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8-K

 
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TNS 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark
One)

 

 

x

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

 

 

 

For the quarterly period ended June 30, 2008

 

 

 

OR

 

 

 

o

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

 

 

 

For the transition period from           to          

 

Commission File Number: 001-32033

 

TNS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

36-4430020

 (State or jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

11480 Commerce Park Drive, Suite 600

Reston, VA 20191

(Address of principal executive offices)

 

(703) 453-8300

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) 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, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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.

 

Shares Outstanding as of July 1, 2008

 

24,943,767 Shares of Common Stock, $0.001 par value

 

 

 



Table of Contents

 

TNS, INC.

 

INDEX

 

 

 

Page

Part I: FINANCIAL INFORMATION

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited)

3

 

Condensed Consolidated Balance Sheets as of December 31, 2007 and June 30, 2008

3

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2007 and 2008

4

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and 2008

5

 

Notes to Condensed Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

25

Item 4.

Controls and Procedures

25

Part II: OTHER INFORMATION

 

Item 1.

Legal Proceedings

26

Item 1A.

Risk Factors

26

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

26

Item 3.

Default Upon Senior Securities

26

Item 4.

Submission of Matters to a Vote of Security Holders

26

Item 5.

Other Information

26

Item 6.

Exhibits

26

 

2



Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements

 

TNS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share and per share data)

 

 

 

December 31,

 

June 30,

 

 

 

2007

 

2008

 

 

 

 

 

(UNAUDITED)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

17,805

 

$

22,494

 

Accounts receivable, net of allowance for doubtful accounts of $3,093 and $3,423, respectively

 

75,112

 

80,946

 

Prepaid expenses

 

6,765

 

7,581

 

Deferred tax assets

 

2,800

 

2,027

 

Other current assets

 

5,952

 

6,358

 

Total current assets

 

108,434

 

119,406

 

Property and equipment, net

 

55,376

 

57,741

 

Identifiable intangible assets, net

 

180,330

 

170,854

 

Goodwill

 

13,513

 

13,225

 

Deferred tax assets, net

 

21,110

 

24,251

 

Other assets

 

4,335

 

4,659

 

Total assets

 

$

383,098

 

$

390,136

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other current liabilities

 

$

57,069

 

$

63,096

 

Deferred revenue

 

18,521

 

23,196

 

Total current liabilities

 

75,590

 

86,292

 

Long-term debt, net of current portion

 

205,500

 

187,500

 

Deferred tax liability

 

5,537

 

2,671

 

Other liabilities

 

4,199

 

2,524

 

Total liabilities

 

290,826

 

278,987

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.001 par value; 130,000,000 shares authorized; 24,274,195 shares issued and 24,258,942 shares outstanding and 25,042,932 shares issued and 24,943,767 shares outstanding, respectively

 

24

 

25

 

Treasury stock, 15,253 shares and 99,165 shares, respectively

 

(239

)

(1,800

)

Additional paid-in capital

 

131,485

 

146,404

 

Accumulated deficit

 

(44,278

)

(41,652

)

Accumulated other comprehensive income

 

5,280

 

8,172

 

Total stockholders’ equity

 

92,272

 

111,149

 

Total liabilities and stockholders’ equity

 

$

383,098

 

$

390,136

 

 

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

 

3



Table of Contents

 

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,

 

 

 

2007

 

2008

 

2007

 

2008

 

Revenues

 

$

79,361

 

$

90,148

 

$

152,022

 

$

174,273

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of network services, exclusive of the items shown separately below

 

40,174

 

42,225

 

79,046

 

82,932

 

Engineering and development

 

6,641

 

7,669

 

13,003

 

14,868

 

Selling, general, and administrative

 

17,581

 

20,955

 

34,755

 

40,400

 

Depreciation and amortization of property and equipment

 

5,433

 

6,094

 

11,237

 

12,061

 

Amortization of intangible assets

 

5,972

 

6,359

 

12,083

 

12,457

 

Total operating expenses

 

75,801

 

83,302

 

150,124

 

162,718

 

Income from operations

 

3,560

 

6,846

 

1,898

 

11,555

 

Interest expense

 

(4,221

)

(2,631

)

(8,189

)

(6,340

)

Interest income

 

429

 

148

 

674

 

327

 

Other income (expense), net

 

491

 

(290

)

1,136

 

(221

)

Income (loss) before income tax benefit and equity in net loss of unconsolidated affiliates

 

259

 

4,073

 

(4,481

)

5,321

 

Income tax (provision) benefit

 

(285

)

(2,977

)

1,292

 

(2,625

)

Equity in net income (loss) of unconsolidated affiliates

 

563

 

(70

)

499

 

(70

)

Net income (loss)

 

$

537

 

$

1,026

 

$

(2,690

)

$

2,626

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net income (loss) per common share

 

$

0.02

 

$

0.04

 

$

(0.11

)

$

0.11

 

Basic weighted average common shares outstanding

 

24,208,755

 

24,699,262

 

24,172,212

 

24,504,459

 

Diluted weighted average common shares outstanding

 

24,219,660

 

25,274,241

 

24,172,212

 

25,002,074

 

Dividends declared per common share

 

$

 

$

 

$

4.00

 

$

 

 

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

 

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Table of Contents

 

TNS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(dollars in thousands)

 

 

 

Six months ended June 30

 

 

 

2007

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(2,690

)

$

2,626

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Non-cash items

 

30,462

 

27,814

 

Working capital items

 

(610

)

(637

)

Net cash provided by operating activities:

 

27,162

 

29,803

 

Cash flows from investing activities

 

 

 

 

 

Purchases of property and equipment

 

(10,302

)

(13,718

)

Proceeds from sale of property and equipment

 

2,163

 

 

Proceeds from sale of investment in unconsolidated affiliate

 

625

 

 

Cash paid for business acquisitions, net of cash acquired

 

(4,166

)

 

Net cash used in investing activities:

 

(11,680

)

(13,718

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from issuance of long-term debt, net of issuance costs of $3,051

 

221,949

 

 

Payment of special dividend, $4 per common share

 

(98,293

)

 

Repayments of long-term debt

 

(132,313

)

(18,000

)

Proceeds from stock option exercises, inclusive of tax benefit

 

31

 

8,946

 

Payment of long-term debt financing costs

 

 

(75

)

Purchase of treasury stock

 

(698

)

(1,561

)

Net cash used in financing activities

 

(9,324

)

(10,690

)

Effect of exchange rates on cash and cash equivalents

 

(559

)

(706

)

Net increase in cash and cash equivalents

 

5,599

 

4,689

 

Cash and cash equivalents, beginning of period

 

17,322

 

17,805

 

Cash and cash equivalents, end of period

 

$

22,921

 

$

22,494

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

3,151

 

$

2,476

 

Cash paid for income taxes

 

$

3,409

 

$

2,748

 

 

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

 

5



Table of Contents

 

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 29 countries, including Canada, Mexico 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., Canada and Mexico, (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, Canada and Mexico.

 

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 adjustments (all of which are of a normal and recurring nature) that are necessary for fair presentation of the periods presented. The results of operations for the three and six months ended June 30, 2008 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 filed with the SEC on March 17, 2008, which includes consolidated financial statements and the notes thereto for the year ended December 31, 2007.

 

Dividends and Recapitalization

 

On March 28, 2007, the Company’s board of directors declared a special dividend of $4.00 per common share, which was paid on April 12, 2007. Also, on March 28, 2007, the Company entered into a secured credit facility, which consists of two facilities: a senior secured term loan facility in an aggregate principal amount of $225 million (the Term Facility) and a senior secured revolving credit facility in an aggregate principal amount of $15 million (the Revolving Facility). The Company used approximately $98.3 million of the proceeds from the Term Facility to pay the special dividend. The remainder of the proceeds from the Term Facility were used to refinance existing debt, to pay fees related to the senior secured credit facility and the special dividend, and for general corporate purposes.

 

Capital Structure

 

During the six months ended June 30, 2008, the Company issued 487,250 shares of common stock following the exercise of stock options and 281,487 shares of common stock following the vesting of restricted stock units. During the six months ended June 30, 2007, the Company issued 1,718 shares of common stock following the exercise of stock options and 138,366 shares of common stock following the vesting of restricted stock units. The Company purchased 83,912 and 42,145 of treasury shares following the vesting of restricted stock units during the six months ended June 30, 2008 and 2007, respectively. The Company retired 73,878 treasury shares during the six months ended June 30, 2007. The Company retired 99,165 treasury shares in July 2008.

