,746                                   |       | 14,367 |   |
| Amortization  of intangible assets                                                                    |       | 20,855                                   |       | 17,763 |   |
| Deferred  income tax (benefit) provision                                                              |       | (3,333                                   | )          | 2,781 |   |
| (Gain) loss  on disposal of property and equipment                                                    |       | (235                                     | )          | 27 |   |
| Amortization  and write-off of deferred financing costs                                               |       | 2,919                                    |       | 2,091 |   |
| Equity in  net loss of unconsolidated affiliates                                                      |       | 780                                      |       | 1,929 |   |
| Stock  compensation expense                                                                           |       | 798                                      |       | 1,789 |   |
| Changes in operating assets and  liabilities, net of effect of acquisitions:                          |       |                                     |       |   |   |
| Accounts  receivable, net                                                                             |       | (6,047                                   | )          | (74 | ) |
| Other  current and noncurrent assets                                                                  |       | (4,076                                   | )          | (3,546 | ) |
| Accounts  payable, accrued expenses and other current and noncurrent liabilities                      |       | 2,660                                    |       | (4,162 | ) |
| Deferred  revenue                                                                                     |       | 2,357                                    |       | (3,848 | ) |
|                                                                                                  |       |                                     |       |   |   |
| Net cash  provided by operating activities:                                                           |       | 33,979                                   |       | 33,455 |   |
|                                                                                                  |       |                                     |       |   |   |
| Cash flows from investing activities:                                                                 |       |                                     |       |   |   |
| Purchases of  property and equipment                                                                  |       | (16,396                                  | )          | (14,087 | ) |
| Purchase of  Synapse assets from USWD                                                                 |       | (6,077                                   | )          | — |   |
| Purchase of  vending assets from USWD                                                                 |       | (3,748                                   | )          | — |   |
| Investments  in affiliated entities                                                                   |       | (3,600                                   | )          | (5,505 | ) |
| Purchase of  FusionPoint assets                                                                       |       | —                                   |       | (3,501 | ) |
| Purchase of  Process Logistics assets                                                                 |       | —                                   |       | (558 | ) |
|                                                                                                  |       |                                     |       |   |   |
| Net cash  used in investing activities:                                                               |       | (29,821                                  | )          | (23,651 | ) |
|                                                                                                  |       |                                     |       |   |   |
| Cash flows from financing activities:                                                                 |       |                                     |       |   |   |
| Proceeds  from issuance of long-term debt, net of financing costs of $1,979 and $2,727,  respectively |       | 84,531                                   |       | 165,188 |   |
| Repayment of  long-term debt                                                                          |       | (158,646                                 | )          | (99,740 | ) |
| Payment of  long-term debt financing costs                                                            |       | —                                   |       | (75 | ) |
| Payment of  dividends on preferred stock                                                              |       | (173                                     | )          | — |   |
| Proceeds  from stock option exercises                                                                 |       | 101                                      |       | 1,554 |   |
| Purchase of treasury  stock                                                                           |       | —                                   |       | (511 | ) |
| Purchase of  common stock, inclusive of fees of $996                                                  |       | —                                   |       | (116,869 | ) |
| Proceeds  from issuance of common stock, net                                                          |       | 71,516                                   |       | 46,065 |   |
|                                                                                                  |       |                                     |       |   |   |
| Net cash  used in financing activities:                                                               |       | (2,671                                   | )          | (4,388 | ) |
|                                                                                                  |       |                                     |       |   |   |
| Effect of exchange rates on cash and cash  equivalents                                                |       | 405                                      |       | (640 | ) |
|                                                                                                  |       |                                     |       |   |   |
| Net increase in cash and cash equivalents                                                             |       | 1,892                                    |       | 4,776 |   |
| Cash and cash equivalents, beginning of  period                                                       |       | 11,074                                   |       | 19,788 |   |
|                                                                                                  |       |                                     |       |   |   |
| Cash and cash equivalents, end of period                                                              |       | 12,966                                   |       | 24,564 |   |
|                                                                                                  |       |                                     |       |   |   |
| Supplemental disclosures of cash flow  information:                                                   |       |                                     |       |   |   |
| Cash paid  for interest                                                                               |       | 4,244                                    |       | 4,543 |   |
|                                                                                                  |       |                                     |       |   |   |
| Cash paid  for income taxes                                                                           |       | $                                        | 3,121      |   | $ | 4,186 |   |

 

See accompanying notes tocondensed consolidated financial statements (unaudited).

 

4

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

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

 

TNS, Inc. (TNS or the Company) is aDelaware corporation. 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 telecommunications industryand of secure data and voice network services to the global financial servicesindustry. TNS’ data communication services enable secure and reliabletransmission of time–sensitive, transaction–related information critical to itscustomers’ operations. The Company’s customers outsource their datacommunication requirements to TNS because of the Company’s expertise,comprehensive customer support, and cost–effective services. TNS providesservices to customers in the United States and increasingly to internationalcustomers.  Internationally, TNS operatesnetworks in 18 countries, including Canada and countries in Europe and theAsia–Pacific region, and uses these networks to provide services to customersin these countries.

 

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

 

The Company has four business divisions: (1) thepoint–of–sale/point–of–service (POS) division, which provides datacommunications services 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 condensedconsolidated financial statements have been prepared in accordance with UnitedStates generally accepted accounting principles (GAAP) for interim financial informationand in conjunction with the rules and regulations of the Securities andExchange Commission (SEC). Certain information and note disclosures normallyincluded in the annual financial statements, required by GAAP, have beencondensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationpresented not misleading.

 

In the opinion of management, theaccompanying unaudited condensed consolidated financial statements reflect allnecessary adjustments (all of which are of a normal and recurring nature) thatare necessary for fair presentation for the periods presented. The results ofoperations for the three and nine months ended September 30, 2005 are notnecessarily indicative of the results to be expected for any subsequent interimperiod or for the fiscal year. It is suggested that these unaudited condensedconsolidated financial statements be read in conjunction with the Company’sprospectus filed with the SEC on September 16, 2005 (File No. 333-127851),which includes consolidated financial statements and the notes thereto for theyear ended December 31, 2004.

 

**Use of Estimates**

 

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

 

5

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**Revenue Recognition**

 

The Company recognizes revenue whenpersuasive evidence of an agreement exists, the terms are fixed anddeterminable, services are performed, and collection is probable. Cash receivedin advance of revenue recognition is recorded as deferred revenue. POS servicesrevenue is derived primarily from per transaction fees paid by the Company’scustomers for the transmission of transaction data, through the Company’snetworks, between payment processors and POS or ATM terminals.Telecommunication services revenue is derived primarily from fixed monthly feesfor call signaling services and per query fees charged for database access andvalidation services. Financial services revenue is derived primarily frommonthly recurring fees based on the number of customer connections to andthrough the Company’s networks. Incentives granted to new customers or uponcontract renewals are deferred and recognized ratably as a reduction of revenueover the contract period to the extent that the incentives are recoverableagainst the customer’s minimum purchase commitments under the contract. Inaddition, the Company receives installation fees related to the configurationof the customers’ systems. Revenue from installation fees is deferred andrecognized ratably over the customer’s contractual service period, generallythree years.

 

**Cost of Network Services**

 

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

 

**Goodwill and Identifiable Intangible Assets**

 

Amortization of intangible assets is recordedon a straight-line basis over their expected useful lives. The Companyevaluates the useful lives assigned to intangible assets on a regular basis

 

Developed technology represents the Company’sproprietary knowledge, including processes and procedures, used to configureits networks. Network equipment and software, both purchased and internallydeveloped, are components used to build the networks and are separatelyidentified assets classified within property and equipment.

 

For purposes of measuring and recognizingimpairment of long-lived assets, including intangibles, the Company assesseswhether separate cash flows can be attributed to the individual asset.  For the Company’s customer relationshipassets, the Company recognizes and measures impairment upon the significant lossof revenue from a customer. Included in amortization of intangibles expense forthe nine months ended September 30, 2004 and September 30, 2005 isapproximately $2.2 million and $3.1 million, respectively, in acceleratedamortization on a portion of the Company’s customer relationship assets inconnection with the loss of certain customers during those respectiveperiods.  The Company has experiencedrevenue and transaction volume declines with a major customer during 2004 and2005.  The customer relationshipintangible asset assigned to this customer is approximately $24.1 million as ofSeptember 30, 2005.  The Companyassessed the recoverability of this customer relationship intangible assetbased upon undiscounted anticipated future cash flows and concluded that noimpairment existed as of September 30, 2005.

 

The Company adopted SFAS No. 142, “Goodwilland Other Intangible Assets,” on January 1, 2002. Under this standard,goodwill and intangible assets deemed to have indefinite lives are not amortizedand are subject to annual impairment tests. Other intangible assets areamortized over their useful lives. As a result of the adoption of SFAS No. 142on January 1, 2002, the Company reclassified approximately $2.6 million ofnet book value allocated to assembled workforce to goodwill, and these assetsare no longer amortized. The cost and net book value of the Company’s goodwillwas $4.5 million and $4.0 million, respectively, as of January 1, 2002.

 

The Company performs its annual SFAS No. 142impairment testing of its goodwill as of October 1 of each year, whichcould have an adverse effect on the Company’s future results of operations ifimpairment occurs. To date, the Company’s testing has indicated that there isno impairment of its goodwill.

 

**Income Taxes**

 

The Company accounts for income taxes inaccordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS

 

6

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No. 109,deferred tax assets or liabilities are computed based upon the difference betweenfinancial statement and income tax bases of assets and liabilities using theenacted marginal tax rate. The Company provides a valuation allowance on itsnet deferred tax assets when it is more likely than not that such assets willnot be realized. Deferred income tax expense or benefits are based upon thechanges in the asset or liability from period to period.

 

The American JobsCreation Act of 2004 (the Jobs Act), enacted on October 22, 2004, providesfor a temporary 85 percent dividends received deduction on certain foreignearnings repatriated during a one-year period. The deduction would result in anapproximate 5.25 percent federal tax rate on the repatriated earnings. Toqualify for the deduction, the earnings must be reinvested in the United Statespursuant to a domestic reinvestment plan established by a company’s chiefexecutive officer and approved by the company’s board of directors. Certainother criteria in the Jobs Act must be satisfied as well. For the Company, theone-year period during which the qualifying distributions can be made iscalendar year 2005.

 

In April 2005, the Company decided torepatriate $10.0 million of foreign earnings under the repatriation provisionsof the Jobs Act.  Accordingly, theCompany has recorded an additional income tax provision of approximately $0.5million related to this decision, which is included in income tax provision inthe accompanying condensed consolidated statements of operations for the ninemonths ended September 30, 2005. The Company repatriated $9.3 millionduring the nine months ended September 30, 2005 and an additional $0.7million in October 2005.

