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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
Commission File Number: 0-23856
TRANSACTION NETWORK SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or jurisdiction of incorporation or organization)
54-1555332
(I.R.S. Employer Identification Number)
1939 ROLAND CLARKE PLACE
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 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 October 17, 1996
12,310,110 Shares of Common Stock, $0.01 par value
Page 1 of 16
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TRANSACTION NETWORK SERVICES, INC.
BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $15,258 $18,681
Short-term investments 12,158 4,551
Accounts receivable, net of allowance for doubtful
accounts of $398 and $432, respectively 10,141 7,716
Other current assets 595 630
------- -------
Total current assets 38,152 31,578
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EQUIPMENT, at cost:
Network equipment 20,511 17,067
Office equipment 2,641 1,249
Less - Accumulated depreciation (9,059) (6,291)
------- -------
14,093 12,025
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INTANGIBLE ASSETS:
Software and intangibles 13,726 12,090
Less - Accumulated amortization (2,802) (1,701)
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10,924 10,389
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OTHER ASSETS 931 1,350
NOTE RECEIVABLE -- 3,600
LONG-TERM INVESTMENTS 2,617 2,406
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Total assets $66,717 $61,348
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------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITES:
Current portion of capital lease obligations $-- $18
Accounts payable and accrued expenses 6,172 5,781
Total current liabilities 6,172 5,799
DEFERRED INCOME TAX, net of current amount 956 956
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Total liabilities 7,128 6,755
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STOCKHOLDERS' EQUITY
Common Stock 123 81
Additional paid-in capital 48,853 48,160
Unearned compensation (84) (106)
Retained Earnings 10,697 6,458
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Total stockholders' equity 59,589 54,593
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Total liabilities and stockholders' equity $66,717 $61,348
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------- -------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
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TRANSACTION NETWORK SERVICES, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1996 1995 1996 1995
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Revenues $14,840 $11,386 $38,941 $29,550
Cost of network services 8,166 6,024 21,539 15,890
-------- -------- -------- -------
Gross profit 6,674 5,362 17,402 13,660
-------- -------- -------- -------
Other operating expenses:
Engineering & development 642 577 2,022 1,642
Selling, general & administrative 1,913 1,469 5,650 4,158
Depreciation 1,053 815 2,970 2,223
Amortization of intangibles 382 318 1,100 798
-------- -------- -------- -------
Total other operating expenses 3,990 3,179 11,742 8,821
-------- -------- -------- -------
Income from operations 2,684 2,183 5,660 4,839
Interest income 397 217 1,247 420
-------- -------- -------- -------
Income before provision for income taxes 3,081 2,400 6,907 5,259
Provision for income taxes 1,214 912 2,668 1,999
-------- -------- -------- -------
Net income $1,867 $1,488 $4,239 $3,260
-------- -------- -------- -------
-------- -------- -------- -------
Net income per common and
equivalent share $0.15 $0.13 $0.34 $0.29
-------- -------- -------- -------
-------- -------- -------- -------
Weighted average common and
equivalent shares outstanding 12,618 11,810 12,605 11,211
-------- -------- -------- -------
-------- -------- -------- -------
</TABLE>
The accompanying notes are an integral part of these statements.
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TRANSACTION NETWORK SERVICES, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1996 1995
------ ------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $4,239 $3,260
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,070 3,021
Stock option compensation 22 43
Loss (gain) on disposal of equipment 16 (7)
Increase in accounts receivable (2,425) (2,500)
Decrease (increase) in other current assets 35 (343)
Decrease (increase) in other assets 419 (1,153)
Increase in accounts payable and accrued expenses 618 1,739
------ ------
Net cash provided by operating activities 6,994 4,060
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment (5,148) (4,495)
Purchases of intangible assets (1,636) (3,500)
Proceeds from disposal of equipment 33 58
Repayment of note receivable 3,600 --
Purchases of short-term investments (7,607) (1,000)
Purchases of long-term investments (211) (4,965)
------ ------
Net cash used in investing activities (10,969) (13,902)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock -- 23,490
Proceeds from options, warrants and employee stock
purchase plan 570 385
Income tax benefit of deduction for income tax
purposes on exercise of stock options -- 568
Repayment of equipment notes and capital leases (18) (241)
------ ------
Net cash provided by financing activities 552 24,202
------ ------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (3,423) 14,360
CASH AND CASH EQUIVALENTS, beginning of period 18,681 7,313
------ ------
CASH AND CASH EQUIVALENTS, end of period $15,258 $21,673
------ ------
------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Common Stock issued for 401k matching contribution $165 $56
Cash paid for income taxes 2,250 326
</TABLE>
The accompanying notes are an integral part of these statements.