 

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Table of Contents

 

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, estimates of the fair value of assets and liabilities assumed 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 and 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 per transaction fees paid by the Company’s customers for the transmission of transaction data, through the Company’s networks, between payment processors and POS or ATM terminals and monthly recurring fees for broadband and wireless offerings. TSD revenue is derived primarily from fixed monthly fees for call signaling services and per query fees charged for database access and call 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.

 

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 customers’ systems. Revenue from installation fees is 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 charges, 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, 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 by the Company as incurred. The Company recognizes a liability for telecommunications charges based upon network services utilized at historical invoiced rates. Depreciation expense on network equipment and amortization expense on developed technology are excluded from cost of network services and included in depreciation and amortization of property and equipment and amortization of intangible assets in the accompanying condensed consolidated statements of operations.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation under Statement of Financial Accounting Standards (SFAS) No. 123R “Share Based Payment”, using the modified prospective transition method. SFAS No. 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. Stock-based compensation 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 No. 123R for all awards granted or modified after January 1, 2006.

 

Stock-based compensation expense has been included in the following categories in the accompanying condensed consolidated statements of operations (in thousands)

 

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Table of Contents

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

Cost of network services

 

$

222

 

$

249

 

$

474

 

$

576

 

Engineering and development

 

421

 

300

 

1,177

 

755

 

Selling, general and administrative

 

1,680

 

2,536

 

3,772

 

4,719

 

 

 

$

2,323

 

$

3,085

 

$

5,423

 

$

6,050

 

 

On March 28, 2007 the Company’s Board of Directors decided to allow the outstanding restricted stock units to receive dividend equivalent payments. As a result of this decision, the Company recorded $1.5 million of stock-based compensation, which is included in the $5.4 million of stock-based compensation mentioned above for the six months ended June 30, 2007. The $1.5 million charge related to this decision is reported as follows in the accompanying condensed consolidated statement of operations for the six months ended June 30, 2007: $0.1 million is included in cost of network services, $0.4 million is included in engineering and development and $1.0 million is included in selling, general and administrative expenses. This modification increased net loss per share by $0.04 per share. As of June 30, 2008, there was a total of $16.5 million of deferred compensation cost related to stock-based awards, which is expected to be recognized over a weighted average period of approximately two years.

 

Time-Vested Awards

 

Time-vested awards are subject to a vesting period determined at the date of the grant, generally in equal installments over three or four years. The Company uses the Black Scholes option pricing model to determine the grant date fair value of any time-vested stock options. The Company uses the market price of the Company’s stock on the date of grant to determine the fair value of any time-vested restricted stock units. The Company recognizes compensation cost on these time-vested awards in equal installments over the vesting period.

 

During the three months ended June 30, 2007, the Company granted 323,324 stock options and 325,902 restricted stock units at weighted average estimated fair values of $6.20 and $12.35, respectively. During the six months ended June 30, 2007, the Company granted 332,324 stock options and 464,927 restricted stock units at weighted average estimated fair values of $6.26 and $14.36, respectively. During the three months ended June 30, 2008, the Company granted 9,500 stock options and 2,550 restricted stock units at weighted average estimated fair values of $9.68 and $23.00, respectively. During the six months ended June 30, 2008, the Company granted 25,000 stock options and 20,100 restricted stock units at weighted average estimated fair values of $7.92 and $17.00, respectively.

 

Performance-Based Awards

 

Performance-based awards are tied to the Company’s annual performance against pre-established internal targets for revenues and adjusted earnings per share and may vary from zero to 200% of an employee’s target payout, based upon the Company’s actual performance over the fiscal year. The Company uses the Black Scholes option pricing model to determine the grant date fair value of any performance-based stock options. The Company uses the market price of the Company’s stock on the date of grant to determine the fair value of any performance-based restricted stock units. Performance-based awards are also subject to vesting requirements, and generally vest in equal installments over three years. Compensation cost is based on the expected payout level that will be achieved and is adjusted in subsequent periods as changes in the estimates occur until the performance criteria have been satisfied. The Company recognizes compensation cost on these performance based awards using an accelerated attribution method.

 

In May 2007, the Company put in place a long-term performance-based stock compensation plan (the 2007 Equity Performance Plan). The actual payout under the Company’s 2007 Equity Performance Plan was 147% of the targeted payout, the results of which were approved by the Company’s board of directors in February 2008. The total performance-based awards issued under the Company’s 2007 Equity Performance Plan were 576,076 stock options and 236,341 restricted stock units. The weighted average grant date fair value of performance-based stock options and restricted stock units granted was $6.23 and $12.39, respectively.  As of June 30, 2008, there was a total of $1.9 million of deferred compensation expense related to these performance-based awards which is included in the $16.5 million total deferred compensation cost mentioned previously.

 

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Table of Contents

 

In February 2008, the Company put in place a long-term performance-based stock compensation plan (the 2008 Equity Performance Plan). The target payout under the 2008 Equity Performance Plan may range from 0% to 100% of an employee’s target payout. The total number of awards that would be issued under the Company’s 2008 Equity Performance Plan, assuming that the target payout level was achieved, would be 253,266 stock options and 248,142 restricted stock units. The weighted average grant date fair value of performance-based stock options and restricted stock units granted was $6.78 and $16.15, respectively.  As of June 30, 2008, there was a total of $4.3 million of deferred compensation expense related to these performance based awards which is included in the $16.5 million total deferred compensation cost mentioned above.

 

Income Taxes

 

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 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. The Company also recognizes interest and penalties related to uncertain tax positions in income tax expense.

 

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48), which 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, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN 48 did not result in a cumulative adjustment to the Company’s accumulated deficit.

 

The Company records interest and penalties related to income taxes as components of the income tax provision, which totaled $326,000 and $40,000 for the six months ended June 30, 2007 and June 30, 2008, respectively. Of the $4.4 million liability for unrecognized income tax benefits as of June 30, 2008, the Company’s accrual for potential interest and penalties associated with uncertain tax positions was $185,000. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reversed and reflected as a reduction of the overall income tax provision.

 

The Company remains subject to examination by U.S. Federal, state, local and foreign tax authorities for tax years 2004 through 2007.  With few exceptions, the Company is no longer subject to U.S. Federal, state, local or foreign tax examinations for the tax years prior to 2004.

 

A reconciliation of the beginning and ending balance for liabilities associated with unrecognized tax benefits, excluding interest and penalties, is as follows (in thousands)

 

Balance as of January 1, 2008

 

$

3,863

 

Additions for tax positions related to the current period

 

400

 

Balance as of June 30, 2008

 

$

4,263

 

 

The entire balance of unrecognized tax benefits as of June 30, 2008 would impact the effective tax rate if recognized.

 

The Company’s effective tax rate for the six months ended June 30, 2007 and June 30, 2008 of 33.3% and 49.9%, respectively, differ from the U.S. Federal statutory rate primarily due to stock-based compensation expense not deductible for income tax purposes and profits of our international subsidiaries being taxed at rates different than the U.S. statutory rate.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands

 

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disclosures about fair value measurements. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. For financial assets and financial liabilities, SFAS 157 was effective for the Company on January 1, 2008. The adoption of SFAS 157 to the Company’s financial assets and financial liabilities did not have a material effect on the Company’s consolidated financial statements. As we did not elect to fair value any of our financial instruments under the provisions of SFAS 159, the adoption of this statement did not have any impact on our financial position or results of operations.

 

In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations, a revision of SFAS No. 141”.
SFAS No. 141 (R) establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS No. 141 (R) is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations we engage in will be recorded and disclosed following existing GAAP until January 1, 2009. The Company expects SFAS No. 141 (R) will have an impact on its consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions the Company consummates after the effective date. The Company is still assessing the full impact of this standard on its future consolidated financial statements.

 

2.             Acquisition and Long-term Investments

 

Dialect Payment Technologies, Pty Limited Acquisition

 

On June 8, 2007, the Company acquired all of the outstanding shares of Dialect Payment Technologies Pty Limited (Dialect), an Australian provider of internet payment gateway services to the card-not-present transaction market, for a purchase price of $4.2 million, plus direct acquisition costs of approximately $0.4 million. The purchase price includes approximately $0.9 million which is currently held in escrow and which may be refundable to the Company depending on the performance of a particular customer contract. The Company accounted for the transaction as a purchase under the provisions of SFAS No. 141. The Company purchased Dialect primarily to expand its current suite of POS product offerings. The purchase price for Dialect was allocated as follows (in thousands):

 

Current assets

 

$

580

 

Accounts receivable

 

964

 

Property and equipment

 

866

 

Developed technology

 

6,315

 

Customer relationships

 

5,132

 

Tradename

 

168

 

Non-compete agreements

 

946

 

Deferred tax asset

 

206

 

Accounts payable, accrued expenses and other liabilities

 

(1,983

)

Deferred revenue

 

(8,608

)

Net assets acquired

 

$

4,586

 

 

The amounts allocated to the customer relationships and developed technology are being amortized over their estimated useful life of seven years. The amounts allocated to the non-compete agreements and tradename are being amortized over their estimated useful life of three years and two 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 include the operating results of this acquisition beginning June 8, 2007.

