TNS (TNS)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended June 30, 2006

Commission File Number: 001-32033

TNS, INC.

(Exact name of registrant as specified in its charter)

 

11480 Commerce Park Drive, Suite 600
Reston, VA 20191

(Address of principal executive offices)

(703) 453-8300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.  x Yes  o No

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

Large accelerated filer   o

Accelerated filer   x

Non-accelerated filer   o

 

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

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

 

 

TNS, INC.

INDEX

Part I: FINANCIAL INFORMATION
	Item 1.		Condensed Consolidated Financial Statements (Unaudited)
			Condensed Consolidated Balance Sheets as of December 31, 2005 and June 30, 2006
			Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2005 and 2006
			Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2006
			Notes to Condensed Consolidated Financial Statements
	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.		Quantitative and Qualitative Disclosures About Market Risk
	Item 4.		Controls and Procedures
Part II: OTHER INFORMATION
	Item 1.		Legal Proceedings
	Item 2.		Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
	Item 3.		Default Upon Senior Securities
	Item 4.		Submission of Matters to a Vote of Security Holders
	Item 5.		Other Information
	Item 6.		Exhibits

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PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

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

		December 31, 2005			June 30, 2006
					(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	26,628		$	21,188
Accounts receivable, net of allowance for doubtful accounts of $5,260 and $5,984, respectively		48,773			57,566
Prepaid expenses		4,407			4,883
Deferred tax assets		5,236			3,542
Other current assets		5,813			7,450
Total current assets		90,857			94,629
Property and equipment, net		52,448			55,508
Identifiable intangible assets, net		187,233			194,049
Goodwill		5,160			8,468
Other assets		16,486			19,068
Total assets		$	352,184		$	371,722
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	—		$	825
Accounts payable, accrued expenses and other current liabilities		46,933			53,311
Deferred revenue		10,810			14,050
Total current liabilities		57,743			68,186
Long-term debt, net of current portion		113,448			118,623
Other liabilities		3,147			3,611
Total liabilities		174,338			190,420
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.001 par value; 130,000,000 shares authorized; 23,998,715 shares issued and 23,971,001 shares outstanding and 24,129,152 shares issued and 24,100,487 shares outstanding, respectively		24			24
Treasury stock, 27,714 shares and 28,665 shares, respectively		(517		)	(536		)
Additional paid-in capital		217,434			213,776
Accumulated deficit		(31,567		)	(32,964		)
Deferred stock compensation		(7,150		)	—
Accumulated other comprehensive (loss) income		(378		)	1,002
Total stockholders’ equity		177,846			181,302
Total liabilities and stockholders’ equity		$	352,184		$	371,722

 

See accompanying notes to condensed consolidated financial statements (unaudited).

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

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

 

See accompanying notes to condensed consolidated financial statements (unaudited).

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TNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)

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

 

See accompanying notes to condensed consolidated financial statements (unaudited).

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.                                      Description of Business and Basis of Presentation

TNS, Inc. (TNS or the Company) is a Delaware corporation. TNS is a leading provider of business-critical data communications services to processors of credit card, debit card and automated teller machine (ATM) transactions. TNS is also a leading provider of call signaling and database access services to the domestic telecommunications industry and of secure data and voice network services to the global financial services industry. TNS’ data communication services enable secure and reliable transmission of time-sensitive, transaction-related information critical to its customers’ operations. The Company’s customers outsource their data communication requirements to TNS because of the Company’s expertise, comprehensive customer support, and cost-effective services. TNS provides services to customers in the United States and increasingly to customers in 27 countries, including Canada and countries in Europe, Latin America and the Asia-Pacific region.

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

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

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in the annual financial statements, required by GAAP, have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading.

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

Stock Repurchase and Offerings of Common Stock

On May 5, 2005, the Company purchased and retired 6,263,435 shares of its common stock, pursuant to a modified Dutch auction tender offer, for $18.50 per share plus expenses of approximately $1.0 million. Of the shares tendered, 6 million shares were tendered by the Company’s then controlling stockholder, GTCR Golder Rauner L.L.C. and its affiliated investment funds (“GTCR”).