4
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TRANSACTION NETWORK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
(UNAUDITED)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Transaction Network Services, Inc. (the "Company" or "TNS") was
incorporated on August 20, 1990, in the state of Delaware and is a nationwide
communications network company specializing in transaction-oriented data
services. The Company currently addresses three primary markets through its
service offerings: (1) the domestic point-of-sale/point-of-service ("POS")
transaction market through its TransXpress-Registered Trademark- network
services, (2) the domestic telephone call billing validation and fraud control
market through its CARD*TEL-Registered Trademark- telecommunications services,
and (3) international markets for the Company's products and services. The
Company provides participants in these markets with high speed, reliable,
inexpensive communications for real-time validation necessary to reduce losses
resulting from the bad debt and fraud often associated with credit cards, debit
cards and "0+" telephone calls.
The financial statements include the accounts of Transaction Network
Services, Inc. and of Fortune Telecommunications, Inc. ("FTI") which was a
wholly owned subsidiary from the date of its acquisition, June 6, 1994, through
February 28, 1995, when FTI was merged into the Company. In 1996, the Company
formed a 70%-owned subsidiary which intends to provide POS network services in
Ireland in the future. Significant intercompany accounts have been eliminated
in consolidation.
The condensed financial statements included herein have been prepared
by the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC") and include, in the opinion of
management, all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of interim period results. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. The Company
believes that its disclosures are adequate to make the information presented not
misleading. These condensed financial statements should be read in conjunction
with the financial statements and notes thereto included in the Company's Annual
Report on Form 10-K. The results of operations for the three and nine month
periods ended September 30, 1996 and 1995 are not necessarily indicative of the
results to be expected for the full year.
STOCK SPLIT
On April 18, 1996, the Company declared a 3-for-2 stock split of the
outstanding shares of its Common Stock. This stock split entitled shareholders
to receive one additional share for each two outstanding shares of Common Stock
held of record as of the close of business on April 30, 1996. The payable date
was May 10, 1996. All share and per share data presented have been
retroactively adjusted to reflect the stock split.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FINANCIAL INSTRUMENTS
The Company considers all securities purchased with a maturity of three
months or less to be cash equivalents.
At December 31, 1995 and September 30, 1996, the Company's securities
consisted primarily of U.S. government and government agency securities,
investment grade corporate bonds, money market accounts (classified as cash
equivalents), and overnight reverse repurchase agreements (classified as cash
equivalents), all of which the Company has both the positive intent and ability
to hold until maturity. These securities are reported at amortized cost.
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The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short maturity
of those instruments.
SHORT TERM AND LONG TERM INVESTMENTS
The fair values of the investments, which consist of U.S. government and
government agency securities and investment grade corporate bonds, are
estimated based on quoted market prices on national exchanges and
approximate the carrying amounts.
REVENUE RECOGNITION
The Company recognizes revenue as the related services are performed.
Advance payments for services are deferred and recognized as revenue when
earned. As of January 1, 1996 the Company began reporting a single line item of
revenue which includes POS services revenue, Telecom services revenue and
International revenue. POS services revenue from the Company's POS transaction
communications business is derived primarily from the transmission through its
network of transaction information between merchant or service provider POS
terminals and transaction-processing computer centers. Telecom services
revenue consists primarily of fees charged on a per query basis to customers for
telephone call fraud-control and billing validation services. International
revenue currently consists primarily of development fees and hardware sales
revenue, and in the future may consist also of maintenance and software license
fee revenue and royalties. Equipment sales revenue is generally recognized upon
shipment.
RECLASSIFICATIONS
Certain reclassifications of prior period amounts have been made to conform
with current period presentation.