 

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3.             Long-term Debt

 

On March 28, 2007, the Company entered into a $240.0 million senior secured credit facility (2007 Credit Facility) to finance the special cash dividend and to refinance its 2005 amended and restated senior secured credit facility (2005 Credit Facility). The 2007 Credit Facility consists of a senior secured term loan facility in an aggregate principal amount of $225.0 million (Term Facility) and a senior secured revolving credit facility in an aggregate principal amount of $15.0 million (Revolving Facility), under which there were no borrowings as of June 30, 2008. The Revolving Facility matures March 27, 2013. Payments on the Term Facility are due in quarterly installments over the seven year term beginning June 30, 2007, with the remainder payable on March 28, 2014. Voluntary prepayments on the Term Facility are applied as directed by the Company. The Company made voluntary pre-payments on the Term Facility totaling $18.0 million during the six months ended June 30, 2008.

 

As of June 30, 2008, the total scheduled remaining payments on the Term Facility are as follows (in thousands):

 

Six months ending December 31, 2008

 

$

 

2009

 

 

2010

 

 

2011

 

 

2012

 

 

Thereafter

 

187,500

 

 

 

$

187,500

 

 

Interest on the outstanding balances under the Revolving Facility is payable, at the Company’s option, at a rate equal to the higher of the Wall Street Journal published “base rate on corporate loans posted by at least 75% of the nation’s largest banks” or the federal funds rate plus 50 basis points (the “Base Rate”), in each case, plus a margin of 0.75% or at the London Interbank Offered Rate (“LIBOR”), plus a margin of 1.75%. Interest on the outstanding balances under the Term Facility is payable, at the Company’s option, at the Base Rate plus a margin of 1.0%, or at LIBOR plus a margin of 2.0%. For the six months ended June 30, 2008, borrowings on the Term Facility bore interest at the LIBOR rate (4.5% as of June 30, 2008, inclusive of 2.0% margin).  The weighted average interest rate for the six months ended June 30, 2008 was 6.4%.  The weighted average interest rate for the six months ended June 30, 2007 was 7.3%.  The Revolving Credit Facility is subject to an annual commitment fee in an amount equal to 0.5% per annum multiplied by the amount of funds available for borrowing under the Revolving Facility. Interest payments on the 2007 Credit Facility are due biweekly, monthly, bimonthly or quarterly at the Company’s option.

 

The terms of the 2007 Credit Facility require the Company to make an annual prepayment in an amount that may range from 0% to 50% of the Company’s “excess cash flow” (as such term is defined in the Credit Agreement) depending on the Company’s Leverage Ratio for any fiscal year. Prepayments are also required to be made in other circumstances, including upon asset sales.

 

The terms of the 2007 Credit Facility require the Company to comply with financial and nonfinancial covenants, including maintaining a specified leverage ratio at the end of each fiscal quarter and complying with specified annual limits on capital expenditures. As of June 30, 2008, the Company was required to maintain a leverage ratio of less than 3.1 to 1.0. The maximum leverage ratio continues to decline over the term of the 2007 Credit Facility. The Company’s leverage ratio as of June 30, 2008 was 2.2 to 1.0. The 2007 Credit Facility also contains nonfinancial covenants that restrict some of the Company’s corporate activities, including its ability to dispose of assets, incur additional debt, pay dividends, create liens, make investments, make capital expenditures and engage in specified transactions with affiliates. Noncompliance with any of the financial or nonfinancial covenants without cure or waiver would constitute an event of default under the 2007 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 Revolving Facility. The 2007 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 non-financial covenants of the 2007 Credit Facility as of June 30, 2008.

 

In connection with the closing of the 2007 Credit Facility, the Company incurred approximately $3.1 million in financing costs. These financing costs were deferred and are being amortized using the effective interest method over the life of the 2007 Credit Facility. In connection with the repayment of the 2005 Credit Facility in March 2007, the Company wrote-off approximately $1.4 million in unamortized deferred financing costs related to the 2005 Credit Facility. Such write-off has been included in interest expense in the accompanying condensed consolidated statement of operations for the six months ended June 30, 2007.

 

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4.             Comprehensive (Loss) Income

 

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

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

Net income (loss)

 

$

537

 

$

1,026

 

$

(2,690

)

$

2,626

 

Foreign currency translation adjustments

 

525

 

452

 

918

 

2,892

 

Total comprehensive income (loss)

 

$

1,062

 

$

1,478

 

$

(1,772

)

$

5,518

 

 

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 six months ended June 30, 2007, the treasury stock effect of options to purchase 2,041,330 shares of common stock and 667,464 restricted stock units were not included in the computation of diluted income (loss) per common share as their effect would have been anti-dilutive.

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

Net income (loss)

 

$

537

 

$

1,026

 

$

(2,690

)

$

2,626

 

Weighted average common share calculation:

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

24,208,755

 

24,699,262

 

24,172,212

 

24,504,459

 

Treasury stock effect of outstanding options to purchase

 

 

271,081

 

 

296,941

 

Treasury stock effect of unvested restricted stock units

 

10,905

 

303,898

 

 

200,674

 

Diluted weighted average common shares outstanding

 

24,219,660

 

25,274,241

 

24,172,212

 

25,002,074

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

Basic and diluted net income (loss) per common share

 

$

0.02

 

$

0.04

 

$

(0.11

)

$

0.11

 

 

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 major 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.

 

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

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

ISD

 

$

32,380

 

$

42,608

 

$

60,587

 

$

79,778

 

POS

 

20,754

 

19,145

 

40,553

 

37,500

 

TSD

 

16,109

 

16,814

 

31,022

 

34,668

 

FSD

 

10,118

 

11,581

 

19,860

 

22,327

 

Total revenues

 

$

79,361

 

$

90,148

 

$

152,022

 

$

174,273

 

 

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

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

ISD

 

$

11,727

 

$

16,718

 

$

16,346

 

$

29,597

 

North Ameirca

 

5,561

 

5,666

 

14,295

 

12,526

 

Total EBITDA before stock compensation expense

 

$

17,288

 

$

22,384

 

$

30,641

 

$

42,123

 

 

EBITDA before stock compensation expense differs from income (loss)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

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

EBITDA before stock compensation expense

 

$

17,288

 

$

22,384

 

$

30,641

 

$

42,123

 

Reconciling items:

 

 

 

 

 

 

 

 

 

Depreciation and amortization of property and equipment

 

(5,433

)

(6,094

)

(11,237

)

(12,061

)

Amortization of intangible assets

 

(5,972

)

(6,359

)

(12,083

)

(12,457

)

Stock compensation expense

 

(2,323

)

(3,085

)

(5,423

)

(6,050

)

Interest expense

 

(4,221

)

(2,631

)

(8,189

)

(6,340

)

Interest income and other income (expense), net

 

920

 

(142

)

1,810

 

106

 

Income (loss) before income taxes and equity in net loss of unconsolidated affiliates

 

$

259

 

$

4,073

 

$

(4,481

)

$

5,321

 

 

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

 

 

 

December 31,

 

June 30,

 

 

 

2007

 

2008

 

POS

 

$

114,573

 

$

108,947

 

ISD

 

54,430

 

51,851

 

TSD

 

3,760

 

3,196

 

FSD

 

21,080

 

20,085

 

Total goodwill and identifiable intangible assets, net

 

$

193,843

 

$

184,079

 

 

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Geographic Information

 

The Company sells its services through foreign subsidiaries in Australia, Austria, Bermuda, Canada, France, Germany, India, Ireland, Italy, Japan, Mexico, 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

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

North America

 

$

46,981

 

$

47,540

 

$

91,435

 

$

94,495

 

Europe

 

27,928

 

33,842

 

52,580

 

63,441

 

Asia-Pacific

 

4,452

 

8,766

 

8,007

 

16,337

 

Total revenues

 

$

79,361

 

$

90,148

 

$

152,022

 

$

174,273

 

 

Revenues from the Company’s subsidiaries in the United Kingdom were $17.2 million and $19.9 million for the three months ended June 30, 2007 and 2008, respectively. Revenues from the Company’s subsidiaries in the United Kingdom were $32.4 million and $37.2 million for the six months ended June 30, 2007 and 2008, respectively.

