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TNS 10-Q 2009

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 March 31, 2009

 

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.  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

 

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).  Yes o No x

 

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 April 1, 2009

 

25,197,302 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, 2008 and March 31, 2009

3

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2008 and 2009

4

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2009

5

 

Notes to Condensed Consolidated Financial Statements

6

Item 2.

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

17

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

24

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,

 

March 31,

 

 

 

2008

 

2009

 

 

 

 

 

(UNAUDITED)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

38,851

 

$

35,028

 

Accounts receivable, net of allowance for doubtful accounts of $3,631 and $3,353, respectively

 

69,501

 

68,522

 

Prepaid expenses

 

5,351

 

5,959

 

Deferred tax assets

 

1,805

 

1,720

 

Other current assets

 

4,965

 

4,971

 

Total current assets

 

120,473

 

116,200

 

Property and equipment, net

 

58,795

 

58,424

 

Identifiable intangible assets, net

 

151,811

 

145,586

 

Goodwill

 

10,954

 

10,817

 

Deferred tax assets, net

 

16,141

 

14,013

 

Other assets

 

3,740

 

3,920

 

Total assets

 

$

361,914

 

$

348,960

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other current liabilities

 

$

59,424

 

$

49,781

 

Deferred revenue

 

16,360

 

15,286

 

Total current liabilities

 

75,784

 

65,067

 

Long-term debt, net of current portion

 

178,500

 

178,500

 

Deferred tax liability

 

2,420

 

2,263

 

Other liabilities

 

2,395

 

2,318

 

Total liabilities

 

259,099

 

248,148

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.001 par value; 130,000,000 shares authorized; 25,082,007 shares issued and 25,053,226 shares outstanding and 25,302,460 shares issued and 25,197,302 shares outstanding, respectively

 

25

 

25

 

Treasury stock, 28,781 shares and 105,158 shares, respectively

 

(578

)

(1,168

)

Additional paid-in capital

 

150,839

 

151,702

 

Accumulated deficit

 

(40,800

)

(40,824

)

Accumulated other comprehensive income

 

(6,671

)

(8,923

)

Total stockholders’ equity

 

102,815

 

100,812

 

Total liabilities and stockholders’ equity

 

$

361,914

 

$

348,960

 

 

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

 

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Table of Contents

 

TNS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

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

 

 

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

Revenues

 

$

84,125

 

$

75,266

 

Operating expenses:

 

 

 

 

 

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

 

40,707

 

36,790

 

Engineering and development

 

7,199

 

6,407

 

Selling, general, and administrative

 

19,445

 

17,756

 

Depreciation and amortization of property and equipment

 

5,967

 

5,834

 

Amortization of intangible assets

 

6,098

 

5,605

 

Total operating expenses

 

79,416

 

72,392

 

Income from operations

 

4,709

 

2,874

 

Interest expense

 

(3,709

)

(1,451

)

Interest income

 

180

 

50

 

Other income, net

 

69

 

20

 

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

 

1,249

 

1,493

 

Income tax benefit (provision)

 

352

 

(1,487

)

Equity in net loss of unconsolidated affiliates

 

 

(30

)

Net income (loss)

 

$

1,601

 

$

(24

)

 

 

 

 

 

 

Basic net income (loss) per common share

 

$

0.07

 

$

(0.00

)

Diluted net income (loss) per common share

 

$

0.06

 

$

(0.00

)

Basic weighted average common shares outstanding

 

24,309,655

 

25,127,069

 

Diluted weighted average common shares outstanding

 

24,738,286

 

25,127,069

 

 

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

 

4



Table of Contents

 

TNS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(dollars in thousands)

 

 

 

Three months ended March 31

 

 

 

2008

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

1,601

 

$

(24

)

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

 

 

 

 

 

Non-cash items

 

13,343

 

15,326

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

3,703

 

(537

)

Other current and noncurrent assets

 

288

 

166

 

Accounts payable and accrued expenses

 

(1,363

)

(10,234

)

Deferred revenue

 

(360

)

(943

)

Other current and noncurrent liabilities

 

(1,542

)

(76

)

Net cash provided by operating activities:

 

15,670

 

3,678

 

Cash flows from investing activities

 

 

 

 

 

Purchases of property and equipment

 

(6,664

)

(5,824

)

Net cash used in investing activities:

 

(6,664

)

(5,824

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from tax benefits for share based payments

 

200

 

 

Repayments of long-term debt

 

(4,000

)

 

Proceeds from stock option exercises, inclusive of tax benefit

 

587

 

 

Payment of long-term debt financing costs

 

(75

)

(75

)

Purchase of treasury stock

 

(1,233

)

(590

)

Net cash used in financing activities

 

(4,521

(665

)

Effect of exchange rates on cash and cash equivalents

 

566

 

(1,012

)

Net increase in cash and cash equivalents

 

5,051

 

(3,823

)

Cash and cash equivalents, beginning of period

 

17,805

 

38,851

 

Cash and cash equivalents, end of period

 

$

22,856

 

$

35,028

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

3,823

 

$

1,484

 

Cash paid for income taxes

 

$

2,012

 

$

1,523

 

 

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 the fair presentation of the periods presented. The results of operations for the three months ended March 31, 2009 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 16, 2009, which includes consolidated financial statements and the notes thereto for the year ended December 31, 2008.