2. PUBLIC OFFERING:
On August 16, 1995, the Company completed a public offering of
2,700,000 shares of Common Stock. Of the 2,700,000 shares, 1,500,000 were sold
by the Company and 1,200,000 were sold by selling shareholders. After
underwriting discounts, commissions and other professional fees, net proceeds to
the Company from the offering were approximately $23 million.
3. PURCHASE OF INTANGIBLE ASSETS
On June 30, 1995, the Company completed the purchase from Intellicall of
certain contract rights related to Intellicall's telephone call validation and
fraud control services, including Intellicall's validation services contracts
with customers. The Company also purchased a validation services contract with
Intellicall and an exclusive U.S. license to Intellicall's VICS software
(excluding certain markets). Intellicall also agreed not to compete for ten
years with the Company in the provision of validation services and to
exclusively market the Company's validation services to Intellicall's customers
(excepting, in each case, such excluded markets). The Company paid $3 million in
cash at closing for these assets. The cost of these assets has been included in
intangible assets in the December 31, 1995 accompanying balance sheet. The
Company will amortize the cost of these assets over ten years.
On March 29, 1996, the Company completed an asset purchase from AMNEX, Inc.
("AMNEX") of AMNEX's proprietary fraud-control system and related databases.
The transaction also provided for a ten year exclusive service agreement, a
joint marketing agreement to cross-sell each other's services and a warrant
agreement giving the Company the right to purchase 100,000 shares of AMNEX
Common Stock at $3.91. The Company paid approximately $1.5 million in cash for
these assets. In connection with the asset purchase agreement, the Company has
purchased additional assets from AMNEX which AMNEX acquired in a subsequent
business combination for $175,000. These assets include assets used to provide
fraud control, and billing validation services. The Company will amortize the
cost of these assets over five to ten years.
6
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4. INCOME TAXES
The Company recorded a provision for income taxes of $1,214,000 and
$2,668,000 for the three and nine month periods ended September 30, 1996. The
Company's provision for income taxes for the three and nine month periods ended
September 30, 1996 is based upon the anticipated annual effective income tax
rate of 39%. This effective income tax rate differs from the Federal statutory
rate as follows:
Statutory Federal income tax rate 35.0%
Effect of graduated rate (1.0)
State income taxes, net of Federal benefit 4.0
Effect of foreign tax rates 1.0
-----
Anticipated effective income tax rate 39.0%
-----
-----
5. NOTE RECEIVABLE
On October 10, 1995, the Company funded a $3.6 million promissory note
to Pond Building, L.L.C., the purchaser of the office building in which the
Company's headquarters are located. The note was paid in full on June 10, 1996.
7
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Item 2.
TRANSACTION NETWORK SERVICES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company was incorporated in August 1990 to build and operate a
communications network focused on the network services needs of the POS
(Point-of-Sale/Point-of-Service) transaction processing industry. Between
August 1990 and May 1991, the Company was primarily engaged in raising capital
from investors and in the initial development of its network. In June 1991 the
Company transmitted its first POS transaction, and since then has increased its
average daily transaction volume from approximately 17,000 in the third quarter
of 1991 to more than 5.7 million in the third quarter of 1996. In June 1994, the
Company acquired Fortune Telecommunications, Inc. ("FTI") of Ft. Lauderdale,
Florida, which provided customers in the telecommunications industry with
telephone call fraud control and billing validation services. The Company is
organized around its three key service/product offerings: (1) POS services
include the Company's TransXpress-Registered Trademark- network services for the
POS transaction processing industry. (2) Telecom services include FTI's
CARD*TEL-Registered Trademark- telephone call billing validation and fraud
control services and other services targeted primarily to the telecommunications
industry. TNS has strengthened its position in the telephone call billing
validation and fraud control market through the purchase of assets -- primarily
contract rights, marketing and services agreements, non-compete agreements and
computer software and databases -- from Intellicall Corporation in June of 1995
and from AMNEX, Inc. in March of 1996. (3) International activities - In 1996,
the Company began to recognize revenue from a third area, the sale of products
and services in international markets. The Company continues to actively market
its products and services to potential international customers.