 

In October 2005, the Company decided torepatriate an additional $5.4 million of foreign earnings under therepatriation provisions of the Jobs Act. Repatriation of these earnings will result in recognition of additionalincome tax expense in the fourth quarter of 2005, which will be approximately$0.3 million.  The Company intends toreinvest the remaining undistributed foreign earnings indefinitely and,therefore, no provision for U.S. income taxes has been provided against theseundistributed earnings.

 

**Stock Based Compensation**

 

In February 2004, the Board of Directorsof the Company adopted the TNS, Inc. 2004 Long–Term Incentive Plan (thePlan) and the Company’s stockholders approved the Plan in March 2004. In May 2005,the Company’s stockholders approved an amendment to the Plan to increase thenumber of shares of common stock available for issuance under the Plan by2,261,000.  The Plan reserves 3,847,384shares of common stock for grants of incentive stock options, nonqualifiedstock options, restricted stock awards and performance shares to employees,non–employee directors and consultants performing services for the Company.Options granted under the Plan have an exercise price equal to or greater thanthe fair market value of the underlying common stock at the date of grant andbecome exercisable based on a vesting schedule determined at the date ofgrant, generally in equal monthly installments over four years. The optionsexpire 10 years from the date of grant. During the three and nine monthsended September 30, 2005, 53,227 and 74,060 shares of common stock wereissued from option exercises.  Restrictedstock awards and performance shares granted under the Plan are subject to avesting period determined at the date of grant, generally in equal annualinstallments over four years. As of September 30, 2005, the Company has434,476 unvested restricted stock units outstanding and approximately$7.6 million of deferred compensation related to these restricted stockunits. The deferred compensation is being amortized over the vesting period ofthe restricted stock units. For the three and nine months ended September 30,2005, the Company recorded compensation expense of approximately $0.7 millionand $1.7 million, respectively, related to these restricted stock units.  For the three and nine months ended September 30,2004, the Company recorded compensation expense of approximately $0.4 millionand $0.8 million, respectively, related to restricted stock units.  During the three and nine months ended September 30,2005, 7,832 shares and 88,707 shares of common stock were issued upon thevesting of restricted stock units.

 

The Company continues to account for employeestock options or similar equity instruments to employees under the intrinsicvalue method prescribed by Accounting Principles Board (APB) Opinion No. 25,“Accounting for Stock Issued to Employees.” Under the intrinsic value method,compensation cost is the excess, if any, of the fair value of the stock at thegrant date or other measurement date over the amount an employee must pay toacquire the stock. Statement of Financial Accounting Standards (SFAS) No. 123,“Accounting for Stock–Based Compensation” defines a fair value method ofaccounting for employee stock options or similar equity instruments. Under thefair value method, compensation cost is measured at the grant date based on thevalue of the award and is recognized over the service period. SFAS No. 123allows an entity to continue to use the intrinsic value method. However,entities electing to account for employee stock options or similar instrumentspursuant to APB Opinion No. 25 must make pro forma disclosures of net income,as if the fair value method of accounting had been applied.

 

7

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If stock compensation expense hadbeen determined based upon the fair value method at the grant dates using theBlack-Schoels model, the Company’s net income (loss) attributable to commonstockholders would have increased to the pro forma amounts indicated below (inthousands, except per share data):

 
| ** **                                                                                                                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income  (loss) attributable to common stockholders, as reported                                                                           |       | $                                          | 2,750      |                                      | $          | 2,634 |   | $ | (873 | ) | $ | 4,338 |   |
| Add:  Stock-based employee compensation expense included in reported net income  (loss), net of related tax effects                           |       | 216                                        |       | 453                                       |       | 479 |   | 1,073 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effects |       | (696                                       | )          | (928                                      | )          | (1,612 | ) | (2,465 | ) |
| Pro forma  net income (loss) attributable to common stockholders                                                                              |       | $                                          | 2,270      |                                      | $          | 2,159 |   | $ | (2,006 | ) | $ | 2,946 |   |
| Basic net  income (loss) per common share, as reported                                                                                        |       | $                                          | 0.10       |                                      | $          | 0.12 |   | $ | (0.04 | ) | $ | 0.18 |   |
| Diluted net  income (loss) per common share, as reported                                                                                      |       | $                                          | 0.10       |                                      | $          | 0.12 |   | $ | (0.04 | ) | $ | 0.17 |   |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Pro forma  basic and diluted net income (loss) per common share                                                                               |       | $                                          | 0.08       |                                      | $          | 0.10 |   | $ | (0.09 | ) | $ | 0.12 |   |

 

##### **Recent Accounting Pronouncements**

##### ** **

In December 2004, the FinancialAccounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-BasedPayment” (SFAS No. 123R), which is a revision of SFAS No. 123, “Accountingfor Stock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,“Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statementof Cash Flows”. The Company will adopt SFAS No. 123R on January 1,2006. SFAS No. 123R requires all share-based payments to employees,including grants of employee stock options, to be recorded as an expense basedon their fair values. Information about the fair value of stock options underthe Black-Scholes model and its pro forma impact on its net income (loss) andbasic and diluted net income (loss) per common share for the three and ninemonths ended September 30, 2004 and 2005 (which may differ from theultimate impact of adopting the new standard) can be found in this Note 1.  Under SFAS No. 123(R), theCompany must determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost and thetransition method to be used at the date of adoption. The transitionalternatives include the modified prospective or the modified retrospectiveadoption methods. Under the modified retrospective method, prior periods may berestated either as of the beginning of the year of adoption or for all periodspresented. The modified prospective method requires that compensation expensebe recorded for all unvested stock options and share awards at the beginning ofthe first quarter of adoption of SFAS No. 123(R), while the modifiedretrospective methods would record compensation expense for all unvested stockoptions and share awards beginning with the first period restated.  The Company is currently evaluating theimpact of adopting SFAS No. 123R and has not determined its adoptionmethod.

 

**2.**                                      **StockRepurchase and****Offeringsof Common Stock**

 

On May 4, 2005, the Company purchasedand retired 6,263,435 shares of its common stock, pursuant to a modified Dutchauction tender offer, for $18.50 per share plus expenses of approximately $1.0million.  Of the shares tendered, 6 millionshares were tendered by the Company’s then controlling stockholder, GTCR GolderRauner L.L.C. and its affiliated investment funds.

 

On September 21, 2005, the Companycompleted a follow-on offering of common stock issuing 1,200,000 common sharesat $23.25 per share, which generated proceeds, net of offering costs, ofapproximately $26.1 million.  On September 21,2005, in connection with the follow-on offering, the underwriters exercisedtheir over-allotment option and the Company issued an additional 900,000 sharesof common stock at $23.25 per share, which generated proceeds net of offeringcosts of approximately $20.0 million. The net proceeds from the follow-on offering were used to repay aportion of the Company’s long-term debt outstanding under its existingcredit-facility.

 

8

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**3.****                                      Long-termInvestments and Acquisitions**

 

In August 2004, the Company made an investmentin WAY Systems, Inc. (WAY), which provides mobile POS transactioninfrastructure and solutions for mobile merchants. The Company purchased5,952,381 shares or 38.5 percent of WAY’s Series B convertible preferredstock for $2.5 million and became entitled to representation on WAY’s board ofdirectors. As of December 31, 2004, the Company owned 18.1 percent of WAY’stotal outstanding shares. In March 2005, the Company made an additionalinvestment of $0.8 million to purchase 1,910,401 shares of WAY’s Series Bconvertible preferred stock representing an additional 1.9 percent of WAY’soutstanding shares.  In July 2005,the Company made an additional investment of $0.7 million in exchange for aconvertible note bearing interest at a rate of 8 percent per annum and due January 1,2009.  In September 2005, theCompany exercised its option on the convertible note to convert the outstandingprincipal and accrued interest of approximately $0.8 million to 1,185,085shares of WAY’s Series C convertible preferred stock and made anadditional investment of $1.1 million to purchase 1,676,429 shares of WAY’sSerices C convertible preferred stock. As of September 30, 2005 theCompany owned approximately 17.0 percent of WAY’s total outstandingshares.  The Company is accounting forits investment under the equity method of accounting. Due to timing of the receiptof WAY’s financial statements, the Company is accounting for the income or lossin this equity method investment on a one-month lag.  For the three and nine months ended September30, 2004, the Company recognized a net loss in the equity of an unconsolidatedaffiliate of approximately $0.1 million. For the three and nine months ended September 30, 2005, the Companyrecognized a net loss in the equity of an unconsolidated affiliate ofapproximately $0.4 million and $1.0 million, respectively.

 

In September 2004, TNS madean investment in AK Jensen Group, Limited (AKJ), a company that providesorder–routing systems and integrated electronic trading solutions to financialsoftware companies and end–clients.  The Company purchased 94,429 commonshares or 8.4% of the company’s total outstanding shares for $1.0 million andobtained representation on the company’s board of directors.  The Companyis accounting for its investment under the equity method of accounting as theCompany has significant influence through its representation on the board ofdirectors. Due to timing of the receipt of the company’s financial statements,TNS is accounting for the income or loss in this equity method investment on aone–month lag.  As a result, for the three and nine months ended September 30,2004, the Company recognized no income or loss in the equity of anunconsolidated affiliate.  For the threeand nine months ended September 30, 2005 the Company recognized a net lossin the equity of an unconsolidated affiliate of approximately $23,000 and $0.1million, respectively.

 

In January 2005, the Companymade an investment in IP Commerce, Inc., a company that provides operatingsoftware to facilitate the authorization of IP-based retail paymenttransactions. The Company purchased 2,368,545 Series A preferred shares or39.9 percent of IP Commerce’s total outstanding shares for $2.0 million andbecame entitled to representation on IP Commerce’s board of directors. TheCompany is accounting for its investment under the equity method of accounting.Due to timing of the receipt of IP Commerce’s financial statements, the Companyis accounting for the income or loss in this equity method investment on aone-month lag.  For the three and ninemonths ended September 30, 2005, the Company recognized a net loss in theequity of an unconsolidated affiliate of approximately $0.4 million and $0.8million, respectively.  In September 2005, the Company made anadditional investment of $0.9 million in exchange for a convertible notebearing interest at a rate of 8 percent per annum which is payable on demand,no earlier than February 1, 2007.

 

On May 12, 2005, the Company paid approximately$3.5 million, including direct acquisition costs of $0.1 million, for certaintangible and intangible assets of FusionPoint Technology Solutions(FusionPoint)  from Techlan, Inc. aswell as a two-year, non-compete agreement. FusionPoint designs and installs turn-key solutions that integratelegacy devices found in convenience stores and service stations onto an IPnetwork.