 

Capital Structure

 

During the three months ended March 31, 2009, the Company issued 220,453 shares of common stock following the vesting of restricted stock units, of which 76,377 shares were surrendered by employees to satisfy payroll tax withholding obligations and held by the Company as treasury shares.

 

6



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 in business acquisitions 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):

 

7



Table of Contents

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2008

 

2009

 

Cost of network services

 

$

327

 

$

252

 

Engineering and development

 

455

 

370

 

Selling, general and administrative

 

2,183

 

1,383

 

 

 

$

2,965

 

$

2,005

 

 

As of March 31, 2009, there was a total of $10.0 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 March 31, 2008, the Company granted 15,500 stock options and 17,550 restricted stock units at weighted average estimated fair values of $6.84 and $16.31, respectively. During the three months ended March 31, 2009, the Company granted 2,000 stock options and 5,050 restricted stock units at weighted average estimated fair values of $3.33 and $7.00, 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 total performance-based awards issued under the Company’s 2007 Equity Incentive 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 March 31, 2009, there was a total of $0.7 million of deferred compensation expense related to these performance-based awards which is included in the $10.0 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 potential payout under the 2008 Equity Incentive Plan ranged from 0% to 100% of an employee’s target payout.  Based upon the Company’s performance in 2008, the results of which were approved by the Company’s board of directors in February 2009, the plan participants earned 50% of the potential payout under the Company’s 2008 Equity Incentive Plan.  The total performance based awards issued under the Company’s 2008 equity incentive plan were 121,269 stock options and 118,817 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 March 31, 2009, there was a total of $0.8 million of deferred compensation expense related to these performance based awards which is included in the $10.0 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 $20,000 and $0 for the three months ended March 31, 2008 and March 31, 2009, respectively. Of the $4.9 million liability for unrecognized income tax benefits as of March 31, 2009, the Company’s accrual for potential interest and penalties associated with uncertain tax positions was $377,000. 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 2008.  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, 2009

 

$

4,749

 

Additions for tax positions related to the current period

 

163

 

Effects of foreign currency translation

 

(315

)

Balance as of March 31, 2009

 

$

4,597

 

 

The entire balance of unrecognized tax benefits as of March 31, 2009 would impact the effective tax rate if recognized.

 

The Company’s effective tax rate for the three months ended March 31, 2008 and March 31, 2009 of (28.2)% and 101.7%, respectively, differ from the U.S. Federal statutory rate primarily due to stock-based compensation expense not deductible for income tax purposes, profits of our international subsidiaries being taxed at rates different than the U.S. statutory rate and the effect of adjustments for the three months ending March 31, 2009 to the provision resulting from the finalization of tax returns in the United Kingdom.

 

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Table of Contents

 

Recent Accounting Pronouncements

 

In June 2008, the FASB issued FSP EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” This FSP provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. The adoption of FSP No. EITF 03-6-1 on January 1, 2009 did not have a material effect on the Company’s consolidated financial statements.

 

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. The Company adopted SFAS No. 141(R) on January 1, 2009. Accordingly, any business combination we engage in beginning January 1, 2009 will be recorded and disclosed following SFAS No. 141(R). The adoption of SFAS No. 141(R) did not have a material impact on the Company’s consolidated financial statements.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS No. 157) which is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 157 on January 1, 2008. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The adoption of SFAS 157 to the Company’s financial assets and liabilities did not have a material effect on the Company’s consolidated financial statements. In November 2007, the FASB agreed to a one-year deferral of the effective date for nonfinancial assets and liabilities that are recognized or disclosed at fair value on a nonrecurring basis. Accordingly, for nonfinancial assets and liabilities, SFAS No. 157 became effective on January 1, 2009 and the Company will apply its disclosure provision prospectively whenever applicable.

 

2.                                      Long-term Debt

 

2007 Credit Facility

 

On March 28, 2007, the Company entered into a $240.0 million senior secured credit facility (2007 Credit Facility) to finance a 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 March 31, 2009. 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.

 

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Table of Contents

 

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 three months ended March 31, 2009, borrowings on the Term Facility bore interest at the LIBOR rate (2.5% as of March 31, 2009, inclusive of 2.0% margin).  The weighted average interest rate for the three months ended March 31, 2009 was 2.84%.  The weighted average interest rate for the three months ended March 31, 2008 was 6.9%.  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 March 31, 2009, the Company was required to maintain a leverage ratio of less than 2.8 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 March 31, 2009 was 2.1 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 March 31, 2009.