RESULTS OF OPERATIONS
REVENUES
Total revenues increased by 30% to $14,840,000 for the three month period
ended September 30, 1996 from $11,386,000 for the same period in 1995 and by 32%
to $38,941,000 for the first nine months of 1996 from $29,550,000 for the same
period in 1995. Of the $3,454,000 and $9,391,000 increase for the three and
nine month periods, 60% and 64%, respectively, was due to the increased usage of
the TNS network by the Company's POS services customers. Telecommunications
service customers contributed 5% and 19% of the growth for the three and nine
month periods. The remaining 35% and 17% of the growth for the three and nine
month periods resulted primarily from development fees and equipment sales
derived from the Company's International activities. As of January 1, 1996, the
Company began reporting a single line item of revenue which includes POS
services revenue, Telecom services revenue and International revenue.
POS services revenue increased by 27% to $9,860,000 from $7,794,000 for
the third quarter of 1996 versus the comparable period in 1995, and by 29% to
$26,868,000 from $20,842,000 for the nine months ended September 30, 1996
versus the comparable period in 1995. The growth in POS services revenue
resulted primarily from an increase in transaction volume and associated
revenue from the Company's existing POS customers. POS transaction volume
increased by 57% to 521 million from 334 million transactions for the third
quarter of 1996 versus 1995 and by 56% to 1,345 million for the nine month
period ended September 30, 1996 from 865 million for the same period in 1995
The transaction volume growth rate exceeded the revenue growth rate
primarily because the average revenue per transaction declined by approximately
22% for the three month period, and 23% for the nine month period. This decline
in average revenue per transaction occurred as a result of several factors.
First Data Corporation ("FDC"), the Company's largest customer, entered into a
new five year service contract with TNS which resulted in a significant price
reduction for FDC effective January 1, 1996. Under the terms of the contract,
FDC has agreed to a minimum revenue commitment to TNS of $55 million over the
term of the contract, which extends to December 31, 2000.
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Several of the Company's other largest customers entered into new long term
contracts with the Company which resulted in significant price reductions for
those customers. Including FDC, three of the Company's five largest customers
benefited from new long term contracts incorporating immediate price
reductions during the year. In the most recent of these large contract
re-negotiations in July 1996, the Company entered into a new contract with
one of its customers which resulted in lower pricing in exchange for a
significant transaction commitment extending to the year 2000. Subsequent to
the execution of the new contract, this customer acquired one of the
Company's five largest customers and included that customer's transaction
volume under the new contract. As a result, the Company's average revenue
per transaction was further reduced in September 1996. The effect of this
acquisition on average revenue per transaction will be fully felt in the
fourth quarter of 1996 as the new pricing will be in place for the entire
quarter. Average revenue per transaction also declined as a result of price
discounts based on increasing transaction volumes for many customers and from
the relative contribution to total transaction volume of certain of the
Company's customers.
During the nine month period ended September 30, 1996, the Company
recognized approximately $270,000 in revenue as a result of a prepayment of a
note receivable relating to POS services rendered during a 24 month period. The
services were provided under a loan agreement between the Company and a customer
whereby amounts charged to the customer for services rendered were converted to
an interest bearing note receivable to be paid over a 10-year period. The
Company recognized revenues relating to the services provided under the loan
agreement on a cash basis as principal payments were received.
Telecommunications revenue increased by 5% to $3,775,000 for the three
months ended September 30, 1996 from $3,592,0000 for the same period in 1995 and
by 20% to $10,470,000 for the first nine months of 1996 from $8,708,000 for the
same period in 1995. This revenue was generated primarily by fees charged on a
per query basis to telecommunications customers for the Company's telephone call
fraud control and billing validation services. The growth in revenue was due to
growth in queries processed for the Company's telecommunications customers for
the three and nine month periods, and from the inclusion of the revenues derived
from the June 30, 1995 Intellicall asset purchase and to a much lesser extent
from the purchase of intangible assets including an exclusive services agreement
from AMNEX, Inc.
On March 29, 1996, the Company completed an asset purchase from AMNEX, Inc.
("AMNEX") of AMNEX's proprietary fraud-control system and related databases.
The transaction also provided for a ten year exclusive service agreement, a
joint marketing agreement to cross-sell each other's services and a warrant
giving the Company the right to purchase 100,000 shares of AMNEX
Common Stock at $3.91. The Company paid approximately $1.5 million in cash for
these assets. In connection with the Asset Purchase Agreement, the Company has
purchased additional assets from AMNEX which AMNEX acquired in a subsequent
business combination for $175,000. These assets include assets used to provide
fraud control and billing validation services. The Company will amortize the
cost of the depreciable assets over five to ten years.