 

The purchase price for the FusionPoint assets wasallocated, on a preliminary basis, as follows (in thousands):

 
| Customer  relationships |   | $   | 2,960  |   |
|-------------------------|--------|-----|--------|--------|
| Non-compete agreement   |   | 522 |   |
| Other tangible assets   |   | 19  |   |
| Net assets  acquired    |   | $   | 3,501  |   |

 

The amount allocated to customer relationships isbeing amortized over their estimated useful life of three years and the amountallocated to the non-compete agreement is being amortized over its estimateduseful life of two years.  Unaudited proforma results of operations are not provided because the historical operatingresults were not significant and pro forma results would not be significantlydifferent from reported results for the periods presented.  The Company’s results of operations for thethree and nine months ended September 30, 2005 include the operatingresults of the acquisition from May 12, 2005 through September 30,2005.

 

On August 2, 2005, theCompany paid approximately $0.5 million, including direct acquisition costs ofapproximately $27,000, for certain intangible assets of Process Logistics, aswell as a three-year, non-compete agreement. Process Logistics provides POS services in the United Kingdom.

 

9

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

 
| Customer  relationship |   | $  | 417    |   |
|------------------------|--------|----|--------|--------|
| Non-compete agreement  |   | 53 |   |
| Capitalized software   |   | 88 |   |
| Net assets  acquired   |   | $  | 558    |   |

 

The amount allocated to the customer relationship isbeing amortized over its estimated useful life of five years and the amountallocated to the non-compete agreement is being amortized over its estimateduseful life of three years.  Unauditedpro forma results of operations are not provided because the historicaloperating results were not significant and pro forma results would not besignificantly different from reported results for the periods presented.  The Company’s results of operations for thethree and nine months ended September 30, 2005 include the operatingresults of the acquisition from August 2, 2005 through September 30,2005.

 

**4.****                                      Long–termDebt**

 

Debt consists of the following (inthousands):

 
| ** **            | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|-----------------------|------------|-----------------------------|------------|------------------------------|------------|
| Term A Loan           |       | $                           | 51,000     |                         | $          | — |   |
| Term B Loan           |       | —                      |       | 119,175                      |       |
|                  |       | 51,000                      |       | 119,175                      |       |
| Less: Current portion |       | (9,000                      | )          | (1,650                       | )          |
| Long-term portion     |       | $                           | 42,000     |                         | $          | 117,525 |   |

 

On May 4, 2005, the Company entered intoan amended and restated senior secured credit facility (the May 4, 2005Credit Facility) to finance the stock repurchase described in Note 2 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 wereno borrowings as of September 30, 2005. The May 4, 2005 CreditFacility matures May 4, 2012. Payments on the Term B Loan are due inquarterly installments over the seven–year term, beginning on June 1,2005, with the remainder payable on May 4, 2012. As of September 30,2005 total remaining payments on the Term Loan are as follows (in thousands):

 
| Three months  ending December 31, 2005 |   | $       | 413     |   |
|---------------------------------------------|--------|---------|---------|--------|
| 2006                                        |   | 1,650   |    |
| 2007                                        |   | 1,650   |    |
| 2008                                        |   | 1,650   |    |
| 2009                                        |   | 1,650   |    |
| Thereafter                                  |   | 112,162 |    |
|                                        |   | $       | 119,175 |   |

 

For the period through September 30,2005, borrowings on the New Revolving Credit Facility and the Term B Loan boreinterest at a rate of 2.00 percent over the LIBOR rate (5.85 percent as ofSeptember 30, 2005). Thereafter, if the Company achieves a leverage ratioof less than 1.75, the borrowings on the New Revolving Credit Facility and theTerm B Loan generally will bear interest at a rate, at the Company’s option, ofeither 0.75 percent over the lender’s base rate or 1.75 percent overthe LIBOR rate. The Company’s leverage ratio as of September 30, 2005 was1.80 to 1.0. The New Revolving Credit Facility is subject to an annual non-usecommitment fee in an amount equal to 0.375 percent or 0.5 percent perannum, depending on the Company’s leverage ratio, multiplied by the amount offunds available for borrowing under the New Revolving Credit Facility. Interestpayments on the May 4, 2005 Credit Facility are due monthly, bimonthly, orquarterly at the Company’s option.

 

The terms of the May 4, 2005 CreditFacility require the Company to comply with financial and nonfinancialcovenants, including maintaining certain leverage, interest and fixed chargecoverage ratios at the end of each fiscal quarter. As of September 30,2005, the Company was required to maintain a leverage ratio of less than 2.85to 1.0, an interest coverage ratio of greater than 4.0 to 1.0 and a fixedcharge ratio of greater than 2.5 to 1.0. Certain of the financial covenantswill become more restrictive over the term of the May 4, 2005 CreditFacility. The May 4, 2005 Credit Facility also contains nonfinancialcovenants that restrict some of the Company’s corporate activities, includingthe Company’s ability to dispose of assets, incur additional debt, paydividends, create liens, make investments, make capital expenditures and engagein specified transactions with affiliates. The Company’s future results ofoperations and its ability to comply with the covenants could be adverselyimpacted by increases in the general level of interest rates since the intereston a majority of the Company’s debt is variable. Noncompliance with any of thefinancial or nonfinancial covenants without cure or waiver would constitute anevent of default under the May 4, 2005 Credit Facility. An event ofdefault resulting from a breach of a financial or nonfinancial covenant mayresult, at the option of the lenders, in an acceleration of the principal andinterest 

 

10

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outstanding, and a termination of the May 4, 2005 Revolving CreditFacility. The May 4, 2005 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. The Company was in compliancewith the financial and nonfinancial covenants of the May 4, 2005 CreditFacility as of September 30, 2005.

 

In connection with the closing of the May 4,2005 Credit Facility, the Company incurred approximately $2.7 million infinancing costs. These financing costs were deferred and are being amortizedusing the effective interest method over the life of the May 4, 2005Credit Facility. In connection with the termination of the March 19, 2004Credit Facility in May 2005, the Company wrote–off approximately$1.1 million in unamortized deferred financing costs related to the March 19,2004 Credit Facility. Such write–off has been included in interest expense inthe accompanying condensed consolidated statement of operations for the ninemonths ended September 30, 2005.

 

On March 19, 2004, the Company enteredinto a senior secured credit facility (the March 19, 2004 Credit Facility)consisting of a $65.0 million term loan (Term A Loan) and a revolvingcredit facility of $30.0 million (Revolving Credit Facility) to replaceits 2001 senior secured credit facility. In connection with the closing of the March 19, 2004 CreditFacility, the Company incurred approximately $2.0 million in financingcosts. These financing costs were deferred and were being amortized using theeffective interest method over the life of the March 19, 2004 CreditFacility. In connection with the termination of the 2001 senior secured creditfacility in March 2004, the Company wrote–off approximately$2.0 million in unamortized deferred financing costs related to the 2001senior secured credit facility. Such write–off has been included in interestexpense in the accompanying condensed consolidated statement of operations forthe nine months ended September 30, 2004.

 

**5.****                                      ComprehensiveIncome**

 

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

 
| ** **                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                               | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income                               |       | $                                                    | 2,750      |                                                | $          | 2,634 |   | $ | 2,555 |   | $ | 4,338 |   |
| Foreign currency translation adjustments |       | 269                                                  |       | (426                                                | )          | 299 |   | (2,597 | ) |
| Total comprehensive income               |       | $                                                    | 3,019      |                                                | $          | 2,208 |   | $ | 2,854 |   | $ | 1,741 |   |

 

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

 

SFAS No. 128, “Earnings Per Share”,requires the presentation of basic and diluted earnings per share. Basicearnings (loss) per common share is computed by dividing income (loss)attributable to common stockholders by the weighted average number of commonshares outstanding for the period. The diluted earnings (loss) per common sharedata is computed using the weighted average number of common shares outstandingplus the dilutive effect of common stock equivalents, unless the common stockequivalents are anti–dilutive. For the period prior to the Company’s initialpublic offering on March 16, 2004, the effect of the Class APreferred Stock converting into shares of common stock was not included in thecomputation of diluted net loss per common share as the effect would beanti–dilutive.  In addition, options to purchase 1,195,054shares of common stock that were outstanding as of September 30, 2004 wereexcluded from the computation of diluted net loss per common share for the ninemonths ended September 30, 2004 as their effect would be anti-dilutive.The treasury stock effect of 314,250 shares of unvested restricted stock unitsheld by executives and employees as of September 30, 2004 was not includedin the computation of diluted net loss per common share for the nine monthsended September 30, 2004 as the effect would be anti-dilutive.

 

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

 
| ** **                                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income                                                |       | $                                          | 2,750      |                                      | $          | 2,634 |   | $ | 2,555 |   | $ | 4,338 |   |
| Dividends on preferred stock                              |       | —                                     |       | —                                    |       | (3,428 | ) | — |   |
|                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss) attributable to common  stockholders    |       | $                                          | 2,750      |                                      | $          | 2,634 |   | $ | (873 | ) | $ | 4,338 |   |
|                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Weighted average common share calculation:                |       |                                       |       |                                      |       |   |   |   |   |
| Basic  weighted average common shares outstanding         |       | 26,781,393                                 |       | 22,040,253                                |       | 22,836,485 |   | 24,703,641 |   |
| Treasury  stock effect of unvested restricted stock units |       | 318,995                                    |       | 437,541                                   |       | — |   | 343,725 |   |
| Treasury  stock effect of options                         |       | 110,575                                    |       | 153,830                                   |       | — |   | 63,322 |   |
|                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Diluted  weighted average common shares outstanding       |       | 27,210,963                                 |       | 22,631,624                                |       | 22,836,485 |   | 25,110,688 |   |
|                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss) per common share:                       |       |                                       |       |                                      |       |   |   |   |   |
| Basic net  income (loss) per common share                 |       | $                                          | 0.10       |                                      | $          | 0.12 |   | $ | (0.04 | ) | $ | 0.18 |   |
| Diluted net  income (loss) per common share               |       | $                                          | 0.10       |                                      | $          | 0.12 |   | $ | (0.04 | ) | $ | 0.17 |   |

 

11

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**7.****                                      SegmentInformation**

 

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

 

Management evaluates the North American andISD performance on EBITDA before stock compensation expense because operatingexpenses are distinguishable between North American and ISD operations. TheCompany defines EBITDA before stock compensation expense as income fromoperations before depreciation, amortization and stock compensation expense.EBITDA before stock compensation expense is not a generally accepted accountingprinciple measure, but rather a measure employed by management to view operatingresults adjusted for major noncash items. The Company’s definition of EBITDAbefore stock compensation expense may not be comparable to similarly titledmeasures used by other entities. Assets are not segregated between reportablesegments, and management does not use asset information by segments to evaluatesegment performance. As such, no information is presented related to fixedassets by reportable segment and capital expenditures for each segment.