 

2009 Credit Facility

 

On May 1, 2009, the Company entered into a $423.5 million amended and restated senior secured credit facility (2009 Credit Facility) to finance the acquisition of the Communications Services Group assets from Verisign, Inc. (see Note 10) and to refinance the 2007 Credit Facility.  The 2009 Credit Facility consists of a fully funded term loan facility with an outstanding principal amount equal to $178.5 million (the Existing Term Loan Facility), a new fully funded term loan facility with an outstanding principal amount equal to $230.0 million (the New Term Loan Facility) and a senior secured revolving credit facility in an aggregate principal amount of $15.0 million (the Existing Revolving Facility), under which there were no borrowings as of May 1, 2009. The Existing Revolving Facility matures March 27, 2013. Payments on the Existing Term Loan Facility and the New Term Loan Facility are due in quarterly installments over the term beginning June 30, 2009, with the remainder payable on March 28, 2014. Voluntary prepayments on the New and Existing Term Facilities are applied as directed by the Company.

 

The total scheduled remaining payments on the New and Existing Term Facilities are as follows (in thousands):

 

Nine months ending December 31, 2009

 

$

22,978

 

2010

 

38,297

 

2011

 

40,850

 

2012

 

48,509

 

2013

 

51,063

 

Thereafter

 

206,803

 

 

 

$

408,500

 

 

Interest on the outstanding balances under the Existing Revolving Facility is payable, at the Company’s option, at a rate equal to the higher of the prime rate announced by SunTrust Bank,  the federal funds rate plus 50 basis points, or the one-month LIBOR rate plus 100 basis points (the “Base Rate”), in each case, plus a margin of 5.0% or at the London Interbank Offered Rate (“LIBOR”), plus a margin of 6.0%. The applicable margins on the Existing Revolving Credit Facility are subject to step-downs based on the Company’s leverage ratio.  Interest on the outstanding balances under the New and Existing Term Loan Facilities is payable, at the

 

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Company’s option, at the Base Rate plus a margin of 5.0%, or at LIBOR plus a margin of 6.0%.  Additionaly, in no event will the LIBOR rate be less than 3.5%.  The Existing Revolving Credit Facility is subject to an annual commitment fee in an amount equal to between 0.375% and 0.5% (based on the Company’s leverage ratio) per annum multiplied by the amount of funds available for borrowing under the Revolving Facility. Interest payments on the 2009 Credit Facility are due biweekly, monthly, bimonthly or quarterly at the Company’s option.

 

The terms of the 2009 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 and sale-leaseback transaction in excess of $2 million.  The Company is permitted to repay borrowings under the 2009 Credit Facility at any time in whole or in part without premium or penalty, provided that prepayments resulting from the refinancing of the Term Loan Facilities made during the first year after the closing with first lien debt financing containing terms similar to the terms governing the 2009 Credit Facility will be subject to a 1% prepayment premium.

 

The obligations under the 2009 Credit Facility are unconditionally and irrevocably guaranteed, subject to certain exceptions, by the Company and each existing and future direct and indirect domestic subsidiary of the Company.  In addition, the 2009 Credit Facility is secured, subject to certain exceptions, by a first priority perfected security interest in substantially all of the present and future property and assets (real and personal) of the Company and a pledge of 100% of the Company’s capital stock of its respective domestic subsidiaries and 65% of the Company’s capital stock of its respective first-tier foreign subsidiaries.

 

The terms of the 2009 Credit Facility require the Company to comply with financial and nonfinancial covenants, including maintaining a maximum specified leverage ratio at the end of each fiscal quarter, a minimum consolidated fixed charge coverage ratio and complying with specified annual limits on capital expenditures. As of June 30, 2009, the Company will be required to maintain a leverage ratio of less than 3.25 to 1.0. The maximum leverage ratio continues to decline over the term of the 2009 Credit Facility. As of June 30, 2009 and as of the end of each subsequent quarter for the twelve month period then ended, the Company will be required to maintain a consolidated fixed charge coverage ratio of not less than 1.20 to 1.0.  The 2009 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 2009 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 2009 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.

 

3.                                      Comprehensive (Loss) Income

 

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

 

 

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

Net income (loss)

 

$

1,601

 

$

(24

)

Foreign currency translation adjustments

 

2,440

 

(2,252

)

Total comprehensive income (loss)

 

$

4,041

 

$

(2,276

)

 

4.                                      Net Income (Loss) Per Common Share

 

SFAS No. 128, “Earnings Per Share”, requires the presentation of basic and diluted earnings per share. Basic earnings (loss) per common share is computed by dividing income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period. The diluted earnings (loss) per common share data is computed using the weighted average number of common shares outstanding plus the dilutive effect of common stock equivalents, unless the common stock equivalents are anti-dilutive. During the three months ended March 31, 2009, the treasury stock effect of options to purchase 1,872,050 shares of

 

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common stock and 615,667 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
March 31,

 

 

 

2008

 

2009

 

Net income (loss)

 

$

1,601

 

$

(24

)

Weighted average common share calculation:

 

 

 

 

 

Basic weighted average common shares outstanding

 

24,309,655

 

25,127,069

 

Treasury stock effect of outstanding options to purchase

 