Since its acquisition in 1994, the Company's Telecom services division has
grown principally through the addition of new customers, through the acquisition
of contract rights and other intangible assets, and through the provision of new
service offerings. The Company's core customers in the fraud control and
billing validation services market have not achieved growth rates comparable
with those experienced by many of the Company's POS customers, and in some cases
have experienced some erosion in call and query volumes and revenues. The
market for third party billing validation and fraud control services has been
adversely impacted by so-called "dial-around" and pre-paid calling card services
which use 800 WATS services to route telephone calls made from pay phones, hotel
phones, or other public use telephones to long distance carriers other than
those chosen by the telephone proprietor. These dial-around offerings
effectively divert telephone calls away from the Company's traditional customer
base for fraud control and billing validation services (primarily operator
services providers and pay telephone providers) to other telecommunications
companies with separate billing validation databases (in many cases MCI and
AT&T).
As part of the Telecommunications Act of 1996, the FCC was authorized to
mandate a payment scheme pursuant to which pay telephone operators are "fairly
compensated" for all access code calls, debit card calls, subscriber 800 and
other toll-free calls which originate on the pay phone service providers
facilities but which are routed to telecommunications carriers other than those
pre-subscribed by the pay phone operators ("dial-around compensation"). In
October 1996, an interim solution for dial-around compensation was announced by
the FCC.
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Under the new regulations, pay telephone operators are to receive an
increased fixed monthly fee of $45 per pay telephone from the long distance
voice carriers which use these pay telephone facilities. While it is uncertain
what impact the new rules will have on dial-around usage and therefore on demand
for traditional TNS's Telecom services offerings, many industry observers
believe that the use of dial-around services will continue to grow at the
expense of the traditional pay telephone long distance services upon which the
Company's core customer base for fraud control and billing validation services
relies. Recently, several Local Exchange Carriers have furthered this trend by
introducing proprietary calling cards which utilize dial-around 800 access.
Management believes that the success of dial-around services to date
is related to both the method of compensation chosen for the interim solution,
which does not directly tie the cost of dial-around compensation to the usage of
dial-around services, and also to other market forces favoring the growth of
these type of services. While there can be no assurance of the Company's
success in new marketing efforts, the Company is currently pursuing several
business opportunities from which it could take advantage of the continuing
trend toward the use of dial-around services by providing fraud control and/or
billing validation services to several potential vendors of dial-around
services.
International revenue, a new source of revenue for TNS in 1996, was $1.2
million in the third quarter and $1.6 million year-to-date 1996, primarily
from equipment and software sales. The Company currently has significant
international activities in the United Kingdom ("UK"), Canada and Ireland.
In the UK and Canada, the Company has entered into technology transfer
arrangements whereby TNS provides POS equipment and software to its
international customers through one-time sales, but also has agreements
entitling it to receive recurring revenues in the form of software license
fees, maintenance fees and royalties based on the POS revenues generated by
its international customers resulting through the use of the Company's POS
technology. Management currently expects to begin to record royalty revenue
under these arrangements in 1997. In Ireland, the Company has formed a
70%-owned subsidiary which intends to provide POS network services in Ireland
in the future. Currently the Irish subsidiary is in a start-up phase and has
not generated any revenue to date.
COST OF NETWORK SERVICES
Cost of network services increased by 36% to $8,166,000 for the three
months ended September 30, 1996 from $6,024,000 for the same period in 1995 and
by 36% to $21,539,000 for the first nine months of 1996 from $15,890,000 for the
same period in 1995. This growth resulted primarily from increases in local
access, "800" usage charges and charges for billing validation information
resulting from increased transaction and query volume. Growth in cost of
network services also resulted from costs associated with increases in network
capacity purchased from outside vendors and from increases in other costs
associated with operating the Company's network. Lastly, the growth of cost of
network services was also increased by the cost of goods sold related to
equipment sales. The reduction in average revenue per transaction for POS
network services was significantly, but not fully, offset by several factors.