 

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

 

 

 

 

 

 

 

December 31,

 

June 30,

 

 

 

 

 

 

 

2007

 

2008

 

North America

 

 

 

 

 

$

204,177

 

$

201,532

 

Europe

 

 

 

 

 

53,310

 

51,630

 

Asia-Pacific

 

 

 

 

 

17,177

 

17,568

 

Total long lived assets, goodwill and intangibles

 

 

 

 

 

$

274,664

 

$

270,730

 

 

7.                                     Restructuring Costs

 

In August 2006, the Company implemented a plan to reduce its cost structure and improve operating efficiencies by reducing its workforce and implementing productivity improvement initiatives and expense reduction measures (2006 Restructuring Plan). In connection with the 2006 Restructuring Plan, the Company incurred approximately $5.6 million of severance associated with its workforce reduction, of which $4.2 million was selling, general and administrative expense, $0.8 million was engineering and development expense and $0.6 million was cost of network services.

 

During 2007 the Company incurred an additional $3.0 million in severance and benefits, of which $2.7 million was selling, general and administrative expense and $0.3 million was engineering and development expense.

 

A summary of the liability for the Company’s severance and benefits obligation is as follows (in thousands):

 

 

 

 

 

 

 

 

 

2008

 

Balance as of January 1

 

 

 

 

 

 

 

$

4,216

 

Accretion of liability due to the passage of time

 

 

 

 

 

 

 

39

 

Effects of foreign currency translation

 

 

 

 

 

 

 

62

 

Cash paid

 

 

 

 

 

 

 

(2,393

)

Balance as of June 30

 

 

 

 

 

 

 

$

1,924

 

 

The remaining cash expenditures relating to the severance and benefits will be paid through June 2009.

 

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8.                                     Litigation and Claims

 

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. On April 25, 2008, the Company entered into a settlement agreement with the remaining state’s Commissioner of Revenue to settle the only state sales tax assessment remaining for the period from 1996 to early 2001. In the settlement, the Company agreed to settle the outstanding sales tax assessment in the amount of $942,000 for a settlement payment in the amount of $250,000. The Company’s customer paid $212,500 of the settlement payment with the remaining $37,500 paid by the Company. Based on the final executed settlement, the Company reduced its net liability for this matter by $0.9 million. This $0.9 million reduction in the liability, or $0.02 per share, is included in selling, general and administrative expenses in the accompanying consolidated statements of operations for the six months ended June 30, 2008.

 

The Company, John J. McDonnell, Jr., the Company’s former Chief Executive Officer, and Henry H. Graham, Jr., the Company’s Chief Executive 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 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. After denying the Company’s motion to dismiss on September 12, 2006, the Court ordered the parties to conduct discovery in the case. In March 2007, the parties agreed to stay further discovery in the case with the Court’s approval pending a mediation designed to reach a settlement resolving the lawsuit. The parties conducted a mediation in April 2007, and subsequently entered into a settlement agreement in February 2008. The settlement agreement provides for a cash settlement payment of $3.6 million to be paid by the Company’s insurer and payment of expenses of plaintiff’s lead counsel not to exceed $50,000. In exchange for the cash settlement payment and expense payment, the Company and all defendants would be released from all claims of class members relating to the action. The Court preliminarily approved the settlement agreement of the parties by an order entered on April 1, 2008, and subsequently granted final approval of the settlement agreement after a fairness hearing on June 20, 2008. We do not expect the final outcome of the lawsuit to have a material adverse affect on our financial condition or operating results. During the year ended December 31, 2006, the Company accrued legal costs of approximately $0.5 million, representing the legal costs to defend itself in this matter not otherwise covered by its insurance carrier.

 

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Table of Contents

 

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

 

You should read the following discussion of the financial condition and results of operations of TNS, Inc. in conjunction with the consolidated financial statements and the related notes included in our annual report on Form 10-K filed with the SEC on March 17, 2008 and available directly from the SEC at www.sec.gov and the condensed consolidated financial statements and the related notes of TNS, Inc., included elsewhere in this quarterly report.

 

There are statements made herein which may not address historical facts and, therefore, could be interpreted to be forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, forecasts and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in, or implied by, the forward-looking statements. The Company has attempted, whenever possible, to identify these forward-looking statements using words such as “may,” “will,” “should,” “projects,” “estimates,” “expects,” “plans,” “intends,” “anticipates,” “believes,” and variations of these words and similar expressions. Similarly, statements herein that describe the Company’s business strategy, prospects, opportunities, outlook, objectives, plans, intentions or goals are also forward-looking statements. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including: the Company’s reliance upon a small number of customers for a significant portion of its revenue; competitive factors such as pricing pressures; uncertainties related to the updated international tax planning strategy implemented by the Company; our customer’s ability to direct their data communications from the Company’s networks to other networks; the Company’s ability to grow its business domestically and internationally by generating greater transaction volumes, acquiring new customers or developing new service offerings; fluctuations in the Company’s quarterly results because of the seasonal nature of the business and other factors outside of the Company’s control; the Company’s substantial debt could adversely affect its financial health because the Company may be unable to obtain additional financing for working capital, capital expenditures, acquisitions and general corporate purposes, the Company may not generate sufficient cash flow to repay the debt on a timely basis or to pre-pay the debt, and a significant portion of the Company’s cash flow from operations will be dedicated to the repayment or servicing of indebtedness, thereby reducing the amount of cash available for other purposes; the Company’s ability to identify, execute or effectively integrate acquisitions; the Company’s ability to identify, execute or effectively integrate future acquisitions; increases in the prices charged by telecommunication providers for services used by the Company; unfavorable foreign exchange movements; the Company’s ability to adapt to changing technology; additional costs related to compliance with the Sarbanes-Oxley Act of 2002, any revised New York Stock Exchange listing standards, SEC rule changes or other corporate governance issues; and other risk factors described in the Company’s annual report on Form 10-K filed with the SEC on March 17, 2008. In addition, the statements in this quarterly report are made as of the date of this filing. The Company expects that subsequent events or developments will cause its views to change. The Company undertakes no obligation to update any of the forward-looking statements made herein, whether as a result of new information, future events, changes in expectations or otherwise. These forward-looking statements should not be relied upon as representing the Company’s views as of any date subsequent to the date of this filing. The forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Sections 27A of the Securities Act and 21E of the Exchange Act.

 

Overview

 

We are an international data communications company which provides networking, data communications and value added services to many of the world’s leading retailers, banks and payment processors. We are also a leading provider of secure data and voice network services to the global financial services industry. We operate one of the largest unaffiliated Signaling System No. 7 networks in the United States capable of providing services nationwide, and we utilize this network to provide call signaling and database access services to the domestic telecommunications industry. Our data communications services enable secure and reliable transmission of time-sensitive, transaction-related information critical to our customers’ operations. Our customers outsource their data communications requirements to us because of our substantial expertise, comprehensive customer support and cost-effective services. We provide services to customers in the United States and increasingly to international customers in 29 countries, including Canada and Mexico and countries in Europe, Latin America and the Asia-Pacific region.

 

We provide services through our multiple data networks, each designed specifically for transaction applications. Our networks support a variety of widely accepted communications protocols and are designed to be scalable and accessible by multiple methods, including dial-up, dedicated, wireless, broadband and internet connections.

 

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Table of Contents

 

We generate revenues through four business divisions:

 

                 POS services. We provide fast, secure and reliable data communications services primarily to payment processors in the United States and Canada. POS services revenue is derived primarily from per transaction fees paid by our customers for the transmission of transaction data through our networks between payment processors and POS or ATM terminals.

 

                 Telecommunication services. We provide call signaling services that enable telecommunications carriers to establish and terminate telephone calls placed by their subscribers. We also provide database access services that enable our customers to provide intelligent network services, such as caller identification, toll-free call routing and local number portability, and validation services, such as credit card, calling card, third- party billing and collect calling. Our telecommunication services division generates revenues primarily from fixed monthly fees charged for our call signaling services and per-query fees charged for our database access and validation services.

 

                 Financial services. We provide fast, secure and reliable private data networking services that enable seamless communications and facilitate electronic trading among commercial banks, mutual funds, pension funds, broker-dealers, alternative trading systems, electronic communications networks, securities and commodities exchanges and other market participants. Our networks support multiple communications protocols including the Financial Information eXchange, or FIX, protocol. Our financial services division generates revenues from monthly recurring fees based on the number of customer connections to and through our networks.

