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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 June 30, 1997
Commission File Number: 0-23856
TRANSACTION NETWORK SERVICES, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE
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(State or jurisdiction of incorporation or organization)
54-1555332
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(I.R.S. Employer Identification Number)
1939 ROLAND CLARKE PLACE
RESTON, VA 20191
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(Address of principal executive offices)
(703) 453-8300
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(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 August 4, 1997
12,207,585 Shares of Common Stock, $0.01 par value
Page 1 of 15
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
------------- -------------
<S> <C> <C>
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 10,656 $ 3,169
Short-term investments 13,728 15,700
Reverse repurchase agreements 5,021 11,566
Accounts receivable, net of allowance for doubtful
accounts of $653 and $598, respectively 9,216 9,350
Other current assets 1,241 617
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Total current assets 39,862 40,402
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EQUIPMENT, at cost:
Network equipment 25,202 21,472
Office equipment 4,254 2,688
Less - Accumulated depreciation (12,198) (10,074)
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17,258 14,086
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INTANGIBLE ASSETS:
Software and intangibles 14,267 13,772
Less - Accumulated amortization (3,954) (3,186)
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10,313 10,586
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OTHER ASSETS 1,046 909
LONG-TERM INVESTMENTS 1,049 2,568
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Total assets $ 69,528 $ 68,551
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 6,136 $ 5,551
DEFERRED INCOME TAX, net of current amount 809 809
------------- -------------
Total liabilities 6,945 6,360
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STOCKHOLDERS' EQUITY
Common Stock, $0.01 par value, 20,000 shares authorized,
12,376 and 12,328 shares issued respectively 123 123
Additional paid-in capital 50,109 49,844
Treasury Stock, 211 shares, at cost (2,491) ---
Unearned compensation (61) (76)
Retained Earnings 14,883 12,272
Foreign currency translation 20 28
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Total stockholders' equity 62,583 62,191
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Total liabilities and stockholders' equity $ 69,528 $ 68,551
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
2
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TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues $ 15,444 $ 13,168 $ 28,559 $ 24,101
Cost of network services 8,614 7,147 16,022 13,373
---------- ---------- ---------- ----------
Gross profit 6,830 6,021 12,537 10,728
---------- ---------- ---------- ----------
Other operating expenses:
Engineering & development 827 691 1,613 1,380
Selling, general & administrative 2,121 2,021 4,198 3,737
Depreciation 1,173 1,004 2,276 1,917
Amortization of intangibles 384 379 768 718
---------- ---------- ---------- ----------
Total other operating expenses 4,505 4,095 8,855 7,752
---------- ---------- ---------- ----------
Income from operations 2,325 1,926 3,682 2,976
Interest Income 432 450 841 850
---------- ---------- ---------- ----------
Income before provision for income taxes 2,757 2,376 4,523 3,826
Provision for income taxes 1,148 903 1,912 1,454
---------- ---------- ---------- ----------
Net income $ 1,609 $ 1,473 $ 2,611 $ 2,372
========== ========== ========== ==========
Net income per common and
equivalent share $ 0.13 $ 0.12 $ 0.21 $ 0.19
========== ========== ========== ==========
Weighted average common and
equivalent shares outstanding 12,560 12,710 12,545 12,624
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
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TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,611 $ 2,372
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,044 2,635
Stock option compensation 15 15
Loss on disposals of equipment 55 7
Changes in assets and liabilities:
Accounts receivable 134 (963)
Other current assets (624) 32
Other assets (137) 344
Accounts payable and accrued expenses 585 25
----------- -----------
Net cash provided by operating activities 5,683 4,467
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment (5,534) (4,665)
Purchases of intangible assets (495) (1,465)
Proceeds from disposal of equipment - 13
Repayment of note receivable - 3,600
Maturities (purchases) of short-term investments 1,972 (4,428)
Maturities (purchases) of reverse repurchase agreements 6,545 (4,705)
Maturities (purchases) of long-term investments 1,519 (3,475)
----------- -----------
Net cash provided by (used in) investing activities 4,007 (15,125)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from options and employee stock purchase plan 265 615
Purchases of treasury stock (2,491) -
Repayment of equipment notes and capital leases - (14)
----------- -----------
Net cash (used in) provided by financing activities (2,226) 601
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 23 -
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 7,487 (10,057)
CASH AND CASH EQUIVALENTS, beginning of period 3,169 15,539
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 10,656 $ 5,482
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Common Stock issued for 401k matching contribution $ - $ 161
Cash paid for income taxes 1,800 1,512
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
4
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TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(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 four primary markets through its service offerings: (1) the
domestic point-of-sale/point-of-service ("POS") transaction market through its
TransXpress(R) network services, (2) the domestic telephone call billing
validation and fraud control market through its CARD*TEL(R) telecommunications
services, (3) international markets for the Company's products and services, and
(4) network service in support of the Financial Interface eXchange ("FIX")
messaging protocol through its TNS FASTlink(R) Data Services.