 

Revenue for the Company’s four business unitsis presented below (in thousands):

 
| ** **     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **     | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|           |       |                                       |       |                                      |       |   |   |   |   |
| Revenues:      |       |                                       |       |                                      |       |   |   |   |   |
| POS            |       | $                                          | 28,901     |                                      | $          | 21,109 |   | $ | 86,372 |   | $ | 66,380 |   |
| TSD            |       | 8,595                                      |       | 11,864                                    |       | 25,446 |   | 33,114 |   |
| FSD            |       | 6,469                                      |       | 8,032                                     |       | 18,627 |   | 23,074 |   |
| ISD            |       | 20,619                                     |       | 23,831                                    |       | 55,235 |   | 70,753 |   |
|           |       |                                       |       |                                      |       |   |   |   |   |
| Total revenues |       | $                                          | 64,584     |                                      | $          | 64,836 |   | $ | 185,680 |   | $ | 193,321 |   |

 

EBITDA before stock compensation expense forNorth American and ISD operations is reflected below (in thousands):

 
| ** **                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| EBITDA before stock compensation expense:       |       |                                       |       |                                      |       |   |   |   |   |
| North America                                   |       | $                                          | 10,501     |                                      | $          | 8,552 |   | $ | 31,618 |   | $ | 27,008 |   |
| ISD                                             |       | 6,661                                      |       | 9,356                                     |       | 16,495 |   | 25,232 |   |
|                                            |       |                                       |       |                                      |       |   |   |   |   |
| Total EBITDA  before stock compensation expense |       | $                                          | 17,162     |                                      | $          | 17,908 |   | $ | 48,113 |   | $ | 52,240 |   |

 

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

 
| ** **                                                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| EBITDA before stock compensation expense                                        |       | $                                          | 17,162     |                                      | $          | 17,908 |   | $ | 48,113 |   | $ | 52,240 |   |
| Reconciling items:                                                              |       |                                       |       |                                      |       |   |   |   |   |
| Depreciation  and amortization of property and equipment and intangible assets  |       | (11,140                                    | )          | (8,790                                    | )          | (35,601 | ) | (32,130 | ) |
| Stock compensation expense                                                      |       | (360                                       | )          | (755                                      | )          | (798 | ) | (1,789 | ) |
| Interest expense                                                                |       | (1,035                                     | )          | (2,997                                    | )          | (6,472 | ) | (7,036 | ) |
| Interest and other income (expense), net                                        |       | 519                                        |       | 150                                       |       | 437 |   | (99 | ) |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Income  before income taxes and equity in net loss of unconsolidated affiliates |       | $                                          | 5,146      |                                      | $          | 5,516 |   | $ | 5,679 |   | $ | 11,186 |   |

 

12

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

 
| ** **                                              | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| POS                                                     |       | $                           | 147,936    |                         | $          | 138,827 |   |
| TSD                                                     |       | 5,117                       |       | 4,643                        |       |
| FSD                                                     |       | 28,233                      |       | 25,865                       |       |
| ISD                                                     |       | 29,308                      |       | 26,969                       |       |
| Total goodwill and identifiable intangible  assets, net |       | $                           | 210,594    |                         | $          | 196,304 |   |

 

**Geographic Information**

 

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

 

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

 
| ** **     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **     | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues:      |       |                                       |       |                                      |       |   |   |   |   |
| North America  |       | $                                          | 43,965     |                                      | $          | 41,005 |   | $ | 130,445 |   | $ | 122,568 |   |
| Europe         |       | 16,955                                     |       | 21,110                                    |       | 47,655 |   | 62,603 |   |
| Asia-Pacific   |       | 3,664                                      |       | 2,721                                     |       | 7,580 |   | 8,150 |   |
|           |       |                                       |       |                                      |       |   |   |   |   |
| Total revenues |       | $                                          | 64,584     |                                      | $          | 64,836 |   | $ | 185,680 |   | $ | 193,321 |   |

 

The Company’s long–lived assets includinggoodwill and identifiable intangible assets, net were located as follows (inthousands):

 
| ** **              | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|-------------------------|------------|-----------------------------|------------|------------------------------|------------|
| North America           |       | $                           | 231,570    |                         | $          | 218,797 |   |
| Europe                  |       | 42,441                      |       | 37,846                       |       |
| Asia-Pacific            |       | 5,368                       |       | 4,715                        |       |
| Total long-lived assets |       | $                           | 279,379    |                         | $          | 261,358 |   |

 

**8.****                                      Litigationand Claims**

 

The Company is periodically involved indisputes arising 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 filedin the Superior Court of the State of Delaware by persons alleging that theCompany breached an agreement to purchase an unrelated entity. On February 28,2005, the court denied the Company’s motion for summary judgment filed in June 2004.  After considering the defense costs,potential damages should the plaintiffs prevail, and continued diversion ofmanagement resources, the Company determined in March 2005 that asettlement was warranted, but had not yet executed an agreement as of March 31,2005. In April 2005, the Company made the payment of $3.3 million in cashto the plaintiffs and received the dismissal of all claims, with prejudice, bythe plaintiffs, thereby settling this dispute. This $3.3 million settlement is included in selling, general andadministrative expenses in the accompanying condensed consolidated statement ofoperations for the nine months ended September 30, 2005.

 

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Certain states in which the Company operatesassess sales taxes on certain services provided by the Company. The Companybelieves it has no liability because its customer contracts contain terms thatstipulate the customer, not the Company, is responsible for any sales taxliability. In jurisdictions where the customer may be liable for sales taxes,the Company either includes sales tax on its invoice or has obtained anexemption certificate from the customer. Certain states have audited theCompany from 1996 to early 2001 and originally proposed $6.7 million inassessments on the basis that sales taxes are owed. In March 2005, theCompany received verbal notification from a state sales tax auditor that one ofthe states was likely to reduce its proposed assessment by an amount in excessof  $4 million.  In April 2005, the Company receivedwritten confirmation from that state’s Department of Revenue that the state’sassessment would be reduced by $4.3 million. Based on this written confirmation, the Company reduced its liabilityfor this matter by $4.3 million during the first quarter of 2005.  In July 2005, the Company entered intoan agreement with that state’s Department of Revenue to settle the outstandingliability for $0.8 million and concurrently entered into an agreement with acustomer to reimburse the Company for $0.5 million of the settlementamount.  Based on these final executedsettlements, the Company reduced its net liability for this matter by $1.5million during the second quarter of 2005. This $5.8 million reduction in theliability is included in selling, general and administrative expenses in theaccompanying condensed consolidated statements of operations for nine monthsended September 30, 2005. In addition, the Company was able to favorablyresolve sales tax disputes in several other states during the three monthsended September 30, 2005.  Includedin selling, general and administrative expenses in the accompanying condensedconsolidated statement of operations for the three and nine months ended September 30,2005 is a $0.7 benefit related to the favorable resolution of these matters. 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 innet income in the accompanying condensed consolidated statements of operationsfor the three months ended September 30, 2005 is a $0.4 million benefit, or$0.02 per share, related to the reduced state sales tax liabilities, and forthe nine months ended September 30, 2005 a $1.9 million net benefit, or $0.08per share, related to the reduced state sales tax liabilities and legalsettlement.

 

**9.****                                      RelatedParty Transactions**

 

During the three and nine months ended September 30,2005, the Company paid approximately $0.4 million for the use of an aircraft toa company that is owned by the Chairman and CEO.

 

On September 21, 2005, the Company entered intoa lease to rent office space in the UK with a company that is majority owned bythe Senior Vice President and General Manager of our subsidiary, TransactionNetwork Services (UK) Limited.  Prior toentering into this lease, the Company obtained an independent appraisalconfirming that the terms of the lease were consistent with marketstandards.  The lease provides forquarterly payments in equal installments of approximately £26,000 and expires on September 20, 2017.

 

The following is a schedule by year of futureminimum rental payments due to the company under this operating lease agreement(in thousands):

 
| Three months  ending December 31, 2005 |   | £ | — |   |
|---------------------------------------------|--------|--------|--------|--------|
| 2006                                        |   | 56     |   |
| 2007                                        |   | 105    |   |
| 2008                                        |   | 105    |   |
| 2009                                        |   | 105    |   |
| Thereafter                                  |   | 814    |   |
|                                        |   | £ | 1,185  |   |

 

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

 

You should read the following discussion ofthe financial condition and results of operations of TNS, Inc. inconjunction with the consolidated financial statements and the related notesincluded in our prospectus (File No. 333-127851) filed with the SEC on September 16,2005 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 maynot address historical facts and, therefore, could be interpreted to beforward–looking statements within the meaning of The Private SecuritiesLitigation Reform Act of 1995. These forward–looking statements are based oncurrent expectations, forecasts and assumptions that are subject to risks anduncertainties that could cause actual results to differ materially from thoseset forth in, or implied by, the forward–looking statements. The Company hasattempted, whenever possible, to identify these forward–looking statementsusing words such as “may,” “will,” “should,” “projects,” “estimates,”“expects,” “plans,” “intends,” “anticipates,” “believes,” and variations ofthese words and similar expressions. Similarly, statements herein that describethe Company’s business strategy, prospects, opportunities, outlook, objectives,plans, intentions or goals are also forward–looking statements. Actual resultsmay differ materially from those indicated by such forward–looking statementsas a result of various important factors, including: the Company’s relianceupon a small number of customers for a significant portion of its revenue;competitive factors such as pricing pressures; our customer’s ability to directtheir data communications from the Company’s networks to other networks; theCompany’s ability to grow its business domestically and internationally bygenerating greater transaction volumes, acquiring new customers or developingnew service offerings; fluctuations in the Company’s quarterly results becauseof the seasonal nature of the business and other factors outside of the Company’scontrol; the Company’s ability to identify, execute or effectively integratefuture acquisitions; the Company’s ability to adapt to changing technology;additional costs related to compliance with the Sarbanes–Oxley Act of 2002, anyrevised New York Stock Exchange listing standards, SEC rule changes orother corporate governance issues; and other risk factors described in theCompany’s prospectus filed with the SEC on September 16, 2005. Inaddition, the statements in this quarterly report are made as of the date ofthis filing. The Company expects that subsequent events or developments willcause its views to change. The Company undertakes no obligation to update any ofthe forward–looking statements made herein, whether as a result of newinformation, future events, changes in expectations or otherwise. Theseforward–looking statements should not be relied upon as representing theCompany’s views as of any date subsequent to the date of this filing.  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 leadingprovider of business-critical data communications services to processors ofcredit card, debit card and ATM transactions. We are also a leading provider ofsecure data and voice network services to the global financial servicesindustry. We operate one of four unaffiliated Signaling System No. 7networks in the United States capable of providing services nationwide, and weutilize this network to provide call signaling and database access services tothe domestic telecommunications industry. Our data communications servicesenable secure and reliable transmission of time-sensitive, transaction-relatedinformation critical to our customers’ operations. Our customers outsourcetheir data communications requirements to us because of our substantialexpertise, comprehensive customer support and cost-effective services.Internationally, we provide services to customers in 18 countries, includingCanada and countries in Europe and the Asia-Pacific region.