 

                 International services. We sell our POS and financial services through our international services division. We are one of the leading providers of data communications services to the POS industry in the United Kingdom. Our international services division also provides POS and financial services in Australia, Austria, Belgium, Bermuda, Finland, France, Gibraltar, Germany, Hong Kong, India, Ireland, Italy, Japan, Malaysia, the Netherlands, New Zealand, Norway, Poland, Romania, Singapore, South Korea, Spain, Sweden, Taiwan and Thailand.

 

Our most significant expense is cost of network services, which is comprised primarily of telecommunications charges, including 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 some 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 our data networks. Depreciation expense on our network equipment and amortization of developed technology are excluded from our cost of network services and included in depreciation and amortization of property and equipment and amortization of intangible assets in our consolidated statements of operations.

 

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

 

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

 

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Table of Contents

 

Results of Operations

 

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

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2008

 

2007

 

2008

 

Revenues

 

$

79,361

 

$

90,148

 

$

152,022

 

$

174,273

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of network services, exclusive of the items shown separately below

 

40,174

 

42,225

 

79,046

 

82,932

 

Engineering and development

 

6,641

 

7,669

 

13,003

 

14,868

 

Selling, general, and administrative

 

17,581

 

20,955

 

34,755

 

40,400

 

Depreciation and amortization of property and equipment

 

5,433

 

6,094

 

11,237

 

12,061

 

Amortization of intangible assets

 

5,972

 

6,359

 

12,083

 

12,457

 

Total operating expenses

 

75,801

 

83,302

 

150,124

 

162,718

 

Income from operations

 

3,560

 

6,846

 

1,898

 

11,555

 

Interest expense

 

(4,221

)

(2,631

)

(8,189

)

(6,340

)

Interest income

 

429

 

148

 

674

 

327

 

Other income (expense), net

 

491

 

(290

)

1,136

 

(221

)

Income (loss) before income tax benefit and equity in net loss of unconsolidated affiliates

 

259

 

4,073

 

(4,481

)

5,321

 

Income tax (provision) benefit

 

(285

)

(2,977

)

1,292

 

(2,625

)

Equity in net income (loss) of unconsolidated affiliates

 

563

 

(70

)

499

 

(70

)

Net income (loss)

 

$

537

 

$

1,026

 

$

(2,690

)

$

2,626

 

 

Three months ended June 30, 2008 compared to the three months ended June 30, 2007

 

Revenues. Total revenues increased $10.7 million, or 13.6%, to $90.1 million for the three months ended June 30, 2008, from $79.4 million for the three months ended June 30, 2007. We generate revenues through four operating divisions.

 

International services division. Revenues from the international services division increased $10.2 million, or 31.6%, to $42.6 million for the three months ended June 30, 2008, from $32.4 million for the three months ended June 30, 2007. On a constant dollar basis, revenue for the three months ended June 30, 2008 would have increased $8.0 million, or 24.7% to $40.4 million. This increase was the result of an additional $4.5 million from higher transaction volumes and increased broadband connections from POS customers in Europe and Asia Pacific, $2.1 million in incremental revenue from our Dialect acquisition and $1.4 million from additional connections from financial services customers. Revenues from our U.K. subsidiaries increased $2.7 million, or 15.9%, to $19.9 million for the three months ended June 30, 2008, from $17.2 million for the three months ended June 30, 2007. On a constant dollar basis, revenue from the U.K. subsidiaries for the three months ended June 30, 2008 would have increased $2.8 million, or 16.7%, to $20.0 million. Future revenue growth in the international services division depends on a number of factors including the success of our POS and financial service products in countries we have recently entered, the success of our new product offerings and the successful integration of our card-not-present service offerings through our acquisition of Dialect.

 

POS division. Revenues from the POS division decreased $1.7 million, or 7.8%, to $19.1 million for the three months ended June 30, 2008, from $20.8 million for the three months ended June 30, 2007. Included in POS revenue for the three months ended June 30, 2008 is $0.5 million in pass-through revenues compared with $0.7 million for the three months ended June 30, 2007. POS dial-up transaction volumes decreased 8.2% to 1.38 billion transactions for the three months ended June 30, 2008, from 1.51 billion transactions for the three months ended June 30, 2007. Excluding the decrease in pass-through revenues, revenues from the POS division decreased 6.7% to $18.6 from $20.0 million million for the three months ended June 30, 2008 and 2007 respectively due to lower transaction volumes primarily resulting from a customer moving a portion of their traffic off our network for the stated purpose of increasing its vendor diversification. This was partially offset by increased revenue from sales of our managed broadband products. Growth in the POS division depends on a number of factors including the success of our new broadband, wireless and vending service offerings as well as the total number of POS dial-up transactions we transport.

 

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Telecommunication services division. Revenues from the telecommunication services division increased $0.7 million, or 4.4%, to $16.8 million for the three months ended June 30, 2008, from $16.1 million for the three months ended June 30, 2007. Included in TSD revenue for the three months ended June 30, 2008 is $1.6 million in pass-through revenues compared with $1.4 million for the three months ended June 30, 2007. Excluding the increase in pass-through revenues, revenues increased $0.5 million, or 3.1% to $15.2 million from $14.7 million for the three months ended June, 30 2008 and 2007 respectively. This increase was primarily due to an increase in network and database access services provided to cable customers and to a lesser extent volume growth from our traditional wireline telecommunications customers which more than offset the effects of pricing compression we experienced in connection with the renewal of certain customer contracts. Future revenue growth in the telecommunication services division depends on a number of factors including the number of database access queries we transport, the number of call signaling routes our customers purchase and the success of our new product offerings, which potentially may be offset by customers seeking pricing discounts due to industry consolidation or other reasons.

 

Financial services division. Revenues from the financial services division increased $1.5 million, or 14.5%, to $11.6 million for the three months ended June 30, 2008, from $10.1 million for the three months ended June 30, 2007. The increase in revenues was primarily due to increases in new customer endpoint installations and increases in connectivity between existing customers and to a lesser extent from increased demand for greater bandwidth connectivity which results in higher average revenue per customer endpoint. Future revenue growth in the financial services division depends on a number of factors including the number of connections to and through our networks as well as the success of our new product offerings. We have begun to see an increased demand from our customers for larger bandwidth connections to our network and while these connections create greater revenue per physical endpoint, they require longer sales and installation lead-times.

 

Cost of network services. Cost of network services increased $2.1 million, or 5.1%, to $42.2 million for the three months ended June 30, 2008, from $40.2 million for the three months ended June 30, 2007. On a constant dollar basis, cost of network services would have increased $1.2 million, or 3.1%, to $41.4 million. Cost of network services were 46.8% of revenues for the three months ended June 30, 2008, compared to 50.6% of revenues for the three months ended June 30, 2007. Excluding the effect of foreign exchange, the increase in cost of network services resulted primarily from higher volumes in our international services and telecommunications services divisions and to a lesser extent our financial services division. This was partially offset by declines in transaction volumes in our POS division, as mentioned above as well as reductions in the cost of services provided to us through focus on cost control of key suppler contracts in our POS and telecommunication services divisions.

 

Gross profit represented 53.2% of total revenues for the three months ended June 30, 2008, compared to 49.4% for the three months ended June 30, 2007. The improvement in gross margin from last year is a result of increased contribution from our international services division, our highest gross margin division, and improvement in the gross margins of our POS division as we worked to lower the cost of services provided to us.

 

Future cost of network services depends on a number of factors including total transaction and query volumes, the relative growth and contribution to total transaction volume of each of our customers, the success of our new service offerings, the timing and extent of our network expansion and the timing and extent of any network cost increases or reductions.

 

Engineering and development expense. Engineering and development expense increased $1.0 million, or 15.5%, to $7.7 million for the three months ended June 30, 2008, from $6.6 million for the three months ended June 30, 2007. On a constant dollar basis, engineering and development expense would have increased $0.8 million, or 12.1% to $7.4 million. Engineering and development expense represented 8.5% of revenues for the three months ended June 30, 2008 and 8.4% of revenues for the three months ended June 30, 2007. Included in engineering and development expense for the three months ended June 30, 2008 and 2007 is $1.4 million and $0.3 million, respectively, relating to Dialect. This increase was due to additional headcount to develop our card-not-present gateway application resulting from our acquisition of Dialect in June 2007. Included in engineering and development expense for the three months ended June 30, 2008 and 2007 is stock compensation expense of $0.3 million and $0.4 million, respectively. Excluding the items mentioned above and the effects of foreign exchange, engineering and development expense would have decreased $0.1 million to $5.7 million, or 6.3% of revenues, for the three months ended June 30, 2008 from $6.0 million, or 7.5% of revenues, for the three months ended June 30, 2007.