The consolidated financial statements include the accounts of Transaction
Network Services, Inc. and Transaction Network Services Limited ("TNSL"). TNSL,
formed in June 1996, is a majority-owned subsidiary located in Ireland.
Significant intercompany accounts have been eliminated in consolidation.
The condensed consolidated 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 six month periods ended June 30,
1997 and 1996 are not necessarily indicative of the results to be expected for
the full year.
Financial Instruments
The Company considers all securities purchased with an original maturity of
three months or less at the date of purchase to be cash equivalents. The Company
has not used derivatives.
At June 30, 1997 and December 31, 1996, the Company's securities consisted
primarily of money market mutual funds (classified as cash equivalents), U.S.
government and government agency securities, investment grade corporate bonds,
and overnight reverse repurchase agreements, all of which the Company has both
the positive intent and ability to hold until maturity. These securities are
reported at amortized cost.
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:
Current Assets and Current Liabilities
The carrying amount approximates fair value because of the short maturity
of those instruments.
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.
5
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2. INCOME TAXES
- ----------------
During 1997, the effective tax rate increased as a result of operating losses
generated by TNSL's activities in Ireland. TNSL intends to provide POS network
services in Ireland by the end of 1997. Failure to successfully implement these
services in a timely manner may result in further adverse effects on future
effective tax rates. The Company has not recorded a tax asset for these losses
due to TNSL's brief operating history. If TNSL becomes profitable, TNSL may
cause a reduction in the effective tax rate due to a lower effective tax rate in
Ireland than in the United States. The anticipated annual effective income
taxes for the six month period ended June 30, 1997 is based upon the anticipated
annual effective income tax rate. 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 4.5
Effect of TNSL losses 3.8
----
Anticipated effective income tax rate 42.3%
====
3. EARNINGS PER SHARE
- ----------------------
On March 3, 1997 the Financial Accounting Standards Board ("FASB") released
Statement No. 128, "Earnings Per Share." Statement No. 128 requires dual
presentation of basic and diluted earnings per share on the face of the income
statement for all periods presented. Basic earnings per share excludes dilution
and is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted earnings per share is computed similarly
to fully diluted earnings per share pursuant to Accounting Principles Bulletin
No. 15. Statement No. 128 is effective for fiscal years ending after December
15, 1997 and, when adopted will require restatement of prior years' earnings per
share.
The Company anticipates that upon implementing Statement No. 128, diluted
earnings per share will approximate previously reported primary earnings per
share under the Company's current capital structure. Basic earnings per share
under Statement No. 128 may be greater than amounts previously presented as
primary earnings per share due to the exclusion of common stock equivalents
(stock options) from shares outstanding. The pro-forma impact of Statement No.
128 on previously reported second quarter 1997 and 1996 earnings per share would
be as shown below.