 

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

 

We generate revenues through four businessdivisions:

 

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

 

•                  ***International services***.We are one of the leading providers of data communications services to the POSindustry in the United Kingdom. Our international services division also hasoperations in Australia, France, Germany, Ireland, Italy, Japan, theNetherlands, New Zealand, Spain and Sweden. Additionally, through our international subsidiaries, we provide servicesto customers located in Finland, Hong Kong, Norway, Poland, Singapore andThailand. 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 

 

15

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fixed monthly fees charged for our callsignaling services and per-query fees charged for our database access andvalidation services.

 

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

 

Our most significant expense is cost ofnetwork services, which is comprised primarily of telecommunications charges,including data transmission and database access, leased digital capacitycharges, circuit installation charges and activation charges. The cost of datatransmission is based on a contract or tariff rate per minute of usage inaddition to a prescribed rate per transaction for some vendors. The costs ofdatabase access, circuits, installation charges and activation charges arebased on fixed fee contracts with local exchange carriers and interexchangecarriers. The cost of network services also includes salaries, equipmentmaintenance and other costs related to the ongoing operation of our datanetworks. Depreciation expense on our network equipment and amortization ofdeveloped technology are excluded from our cost of network services andincluded in depreciation and amortization of property and equipment andamortization of intangible assets in our consolidated statements of operations.

 

Our engineering and development expensesinclude salaries and other costs related to product development, engineeringand materials. The majority of these costs are expensed as incurred, includingcosts related to the development of internal use software in the preliminaryproject design, the post-implementation and operation stages. Development costswe incur during the software application development stage are capitalized andamortized over the estimated useful life of the developed software.

 

Our selling, general and administrativeexpenses include costs related to sales, marketing, administrative andmanagement personnel, as well as outside legal, accounting and consultingservices. We believe that selling, general and administrative expenses, as apercentage of revenues, will remain constant or increase to support expansionof the international services division, as well as from the additional costs ofbeing a publicly traded company, including the legal, audit, insurance, boardof directors compensation and costs needed to establish and maintain compliancewith the Sarbanes-Oxley Act of 2002.

 

In March 2004, we completed our initialpublic offering (IPO) of common stock issuing 4,420,000 common shares at $18.00per share, which generated proceeds, net of offering costs, of approximately$71.5 million. The net proceeds of the IPO were used to repay a portion of theoutstanding debt under our 2001 senior secured credit facility. Concurrent withthe closing of the IPO, we entered into our 2004 senior secured credit facilityand used the net proceeds from borrowings to repay the remaining debtoutstanding under our 2001 senior secured credit facility.

 

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

 

On October 1, 2004, we completed afollow-on offering of common stock issuing 1,084,744 common shares at $20.00per share, which generated proceeds, net of offering costs, of approximately$19.9 million. On November 1, 2004, in connection with the follow-onoffering, the underwriters exercised a portion of their over-allotment optionand we issued an additional 118,232 common shares at $20.00 per share, whichgenerated proceeds, net of offering costs of approximately $2.3 million. Thenet proceeds from the follow-on offering were used to repay a portion of ourlong-term debt outstanding under our 2004 senior secured credit facility.

 

In connection with the completion of ourtender offer, as described below, on May 4, 2005, we entered into anamended and restated senior secured credit facility, which consists of twoamended and restated facilities:  asenior term loan facility in an aggregate principal amount of $165 million anda senior revolving credit facility in an aggregate principal amount of $30million.  Pursuant to the amended andrestated senior secured credit facility, certain term lenders holding loansunder our 2004 senior secured credit facility exchanged $48 million of old termloans for term loans under the amended term facility and $117 million ofadditional term loans were made to us to finance the purchase of shares of ourcommon stock, including fees and expenses incurred therewith, in connectionwith the tender offer.  The amended andrestated senior secured credit facility may also be used for general corporatepurposes.

 

On May 5, 2005, we completed a modifiedDutch auction tender offer, purchasing and retiring 6,263,435 shares of ourcommon stock at a price of $18.50 per share net to each seller in cash, for anaggregate purchase price of $116.9 million. The 6,263,435 shares tendered included 6,000,000 shares tendered by ourthen controlling 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, in connection with the follow-on offering,the underwriters exercised their over-allotment option and we issued anadditional 900,000 shares of common stock at $23.25 per share, which generatedproceeds, net of offering costs, of approximately $20.0 million.  The net proceeds from the follow-on offeringwere used to repay a portion of our long-term debt outstanding under ouramended and 

 

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restated senior secured credit facility.

 

**Long–term Investments and Acquisitions**

 

In August 2004, we made an investment in WAYSystems, Inc. (WAY), which provides mobile POS transaction infrastructureand solutions for mobile merchants.  Wepurchased 5,952,381 shares or 38.5 percent of WAY’s Series B convertiblepreferred stock for $2.5 million and became entitled to representation on WAY’sboard of directors. As of December 31, 2004, we owned 18.1 percent of WAY’stotal outstanding shares. In March 2005, we made an additional investmentof $0.8 million to purchase 1,910,401 shares of WAY’s Series B convertiblepreferred stock representing an additional 1.9 percent of WAY’s outstandingshares.  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 due January 1,2009.  In September 2005, weexercised our option on the convertible note to convert the outstandingprincipal and accrued interest of approximately $0.8 million to 1,185,085shares of WAY’s Series C convertible preferred stock and made anadditional investment of $1.1 million to purchase 1,676,429 shares of WAY’sSerices C convertible preferred stock. As of September 30, 2005, we owned17.0 percent of WAY’s outstanding shares. We are accounting for this investmentunder the equity method of accounting. Due to timing of the receipt of WAY’sfinancial statements, we are accounting for the income or loss in this equitymethod investment on a one-month lag.  Forthe three and nine months ended September 30, 2004, we recognized a netloss in the equity of an unconsolidated affiliate of approximately $0.1million.  For the three and nine monthsended September 30, 2005, we recognized a net loss in the equity of anunconsolidated affiliate of approximately $0.4 million and $1.0 million,respectively.

 

In September 2004, we made aninvestment in AK Jensen Group, Limited (AKJ), a company that providesorder–routing systems and integrated electronic trading solutions to financialsoftware companies and end–clients.  We purchased 94,429 common shares or8.4% of AKJ’s total outstanding shares for $1.0 million and obtainedrepresentation on AKJ’s board of directors.  The Company is accounting forits investment under the equity method of accounting as the Company hassignificant influence through its representation on the board of directors. Dueto timing of the receipt of AKJ’s financial statements, we are accounting forthe income or loss in this equity method investment on a one–month lag. As a result, for the three and nine months ended September 30, 2004, werecognized no income or loss in the equity of an unconsolidated affiliate.  For the three and nine months ended September 30,2005 we recognized a net loss in the equity of an unconsolidated affiliate ofapproximately $23,000 and $0.1 million, respectively.

 

In January 2005,we made an investment in IP Commerce, Inc., a company that providesoperating software to facilitate the authorization of IP-based retail paymenttransactions. We purchased 2,368,545 Series A preferred shares or 39.9percent of IP Commerce’s total outstanding shares for $2.0 million and becameentitled to representation on IP Commerce’s board of directors. We areaccounting for this investment under the equity method of accounting.  Due to timing of the receipt of IP Commerce’sfinancial statements, we are accounting for the income or loss in this equitymethod investment on a one-month lag. For the three and nine months ended September 30, 2005, werecognized a net loss in the equity of an unconsolidated affiliate ofapproximately $0.4 million and $0.8 million, respectively.  In September 2005, we made an additionalinvestment of $0.9 million in exchange for a convertible note bearing interestat a rate of 8 percent per annum which is payable on demand, no earlier than February 1,2007.

 

On May 12, 2005 we paid approximately $3.5million, including direct acquisition costs of $0.1 million, for certaintangible and intangible assets of FusionPoint Technology Solutions(FusionPoint) from Techlan, Inc. as well as a two-year, non-competeagreement.  FusionPoint designs and installsturn-key solutions that integrate legacy devices found in convenience storesand service stations onto an IP network. We accounted for the acquisition of the FusionPoint assets under thepurchase method with the total consideration allocated, on a preliminary basis,to the fair value of the assets acquired and liabilities assumed, includingidentifiable intangibles of $3.5 million. Our consolidated results of operations for the three and nine monthsended September 30, 2005 include the operating results of this acquisitionfrom May 12, 2005 through September 30, 2005.

 

On August 2, 2005, we paidapproximately $0.5 million, including direct acquisition costs of approximately$27,000, for certain intangible assets of Process Logistics, as well as athree-year, non-compete agreement. Process Logistics provides POS services in the United Kingdom.  We accounted for the acquisition of theProcess Logistics assets under the purchase method with the total considerationallocated, on a preliminary basis, to the fair value of the assets acquired, including identifiableintangibles of $0.5 million.  Ourconsolidated results of operations for the three and nine months ended September 30,2005 include the operating results of this acquisition from August 2, 2005through September 30, 2005.