On September 21, 2005, the Company completed a follow-on offering of common stock issuing 1,200,000 common shares at $23.25 per share, which generated proceeds, net of offering costs, of approximately $26.1 million. On September 21, 2005, in connection with the following-on offering, the underwriters exercised their over-allotment option and the Company issued an additional 900,000 shares of common stock at $23.25 per share, which generated proceeds net of offering costs of approximately $20.0 million. The net proceeds from the follow-on offering were used to repay a portion of the Company’s long-term debt outstanding under its existing credit-facility.

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Use of Estimates

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

Revenue Recognition

The Company recognizes revenue when persuasive evidence of an agreement exists, the terms are fixed or determinable, services are performed, and collection is probable. Cash received in advance of revenue recognition is recorded as deferred revenue. POS services revenue is derived primarily from the transmission of transaction data through the Company’s networks between payment processors and POS or ATM terminals. Telecommunication services revenue is derived primarily from fixed monthly recurring fees for the Company’s call signaling services and per query fees charged for the Company’s database access and validation services. Financial services revenue is derived primarily from monthly recurring fees based on the number of customer connections to and through the Company’s networks. Customer incentives granted to new customers or upon contract renewals are deferred and recognized ratably as a reduction of revenue over the contract period to the extent that the incentives are recoverable against the customer’s minimum purchase commitments under the contract. In addition, the Company receives installation fees related to the configuration of the customer’s systems. Revenue from installation fees are deferred and recognized ratably over the customer’s contractual service period, generally three years. The Company performs periodic evaluations of its customer base and establishes allowances for estimated credit losses.

Cost of Network Services

Cost of network services is comprised primarily of telecommunications charges, which include data transmission and database access, leased digital capacity charges, circuit installation charges and activation charges. The cost of data transmission is based on a contract or tariff rate per minute of usage in addition to a prescribed rate per transaction for certain vendors. The costs of database access, circuits, installation charges and activation charges are based on fixed fee contracts with local exchange carriers and interexchange carriers. The cost of network services also includes salaries, equipment maintenance and other costs related to the ongoing operation of the Company’s data networks. These costs are expensed as incurred. The Company records its accrual for telecommunications charges based upon network services utilized at historical invoiced rates. Depreciation expense on the Company’s network equipment and amortization of developed technology are excluded from the Company’s cost of network services and included in depreciation and amortization of property and equipment and amortization of intangible assets in the condensed consolidated statement of operations.

Stock-Based Compensation

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

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Identifiable Intangible Assets

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

Developed technology represents the Company’s proprietary knowledge, including processes and procedures, used to configure its networks. Network equipment and software, both purchased and internally developed, are components used to build the networks and are separately identified assets classified within property and equipment.

For purposes of measuring and recognizing impairment of long-lived assets, including intangibles, the Company assesses whether separate cash flows can be attributed to the individual asset.  For the customer relationship intangible assets, the Company recognizes and measures impairment upon the significant loss of revenue from a customer. Included in amortization of intangibles expense for the three and six months ended June 30, 2005 and for the three and six months ended June 30, 2006 is approximately $3.1 million and $0.1 million, respectively, in accelerated amortization on a portion of the Company’s customer relationship assets in connection with the loss of certain customers during those respective periods.  The Company has experienced revenue and transaction volume declines with a major customer during 2005 and 2006.  The customer relationship intangible asset assigned to this customer is approximately $23.1 million as of June 30, 2006.  The Company assessed the recoverability of this customer relationship intangible asset based upon undiscounted anticipated future cash flows and concluded that no impairment existed as of June 30, 2006.

Income Taxes

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

For the three and six months ended June 30, 2005, the Company’s effective tax rate was approximately 78.7% and 62.4%, respectively. For the three and six months ended June 30, 2006 the Company’s effective tax rate was approximately 32.9% and 24.1%, respectively.  The Company’s tax rate fluctuates from the U.S. Federal statutory tax rate of 34.0% as a result of losses in certain international jurisdictions and losses on equity method investments for which a valuation allowance has been established on the deferred tax assets created by such net losses. In addition, the majority of the Company’s operations in foreign countries that are generating pre-tax income are generally taxed at rates less than 34.0%.