109,421

 

 

Treasury stock effect of unvested restricted stock units

 

319,210

 

 

Diluted weighted average common shares outstanding

 

24,738,286

 

25,127,069

 

 

 

 

 

 

 

Net income (loss) per common share:

 

 

 

 

 

Basic net income (loss) per common share

 

$

0.07

 

$

(0.00

)

Diluted net income (loss) per common share

 

$

0.06

 

$

(0.00

)

 

5.                                      Segment Information

 

The Company classifies its business into two segments: North America and ISD. In addition, the Company’s management evaluates revenues for its four business divisions: POS, TSD, FSD and ISD. A significant portion of the Company’s North American operating expenses are shared between POS, TSD and FSD divisions, and, therefore, management analyzes operating results for these three divisions 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.

 

Revenue for the Company’s two segments is presented below (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

Revenues:

 

 

 

 

 

POS

 

$

18,355

 

$

17,967

 

TSD

 

17,854

 

15,019

 

FSD

 

10,746

 

12,055

 

Total North America

 

46,955

 

45,041

 

ISD

 

37,170

 

30,225

 

Total revenues

 

$

84,125

 

$

75,266

 

 

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

 

 

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

ISD

 

$

12,879

 

$

9,539

 

North America

 

6,860

 

6,779

 

Total EBITDA before stock compensation expense (i)

 

$

19,739

 

$

16,318

 

 


(i)                                     Management evaluates the performance of its segments before consideration of certain intercompany transactions. Accordingly, these transactions are not reflected EBITDA by segment. In addition, certain corporate expenses are reflected in the North American segment, consistent with information reviewed by our chief operating decision maker.

 

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

 

 

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

EBITDA before stock compensation expense

 

$

19,739

 

$

16,318

 

Reconciling items:

 

 

 

 

 

Depreciation and amortization of property and equipment

 

(5,967

)

(5,834

)

Amortization of intangible assets

 

(6,098

)

(5,605

)

Stock compensation expense

 

(2,965

)

(2,005

)

Interest expense

 

(3,709

)

(1,451

)

Interest income and other income, net

 

249

 

70

 

Income before income taxes and equity in net loss of unconsolidated affiliate

 

$

1,249

 

$

1,493

 

 

Geographic Information

 

The Company sells its services through foreign subsidiaries in Australia, Austria, Bermuda, Canada, France, Germany, Hong Kong, India, Ireland, Italy, Japan, Malaysia, Mexico, the Netherlands, New Zealand, Poland, Romania, Singapore, 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):

 

 

 

March 31,

 

March 31,

 

 

 

2008

 

2009

 

North America

 

$

46,956

 

$

45,042

 

Europe

 

29,599

 

23,499

 

Asia-Pacific

 

7,570

 

6,725

 

Total revenues

 

$

84,125

 

$

75,266

 

 

Revenues from the Company’s subsidiaries in the United Kingdom were $17.3 million and $12.3 million for the three months ended March 31, 2008 and 2009, respectively.

 

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

 

 

 

December 31,

 

March 31,

 

 

 

2008

 

2009

 

North America

 

$

182,990

 

$

166,841

 

Europe

 

23,408

 

32,630

 

Asia-Pacific

 

15,162

 

15,356

 

Total long lived assets

 

$

221,560

 

$

214,827

 

 

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Total assets are located in the following reporting segments (in thousands):

 

 

 

December 31,

 

March 31,

 

 

 

2008

 

2009

 

North America

 

$

260,213

 

$

254,762

 

ISD

 

101,701

 

94,198

 

Total assets

 

361,914

 

348,960

 

 

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

 

 

 

December 31,

 

March 31,

 

 

 

2008

 

2009

 

North America

 

$

123,668

 

$

125,204

 

ISD

 

39,097

 

31,199

 

Total goodwill and intangible assets

 

162,765

 

156,403

 

 

6.                                     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.

 

During 2008 the Company incurred an additional $1.2 million in severance and benefits, which was included in selling, general and administrative expense.

 

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

 

 

 

2009

 

Balance as of January 1

 

$

953

 

Accretion of liability due to the passage of time

 

137

 

Effects of foreign currency translation

 

(35

)

Cash paid

 

(331

)

Balance as of March 31

 

$

724

 

 

The above severance and benefits expenses are based on estimates that are subject to change. This liability is classified as accounts payable, accrued expenses and other liabilities in the accompanying consolidated balance sheet.

 

7.                                     Litigation and Claims

 

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

 

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 2000. In the settlement, the Company agreed to settle

 

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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 benefit, related to the reduction in the sales tax liability, is included in selling, general and administrative expenses in the accompanying consolidated statement of operations for the three months ended March 31, 2008.