6
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<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average shares outstanding
(basic earnings per share) 12,255,935 12,247,358 12,310,455 12,217,326
Stock option equivalents 304,087 462,448 304,087 405,125
---------- ---------- ---------- ----------
Weighted average shares and equivalents
(diluted earnings per share) 12,560,022 12,709,806 12,614,542 12,622,451
---------- ---------- ---------- ----------
Basic earnings per share $ 0.13 $ 0.12 $ 0.21 $ 0.19
Diluted earnings per share $ 0.13 $ 0.12 $ 0.21 $ 0.19
</TABLE>
4. TREASURY STOCK PURCHASES
- ----------------------------
In December, 1996 the Board of Directors authorized the Company to purchase
up to 1,000,000 shares of its issued and outstanding common stock, such
purchases to be effected from time to time on the Nasdaq National Market and/or
by block purchases, as determined by the officers of the Corporation. Purchased
shares will be held in treasury for use in funding the Company's stock option
program, or such other uses as the Board may approve. During the second quarter
ending June 30, 1997, the Company purchased a total of 211,500 shares for
approximately $2.5 million.
5. RECENT AUTHORITATIVE PRONOUNCEMENTS
- ---------------------------------------
In July, 1997, the FASB issued Statement No. 130 "Reporting Comprehensive
Income" and Statement No. 131 "Disclosures About Segments of an Enterprise and
Related Information." Statement No. 130 requires the Company to present an
aggregate amount of "comprehensive income" and the components of "other
comprehensive income" in its December 31, 1998 financial statements and/or notes
thereto. The Company's only component of "other comprehensive income" consists
of foreign currency translation adjustments and has not been material. Statement
No. 131 will require the Company to disclose segment information using a
"management approach" beginning with its December 31, 1998 financial statements.
7
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Item 2.
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
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 6.4 million in the second quarter of 1997. 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 four primary markets/product offerings:
(1) POS services include the Company's TransXpress(R) network services for
the POS transaction processing industry.
(2) Telecom services include FTI's CARD*TEL(R) telephone call billing
validation and fraud control services and other services targeted
primarily to the telecommunications industry.
(3) International activities - In 1996, the Company began to recognize
revenue from the sale of products and services in international
markets. In Ireland, the Company has formed Transaction Network
Services Limited ("TNSL") a majority-owned subsidiary to provide POS
network services in Ireland. The Company continues to actively market
its products and services to potential international customers.
(4) In March 1997, the Company announced the formation of a new division -
Financial Services Division and a new product line - TNS FASTLink(R)
Data Services. This new line of services is currently being deployed
and will offer network services in support of the Financial Interface
eXchange ("FIX") messaging protocol between brokerage firms and
financial institutions. TNS FASTLink(R) Data Services revenues will
consist of a one-time installation fee and fixed monthly recurring
revenues thereafter based on the number of connections. The TNS
FASTLink(R) Data Services offering will require the Company to build
and support a backbone network as well as acquire a significant amount
of dedicated hardware. Current facilities are sufficient to house the
additional required hardware. The Company does not expect to generate
significant revenues from this new service during 1997.
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 suppliers and
customers, dependence on market expansion, competition, technological change,
the ability to develop new services, dependence on proprietary rights, changes
in government regulation, seasonality and fluctuations in quarterly results.
8
<PAGE>
RESULTS OF OPERATIONS
- ---------------------
REVENUES
Total revenues increased by 17% to $15,444,000 for the three month period
ended June 30, 1997 from $13,168,000 for the same period in 1996 and by 18% to
$28,559,000 for the first six months of 1997 from $24,101,000 for the same
period in 1996. Of the increase for the three and six month periods, 41% and
64%, respectively, was due to the increased usage of the TNS network by the
Company's POS services customers and telecommunications service customers
contributed 61% and 37%. International revenues and TNS FASTLink(R) Data
Services revenues were relatively immaterial for all periods presented.
POS services revenue increased by 10% to $10,518,000 from $9,582,000 for
the three months ended June 30, 1997 versus the comparable period in 1996 and by
17% to $19,871,000 from $17,008,000 for the first six months of 1997 versus the
same period in 1996. 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 21% to 584 million
from 483 million transactions for the second quarter of 1997 versus 1996.