New Accounting Pronouncements

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

2.                                      Acquisitions and Long-term Investments

Acquisition of Connet-Ro

On December 13, 2005, the Company completed the acquisition of a Romanian company, SC Connet-Ro SRL (Connet-Ro) for a purchase price of $1.4 million, including direct acquisition costs of approximately $0.1 million. The Company accounted for the transaction as a purchase under the provisions of SFAS No. 141 “Business Combinations”. The purchase agreement allowed for additional consideration of up to $0.4 million to be paid, based upon the results of operations of Connet-Ro for the year ended December 31, 2005.  In May 2006, the Company made an additional payment of $0.2 million based upon the results of operations of Connet-Ro.  This contingent consideration has been allocated to the customer relationship intangible asset.

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

Other current assets		$	450
Property and equipment		294
Customer relationship		1,292
Non-compete agreements		125
Accounts payable, accrued expenses and other liabilities		(572		)
Net assets acquired		$	1,589

 

The amounts allocated to the customer relationship and to the non-compete agreements are being amortized on a straight-line basis over their estimated useful life of five years and three years, respectively.

 

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Acquisition of CommsXL

On January 6, 2006, the Company completed the acquisition of two companies in the United Kingdom, CommsXL Services and CommsXL Limited (collectively, CommsXL). Pursuant to two separate purchase agreements, the Company paid approximately $11.7 million, including direct acquisition costs of approximately $0.3 million, for CommsXL. The Company purchased CommsXL to advance its end-to-end POS service offerings in the United Kingdom as well as to penetrate new vertical markets.

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

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

 

The amounts allocated to the customer relationships, developed technology and to the non-compete agreements are being amortized on a straight-line basis over their estimated useful life of five years, five years and three years, respectively. Unaudited pro forma results of operations are not provided because the historical operating results were not significant and pro forma results would not be significantly different from reported results for the periods presented. The Company’s results of operations for the six months ended June 30, 2006 include the operating results of these acquisitions from January 6, 2006.

Acquisition of InfiniRoute Assets

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

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

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

 

The amounts allocated to the customer relationships, developed technology and to the non-compete agreements are being amortized on a straight-line basis over their estimated useful lives of three years. Unaudited pro forma results of operations are not provided because the historical operating results were not significant and pro forma results would not be significantly different from reported results for the periods presented. The Company’s results of operations for the six months ended June 30, 2006 include the operating results of this acquisition from March 1, 2006.

Acquisition of Sonic Assets

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

 

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

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

 

The amounts allocated to the customer relationships, developed technology and to the non-compete agreements are being amortized on a straight-line basis over their estimated useful life of five years, five years and three years, respectively. Unaudited pro forma results of operations are not provided because the historical operating results were not significant and pro forma results would not be significantly different from reported results for the periods presented. The Company’s results of operations for the six months ended June 30, 2006 include the operating results of this acquisition from March 1, 2006.

Way Systems Investment

In August 2004, the Company made an investment in WAY Systems, Inc. (WAY), which provides mobile POS transaction infrastructure and solutions for mobile merchants. The Company purchased 5,952,381 shares or 38.5 percent of WAY’s Series B convertible preferred stock for $2.5 million and became entitled to representation on WAY’s board of directors. In March 2005, the Company made an additional investment of $0.8 million to purchase 1,910,401 shares of WAY’s Series B convertible preferred stock for an additional 1.9 percent of WAY’s outstanding shares. In July 2005, the Company made an additional investment of $0.7 million in exchange for a convertible note bearing interest at a rate of 8 percent per annum and due January 1, 2009. In September 2005, the Company exercised its right on the convertible note to convert the outstanding principal and accrued interest of approximately $0.8 million to 1,185,085 shares of WAY’s Series C convertible preferred stock and made an additional investment of $1.1 million to purchase 1,676,429 shares of WAY’s Series C convertible preferred stock. The Company owned 17.1 percent of Way’s total outstanding shares as of June 30, 2006. The Company is accounting for its investment under the equity method of accounting as the Company has significant influence over the financing and operating activities of WAY through its representation on the WAY board of directors. Due to timing of the receipt of WAY’s financial statements, the Company is accounting for the income or loss in this equity method investment on a one-month lag.