 

Selling, general and administrative expense. Selling, general and administrative expenses increased $3.4 million, or 19.2%, to $21.0 million for the three months ended June 30, 2008, from $17.6 million for the three months ended June 30, 2007. On a constant dollar basis, selling, general and administrative expenses would have increased $2.8 million, or 16.2%, to $20.4 million. Selling, general and administrative expenses represented 23.2% of revenues for the three months ended June

 

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30, 2008, compared to 22.2% of revenues for the three months ended June 30, 2007. Included in selling, general and administrative expenses for the three months ended June 30, 2008 and 2007 was $0.8 million and $0.1 million, respectively, relating to Dialect. This increase was due to investment in the sales force to drive sales of our card-not-present gateway application resulting from our acquisition of Dialect in June 2007. Included in selling, general and administrative expenses for the three months ended June 30, 2008 and 2007 is $2.5 million and $1.7 million of stock compensation expense, respectively. The increase in stock compensation expense relates primarily to additional performance based grants made during the year. Excluding these items and the effects of foreign exchange, selling, general and administrative expenses would have increased $1.3 million to $17.0 million, or 18.9% of revenues, for the three months ended June 30, 2008 from $15.8 million, or 19.9% of revenues, for the three months ended June 30, 2007 due primarily to our planned investment in our business development group that is focused on driving revenue growth from our customers in our domestic and international POS business.

 

Depreciation and amortization of property and equipment. Depreciation and amortization of property and equipment increased $0.7 million, or 12.2%, to $6.1 million for the three months ended June 30, 2008, from $5.4 million for the three months ended June 30, 2007. Depreciation and amortization of property and equipment represented 6.8% of revenues for both the three month periods ended June 30, 2008 and 2007. Depreciation expense increased due to capital expenditures made to support our revenue growth, primarily in the international services division.

 

Amortization of intangible assets. Amortization of intangible assets increased $0.4 million, or 6.5%, to $6.4 million for the three months ended June 30, 2008, from $6.0 million for the three months ended June 30, 2007 and relates solely to intangible assets resulting from acquisitions. On a constant dollar basis, amortization of intangible assets would have increased $0.1 million, or 2.5% to $6.1 million. For purposes of measuring and recognizing impairment of long-lived assets including intangibles, we assess whether separate cash flows can be attributed to an individual asset. For our customer relationship intangible assets, we recognize and measure impairment upon the significant loss of revenue from a customer. Based upon our contract with one of our major customers, we believe that revenues and related transaction volumes from this customer will continue to decline in 2008 and may decline further thereafter. The intangible asset value attributable to this customer relationship was approximately $20.1 million as of June 30, 2008. We assessed the recoverability of this customer relationship asset based upon undiscounted anticipated future cash flows and concluded no impairment existed as of June 30, 2008.

 

Interest expense. Interest expense decreased $1.6 million, or 37.7%, to $2.6 million for the three months ended June 30, 2008, from $4.2 million for the three months ended June 30, 2007. Interest expense decreased primarily as a result of the lower effective interest rate associated with our 2007 credit facility and to a lesser extent our reduced debt levels.

 

Interest income. Interest income was $0.1 million for the three months ended June 30, 2008, compared to $0.4 million for the three months ended June 30, 2007. The decrease in interest income is due to the release of the restricted cash on hand, related to our special cash dividend payment made in April 2007.

 

Other income (expense), net. Other income (expense), net was an expense of $0.3 million for the three months ended June 30, 2008 compared to income of $0.5 million for the three months ended June 30, 2007. Included in other income (expense), net for the three months ended June 30, 2008 are foreign currency revaluation losses of approximately $0.2 million due to fluctuations in the value of the U.S. dollar principally against the Euro and Pound Sterling, versus a gain on foreign currency revaluation of $0.4 million for the three months ended June 30, 2007.

 

Income tax provision. For the three months ended June 30, 2008, our income tax provision was approximately $3.0 million compared to $0.3 million for the three months ended June 30, 2007. The increase in our income tax provision is primarily related to higher income in foreign jurisdictions that cannot be offset by losses in other jurisdictions. Our effective tax rate was 74.6% and 34.7% for the three months ended June 30, 2008 and 2007, respectively. Our effective tax rate differs from the U.S. Federal statutory rate primarily due to stock-based compensation expense not deductible for income tax purposes and profits of our international subsidiaries being taxed at rates different than the U.S. Federal statutory rate.

 

Equity in net income (loss) of unconsolidated affiliates. Equity in net income (loss) of unconsolidated affiliates for the three months ended June 30, 2008 was a loss of $0.1 million, compared to income of $0.6 million for the three months ended June 30, 2007. The decrease was due to the gain of $0.6 million on the sale of all of our outstanding shares of our investment in WAY Systems, Inc. during the three months ended June 30, 2007. The loss for the three month period ended June 30, 2008 relates to our investment in AK Jensen, Inc. As of June 30, 2008, the carrying value of our investment in AK Jensen, Inc. was $0.7 million.

 

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Six months ended June 30, 2008 compared to the six months ended June 30, 2007

 

Revenues. Total revenues increased $22.2 million, or 14.6%, to $174.2 million for the six months ended June 30, 2008, from $152.0 million for the six months ended June 30, 2007. We generate revenues through four operating divisions.

 

International services division. Revenues from the international services division increased $19.2 million, or 31.7%, to $79.8 million for the six months ended June 30, 2008, from $60.6 million for the six months ended June 30, 2007. On a constant dollar basis, revenue for the six months ended June 30, 2008 would have increased $14.4 million, or 24.0% to $75.0 million. This increase was the result of $6.1 million from higher transaction volumes and increased broadband connections from POS customers in Europe and Asia Pacific, an incremental $5.6 million from our Dialect acquisition and $2.6 million from additional connections from financial services customers. Revenues from our U.K. subsidiaries increased $4.8 million, or 14.8%, to $37.2 million for the six months ended June 30, 2008, from $32.4 million for the six months ended June 30, 2007. On a constant dollar basis, revenue for the U.K. subsidiary for the six months ended June 30, 2008 would have increased $4.7 million, or 14.6%, to $37.1 million. Future revenue growth in the international services division depends on a number of factors including the success of our POS and financial service products in countries we have recently entered, the success of our new product offerings and the successful integration of our card-not-present service offerings through our acquisition of Dialect.

 

POS division. Revenues from the POS division decreased $3.0 million, or 7.5%, to $37.5 million for the six months ended June 30, 2008, from $40.5 million for the six months ended June 30, 2007. Included in POS revenue for the six months ended June 30, 2008 is $0.9 million in pass-through revenues compared with $1.4 million for the six months ended June 30, 2007. POS dial-up transaction volumes decreased 8.4% to 2.7 billion transactions for the six months ended June 30, 2008, from 2.9 billion transactions for the six months ended June 30, 2007. Excluding the decrease in pass-through revenues, revenues for the six months ended June 30, 2008 decreased 6.5% to $36.3 from $39.1 million for the six months ended June 30, 2007 due to lower transaction volumes primarily from a customer moving a portion of their traffic off our network for the stated purpose of vendor diversification. This was partially offset by increased revenue from sales of our managed broadband products. Growth in the POS division depends on a number of factors including the success of our new broadband, wireless and vending service offerings as well as the total number of POS dial-up transactions we transport.

 

Telecommunication services division. Revenues from the telecommunication services division increased $3.6 million, or 11.8%, to $34.7 million for the six months ended June 30, 2008, from $31.1 million for the three months ended June 30, 2007. Included in TSD revenue for the six months ended June 30, 2008 is $3.4 million in pass-through revenues compared with $2.7 million for the six months ended June 30, 2007. Excluding the increase in pass-through revenues, revenues increased $2.9 million, or 10.2% to $31.3 million from $28.4 million for the three months ended June 30, 2008 and 2007 respectively. This was due to an increase in network and database access services provided to cable customers and to a lesser extent volume growth from our traditional wireline telecommunications customers which more than offset the effects of pricing compression we experienced in connection with the renewal of certain customer contracts. Future revenue growth in the telecommunication services division depends on a number of factors including the number of database access queries we transport, the number of call signaling routes our customers purchase and the success of our new product offerings, which potentially may be offset by customers seeking pricing discounts due to industry consolidation or other reasons.