 

10.                               Subsequent Events

 

On March 2, 2009, the Company entered into that certain Asset Purchase Agreement, dated March 2, 2009 (the Purchase Agreement), by and between the Company and VeriSign, Inc. (the Seller) pursuant to which the Company agreed to purchase certain assets and assume certain liabilities of the Seller’s Communications Services Group (CSG).  On May 1, 2009, the Company completed the acquisition in accordance with the terms and conditions of the Purchase Agreement.  The initial purchase price was approximately $226.2 million in cash and is subject to a post-closing working capital adjustment. The Company funded the transaction through a new $230 million term loan facility as part of its 2009 Credit Facility (see Note 2). CSG provides call signaling services and intelligent database services such as caller ID, toll-free call routing and local number portability to the U.S. telecommunications industry.  In addition, CSG provide wireless roaming and clearing services to mobile phone operators.  The Company will integrate CSG into its telecommunications services division.

 

This acquisition will be accounted for as a business combination under SFAS No. 141(R). While the Company has commenced the appraisals necessary to assess the fair values of the tangible and intangible assets acquired and liabilities assumed, the initial purchase price allocation is not yet available. No financial activity from this acquisition has been included in the Company’s consolidated financial statements as of March 31, 2009.

 

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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 16, 2009 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 such as fluctuations in foreign exchange rates; 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 including the acquisition of CSG; 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 16, 2009. 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.

 

We generate revenues through four business divisions:

 

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·                  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 service providers 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, Greece, 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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Results of Operations

 

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

 

 

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

Revenues

 

$

84,125

 

$

75,266

 

Operating expenses:

 

 

 

 

 

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

 

40,707

 

36,790

 

Engineering and development

 

7,199

 

6,407

 

Selling, general, and administrative

 

19,445

 

17,756

 

Depreciation and amortization of property and equipment

 

5,967

 

5,834

 

Amortization of intangible assets

 

6,098

 

5,605

 

Total operating expenses

 

79,416

 

72,392

 

Income from operations

 

4,709

 

2,874

 

Interest expense

 

(3,709

)

(1,451

)

Interest income

 

180

 

50

 

Other income (expense), net

 

69

 

20

 

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

 

1,249

 

1,493

 

Income tax benefit (provision)

 

352

 

(1,487

)

Equity in net loss of unconsolidated affiliates

 

 

(30

)

Net income (loss)

 

$

1,601

 

$

(24

)

 

Three months ended March 31, 2009 compared to the three months ended March 31, 2008

 

Revenues. Total revenues decreased $8.8 million, or 10.5%, to $75.3 million for the three months ended March 31, 2009, from $84.1 million for the three months ended March 31, 2008. We generate revenues through four operating divisions.

 

International services division. Revenues from the international services division decreased $7.0 million, or 18.7%, to $30.2 million for the three months ended March 31, 2009, from $37.2 million for the three months ended March 31, 2008. The adverse effect of foreign exchange translation on a year-over-year basis was $8.4 million.  Excluding the adverse impact of foreign exchange rates, international services division increased $1.4 million, or 3.7%, to $38.6 million from $37.2 million for the three months ended March 31, 2009 and 2008, respectively. The increase was the result of an additional $0.7 million from increased sales of our payment gateway services, higher transaction volumes and increased broadband connections from POS customers in Asia Pacific and $0.7 million from additional connections from financial services customers. Revenues from our United Kingdom subsidiaries decreased $5.0 million, or 29.2%, to $12.3 million for the three months ended March 31, 2009, from $17.3 million for the three months ended March 31, 2008. On a constant dollar basis, revenue from the United Kingdom subsidiaries for the three months ended March 31, 2009 would have decreased $0.4 million, or 2.6%, to $16.9 million due to a decrease in transaction volumes which was partially offset by increased revenue from sales of our payment gateway and IP services.

 

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 total number of POS transactions that we transport, the success of our new product offerings,  the successful expansion of our card-not-present service offerings and the effects of foreign currency translation.  In recent months, we have seen a reduction in the growth rates of our dial-up transaction volumes in most of the markets we operate, which we attribute to the overall weakness of the global economy. As we generate the majority of our revenue in the international services division from transaction volumes our future revenue may be adversely affected by the continued weakness of the global economy.

 

In our international services division we enter into arrangements with our customers in the currency of the markets we operate in. As a result, our reported results are affected by fluctuations in the value of the U.S. dollar as compared to foreign currencies, predominantly the British Pound, the Euro and the Australian dollar. The following table shows the currency composition of our revenues in the international services division for the three months ended March 31, 2009 and 2008, respectively, and weighted average exchange rates used to translate our local currency results to the U.S. dollar:

 

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2009

 

2008

 

 

 

% of ISD
Revenue

 

Weighted Average 
Exchange Rates

 

% of ISD
Revenue

 

Weighted Average 
Exchange Rates

 

British Pound

 

41

%

1.44

 

47

%

1.98

 

Euro

 

34

%

1.31

 

31

%

1.50

 

Australian Dollar

 

18

%

0.66

 

17

%

0.91

 

 

For further details on the effects of foreign exchange on our annual reported revenues, please refer to the Outlook section on page 22.