Summarized financial information for WAY is as follows (in thousands):

		December 31, 2005			June 30, 2006
					(unaudited)
Current assets		$	12,473		$	7,393
Non-current assets		743			869
Current liabilities		1,956			2,869
Non-current liabilities		—			—

 

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

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IP Commerce Investment

In January 2005, the Company made an investment in IP Commerce, a company that provides operating software to facilitate the authorization of IP-based retail payment transactions. The Company purchased 2,368,545 Series A preferred shares or 39.9 percent of IP Commerce’s total outstanding shares for $2.0 million and became entitled to representation on IP Commerce’s board of directors. In September 2005, the Company made an additional investment of $0.9 million in exchange for a convertible note bearing interest at a rate of 8 percent per annum which was payable on demand, no earlier than February 1, 2007. In March 2006, the Company exercised its right on the convertible note to convert the outstanding principal and accrued interest of approximately $0.9 million to 675,901 shares of IP Commerce’s Series B convertible preferred stock. The Company owned 29.4 percent of IP Commerce’s total outstanding shares as of June 30, 2006. The Company is accounting for its investment under the equity method of accounting. Due to timing of the receipt of IP Commerce’s financial statements, the Company is accounting for the income or loss in this equity method investment on a one-month lag.

Summarized financial information for IP Commerce is as follows (in thousands):

		December 31, 2005			June 30, 2006
					(unaudited)
Current assets		$	1,426		$	4,443
Non-current assets		274			300
Current liabilities		258			659
Non-current liabilities		2,596			—

 

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

 

3.             Long-term Debt

On May 4, 2005, the Company entered into an amended and restated senior secured credit facility (the May 4, 2005 Credit Facility) to finance the stock repurchase and to replace its prior senior secured credit facility (March 19, 2004 Credit Facility). The May 4, 2005 Credit Facility consists of a $165.0 million Term B Loan (Term B Loan) and a revolving credit facility of $30.0 million (New Revolving Credit Facility), under which there were $6.0 million of borrowings as of June 30, 2006. The May 4, 2005 Credit Facility matures May 4, 2012. Payments on the Term B Loan are due in quarterly installments over the seven-year term, which began on June 1, 2005, with the remainder payable on May 4, 2012. Voluntary prepayments on the Term B Loan are first applied pro-rata to the scheduled quarterly installments due within the next succeeding twelve-month period until paid in full and then applied to the term loan in inverse order of maturity. As of June 30, 2006 total remaining payments on the Term B Loan are as follows (in thousands):

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

 

For the three months ended June 30, 2006, borrowings on the New Revolving Credit Facility and the Term B Loan bore interest at a rate of 2.0 percent over the LIBOR rate (7.4 percent as of June 30, 2006). Thereafter, if the Company achieves a leverage ratio of less than 1.75, the borrowings on the New Revolving Credit Facility and the Term B Loan generally will bear interest at a rate, at the Company’s option, of either 0.75 percent over the lender’s base rate or 1.75 percent over the LIBOR rate. The Company’s leverage ratio as of June 30, 2006 was 1.95 to 1.0. The New Revolving Credit Facility is subject to an annual non-use commitment fee in an amount equal to 0.375 percent or 0.5 percent per annum, depending on the Company’s leverage ratio, multiplied by the amount of funds available for borrowing under the New Revolving Credit Facility. Interest payments on the May 4, 2005 Credit Facility are due monthly, bimonthly, quarterly, semi-annually or annually at the Company’s option.