 

Financial services division. Revenues from the financial services division increased $2.4 million, or 12.4%, to $22.3 million for the six months ended June 30, 2008, from $19.9 million for the six months ended June 30, 2007.  The increase in revenues was primarily due to increases in new customer endpoint installations and increases in connectivity between existing customers and to a lesser extent increased demand for greater bandwidth connectivity which results in higher average revenue per customer endpoint. Future revenue growth in the financial services division depends on a number of factors including the number of connections to and through our networks as well as the success of our new product offerings. We have begun to see an increased demand from our customers for larger bandwidth connections to our network and while these connections create greater revenue per physical endpoint, they require longer sales and installation lead-times.

 

Cost of network services. Cost of network services increased $3.9 million, or 4.9%, to $82.9 million for the six months ended June 30, 2008, from $79.0 million for the six months ended June 30, 2007. On a constant dollar basis, cost of network services would have increased $2.2 million, or 2.8%, to $81.2 million. Cost of network services were 47.6% of revenues for the six months ended June 30, 2008, compared to 52.0% of revenues for the six months ended June 30, 2007. Excluding the effect of foreign exchange, the increase in cost of network services resulted primarily from higher volumes in our international services and telecommunications services divisions and to a lesser extent our financial services division. This which was partially offset by declines in transaction volumes in our POS division, as mentioned above, as well as reductions

 

21



Table of Contents

 

in the cost of services provided to us through focus on cost control of key suppler contracts in our POS and telecommunication services divisions.

 

Gross profit represented 52.4% of total revenues for the six months ended June 30, 2008, compared to 48.0% for the six months ended June 30, 2007. The improvement in gross margin from last year is a result of increased contribution from our international services division, our highest gross margin division, and improvement in the gross margins of our POS division as we worked to lower the cost of services provided to us.

 

Future cost of network services depends on a number of factors including total transaction and query volumes, the relative growth and contribution to total transaction volume of each of our customers, the success of our new service offerings, the timing and extent of our network expansion and the timing and extent of any network cost increases or reductions.

 

Engineering and development expense. Engineering and development expense increased $1.9 million, or 14.3%, to $14.9 million for the six months ended June 30, 2008, from $13.0 million for the six months ended June 30, 2007. On a constant dollar basis, engineering and development expense would have increased $1.4 million, or 11.0% to $14.4 million. Engineering and development expense represented 8.5% of revenues for the six months ended June 30, 2008 and 8.6% of revenues for the six months ended June 30, 2007. Included in engineering and development expense for the six months ended June 30, 2008 and 2007 is $2.8 million and $0.3 million, respectively, relating to Dialect. This increase was due to additional headcount to develop our card-not-present gateway application resulting from our acquisition of Dialect in June 2007. Included in engineering and development expense for the six months ended June 30, 2008 and 2007 is stock compensation expense of $0.8 million and $1.2 million, respectively. The $0.4 million decrease in stock compensation expense related to the decision by the Board of Directors to allow for dividend equivalent payments on the outstanding restricted stock units as of June 30, 2007. Excluding these items and the effects of foreign exchange, engineering and development expense would have decreased $0.4 million to $10.9 million, or 6.3% of revenues, for the six months ended June 30, 2008,  from $11.3 million, or 7.4% of revenues, for the six months ended June 30, 2007.

 

Selling, general and administrative expense. Selling, general and administrative expenses increased $5.7 million, or 16.2%, to $40.4 million for the six months ended June 30, 2008, from $34.7 million for the six months ended June 30, 2007. On a constant dollar basis, selling, general and administrative expenses would have increased $4.6 million, or 13.1%, to $39.3 million. Selling, general and administrative expenses represented 23.2% of revenues for the six months ended June 30, 2008, compared to 22.9% of revenues for the six months ended June 30, 2007. Included in selling, general and administrative expense for the six months ended June 30, 2008 and 2007 is $1.7 million and $0.1 million respectively relating to Dialect. This increase is due to investment in a sales force to drive sales of our card-not-present gateway application resulting from our acquisition of Dialect in June 2007.  Included in selling, general and administrative expenses for the six months ended June 30, 2008 and 2007 is $4.7 million and $3.8 million of stock compensation expense, respectively. The increase in stock compensation expense relates primarily to additional performance-based grants made during the year and was partially offset by expense of $1.0 million related to the decision by the Board of Directors to allow for dividend equivalent payments on the outstanding stock units as of March 31, 2007. Included in selling, general and administrative expenses for the six months ended June 30, 2008 is $0.9 million pre-tax benefit associated with the settlement of a state sales tax liability. Included in selling, general and administrative expenses for the six months ended June 30, 2007 is $0.8 million in severance expenses associated with the departure of certain executives. Excluding these items and the effects of foreign exchange, selling, general and administrative expenses would have increased $3.8 million to $33.8 million, or 19.4% of revenues, for the six months ended June 30, 2008 from $30.0 million, or 19.7% of revenues, for the six months ended June 30, 2007. This increase relates primarily to our planned investment in our business development group that is focused on driving revenue growth from our customers in our domestic and international POS business and to a lesser extent to support our revenue growth in the international services division.

 

Depreciation and amortization of property and equipment. Depreciation and amortization of property and equipment increased $0.8 million, or 7.3%, to $12.0 million for the six months ended June 30, 2008, from $11.2 million for the six months ended June 30, 2007. On a constant dollar basis, depreciation and amortization of property and equipment would have increased $0.6 million, or 5.6% to $11.8 million. Depreciation and amortization of property and equipment represented 6.9% of revenues for the six months ended June 30, 2008, compared to 7.4% of revenues for the six months ended June 30, 2007. Depreciation expense increased primarily due to capital expenditures made to support our revenue growth in the international services division.

 

Amortization of intangible assets. Amortization of intangible assets increased $0.4 million, or 3.1%, to $12.5 million for the six months ended June 30, 2008, from $12.1 million for the six months ended June 30, 2007 and relates solely to intangible assets resulting from acquisitions. On a constant dollar basis, amortization of intangible assets for the six

 

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Table of Contents

 

months ended June 30, 2008 remained unchanged. Included in amortization expense for the six months ended June 30, 2008, was an incremental $0.7 million related to the acquisition of Dialect which was offset by a decrease in expense of $0.6 million as certain intangible assets reached the end of their useful lives. For purposes of measuring and recognizing impairment of long-lived assets including intangibles, we assess whether separate cash flows can be attributed to an individual asset. For our customer relationship intangible assets, we recognize and measure impairment upon the significant loss of revenue from a customer. Based upon our contract with one of our major customers, we believe that revenues and related transaction volumes from this customer will continue to decline in 2008 and may decline further thereafter. The intangible asset value attributable to this customer relationship was approximately $20.1 million as of June 30, 2008. We assessed the recoverability of this customer relationship asset based upon undiscounted anticipated future cash flows and concluded no impairment existed as of June 30, 2008.

 

Interest expense. Interest expense decreased $1.9 million, or 22.6%, to $6.3 million for the six months ended June 30, 2008, from $8.2 million for the six months ended June 30, 2007. Included in interest expense for the six months ended June 30, 2007 is a charge of $1.4 million related to the acceleration of deferred financing costs as a result of the recapitalization in March 2007 supporting our special dividend. Excluding this charge, interest expense decreased $0.5 million due to the lower effective interest rate associated with our 2007 credit facility partially offset by the effects of a higher average balance resulting from our recapitalization in March 2007 supporting the special dividend.

 

Interest income. Interest income was $0.3 million for the six months ended June 30, 2008 compared to $0.7 million for the six months ended June 30, 2007. The decrease in interest income is due to the release of the restricted cash on hand, related to our special cash dividend payment made in April 2007.

 

Other income (expense), net. Other income (expense), net was an expense of $0.2 million for the six months ended June 30, 2008 compared to income of $1.1 million for the six months ended June 30, 2007. Included in other income (expense), net for the six months ended June 30, 2008 are foreign currency revaluation losses of approximately $0.1 million due to fluctuations in the value of the U.S. dollar, principally against the Euro and Pound Sterling, versus a gain on foreign currency revaluation of $0.7 million for the three months ended June 30, 2007. Included in other income (expense), net for the six months ended June 30, 2007 is a gain on the sale of an asset of $0.3 million.