 

POS division. Revenues from the POS division decreased $0.4 million, or 2.1%, to $18.0 million for the three months ended March 31, 2009, from $18.4 million for the three months ended March 31, 2008. POS dial-up transaction volumes decreased 9.7% to 1.18 billion transactions for the three months ended March 31, 2009, from 1.31 billion transactions for the three months ended March 31, 2008. Revenues from the POS division decreased $1.1 million for the three months ended March 31, 2009 due to lower transaction volumes, as mentioned above, which we primarily attribute to softness in the economy, and $1.1 million due to a decrease in revenue per transaction for our dial-up POS offering mainly resulting from the renewal of certain customer contracts.  This was partially offset by a $1.0 million increase in revenue from our managed broadband products, a $0.6 million increase from sales of our ATM processing products, primarily in Canada, and a $0.2 million increase in sales of our wireless payment gateway platform.

 

Telecommunication services division. Revenues from the telecommunication services division decreased $2.8 million, or 15.9%, to $15.0 million for the three months ended March 31, 2009, from $17.9 million for the three months ended March 31, 2008. Revenues decreased $4.3 million due to the loss of two customers’ caller ID business in 2008 and $0.6 million due to volume declines from a customer following the announcement in March 2009 of our agreement to acquire CSG, based on the expectation that we will compete with the customer following the acquisition. These factors were partially offset by an increase of $1.3 million from network and database access services provided to cable customers and $0.8 million in sales and our core SS7 network services.  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, the success of our new product offerings, which potentially may be offset by customers seeking pricing discounts due to industry consolidation or other reasons and the successful integration of the business acquired through our purchase of CSG.

 

Financial services division. Revenues from the financial services division increased $1.3 million, or 12.2%, to $12.1 million for the three months ended March 31, 2009, from $10.7 million for the three months ended March 31, 2008. 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.  We also expect that the current difficulties in the financial services sector may have a negative impact on our future growth rates in this division.

 

Cost of network services. Cost of network services decreased $3.9 million, or 9.6%, to $36.8 million for the three months ended March 31, 2009, from $40.7 million for the three months ended March 31, 2008. On a constant dollar basis, cost of network services would have decreased $0.5 million, or 1.2%, to $40.2 million. Cost of network services were 48.9% of revenues for the three months ended March 31, 2009, compared to 48.4% of revenues for the three months ended March 31, 2008. Excluding the effect of foreign exchange, the decrease in cost of network services resulted primarily from reductions in caller ID query volumes in our telecommunications services division  and to a lesser extent from a reduction in dial-up transaction volumes in our POS division and reductions in the cost of services provided to us in our POS division through negotiated price decreases from our vendors.  This was partially offset by an increase in the number of connections in our financial services division and to a lesser extent from increased broadband connections in our POS division.

 

Gross profit represented 51.1% of total revenues for the three months ended March 31, 2009, compared to 51.6% for the three months ended March 31, 2008. On a constant dollar basis, gross margins for the three months ended 31 March, 2009 increased 40 basis points to 52.0%. The improvement in gross margin, on a constant dollar basis, from last year is primarily a result of improvements in the margins of our POS division as a result of continued focus on controlling the cost of network services provided to us and to a lesser extent as a result of an increase in the contribution our financial services division, one of our highest gross margin divisions.

 

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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 decreased $0.8 million, or 11.0%, to $6.4 million for the three months ended March 31, 2009, from $7.2 million for the three months ended March 31, 2008. On a constant dollar basis, engineering and development expenses would have decreased $0.1 million, or 1.4%, to $7.1 million. Engineering and development expense represented 8.5% and 8.6% of revenues for the three months ended March 31, 2009 and 2008, respectively. Included in engineering and development expense for the three months ended March 31, 2009 and 2008 is stock compensation expense of $0.4 million and $0.5 million, respectively.  Capitalized software development costs, which are offset against engineering and development costs, increased $0.4 million to $1.6 million from $1.2 million for the three month period ended March 31, 2009 and 2008, respectively. The increase in capitalized software development costs is primarily due to our planned investment to enhance our card-not-present payment gateway, and to a lesser extent from development of our back-office systems to enhance our internal reporting and network monitoring capabilities.  Excluding the items mentioned above and the effects of foreign exchange, engineering and development expense before the capitalization of software development costs would have decreased $0.4 million to $5.1 million, or 6.7% of revenues, for the three months ended March 31, 2009 from $5.5 million, or 6.5% of revenues, for the three months ended March 31, 2008.