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The terms of the May 4, 2005 Credit Facility require the Company to comply with financial and nonfinancial covenants, including maintaining certain leverage, interest and fixed charge coverage ratios at the end of each fiscal quarter. As of June 30, 2006, the Company was required to maintain a leverage ratio of less than 2.55 to 1.0, an interest coverage ratio of greater than 4.0 to 1.0 and a fixed charge ratio of greater than 2.5 to 1.0. Certain of the financial covenants will become more restrictive over the term of the May 4, 2005 Credit Facility. The May 4, 2005 Credit Facility also contains nonfinancial covenants that restrict some of the Company’s corporate activities, including the Company’s ability to dispose of assets, incur additional debt, pay dividends, create liens, make investments, make capital expenditures and engage in specified transactions with affiliates. The Company’s future results of operations and its ability to comply with the covenants could be adversely impacted by increases in the general level of interest rates since the interest on a majority of the Company’s debt is variable. Noncompliance with any of the financial or nonfinancial covenants without cure or waiver would constitute an event of default under the May 4, 2005 Credit Facility. An event of default resulting from a breach of a financial or nonfinancial covenant may result, at the option of the lenders, in an acceleration of the principal and interest outstanding, and a termination of the May 4, 2005 Credit Facility. The May 4, 2005 Credit Facility also contains other customary events of default (subject to specified grace periods), including defaults based on events of bankruptcy and insolvency, nonpayment of principal, interest or fees when due, breach of specified covenants, change in control and material inaccuracy of representations and warranties. The Company was in compliance with the financial and nonfinancial covenants of the May 4, 2005 Credit Facility as of June 30, 2006.

In connection with the closing of the May 4, 2005 Credit Facility, the Company incurred approximately $2.7 million in financing costs. These financing costs were deferred and are being amortized using the effective interest method over the life of the May 4, 2005 Credit Facility. In connection with the termination of the March 19, 2004 Credit 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 in the accompanying condensed consolidated statement of operations for the three and six months ended June 30, 2005.

4.             Comprehensive Income (Loss)

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

		Three months ended June 30,						Six months ended June 30,
		2005			2006			2005			2006
Net income (loss)		$	251		$	(930	)	$	1,705		$	(1,397	)
Foreign currency translation adjustments		(1,360		)	1,276			(2,171		)	1,380
Total comprehensive (loss) income		$	(1,109	)	$	346		$	(466	)	$	(17	)

 

5.                                      Net Income (Loss) Per Common Share

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

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

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

 

6.             Segment Information

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

Management evaluates the North American and ISD performance on EBITDA before stock compensation expense because operating expenses are distinguishable between North American and ISD operations. The Company defines EBITDA before stock compensation expense as income from operations before depreciation, amortization and stock compensation expense. EBITDA before stock compensation expense is not a generally accepted accounting principle measure, but rather a measure employed by management to view operating results adjusted for significant noncash items. The Company’s definition of EBITDA before stock compensation expense may not be comparable to similarly titled measures used by other entities. Assets are not segregated between reportable segments, and management does not use asset information by segments to evaluate segment performance. As such, no information is presented related to fixed assets by reportable segment and capital expenditures for each segment.

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

		Three months ended June 30,						Six months ended June 30,
		2005			2006			2005			2006
Revenues:
POS		$	22,113		$	21,422		$	45,272		$	40,214
TSD		11,213			16,725			21,250			31,554
FSD		7,735			8,629			15,042			17,001
ISD		24,293			25,884			46,922			49,799
Total revenues		$	65,354		$	72,660		$	128,486		$	138,568

 

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

 

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

 

 

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

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

 

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

 

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

 

Geographic Information

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

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

		Three months ended June 30,						Six months ended June 30,
		2005			2006			2005			2006
Revenues:
North America		$	41,061		$	46,776		$	81,564		$	88,770
Europe		21,640			22,807			41,493			43,986
Asia-Pacific		2,653			3,077			5,429			5,812
Total revenues		$	65,354		$	72,660		$	128,486		$	138,568

 

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

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

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

 

7.                                           Stock-Based Compensation

As discussed in Note 1, effective January 1, 2006, the Company adopted SFAS 123R using the modified prospective transition method. The following table sets forth total stock-based compensation expense recognized in the condensed consolidated statement of operations related to stock options and restricted stock units (in thousands except per share amounts):

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

 

Prior to the adoption of SFAS 123R, the Company did not make estimates for forfeitures and recognized compensation cost assuming all awards would vest and reversed recognized compensation cost for forfeited awards when the awards were actually forfeited. Upon adoption of SFAS 123R on January 1, 2006, the Company recorded a cumulative effect of a change in accounting principle, net of tax, of approximately $0.1 million related to estimated forfeitures of unvested restricted stock awards for which stock-based compensation was recorded in the Company’s financial statements prior to January 1, 2006. During the three and six months ended June 30, 2006, the Company capitalized approximately $0.1 million and $0.2 million, respectively, of stock-based compensation costs for employees working on capitalized software development projects.