 

Income tax (provision)  benefit. For the six months ended June 30, 2008, our income tax provision was $2.6 million compared to a benefit of $1.3 million for the six months ended June 30, 2007.  The increase in our income tax provision is primarily related to higher income in foreign jurisdictions that cannot be offset by losses in other jurisdictions.  Our effective tax rate was 49.9% and 33.3% for the six months ended June 30, 2008 and 2007, respectively.  Our effective tax rate differs from the U.S. Federal statutory rate primarily due to stock-based compensation expense not deductible for income tax purposes and profits of our international subsidiaries being taxed at rates different than the U.S. Federal statutory rate.

 

Equity in net income (loss) of unconsolidated affiliates. Equity in net income (loss) of unconsolidated affiliates for the six months ended June 30, 2008 was a loss of $0.1 million, compared to income of $0.5 million for the six months ended June 30, 2007. The decrease was due primarily to the realized gain of $0.6 million on the sale of all our outstanding shares of our investment in WAY Systems, Inc. during the six months ended June 30, 2007. The loss for the three month period ended June 30, 2008 relates to our investment in AK Jensen, Inc.  As of June 30, 2008, the carrying value of our investment in AK Jensen, Inc. was $0.7 million.

 

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Liquidity and Capital Resources

 

Our primary liquidity and capital resource needs are to finance the costs of our operations, to make capital expenditures and to service our debt. Based upon our current level of operations, we expect that our cash flow from operations, together with the amounts we are able to borrow under our 2007 senior secured revolving credit facility, will be adequate to meet our anticipated needs for the foreseeable future. Although we have no specific plans to do so, to the extent we decide to pursue one or more significant strategic acquisitions, we will likely need to incur additional debt or sell additional equity to finance those acquisitions.

 

Our operations provided us cash of $29.8 million for the six months ended June 30, 2008, which was attributable to net income of $2.6 million, depreciation, amortization and other non-cash charges of $27.8 million and an increase in working capital of $0.6 million. Our operations provided us cash of $27.2 million for the six months ended June 30, 2007, which was attributable to a net loss of $2.7 million, depreciation, amortization and other non-cash charges of $30.5 million and an increase in working capital of $0.6 million.

 

We used cash of $13.7 million in investing activities for the six months ended June 30, 2008, which comprised solely of capital expenditures to support our revenue growth. We used cash of $11.7 million in investing activities for the six months ended June 30, 2007, which included $4.2 million for our acquisition of Dialect, $10.3 million in capital expenditures to support our revenue growth, and proceeds of $2.2 million from the sale of non-strategic property and equipment and $0.6 million from the sale of all of our outstanding shares of our investment in WAY Systems.

 

We used cash of $10.7 million from financing activities for the six months ended June 30, 2008, which includes $18.0 million of voluntary pre-payments on our 2007 senior secured credit facility and $8.9 million in proceeds from stock options exercised during the three months ended June 30, 2008. We used cash of $9.3 million from financing activities for the six months ended June 30, 2007, which includes net proceeds of $222 million from our 2007 senior secured credit facility, of which $98.3 million was used for payment of a special dividend and $123.3 million was used to repay our 2005 amended and restated senior secured credit facility. In addition, we made voluntary pre-payments of $9.0 million on our 2007 senior secured credit facility.

 

Seasonality

 

Credit card and debit card transactions account for a major percentage of the transaction volume processed by our customers. The volume of these transactions on our networks generally is greater in the third and fourth quarter vacation and holiday seasons than during the rest of the year. Consequently, revenues and earnings from credit card and debit card transactions in the first and second quarter generally are lower than revenues and earnings from credit card and debit card transactions in the third and fourth quarters of the immediately preceding year. We expect that our operating results in the foreseeable future will be significantly affected by seasonal trends in the credit card and debit card transaction market.

 

24



Table of Contents

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Interest rates

 

Our principal exposure to market risk relates to changes in interest rates. As of June 30, 2008, we had $187.5 million outstanding under our 2007 senior secured credit facility with interest rates tied to changes in the lender’s base rate or the LIBOR rate. Based upon the outstanding borrowings on June 30, 2008 and assuming repayment of the Term Loan in accordance with scheduled maturities, each 1.0% increase in these rates could add an additional $1.9 million to our annual interest expense.

 

As of June 30, 2008, we did not hold derivative financial or commodity instruments and all of our cash and cash equivalents were held in money market or commercial accounts.

 

Foreign currency risk

 

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

 

We have operations in 20 countries outside of the U.S., including the United Kingdom, Austria, Australia, Bermuda, Canada, France, German, India, Ireland, Italy, Japan, Mexico, New Zealand, Poland, Romania, South Korea, Spain, Sweden, Thailand and the Netherlands. We provide services in these countries using networks deployed in each country. We manage foreign exchange risk through the structure of our business. In the substantial majority of our transactions, we receive payments denominated in the U.S. dollar, British pound, euro or Australian dollar. Therefore, we do not rely on international currency markets to obtain and pay illiquid currencies. The foreign currency exposure that does exist is limited by the fact that the majority of transactions are paid according to our standard payment terms, which are generally short-term in nature. Our policy is not to speculate in foreign currencies, and we promptly buy and sell foreign currencies as necessary to cover our net payables and receivables, which are denominated in foreign currencies. For the three and six months ended June 30, 2008, we recorded loss on foreign currency transactions of approximately $0.2 million and $0.1 million, respectively.

 

Item 4. Controls and Procedures

 

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

 

Evaluation

 

The Company carried out an evaluation, under the supervision, and with the participation, of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2008. Based on the foregoing, the Company’s Chief Executive Officer and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2008 at the reasonable assurance level.

 

There have been no changes during the three and six months ended June 30, 2008 covered by this report in the Company’s internal control over financial reporting or in other factors that could materially affect or are reasonably likely to materially affect the internal control over financial reporting.

 

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Table of Contents

 

PART II—OTHER INFORMATION

 

Item 1.              Legal Proceedings

 

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

 

Item 1A.     Risk Factors

 

There were no material changes from the risk factors previously disclosed in “Item 1A. Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

Item 2.              Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.              Default Upon Senior Securities

 

None.

 

Item 4.              Submission of Matters to a Vote of Security Holders

 

The Annual Meeting of Stockholders was held on May 22, 2008. The stockholders voted on the following matters as set forth in the proxy statement:

 

1.  ELECTION OF DIRECTORS. The stockholders voted to elect five directors to a one-year term expiring at the annual meeting of stockholders in 2009. The voting tabulation for each nominee was as follows:

 

Director

 

Votes in Favor

 

Votes Withheld

 

 

 

 

 

 

 

John B. Benton

 

20,661,449

 

2,522,068

 

 

 

 

 

 

 

Stephen X. Graham

 

19,925,199

 

3,258,318

 

 

 

 

 

 

 

Henry H. Graham, Jr.

 

21,008,976

 

2,174,541

 

 

 

 

 

 

 

Jay E. Ricks

 

19,925,199

 

3,258,318

 

 

 

 

 

 

 

John V. Sponyoe

 

19,887,112

 

3,296,405

 

 

 

2.  RATIFICATION OF INDEPENDENT ACCOUNTANTS. The stockholders ratified the selection of Ernst & Young LLP as the Company’s independent registered public accounting firm for the current 2008 fiscal year. The voting tabulation was as follows: 23,146,327 votes in favor of the ratification; 35,150 against the ratification; and 2,040 abstentions.

 

3.  APPROVAL OF AMENDMENT TO THE TNS, INC. 2004 LONG-TERM INCENTIVE PLAN WITH RESPECT TO THE ADDITION OF UP TO 800,000 SHARES. The stockholders approved an increase in the aggregate number of shares of Common Stock authorized for issuance under the Company’s 2004 Long-Term Incentive Plan from 3,847,384 to 4,647,384 shares.  The voting tabulation was as follows: 14,465,962 votes in favor of the increase; 6,578,716 votes against the increase; and 124,813 abstentions.

 

Item 5.              Other Information

 

None.

 

Item 6.              Exhibits

 

(31.1)  Certification—Chief Executive Officer

 

(31.2)  Certification — Chief Financial Officer

 

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

 

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Table of Contents

 

SIGNATURES

 

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

 

 

 

TNS, Inc.

 

 

(Registrant)

 

 

 

Date: August 11, 2008

 

By:

/s/ HENRY H. GRAHAM, JR.

 

 

 

 

 

 

Henry H. Graham, Jr.

 

 

 

Chief Executive Officer

 

 

 

Date: August 11, 2008

 

By:

/s/ DENNIS L. RANDOLPH, JR.

 

 

 

 

 

 

Dennis L. Randolph, Jr.

 

 

 

Executive Vice President, Chief Financial Officer & Treasurer

 

27


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