 

Selling, general and administrative expense. Selling, general and administrative expenses decreased $1.7 million, or 8.7%, to $17.8 million for the three months ended March 31, 2009, from $19.4 million for the three months ended March 31, 2008. On a constant dollar basis, selling, general and administrative expenses would have increased $0.2 million, or 1.0%, to $19.6 million. Selling, general and administrative expenses represented 23.6% of revenues for the three months ended March 31, 2009, compared to 23.1% of revenues for the three months ended March 31, 2008. Included in selling, general and administrative expenses for the three months ended March 31, 2009 and 2008 is $1.4 million and $2.2 million of stock compensation expense, respectively. The decrease in stock compensation expense is due to a reduction in performance related stock compensation as a result of fewer grants made during the three months ended March 31, 2009. Included in selling, general and administrative expenses for the three months ended March 31, 2009 are $0.6 million in professional fees related to our acquisition of CSG. Included in selling, general and administrative expenses for the three months ended March 31, 2008 was a $0.9 million pre-tax benefit associated with the settlement of a state sales tax liability. Excluding these items and the effects of foreign exchange, selling, general and administrative expenses would have decreased $0.5 million to $17.6 million, or 23.4% of revenues, for the three months ended March 31, 2009 from $18.1 million, or 21.5% of revenues, for the three months ended March 31, 2008 primarily as a result of our efforts to reduce our overall costs.

 

Depreciation and amortization of property and equipment. Depreciation and amortization of property and equipment decreased $0.2 million, or 2.2%, to $5.8 million for the three months ended March 31, 2009, from $6.0 million for the three months ended March 31, 2008. On a constant dollar basis, depreciation and amortization of property and equipment would have increased $0.2 million, or 3.3% to $6.2 million.  Depreciation and amortization of property and equipment represented 7.8% and 7.1% of revenues for the three month periods ended March 31, 2009 and 2008, respectively.

 

Amortization of intangible assets. Amortization of intangible assets decreased $0.5 million, or 8.1%, to $5.6 million for the three months ended March 31, 2009, from $6.1 million for the three months ended March 31, 2008 and relates solely to intangible assets resulting from acquisitions. On a constant dollar basis, amortization of intangible assets would have remained unchanged at $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. Beginning in 2005, we experienced revenue and transaction volume declines with a major customer. The intangible asset value attributable to the customer relationship was approximately $19.0 million as of March 31, 2009.  We assessed the recoverability of this customer relationship asset based upon undiscounted anticipated future cash flows and concluded that no impairment existed as of March 31, 2009.

 

Interest expense. Interest expense decreased $2.3 million, or 60.9%, to $1.4 million for the three months ended March 31, 2009, from $3.7 million for the three months ended March 31, 2008. 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.

 

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Income tax provision. For the three months ended March 31, 2009, our income tax provision was approximately $1.5 million compared to a credit of $0.4 million for the three months ended March 31, 2008. The increase in our income tax provision is primarily related to higher income in the U.S. that cannot be offset against losses in other jurisdictions and the effect of adjustments to the provision resulting from the finalization of tax returns in the U.K. Our effective tax rate was 101.7% and (28.2)% for the three months ended March 31, 2009 and 2008, 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, and the effect of adjustments to the provision noted above.

 

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 2009 Credit Facility, will be adequate to meet our anticipated needs for the foreseeable future.

 

Our operations provided us cash of $3.7 million for the three months ended March 31, 2009, which was attributable to a net loss of $24,000, depreciation, amortization and other non-cash charges of $15.3 million and an increase in working capital of $11.6 million. The increase in working capital relates primarily to the timing of payments. We expect a large portion of this working capital change to reverse itself in subsequent quarters. Our operations provided us cash of $15.7 million for the three months ended March 31, 2008, which was attributable to net income of $1.6 million, depreciation, amortization and other non-cash charges of $13.3 million and a decrease in working capital of $0.7 million.

 

We used cash of $5.8 million and $6.7 million in investing activities for the three months ended March 31, 2009, and March 31, 2008, respectively, which comprised solely of capital expenditures to support our revenue growth.

 

We used cash of $0.7 million from financing activities for the three months ended March 31, 2008. We used cash of $4.5 million from financing activities for the three months ended March 31, 2008, which includes $4.0 million of voluntary pre-payments on our 2007 senior secured credit facility and $0.6 million in proceeds from stock options exercised during the three months ended March 31, 2008.

 

Outlook

 

In our foreign operations we conduct business in each of our foreign jurisdictions local currency. Due to the recent strengthening of the U.S. Dollar relative to several major foreign currencies, we expect revenues and operating income to be negatively impacted by foreign currency translation. As a point of reference, for the year ended December 31, 2008, the weighted average exchange rate used to translate the Company’s Statement of Operations (U.S. Dollar rate for one unit of foreign currency) was $1.85 for the British Pound, $1.47 for the Euro, and $0.84 for the Australian dollar. For the year ended December 31, 2008, approximately 21%, 14% and 8% of our consolidated revenues were generated in the British Pound, Euro and Australian dollar, respectively. For the year ended December 31, 2008, approximately 16%, 11% and 6% of our consolidated operating expenses were generated in the British Pound, Euro and Australian dollar, respectively. A $0.01 change in exchange rates for each of the major foreign currencies we operate in would have the following impact on revenue for the year ended December 31, 2008: British Pound, $0.4 million, Euro, $0.4 million and Australian Dollar, $0.3 million. The foreign currency exchange rates which impact our revenues and operating income have been volatile recently and are beyond our control. (See Item 3, Foreign Currency Risk, below)

 

22



Table of Contents

 