As permitted by SFAS 123, during 2005 the Company followed APB Opinion No. 25 under which share-based payments to employees were accounted for using the intrinsic value method and, as such, generally recognized no compensation cost for employee stock options. The Company’s pro forma information for the three and six months ended June 30, 2005 under SFAS 123, which reflects compensation expense equal to the fair value of the options and restricted stock awards recognized over their requisite service period, is as follows (in thousands, except per share amounts):

		Three months ended June 30, 2005			Six months ended June 30, 2005
Net income, as reported		$	251		$	1,705
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		326			620
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(806		)	(1,537		)
Pro forma net (loss) income		$	(229	)	$	788
Basic net income per common share, as reported		$	0.01		$	0.07
Diluted net income per common share, as reported		$	0.01		$	0.06
Pro forma basic and diluted net (loss) income per common share		$	(0.01	)	$	0.03

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

Stock-Based Compensation Plans

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

In February 2004, the Board of Directors of the Company adopted the TNS, Inc. 2004 Long-Term Incentive Plan (the Plan) and the Company’s stockholders approved the Plan in March 2004. The Plan reserves 3,847,384 shares of common stock for grants of incentive stock options, nonqualified stock 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 than the fair market value of the underlying common stock at the date of grant and become exercisable based on a vesting schedule determined at the date of grant, generally in equal monthly installments over four years. The options expire 10 years from the date of grant. Restricted stock awards and performance shares granted under the Plan are subject to a vesting period determined at the date of grant, generally in equal annual installments over four years.

Stock Options

The fair value for stock options granted during the periods were estimated at the grant date using a Black-Scholes option pricing model with the following weighted average assumptions:

		Six months ended June 30,
		2005 (a)		2006
Expected life		4 years		5 years
Risk-free interest rate		3.0	%	4.9	%
Volatility		50	%	49	%
Dividend yield		0.0	%	0.0	%

 

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

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

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

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

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

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A summary of time-vested option activity under the Plan as of June 30, 2006, and changes during the six months then ended is presented below (in thousands, except share and per share amounts):

 

		Number of shares		Weighted- average exercise price			Weighted- average remaining  contractual term		Aggregate Intrinsic Value
Outstanding, January 1, 2006		1,488,570		$	19.78
Granted		467,495		20.69
Exercised		(16,758	)	19.13
Canceled		(48,823	)	20.33
Outstanding at June 30, 2006		1,890,484		$	20.00		8 years		$	1,435
Exercisable at June 30, 2006		805,095		$	19.76		7 years		$	847

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

During the three and six months ended June 30, 2006 the Company received approximately $0.2 million and $0.3 million in cash proceeds related to the exercise of stock options, respectively. In addition the Company realized total tax benefits from stock option exercises of approximately $6,000 for the six months ended June 30, 2006, respectively, which were recorded as additions to additional paid-in capital in the condensed consolidated balance sheets. The adoption of SFAS 123R also resulted in reflecting the excess tax benefit from the exercise of stock based compensation awards in cash flows from financing activities.

Performance-Based Stock Options

Performance-based stock options are tied to the Company’s annual performance against pre-established internal budget targets for revenues and EBITDA before stock compensation expense.  Under the Company’s long-term incentive program, the actual payout under these awards may vary from zero to 200% of an employee’s target payout, based upon the Company’s actual performance over the fiscal year.  The fair value for stock options granted during the period was estimated at the grant date using the Black Schole’s option pricing model as described above.  Compensation cost initially recognized assumes the target payout level will be achieved and is adjusted for subsequent changes in the expected outcome of performance-related conditions until the vesting date.