 

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**Results of Operations**

 

The following table sets forth, for the periods indicated, selectedstatement of operations data (dollars in thousands):

 
| ** **                                                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Revenues                                                                        |       | $                                          | 64,584     |                                      | $          | 64,836 |   | $ | 185,680 |   | $ | 193,321 |   |
| Operating expenses:                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Cost of  network services, exclusive of the items shown separately below        |       | 31,344                                     |       | 30,074                                    |       | 91,170 |   | 91,270 |   |
| Engineering  and development                                                    |       | 3,748                                      |       | 3,813                                     |       | 10,680 |   | 11,753 |   |
| Selling,  general, and administrative                                           |       | 12,690                                     |       | 13,796                                    |       | 36,515 |   | 39,847 |   |
| Depreciation  and amortization of property and equipment                        |       | 4,989                                      |       | 4,541                                     |       | 14,746 |   | 14,367 |   |
| Amortization  of intangible assets                                              |       | 6,151                                      |       | 4,249                                     |       | 20,855 |   | 17,763 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Total  operating expenses                                                       |       | 58,922                                     |       | 56,473                                    |       | 173,966 |   | 175,000 |   |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Income from operations                                                          |       | 5,662                                      |       | 8,363                                     |       | 11,714 |   | 18,321 |   |
| Interest expense                                                                |       | (1,035                                     | )          | (2,997                                    | )          | (6,472 | ) | (7,036 | ) |
| Interest and other income (expense), net                                        |       | 519                                        |       | 150                                       |       | 437 |   | (99 | ) |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Income  before income taxes and equity in net loss of unconsolidated affiliates |       | 5,146                                      |       | 5,516                                     |       | 5,679 |   | 11,186 |   |
| Income tax provision                                                            |       | (1,714                                     | )          | (2,085                                    | )          | (2,344 | ) | (4,919 | ) |
| Equity in net loss of unconsolidated  affiliates                                |       | (682                                       | )          | (797                                      | )          | (780 | ) | (1,929 | ) |
|                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| Net income                                                                      |       | $                                          | 2,750      |                                      | $          | 2,634 |   | $ | 2,555 |   | $ | 4,338 |   |

 

**Three months ended September 30, 2005compared to the three months ended September 30, 2004**

 

***Revenues.***  Total revenues increased $0.2 million, or0.4%, to $64.8 million for the three months ended September 30, 2005, from$64.6 million for the three months ended September 30, 2004. We generaterevenues through four business divisions.

 

***POSdivision.*** Revenues from the POS division decreased $7.8 million, or 27.0%, to$21.1 million for the three months ended September 30, 2005, from $28.9million for the three months ended September 30, 2004. The decrease in POSrevenues resulted from a decline in transaction volumes primarily from one ofour five largest customers and to a lesser extent a decrease in revenue pertransaction as a result of negotiated price reductions upon renewal of certaincontracts. POS transaction volumes decreased 21.9% to 1.4 billion transactionsfor the three months ended September 30, 2005, from 1.8 billiontransactions for the three months ended September 30, 2004. 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. Inaddition, we recently amended our contract with one of our five largestcustomers to extend the term of the agreement for two years. The amendedcontract does not contain any minimum transaction or revenue commitments. Webelieve that revenues and related transaction volumes from this customer maycontinue to decline in 2005 and thereafter.

 

***Internationalservices division.*** Revenues from the international services division increased $3.2million, or 15.6%, to $23.8 million for the three months ended September 30,2005, from $20.6 million for the three months ended September 30, 2004.The increase was primarily due to additional revenues generated from our POScustomers in the U.K., Central Europe and Australia.  Included in revenues and cost of sales forthe three months ended September 30, 2004 is $1.4 million associated withthe sale of equipment in Australia. Revenues from our U.K. subsidiary increased $2.2 million, or 18.9%, to$13.8 million for the three months ended September 30, 2005, from$11.6 million for the three months ended September 30, 2004.

 

***Telecommunicationservices division.*** Revenues from the telecommunication services division increased $3.3million, or 38.0%, to $11.9 million for the three months ended September 30,2005, from $8.6 million for the three months ended September 30, 2004. Thegrowth in revenues was primarily due to increased usage of our call signalingservices from new and existing customers.

 

***Financialservices division.*** Revenues from the financial services division increased $1.6 million, or24.1%, to $8.0 million for the three months ended September 30, 2005,from $6.5 million for the three months ended September 30, 2004. Theincrease in revenues was due to the growth in the number of customerconnections, both physical and logical, to and through our networks.

 

***Costof network services.***  Cost of network services decreased $1.3million, or 4.1%, to $30.1 million for the three months ended September 30,2005, from $31.3 million for the three months ended September 30, 2004.Cost of network services were 46.4% of revenues for the three months ended September 30,2005, compared to 48.5% of revenues for the three months ended September 

 

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30, 2004. The decrease in cost of network services resulted primarilyfrom lower usage charges from decreased POS transactions and to a lesser extenta decrease in usage-based vendor telecommunications charges in our POS divisionpartially offset by higher usage charges from our TSD, FSD and ISD services.Included in revenues and cost of sales for the three months ended September 30,2004 was $1.4 million associated with the sale of equipment in Australia.  Gross profit represented 53.6% of totalrevenues for the three months ended September 30, 2005, compared to 51.5%for the three months ended September 30, 2004. The increase in grossprofit as a percentage of total revenues resulted primarily from increasedcontribution of our international services division and financial servicesdivision, and to a lesser extent the decrease in usage-based vendortelecommunications charges associated with our POS services.

 

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

 

***Engineeringand development expense.***  Engineering and development expense increased$0.1 million, or 1.7%, to $3.8 million for the three months ended September 30,2005, from $3.7 million for the three months ended September 30, 2004.Engineering and development expense represented 5.9% of revenues for the threemonths ended September 30, 2005 and 5.8% of revenues for the three monthsended September 30, 2004. Engineering and development expense increasedprimarily from an increase in engineering expenses required to support our newservice offerings in our POS division.

 

***Selling,general and administrative expense.***  Selling, general and administrative expenseincreased $1.1 million, or 8.7%, to $13.8 million for the three months ended September 30,2005, from $12.7 million for the three months ended September 30, 2004.Selling, general and administrative expense represented 21.3% of revenues forthe three months ended September 30, 2005, compared to 19.6% of revenuesfor the three months ended September 30, 2004. Included in selling,general and administrative expenses for the three months ended September 30,2005 is a $0.7 million benefit from the favorable settlement of certain salestax liabilities.  Excluding this item,selling, general and administrative expense increased primarily from theexpenses required to support our revenue growth, mainly within theinternational services division, and to a lesser extent, the incremental costsnecessary to operate as a public company and stock compensation expense.

 

***Depreciationand amortization of property and equipment.***  Depreciation and amortization of property andequipment decreased $0.4 million, or 9.0%, to $4.5 million for the three monthsended September 30, 2005, from $5.0 million for the three months ended September 30,2004. Depreciation and amortization of property and equipment represented 7.0%of revenues for the three months ended September 30, 2005, compared to7.7% of revenues for the three months ended September 30, 2004.

 

***Amortizationof intangible assets.***  Amortization of intangible assets decreased$1.9 million, or 30.9%, to $4.2 million for the three months ended September 30,2005, from $6.2 million for the three months ended September 30, 2004. Theamortization of intangible assets for the three months ended September 30,2005 and 2004 relates solely to the intangible assets resulting fromacquisitions.  The decrease is dueprimarily to a reduction in amortization expense due to certain intangibleassets becoming fully amortized. 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. We believe that revenues and related transaction volumes from one of ourfive largest customers may continue to decline in 2005 and thereafter.  The intangible asset value attributable tothis customer relationship is approximately $24.1 million as of September 30,2005.  During the three months endedSeptember 30, 2005, we  assessed therecoverability of this customer relationship asset based upon anticipatedfuture cash flows and concluded that no impairment existed.

 

***Interestexpense.*** Interest expense increased $2.0 million to $3.0 million for the threemonths ended September 30, 2005, from $1.0 million for the three monthsended September 30, 2004. This increase was primarily due to theadditional borrowings under our amended and restated senior secured creditfacility, as well as the accelerated amortization of approximately $0.6 millionof deferred financing costs in connection with the early repayment of amountsoutstanding under our amended and restated senior secured credit facility withthe net proceeds from our follow-on offering in September 2005.

 

*** Interest and other income (expense), net.***  Interest and other income (expense), net wasincome of $0.1 million for the three months ended September 30, 2005compared to $0.5 million for the three months ended September 30,2004.  Included in other income(expense), net for the three months ended September 30, 2005 and 2004 is again on the sale of equipment of $6,000 and $0.2 million, respectively.  Also included in other income (expense), netfor the three months ended September 30, 2005 is a loss on foreigncurrency translation due to fluctuations in the value of the U.S. dollar ascompared with foreign currencies, predominately, the euro, the British poundand the Australian dollar of $19,000 versus a gain of $0.2 million for thethree months ended September 30, 2004.

 

***Incometax provision.*** For the three months ended September 30, 2005, our income taxprovision was $2.1 million compared to $1.7 million for the three months ended September 30,2004. Our effective tax rate for the three months ended September 30, 2005is 37.8% versus the U.S. federal statutory tax rate of 35.0%, due primarily tothe fact that we have losses from certain of our international subsidiariesthat cannot be used to offset income in other jurisdictions.

 

***Equityin net loss of unconsolidated affiliates.***  For the three months ended September 30,2005, our equity in net loss of 

 

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unconsolidated affiliates was $0.8 million compared to $0.7 million forthe three months ended September 30, 2004. As of September 30, 2005,we have $5.9 million of long-term investments in unconsolidated affiliates, andwe expect to incur additional losses on these investments in 2005 andthereafter.

 

**Nine months ended September 30, 2005compared to the nine months ended September 30, 2004**

 

***Revenues.***  Total revenues increased $7.6 million, or4.1%, to $193.3 million for the nine months ended September 30, 2005, from$185.7 million for the nine months ended September 30, 2004. We generaterevenues through four operating divisions.

 

***POSdivision.*** Revenues from the POS division decreased $20.0 million, or 23.1%, to$66.4 million for the nine months ended September 30, 2005, from $86.4million for the nine months ended September 30, 2004. The decrease in POSrevenues resulted from a decline in transaction volumes primarily from one ofour five largest customers and to a lesser extent a decrease in revenue pertransaction as a result of negotiated price reductions upon renewal of certain contracts.POS transaction volumes decreased 20.4% to 4.4 billion transactions for thenine months ended September 30, 2005, from 5.6 billion transactions forthe nine months ended September 30, 2004. We have negotiated contractrenewals with some of our POS customers, and in several instances we agreed topricing discounts in exchange for maintaining or increasing their minimumtransaction or revenue commitments. As a result, it is likely our revenue pertransaction will decrease and, depending upon the number of transactions wetransport, our POS revenues may continue to decrease. In addition, we recentlyamended our contract with a major customer to extend the term of the agreementfor two years. The amended contract does not contain any minimum transaction orrevenue commitments. Based on the amended contract, we believe that revenuesand related transaction volumes from this customer may continue to decline in2005 and thereafter.

 

***Internationalservices division.*** Revenues from the international services division increased $15.5million, or 28.1%, to $70.8 million for the nine months ended September 30,2005, from $55.2 million for the nine months ended September 30, 2004. Theincrease was primarily due to additional revenues generated from our POScustomers in the U.K., Central Europe and Australia, and to a lesser extent webenefited from favorable foreign exchange. Revenues from our U.K. subsidiaryincreased $8.8 million, or 20.6%, to $42.4 million for the nine monthsended September 30, 2005, from $33.7 million for the nine months ended September 30,2004.