This resulted in a net increase in cost of network services as a percentage of
revenue of about 2% for the third quarter of 1996 versus the same period in
1995. The Company was able to continue to achieve economies of scale on its
network as the growth in transaction and query volume and associated revenue was
larger than the increase in recurring costs for network capacity and network
management. In addition, the company has consistently been able to negotiate
better rates from its large vendors of network capacity and 800 services as it
has increased its consumption of these services. In August 1995, a reduction in
the cost per minute of usage for local access charged by local exchange carriers
went into effect by FCC mandate, effectively reducing the Company's variable
cost per transaction. In July 1996, most of the major Local Exchange Carriers
modestly reduced the cost per minute rate charged for local access to the
Company. However, several of the carriers substantially increased certain rate
elements which had the effect of raising the effective per minute rate for these
carriers, more than offsetting the benefit of cost reductions from the other
carriers. Management believes it can reverse the increase in overall local
access rates and benefit from the generally prevailing modest decreases in local
access rates by modifying its local access arrangements with the carriers at
issue to eliminate the use of services which have recently introduced
substantial rate increases. Plans are currently under way to execute this
modification.
GROSS PROFIT
Gross profit increased by 24% to $6,674,000 for the three months ended
September 30, 1996 from $5,362,000 for the same period of 1995 and by 27% to
$17,402,000 for the nine months of 1996 from $13,660,000 for
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the same period in 1995. This represents 45% and 47% of total revenues for
the third quarter of 1996 and 1995, respectively, and 45% and 46% for the
nine months ended September 30, 1996 and 1995, respectively. The 2% decrease
in gross profit as a percentage of total revenues for the three month period,
and 1% reduction for the nine month period reflect the fact that the
reduction in average revenue per POS transaction over the periods was
largely, but not completely, offset by local access rate reductions and
network efficiencies. These efficiencies from transaction volume and query
growth, and from larger than normally recorded non-transaction revenues
resulting from the prepayment of a note owed to the Company by a customer for
services rendered in previous periods. The gross margin on equipment sales
was not significantly different from the gross margin on network services
during the quarter. For the remainder of 1996, the incremental increase in
transaction and query volume and revenue is not anticipated to fully offset
the significant price reduction and network cost increases associated with
the FDC contract and other new contracts. As a result, a continuation of
gross profit margins at levels below those recorded for comparable periods in
1995 is expected. The eventual level of the gross profit margin depends on
number of factors including total transaction and query volume growth, the
relative growth and contribution to total transaction volume of each of the
Company's customers, the timing and extent of the Company's network expansion
and the timing and extent of any network cost reductions of which the Company
may be able to take advantage. In addition, any significant loss or
significant reduction in the growth of transaction volume could lead to a
decline in gross margin because a significant portion of network costs are
fixed costs, and maintaining the historical gross margin level depends in
part on growth in transaction volume generating economies of scale.
ENGINEERING AND DEVELOPMENT
Engineering and development expense increased by 11% to $642,000 for the
three months ended September 30, 1996 from $577,000 for the same period of 1995
and by 23% to $2,022,000 for the first nine months of 1996 from $1,642,000 for
the same period in 1995. Engineering and development expense is composed of
the salaries, personnel expenses and other expenses related to the Company's
network equipment systems integration, software development and technology
assessment activities. These expenses are incurred primarily to develop and
enhance network software and systems, to develop specialized software and
equipment for new customers, to conduct research and develop new service
offerings, and to build, test, maintain and modify existing network software and
systems. The Company has not capitalized any costs associated with software or
other development performed by its engineering and development groups.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased by 30% to $1,913,000
for the three months ended September 30, 1996 from $1,469,000 for the same
period of 1995 and by 36% to $5,650,000 for the first nine months of 1996 from
$4,158,000 for the same period in 1995. Selling, general and administrative
expenses include sales, marketing, finance, accounting and administrative costs.