A summary of performance-based stock options outstanding as of June 30, 2006, and changes during the six months then ended is presented below (in thousands, except share and per share amounts):

		Number of shares		Weighted- average exercise price			Weighted- average remaining  contractual term		Aggregate Intrinsic Value
Outstanding, January 1, 2006		—		$	—
Granted(1)		330,250		20.56
Exercised		—		—
Canceled		—		—
Outstanding at June 30, 2006(1)		330,250		$	20.56		10 years		$	43
Exercisable at June 30, 2006		—		—			—		$	—
Expected to vest at June 30, 2006		103,446		$	20.56		10 years		$	13

 

(1)             Based on 100% of the target payout

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

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Time-Vested Restricted Stock Units

A summary of the status of the Company’s time-vested restricted stock units as of June 30, 2006, and changes

during the six months then ended is presented below (in thousands, except share and per share amounts):

		Number of shares		Weighted-average grant-date fair value
Non-vested at January 1, 2006		439,316		$	20.52
Granted		175,999		20.47
Vested		(113,679	)	19.98
Forfeited		(12,213	)	21.28
Non-vested at June 30, 2006		489,423		$	20.61

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

Performance-Based Restricted Stock Units

Performance-based restricted stock units are tied to the Company’s annual performance against pre-established internal budget targets for revenues and EBITDA before stock compensation expense.  Under the Company’s long-term incentive program, the actual payout under these awards may vary from zero to 200% of an employee’s target payout, based upon the Company’s actual performance over the fiscal year.  The fair value is based on the market price of the Company’s stock on the date of grant.  Compensation cost initially recognized assumes the target payout level will be achieved and is adjusted for subsequent changes in the expected outcome of performance-related conditions until the vesting date.

A summary of performance-based restricted stock units outstanding as of June 30, 2006, and changes during the six months then ended is presented below (in thousands, except share and per share amounts):

		Number of shares		Weighted-average grant-date fair value
Balance at January 1, 2006		—		$	—
Granted(1)		113,029		20.56
Vested		—		—
Forfeited		—		—
Balance at June 30, 2006(1)		113,029		$	20.56
Expected to vest at June 30, 2006		35,398		$	20.56

 

(1)             Based on 100% of the target payout

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

8.             Litigation and Claims

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

On August 26, 2002, an action was filed in the Superior Court of the State of Delaware by persons alleging that the Company breached an agreement to purchase an unrelated entity. On February 28, 2005, the court denied the Company’s motion for summary judgement. After considering the defense costs, potential damages should the plaintiffs prevail, and continued diversion of management resources, the Company determined in March 2005 that a settlement was warranted. In April 2005, the Company paid $3.25 million in cash to the plaintiffs and received the dismissal of all claims, with prejudice, by the plaintiffs, thereby settling this dispute. This $3.25 million settlement is included in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations for the six months ended June 30, 2005.

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Certain states in which the Company operates assess sales taxes on certain services provided by the Company. The Company believes it has no liability because its customer contracts contain terms that stipulate the customer, not the Company, is responsible for any sales tax liability. In jurisdictions where the customer may be liable for sales taxes, the Company either includes sales tax on its invoice or has obtained an exemption certificate from the customer. Certain states have audited the Company from 1996 to early 2001 and originally proposed $6.7 million in assessments on the basis that sales taxes are owed. In March 2005, the Company received verbal notification from a state sales tax auditor that one of the states was likely to reduce its proposed assessment by $4.4 million. In April 2005, the Company received written confirmation from that state’s Department of Revenue that the state’s assessment would be reduced by $4.3 million.  Based on this written confirmation, the Company reduced its liability for this matter by $4.3 million during the first quarter of 2005.  In July 2005, the Company entered into an agreement with that state’s Department of Revenue to settle the outstanding liability for $0.8 million and concurrently entered into an agreement with a customer to reimburse the Company for $0.5 million of the settlement amount.  Based on these final executed settlements, the Company reduced its net liability for this matter by $1.5 million during the three months ended June 30, 2005. This $1.5 million and $5.8 million reduction in the liability, respectively, is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations for three and six months ended June 30, 2005. Both the Company and the customers involved are vigorously defending the remaining proposed assessments by the sales tax authorities. In the opinion of management, resolution of these matters will not have a material adverse effect upon the financial position or future operating results of the Company. Included in net income in the accompanying condensed consolidated statement of operations for the three months ended June 30, 2005 is a $0.9 million benefit, or $0.04 per share, related to the state sales tax settlement, net of related tax provision described above.  Included in net income in the accompanying condensed consolidated statement of operations for the six months ended June 30, 2005 is a net $1.5 million benefit, or $0.06 per share, related to the legal settlement and reduced state sales tax assessment described above.