 

***Telecommunicationservices division.*** Revenues from the telecommunication services division increased $7.7million, or 30.1%, to $33.1 million for the nine months ended September 30,2005, from $25.4 million for the nine months ended September 30, 2004. Thegrowth in revenues was primarily due to increased usage of our call signalingservices from new and existing customers.

 

***Financialservices division.*** Revenues from the financial services division increased $4.4 million, or23.9%, to $23.1 million for the nine months ended September 30, 2005,from $18.6 million for the nine months ended September 30, 2004. Theincrease in revenues was due to the growth in the number of customerconnections, both physical and logical, to and through our networks.

 

***Costof network services.***  Cost of network services increased $0.1million, or 0.1%, to $91.3 million for the nine months ended September 30,2005, from $91.2 million for the nine months ended September 30, 2004.Cost of network services were 47.2% of revenues for the nine months ended September 30,2005, compared to 49.1% of revenues for the nine months ended September 30,2004. 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 and to a lesser extent a decreasein usage-based vendor telecommunications charges in our POS division. Includedin revenues and cost of sales for the three months ended September 30,2004 was $1.4 million associated with the sale of equipment in Australia.  Gross profit represented 52.8% of totalrevenues for the nine months ended September 30, 2005, compared to 50.9%for the nine months ended September 30, 2004. The increase in gross profitas a percentage of total revenues resulted primarily from increasedcontribution of our international services division and financial servicesdivision, and to a lesser extent the decrease in usage-based vendortelecommunications charges associated with our POS services.

 

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

 

***Engineeringand development expense.***  Engineering and development expense increased$1.1 million, or 10.0%, to $11.8 million for the nine months ended September 30,2005, from $10.7 million for the nine months ended September 30, 2004.Engineering and development expense represented 6.1% of revenues for the ninemonths ended September 30, 2005 and 5.8% of revenues for the nine monthsended September 30, 2004. Engineering and development expense increasedprimarily from an increase in engineering expenses required to support ourinternational expansion and new service offerings in our POS division.

 

***Selling,general and administrative expense.***  Selling, general and administrative expenseincreased $3.3 million, or 9.1%, to $39.8 million for the nine monthsended September 30, 2005, from $36.5 million for the nine months ended September 30,2004. Selling, general and administrative expense represented 20.6% of revenuesfor the nine months ended September 30, 2005, compared to 19.7% ofrevenues for the nine months ended September 30, 2004. Included inselling, general and administrative expenses for the nine months ended September 30,2005 is a charge related to a legal settlement of approximately $3.3 million, abenefit from a reduced state sales tax liability assessment of approximately$5.8 million and a benefit from the favorable settlement of certain sales taxliabilities of approximately $0.7 million. Excluding these items, selling,general and administrative expense increased primarily from the expensesrequired to support our revenue growth, mainly within the internationalservices division, and to a lesser extent, the 

 

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incremental costs necessary to operate as a public company and stockcompensation expense.

 

***Depreciationand amortization of property and equipment.***  Depreciation and amortization of property andequipment decreased $0.4 million, or 2.6%, to $14.4 million for the nine monthsended September 30, 2005, from $14.7 million for the nine months ended September 30,2004. Depreciation and amortization of property and equipment represented 7.4%of revenues for the nine months ended September 30, 2005, compared to 7.9%of revenues for the nine months ended September 30, 2004.

 

***Amortizationof intangible assets.***  Amortization of intangible assets decreased$3.1 million, or 14.8%, to $17.8 million for the nine months ended September 30,2005, from $20.9 million for the nine months ended September 30, 2004. Theamortization of intangible assets for the nine months ended September 30,2005 and 2004 relates solely to the intangible assets resulting fromacquisitions. The decrease was primarily attributable to certain intangibleassets becoming fully amortized.  In thenine months ended September 30, 2005 and 2004 we accelerated amortizationon a portion of our customer relationship intangible assets in connection withthe loss of certain customers by $3.1 million and $2.2 million,respectively.  For purposes of measuringand recognizing impairment of long-lived assets including intangibles, weassess whether separate cash flows can be attributed to the individual asset.For our customer relationship intangible assets, we recognize and measureimpairment upon the significant loss of revenue from a customer. Based on theoutcome of our contract negotiations with one of our five largest customers, webelieve that revenues and related transaction volumes from this customer may continueto decline in 2005 and thereafter.  Theintangible asset value attributable to this customer relationship isapproximately $24.1 million as of September 30, 2005.  We assessed the recoverability of thiscustomer relationship asset based upon anticipated future cash flows, andconcluded no impairment existed as of September 30, 2005.

 

***Interestexpense.*** Interest expense increased $0.6 million to $7.0 million for the ninemonths ended September 30, 2005, from $6.5 million for the ninemonths ended September 30, 2004. Included in interest expense for the ninemonths ended September 30, 2005 is approximately $1.1 million of deferredfinancing costs in connection with the termination of our 2004 senior securedcredit facility and accelerated amortization of approximately $0.6 million ofdeferred financing costs in connection with the early repayment of amountsoutstanding under our amended and restated senior secured credit facility.  Included in interest expense for the ninemonths ended September 30, 2004 is approximately $2.0 million of deferredfinancing costs in connection with the termination of our 2001 senior securedcredit facility.  Excluding these items,interest expense increased primarily due to the additional borrowings under ouramended and restated senior secured credit facility.

 

***Interestand other income (expense), net.***  Interest and other income (expense), net wasan expense of $0.1 million for the nine months ended September 30, 2005compared to income of $0.4 million for the nine months ended September 30,2004.

 

***Incometax provision.*** For the nine months ended September 30, 2005, our income taxprovision was $4.9 million compared to $2.3 million for the nine monthsended September 30, 2004. Our effective tax rate for the nine months endedSeptember 30, 2005 is 44.0% versus the U.S. federal statutory tax rate of35.0%, due primarily to the fact that we have losses from certain of ourinternational subsidiaries that cannot be used to offset income in otherjurisdictions.  In addition, we made thedecision, in April 2005, to repatriate $10.0 million of foreign earningsunder the repatriation provisions of the American Jobs Creation Act of 2004 forwhich we have provided an income tax provision of approximately $0.5million.  In October 2005, we madethe decision to repatriate an additional $5.4 million of foreign earnings underthe repatriation provisions of the American Jobs Creation Act of 2004 whichwill result in recognition of additional income tax expense in the fourthquarter of 2005 of approximately $0.3 million.

 

***Equityin net loss of unconsolidated affiliates.***  For the nine months ended September 30,2005, our equity in net loss of unconsolidated affiliates was $1.9 millioncompared to $0.8 million for the nine months ended September 30, 2004. Asof September 30, 2005, we have $5.9 million of long-term investments inunconsolidated affiliates, and we expect to incur additional losses on theseinvestments in 2005 and we may continue to incur losses thereafter.

 

**Seasonality**

 

Credit card and debit card transactionsaccount for a major percentage of the transaction volume processed by ourcustomers. The volume of these transactions on our networks generally isgreater in the third and fourth quarter vacation and holiday seasons thanduring the rest of the year. Consequently, revenues and earnings from creditcard and debit card transactions in the first and second quarter generally arelower than revenues and earnings from credit card and debit card transactionsin the third and fourth quarters of the immediately preceding year. We expectthat our operating results in the foreseeable future will be significantlyaffected by seasonal trends in the credit card and debit card transactionmarket.

 

**Liquidity and Capital Resources**

 

Our primary liquidity and capital resourceneeds are to finance the costs of our operations, to make capital expendituresand to service our debt. The borrowings under our May 4, 2005 amended andrestated senior secured credit facility were used to finance the stock repurchaseon May 5, 2005, as well as to repay the amounts outstanding under our 2004senior 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 secure 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.

 

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Our operations provided us cash of$33.5 million for the nine months ended September 30, 2005, which wasattributable to net income of $4.3 million, depreciation, amortization andother non-cash charges of $40.7 million and a decrease in working capitalof $11.6 million. Our operations provided us cash of $34.0 millionfor the nine months ended September 30, 2004, which was attributable tonet income of $2.6 million, depreciation, amortization and other non-cashcharges of $36.5 million and a decrease in working capital of$5.1 million.

 

We used cash of $23.7 million ininvesting activities for the nine months ended September 30, 2005, whichincludes capital expenditures of $14.1 million. In addition, we madeinvestments for $2.6 million in WAY and $2.9 million in IP Commerce.  We also purchased certain assets ofFusionPoint and Process Logistics for $3.5 million and $0.6 million,respectively.  We used cashof $29.8 million in investing activities for the nine months ended September 30,2004, which includes capital expenditures of $16.4 million.  In addition, we spent $6.1 million and $3.7million, respectively, to purchase the Synapse and vending assets fromUSWD.  Significant portions of ourcapital expenditures in each period were for network equipment, third-partysoftware and capitalized software development costs we incurred to expand ournetwork platforms and service our customer requirements.  Our remaining capital expenditures were foroffice equipment and leasehold improvements and for general corporatepurposes.  We currently have no significantcapital spending or purchase commitments but expect to continue to engage incapital spending in the ordinary course of business.

 

We used cash of $4.4 million for financingactivities for the nine months ended September 30, 2005, which includesborrowings under our amended and restated senior secure credit facility, net offinancing costs, of $165.2 million that were used to finance the stockrepurchase, inclusive of expenses, for approximately $116.9 million and torepay $48.0 million of long-term debt under our 2004 senior secured creditfacility. We used the net proceeds from our follow-on offering in September 2005of approximately $46.1 million to repay $45.0 million of long-term debt underour amended and restated senior secure credit facility.  In addition we made long-term debt repaymentsof $3.7 million on our amended and restated senior secured credit facility andan additional $3.0 million on our 2004 senior secured credit facility. We usedcash of $2.7 million for financing activities for the nine months ended September 30,2004, which includes $8.2 million of long-term debt repayments on our previoussenior secured credit facility and $150.4 million of long-term debt underour then-existing senior secured credit facility with the net proceedsgenerated from our IPO in March 2004 of $71.5 million and borrowingsunder our new credit facility, net of financing costs, of$79.0 million.  We also borrowed$5.5 million in May 2004 under our previous senior secured creditfacility, the proceeds of which were used to fund the acquisition of theSynapse assets from USWD.

 

In October 2005, we used the remainingnet proceeds from our follow-on offering to repay $1.1 million of long-termdebt under our amended and restated senior secured credit facility.