The increase in these expenses is attributable to several factors. Additional
expenses were incurred as a result of an increase in administrative staff and
expenses associated with the growth of the Company. An increase in sales costs
resulting primarily from an increase in sales staff and salary expense also
contributed to the growth in selling, general and administrative expenses. On
June 30, 1995, TNS entered into a billing agreement with Intellicall whereby,
for a $1,500,000 prepayment, Intellicall provides billing services to TNS for
telecommunications services provided by TNS to customers whose contract rights
were acquired from Intellicall by TNS. During the third quarter of 1995, TNS
began recognizing the billing services expenses associated with the Intellicall
agreement and expects that it will have fully utilized the prepayment for these
services during the next four to six years, depending on the volume of
telecommunications services billed through this agreement. In March 1996, the
Company relocated to a new headquarters facility and began incurring lease
expense on the new building at that time. Increased lease costs and other
expenses related to the relocation also contributed to the growth in selling,
general and administrative expenses. Total lease costs and building expenses
related to the new headquarters facility are expected to be approximately
$750,000 for the full year of 1996.
DEPRECIATION
Depreciation expense increased by 29% to $1,053,000 for the three months
ended September 30, 1996 from $815,000 for the same period in 1995 and by 34% to
$2,970,000 for the first nine months of 1996 from $2,223,000 for
11
<PAGE>
the same period in 1995. Depreciation expense increased primarily as a
result of the acquisition of capital equipment for network expansion to
support growth in the Company's business. Capital expenditures for network
and office equipment amounted to $627,000 and $5,148,000 for the three and
nine month period ending September 30, 1996. Depreciation expense relating
to network and office equipment is recorded using the straight line method
over estimated useful lives ranging from three to five years.
AMORTIZATION OF INTANGIBLES
The amortization of intangible assets increased by 20% to $382,000 for the
three months ended September 30, 1996 from $318,000 for the same period of 1995
and by 38% to $1,100,000 for the first nine months of 1996 from $798,000 for the
same period in 1995. For the three and nine month periods, the increase
resulted from amortization of certain intangible assets acquired from
Intellicall for approximately $3,000,000 on June 30, 1995. On March 29, 1996,
the Company completed an asset purchase from AMNEX of AMNEX's proprietary
fraud-control system and related databases and entered into long term marketing
and service agreements with AMNEX. The Company paid approximately $1,500,000
million in cash for these assets. Amortization of all existing intangible
assets is expected to be approximately $400,000 per quarter over the next
several years.
INCOME TAXES
Provision for income taxes was $1,214,000 for the three months ended
September 30, 1996 and $912,000 for the same period in 1995 and $2,668,000 for
the first nine months of 1996 and $1,999,000 for the same period in 1995. The
effective tax rate in the nine month period ending September 30, 1995
was approximately 38%. In 1996, the effective tax rate has increased to
approximately 39% as a result of the Company's activities in Ireland,
where it has established a subsidiary.
NET INCOME AND EARNINGS PER SHARE
Net income increased by 25% to $1,867,000 for the three months ended
September 30, 1996 from $1,488,000 for the same period in 1995 and by 30% to
$4,239,000 for the first nine months of 1996 from $3,260,000 for the same period
in 1995. On April 18, 1996, the Company declared a 3-for-2 stock split of the
outstanding shares of Common Stock. This stock split entitled shareholders to
receive one additional share for each two outstanding shares of Common Stock
held of record as of the close of business on April 30, 1996. The payable date
was May 10, 1996. All share and per share data presented have been
retroactively adjusted to reflect the stock split. Earnings per share grew to
$0.15 for the three months ended September 30, 1996 from $0.13 for the same
period in 1995 and to $0.34 for the first nine months of 1996 from $0.29 for the
same period of 1995. The weighted average number of shares outstanding used to
calculate earnings per share increased to 12,618,000 for the three months ended
September 30, 1996 from 11,810,000 for the same period in 1995 and to 12,605,000
for the first nine months of 1996 from 11,211,000 for the same period of 1995.
Shares outstanding increased primarily because of the Company's stock offering
in August of 1995 in which 1,500,000 shares were issued by the Company (as
adjusted for the April 18, 1996 3-for-2 stock split).
12
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes sources and uses of cash from the
Company's Statement of Cash Flows for the nine month period ended September 30,
1996.