 

The Company and John J. McDonnell, Jr., the Company’s Chief Executive Officer, and Henry H. Graham, Jr., the Company’s Chief Financial Officer, are defendants in a putative class action lawsuit filed in connection with the Company’s public offering of common stock in September 2005 (“Secondary Offering”).  The Cement Masons and Plasterers Joint Pension Trust, purportedly on behalf of itself and others similarly situated, filed the putative class action lawsuit captioned Cement Masons & Plasterers Joint Pension Trust v. TNS, Inc., et al., Case No. 1:06 CV 363, CMH/BRP, on April 4, 2006 in the United States District Court for the Eastern District of Virginia.  Plaintiff claims that the Registration Statement filed in connection with the Secondary Offering negligently failed to disclose that (1) TNS’ agreement with the Pepsi Bottling Group, Inc. (“Pepsi”) to provide cashless vending to Pepsi had been delayed beyond August 7, 2005; (2) TNS was generating less revenues and income than it had anticipated from its contract with the Royal Bank of Scotland (“RBS”), because RBS purportedly had overstated the number of transactions that TNS would be responsible for processing for RBS; and (3) TNS’ International Services Division was experiencing declining revenues during that time period because of unfavorable foreign exchange rates.  TNS filed a motion to dismiss the lawsuit on July 14, 2006. The Plaintiff filed its memorundum in oposition to TNS’ motion to dismiss on August 4, 2006. The Court has yet to rule on the motion to dismiss.  This action is in the preliminary phase; thus the timing and course of the litigation are not predictable, and, as a result, management cannot estimate a range of possible loss and has therefore not recognized a liability for this expense.  However, TNS intends to take appropriate steps to defend against the lawsuit, the outcome of which could have a material adverse affect on the financial condition or future operating results of TNS. During the six months ended June 30, 2006, the Company accrued legal costs of approximately $0.5 million, representing management’s estimate of the probable legal costs to defend itself in this matter. These legal costs are included in selling, general and administrative expense in the accompanying condensed consolidated statement of operations for the six months ended June 30, 2006.

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The Company and the members of its Board of Directors also are defendants in a putative shareholder class action lawsuit that seeks to enjoin the non-binding proposal announced on March 13, 2006 from senior management of the Company to acquire all outstanding shares of the Company.  Paul Schwartz, purportedly on behalf of himself and others similarly situated, filed the lawsuit captioned Schwartz v. TNS, Inc., et al., C.A. No. 2000-N, on March 13, 2006 in Delaware Chancery Court for New Castle County.  The plaintiff alleges that injunctive relief is necessary because the Company and the members of the Board of Directors allegedly breached their fiduciary duties to TNS shareholders by allegedly causing the Company to negotiate for the sale of TNS at an unfair price, depriving TNS’ public shareholders of the maximum value to which they purportedly are entitled.  The plaintiff further alleges that members of the Board of Directors also breached their fiduciary duties by allegedly not taking adequate measures to ensure that the interests of TNS’ public shareholders are properly protected, as the terms of the proposed transaction allegedly are grossly unfair to the shareholders.  On April 3, 2006, the plaintiff and the defendants entered into a letter agreement that provides the defendants with an open-ended extension of time to answer or otherwise respond to the plaintiff’s complaint, and holds discovery and other matters in the case in abeyance pending an agreement on a management buy-out proposal or other form of transaction.  This action is in the preliminary phase; thus the timing and course of the litigation are not predictable, and, as a result, management cannot estimate a range of possible loss.  However, TNS intends to take appropriate actions to defend against the lawsuit, the outcome of which could have a material adverse affect on the financial condition or future operating results of TNS.  No amounts have been accrued related to this case in the condensed consolidated financial statements for the six months ended June 30, 2006, as management cannot yet estimate the future legal costs to defend against this lawsuit or potential damages, if any, that will be incurred.

 

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