 

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

 

On May 4, 2005, we entered into anamended and restated senior secured credit facility to finance the stockrepurchase and to replace our previous senior secured credit facility. Theamended 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 no borrowings as of September 30,2005. 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. As of September 30, 2005 total remaining payments on the term loanare as follows (in thousands):

 
| Six months  ending December 31, 2005 |   | $       | 413     |   |
|-------------------------------------------|--------|---------|---------|--------|
| 2006                                      |   | 1,650   |    |
| 2007                                      |   | 1,650   |    |
| 2008                                      |   | 1,650   |    |
| 2009                                      |   | 1,650   |    |
| Thereafter                                |   | 112,162 |    |
|                                      |   | $       | 119,175 |   |

 

For the period through September 30,2005, borrowings on the revolving credit facility and the term loan boreinterest at a rate of 2.00 percent over the LIBOR rate (5.85 percent as ofSeptember 30, 2005). Thereafter, if we achieve a leverage ratio of lessthan 1.75, the borrowings on the revolving credit facility and the term loangenerally will bear interest at a rate, at our option, of either0.75 percent over the lender’s base rate or 1.75 percent over theLIBOR rate. Our leverage ratio as of September 30, 2005 was 1.80 to 1.0.The revolving credit facility is subject to an annual non-use commitment fee inan amount equal to 0.375 percent or 0.5 percent per annum, depending onour leverage ratio, multiplied by the amount of funds available for borrowingunder the revolving credit facility. Interest payments on the amended andrestated senior secured credit facility are due monthly, bimonthly, orquarterly at our option.

 

The terms of the amended and restated seniorsecured credit facility require us to comply with financial and nonfinancialcovenants, including maintaining certain leverage, interest and fixed chargecoverage ratios at the end of each fiscal quarter. As of September 30,2005, we were required to maintain a leverage ratio of less than 2.85 to 1.0,an interest coverage ratio of greater than 4.0 to 1.0 and a fixed charge ratioof greater than 2.5 to 1.0. Certain of the financial covenants will become morerestrictive over the term of the amended and restated senior secured creditfacility. The amended and restated senior secured credit facility also containsnonfinancial covenants that restrict some of our corporate activities,including our ability to dispose of assets, incur additional debt, paydividends, create liens, make investments, make capital expenditures and engagein specified transactions with 

 

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affiliates. Our future results of operations and our ability to complywith the covenants could be adversely impacted by increases in the generallevel of interest rates since the interest on a majority of our debt isvariable. Noncompliance with any of the financial or nonfinancial covenantswithout cure or waiver would constitute an event of default under the amendedand restated senior secured credit facility. An event of default resulting froma breach of a financial or nonfinancial covenant may result, at the option ofthe lenders, in an acceleration of the principal and interest outstanding, anda termination of the amended and restated senior secured revolving creditfacility. The amended and restated senior secured credit facility also containsother customary events of default (subject to specified grace periods),including defaults based on events of bankruptcy and insolvency, nonpayment ofprincipal, interest or fees when due, breach of specified covenants, change incontrol and material inaccuracy of representations and warranties. We were incompliance with the financial and nonfinancial covenants of the amended andrestated senior secured credit facility as of September 30, 2005.

 

##### **Recent Accounting Pronouncements**

##### ** **

In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment” (SFAS No. 123(R)), which is arevision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R)supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”,and amends SFAS No. 95, “Statement of Cash Flows.” We will adopt SFAS No. 123(R)on January 1, 2006. SFAS No. 123(R) requires all share-based paymentsto employees, including grants of employee stock options, to be recorded as anexpense based on their fair values. Information about the fair value of stockoptions under the Black-Scholes model and its pro forma impact on net incomeand basic and diluted net income per common share for the three and nine monthsended September 30, 2004 and 2005 (which may differ from the ultimateimpact of the new standard) can be found in Note 1 to the condensedconsolidated financial statements in this Form 10–Q.  Under SFAS No. 123(R), we mustdetermine the appropriate fair value model to be used for valuing share-basedpayments, the amortization method for compensation cost and the transition methodto be used at the date of adoption. The transition alternatives include themodified prospective or the modified retrospective adoption methods. Under themodified retrospective method, prior periods may be restated either as of thebeginning of the year of adoption or for all periods presented. The modifiedprospective method requires that compensation expense be recorded for allunvested stock options and share awards at the beginning of the first quarterof adoption of SFAS No. 123(R), while the modified retrospectivemethods would record compensation expense for all unvested stock options andshare awards beginning with the first period restated.  We are currently evaluating the impact ofadopting SFAS No. 123(R) and have not determined the adoption method.

 

##### **Related Party Transaction**

##### ** **

During the three and nine months ended September 30,2005, we paid approximately $0.4 million for the use of an aircraft to acompany that is owned by our Chairman and CEO.

 

On September 21, 2005, we entered into a lease torent office space in the UK with a company that is majority owned by the SeniorVice President and General Manager of our subsidiary, Transaction NetworkServices (UK) Limited.  Prior to enteringinto this lease, we obtained an independent appraisal confirming that the termsof the lease were consistent with market standards.  The lease provides for quarterly payments inequal installments of approximately £26,000and expires on September 20, 2017.

 

The following is a schedule by year of futureminimum rental payments due to the company under the operating lease agreement(in thousands):

 
| Three months  ending December 31, 2005 |   | £ | — |   |
|---------------------------------------------|--------|--------|--------|--------|
| 2006                                        |   | 56     |   |
| 2007                                        |   | 105    |   |
| 2008                                        |   | 105    |   |
| 2009                                        |   | 105    |   |
| Thereafter                                  |   | 814    |   |
|                                        |   | £ | 1,185  |   |

 

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

 

***Interest rates***

 

Our principal exposure to market risk relatesto changes in interest rates. As of September 30, 2005, we had$119.2 million outstanding under our new senior secured credit facilitywith interest rates tied to changes in the lender’s base rate or the LIBORrate. Based upon the outstanding borrowings on September 30, 2005 andassuming repayment of the Term Loan in accordance with scheduled maturities,each 1.0% increase in these rates could add an additional $1.2 million to ourannual interest expense.

 

As of September 30, 2005, we did nothold derivative financial or commodity instruments and all of our cash and cashequivalents were held in money market or commercial accounts.

 

***Foreign currencyrisk***

 

Our earnings are affected by fluctuations inthe value of the U.S. dollar as compared with foreign currencies, predominatelythe euro, the British pound and the Australian dollar due to our operations inEurope and Australia.

 

We have operations in 18 countries outside ofthe U.S., including the United Kingdom, Australia, Canada, Finland, France,Germany, Hong Kong, Ireland, Italy, Japan, Korea, The Netherlands, NewZealand, Norway, Poland, Spain, Sweden and Thailand. We provide services inthese countries using networks 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 paid accordingto our standard payment terms, which are generally short–term in nature. Ourpolicy is not to speculate in foreign currencies, and we promptly buy and sellforeign currencies as necessary to cover our net payables and receivables,which are denominated in foreign currencies. For the nine months ended September 30,2005, we recorded a loss on foreign currency translation of approximately $0.6million.

 

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**Item 4. Controls and Procedures**

 

The Company maintains disclosure controls andprocedures that are designed to ensure that information required to bedisclosed in the Company’s reports under the Securities Exchange Act of 1934,as amended, is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and that such information isaccumulated and communicated to the Company’s management, including its ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions 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, underthe supervision, and with the participation, of the Company’s management,including the Company’s Chief Executive Officer and the Company’s ChiefFinancial Officer, of the effectiveness of the Company’s disclosure controlsand procedures as of September 30, 2005. Based on the foregoing, theCompany’s Chief Executive Officer and principal financial officers concludedthat the Company’s disclosure controls and procedures were effective as of September 30,2005.

 

There have been no significant changes duringthe quarter covered by this report in the Company’s internal control overfinancial reporting or in other factors that could significantly affect theinternal control over financial reporting.

 

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**PART II—OTHER INFORMATION**

 

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

 

On August 26, 2002, an action was filedin the Superior Court of the State of Delaware by persons alleging that theCompany breached an agreement to purchase an unrelated entity. On February 28,2005, the court denied the Company’s motion for summary judgment filed in June 2004.  After considering the defense costs,potential damages should the plaintiffs prevail, and continued diversion ofmanagement resources, the Company determined in March 2005 that asettlement was warranted. In April 2005, the Company made the payment of$3.25 million in cash to the plaintiffs and received the dismissal of allclaims, with prejudice, by the plaintiffs, thereby settling this dispute.

 

Certain states in which the Company operatesassess sales taxes on certain services provided by the Company. The Companybelieves it has no liability because its customer contracts contain terms thatstipulate the customer, not the Company, is responsible for any sales taxliability. In jurisdictions where the customer may be liable for sales taxes,the Company either includes sales tax on its invoice or has obtained anexemption certificate from the customer. Certain states have audited theCompany from 1996 to early 2001 and originally proposed $6.7 million inassessments on the basis that sales taxes are owed. In March 2005, theCompany received verbal notification from a state sales tax auditor that one ofthe states was likely to reduce its proposed assessment by an amount in excessof  $4 million.  In April 2005, the Company received writtenconfirmation from that state’s Department of Revenue that the state’sassessment would be reduced by $4.3 million. In July 2005, the Company entered into an agreement with that state’sDepartment of Revenue to settle the remaining outstanding liability ofapproximately $1.5 million for $0.8 million and concurrently entered intoan agreement with a customer to reimburse the Company for $0.5 million of thesettlement amount.  Both the Company andthe customers involved are vigorously defending the remaining proposedassessments. In the opinion of management, resolution of these matters will nothave a material adverse effect upon the financial position or future operatingresults of the Company.

 

We also are party to various legalproceedings in the normal course of business. Please see the description underthe caption “Legal Proceedings” in prospectus filed with the Commission on September 16,2005.

 

**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.

 

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

 

None.

 

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

##### ** **

(31.1)         Certification—ChiefExecutive Officer

 

(31.2)         Certification—ChiefFinancial Officer

 

(32.1)         Written Statement ofChief Executive Officer and Chief Financial Officer

 

**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                         | TNS, Inc. |
|------------------------------|----------------|
|                         | (Registrant)   |
|                         |           |
| Date: November 14, 2005 | By:            | /s/ John J. McDonnell, Jr. |   |
|                         |           | John J. McDonnell, Jr. |   |
|                         |           | Chairman and Chief Executive Officer |   |
|                         |           |   |   |
| Date: November 14, 2005 | By:            | /s/ Henry H. Graham, Jr. |   |
|                         |           | Henry H. Graham, Jr. |
|                         |           | Executive Vice President, Chief Financial  Officer & Treasurer |

 

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