Acquisition of the Communications Services Group

 

On March 2, 2009, TNS entered into an asset purchase agreement, dated March 2, 2009, between TNS and VeriSign, Inc. pursuant to which TNS agreed to purchase from Verisign, Inc. certain assets and assume certain liabilities of CSG.  On May 1, 2009, TNS completed the acquisition in accordance with the terms and conditions of the asset purchase agreement.  The initial purchase price was approximately $226.2 million in cash and is subject to a post-closing working capital adjustment.  We funded the transaction through a new $230 million term loan facility as part of its 2009 Credit Facility (see Note 2).  CSG provides call signaling services, intelligent database services such as caller ID, toll-free call routing and local number portability to the U.S. telecommunications industry.  In addition, they provide wireless roaming and clearing services to mobile phone operators.  We will integrate CSG into our telecommunications services division.

 

We expect to experience operational benefits from the acquisition, including additional overall cost savings from the consolidation of our two SS7 call signaling networks, eliminating duplicate intelligent database platforms and reduced network —related costs from the elimination of duplicate facilities.  We also expect reduced overall combined capital expenditures as a result of greater economies of scale and the rationalization of network assets.

 

The acquisition will be accounted for as a business combination under SFAS No. 141(R). While we have commenced the appraisals necessary to assess the fair values of the tangible and intangible assets acquired and liabilities assumed, the initial purchase price allocation is not yet available. No financial activity from this acquisition has been included in our consolidated financial statements as of March 31, 2009.

 

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.

 

Effects of Inflation

 

Our monetary assets, consisting primarily of cash and receivables, and our non-monetary assets, consisting primarily of intangible assets and goodwill, are not affected significantly by inflation. We believe that replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and costs of network services, which may not be readily recoverable in the price of services offered by us.

 

23



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 March 31, 2009 we had $178.5 million outstanding under our 2007 Credit Facility with interest rates tied to changes in the lender’s base rate or the LIBOR rate. Based upon the outstanding borrowings on March 31, 2009 and assuming repayment of the Term Loan in accordance with scheduled maturities, each 1.0% increase or decrease in these rates could affect our annual interest expense by $1.8 million.

 

As of March 31, 2009, 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. (See Item 2, Outlook, above)

 

We have operations in 23 countries outside of the U.S., including the United Kingdom, Austria, Australia, Bermuda, Canada, France, Germany, Hong Kong, India, Ireland, Italy, Japan, Malaysia, Mexico, New Zealand, Poland, Romania, Singapore, 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 months ended March 31, 2009, we recorded a loss on foreign currency revaluation of approximately $0.1 million.

 

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Table of Contents

 

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 March 31, 2009. 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 March 31, 2009 at the reasonable assurance level.

 

There have been no changes during the three months ended March 31, 2009 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.

 

25



Table of Contents

 

PART II—OTHER INFORMATION

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

None.

 

 

 

Item 1A.

Risk Factors

 

 

 

The failure to successfully integrate the CSG acquisition could negatively affect our operating results.

 

 

 

If we are not able to successfully integrate CSG in a timely manner, our operating results may decline, particularly in the

fiscal quarters immediately following the completion of transaction while the operations of CSG are being integrated into our operations. We also may incur substantial costs delays or other operational or financial problems during the integration process.

 

 

 

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

 

 

 

 

 

None.

 

 

 

Item 5.

 

Other Information

 

 

 

Item 6.

 

Exhibits

 

 

 

 

 

(2.1)

Asset Purchase Agreement dated March 2, 2009, by and between Transaction Network Services, Inc. and VeriSign, Inc. (incorporated by reference to Exhibit 2.1 to Form 8-k filed March 8, 2009).

 

 

 

 

 

 

(10.1)

Amended and Restated Credit Agreement, dated May 4, 2009, by and among Transaction Network Services, Inc., as borrower, TNS, Inc., as a credit party, SunTrust Bank, as agent, co-administrative agent, L/C issuer and a lender, General Electric Capital Corporation, as co-administrative agent and a lender, Bank of America, N.A., as syndication agent, the other financial institutions party thereto, as lenders, SunTrust Robinson Humphrey, Inc., as joint lead arranger and sole bookrunner, and GE Capital Markets, Inc., as joint lead arranger (incorporated by reference to Exhibit 10.1 to form 8-K filed May 4, 2009).

 

 

 

 

 

 

(31.1)

Certification—Chief Executive Officer

 

 

(31.2)

Certification — Chief Financial Officer

 

 

(32.1)

Written Statement of Chief Executive Officer and Chief Financial Officer

 

26



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: May 11, 2009

By:

/s/ HENRY H. GRAHAM, JR.

 

 

 

 

 

Henry H. Graham, Jr.

 

 

Chief Executive Officer

 

 

 

Date: May 11, 2009

By:

/s/ DENNIS L. RANDOLPH, JR.

 

 

 

 

 

Dennis L. Randolph, Jr.

 

 

Executive Vice President, Chief Financial Officer & Treasurer

 


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