<TABLE>
<S> <C> <C>
Cash & equivalents as of December 31, 1995 $18,681,000
Net cash provided by operations $6,994,000
Investing activities:
Purchases of equipment (5,148,000)
Purchases of intangible assets (1,636,000)
Purchases of long-term investments (211,000)
Purchases of short-term investments (7,607,000)
Repayment of note receivable 3,600,000
Other investing activities 33,000
-----------
(10,969,000)
Financing activities:
Repayment of debt (18,000)
Other financing activities 570,000
-----------
552,000
Net decrease in cash & equivalents $(3,423,000)
-----------
Cash & equivalents as of September 30, 1996 $15,258,000
-----------
-----------
</TABLE>
At September 30, 1996, principal sources of liquidity were cash and cash
equivalents of $15,258,000, short term investments of $12,158,000, and a bank
line of credit of up to $1,000,000. The line of credit bears an interest rate of
2% above the prime rate of interest and was entirely unused as of September 30,
1996.
At September 30, 1996 the Company had long term commitments to purchase
capital equipment in the amount of approximately $3.2 million, of which
$1.7 million is contingent upon the vendor meeting delivery in accordance with
development milestones. Except for these arrangements, the Company does not have
long-term supply contracts with these or any other limited source vendors. On
September 21, 1995 the Company entered into a lease which commenced in March
1996 on an office building which the Company began to use as its headquarters
facility beginning in March 1996. The lease term is 12 years and calls for the
payment of approximately $620,000 in 1996, and for the payment to escalate every
year thereafter based a factor tied to the change in the Consumer Price Index,
but not to exceed 3% per annum, and for a fixed increase in year six of
approximately $67,000.
During the nine months ended September 30, 1996 operations provided
$6,994,000 in cash.
Investing activities used $10,969,000 in cash during the nine months ended
September 30, 1996. For the nine month period in 1996, purchases of equipment
used $5,148,000, the purchase of certain assets and agreements from AMNEX, Inc.
used $1,636,000, purchases of long term investment-grade fixed-income securities
with original maturities of more than one year used $211,000, purchases of
short-term investments with original maturities of less than one year but more
than three months used $7,607,000, repayment of a note receivable provided
$3,600,000 and other investing activities provided $33,000.
During the nine months ended September 30, 1996, financing activities
provided net cash of $552,000, repayment of debt used $18,000.
The Company believes that the proceeds from its 1995 public offering of
common stock, its other existing cash balances and line of credit, other current
assets and cash flow generated by operating activities will be sufficient to
meet the capital needs of its current business activities for the foreseeable
future.
13
<PAGE>
FORWARD LOOKING STATEMENTS
Statements in "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and elsewhere in this quarterly report that are not
descriptions of historical fact may be forward looking statements that are
subject to risks and uncertainties. Actual results could differ materially from
those currently anticipated due to a number of factors, including , but not
limited to, the Company's reliance on a limited number of major customers,
dependence on market expansion, competition, technological change and necessity
of developing new services, dependence on proprietary rights, changes in
government regulation and seasonality and fluctuations in quarterly results.
14
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. - Not Applicable
Item 2. Changes in Securities. - Not Applicable
Item 3. Default Upon Senior Securities. - Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders. - Not
Applicable
Item 6. Exhibits and Reports on Form 8-K .
(a.) Exhibits.
Financial Data Schedule.
(b.) Reports on Form 8-K. - None
15
<PAGE>
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.
Transaction Network Services, Inc.
(Registrant)
Date: November 14, 1996 By: /s/ John J. McDonnell, Jr.
---------------------------
John J. McDonnell, Jr.
President and Chief
Executive Officer
Date: November 14 , 1996 By: /s/ Brian K. Barnum
---------------------------
Brian K. Barnum
Chief Financial Officer
(Principal Financial Officer)
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CIK> 0000920231
<NAME> TRANSACTION NETWORK SERVICES
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 15,258
<SECURITIES> 12,158
<RECEIVABLES> 10,539
<ALLOWANCES> 398
<INVENTORY> 0
<CURRENT-ASSETS> 38,152
<PP&E> 23,152
<DEPRECIATION> 9,059
<TOTAL-ASSETS> 66,717
<CURRENT-LIABILITIES> 6,172
<BONDS> 0
0
0
<COMMON> 123
<OTHER-SE> 59,466
<TOTAL-LIABILITY-AND-EQUITY> 66,717
<SALES> 38,941
<TOTAL-REVENUES> 38,941
<CGS> 0
<TOTAL-COSTS> 21,539
<OTHER-EXPENSES> 11,742
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,907
<INCOME-TAX> 2,668
<INCOME-CONTINUING> 5,660
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,239
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.34
</TABLE>