The transaction volume growth rate exceeded the revenue growth rate
primarily because the average revenue per transaction declined by approximately
12% for the three month period as compared to the same period in 1996. A number
of the Company's largest customers reached predetermined levels of transaction
volumes per month, qualifying these customers for volume discounts. Also, during
1996 the Company re-negotiated contracts with most of its largest customers.
Several of these contracts call for a single flat rate basic price structure
with increasing volume commitments during the life of the contract, rather than
volume discounts which become effective only after certain volume thresholds are
met. In exchange for extending the term of these contracts, the customers
received significant price reductions. The majority of these customers benefited
from the re-negotiated contracts during 1996; however, the remaining contracts
took effect January 1, 1997. The full anticipated effect of the 1996 contract
re-negotiations was reflected in the average revenue per POS transaction during
the first quarter of 1997. Future average revenue per POS transaction will
depend on the relative contribution to total transaction volume from each of the
Company's sources of POS transactions. Increasing competition from other network
service providers could also contribute to future declining prices per
transaction.
Telecommunications revenue increased by 41% to $4,766,000 from $3,387,000
for the three months ended June 30, 1997 and by 24% to $8,332,000 from
$6,696,000 for the first six months of 1997 versus the same period in 1996. 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.
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 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
affected 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 "1996 Act"), the Federal
Communications Commission ("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
9
<PAGE>
originate on the pay phone service providers facilities but which are routed to
telecommunications carriers other than those pre-subscribed by the telephone
proprietor ("dial-around compensation"). In October 1996, an interim solution
for "dial-around compensation" was announced by the FCC. 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 customer base for
fraud control and billing validation services relies. Recently, several Local
Exchange Carriers ("LECS") 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 types 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 was $114,000 in the second quarter of 1997 and
$199,000 for the same period in 1996 and $299,000 for the first six month period
of 1997 and $397,000 for the same period in 1996. The revenue primarily
consisted of 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. These fees are based on the POS revenues
generated by its international customers resulting from the use of the Company's
POS technology. Management expects to begin to recognize royalty revenue under
these arrangements in 1997. TNSL will provide POS network services in Ireland.
TNSL is in a start-up phase and has not generated revenue to date. TNSL losses
were approximately $224,000 during the second quarter of 1997. These losses are
consolidated with the Company's operating results.
COST OF NETWORK SERVICES
Cost of network services increased by 21% to $8,614,000 from $7,147,000 for
the three months ended June 30, 1997 and by 20% to $16,022,000 from $13,373,000
for the first six months of 1997 versus the same period in 1996. 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,
from increases in other network capacity costs, and cost of goods sold related
to certain equipment sales.
The reduction in average revenue per transaction for POS network services
was offset by several factors. 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 its consumption of these services has
increased. In August 1995, a reduction in the cost per minute of usage for
local access charged by LECs went into effect by FCC mandate, effectively
reducing the Company's variable cost per transaction. In July 1996, most of the
major LECs modestly reduced the cost per minute rate charged for local access.
However, several of the carriers substantially increased certain rate elements
which had the effect of raising their effective per minute rate, more than
offsetting the benefit of cost reductions from the other carriers. On May 7,
1997, the FCC, pursuant to the 1996 Act, adopted changes to the current system
of interstate access charges. The Company has recently obtained impact
statements from certain LEC's which have shown a decrease in access charges
effective July 1, 1997. The final impact of Access Charge Reform on the
Company's future network access costs is unknown but could have a material
effect on the Company's current cost structure.
10
<PAGE>
GROSS PROFIT
Gross profit increased by 13% to $6,830,000 for the three months ended June
30, 1997 from $6,021,000 for the same period of 1996 and by 17% to $12,537,000
for the first six months of 1997 from $10,728,000 for the same period in 1996.
This represents 44% and 45% of total revenues for the six month period of 1997
and 1996, respectively. The 1% decrease in gross profit as a percentage of total
revenues reflects the fact that the reduction in average revenue per POS
transaction over the periods was not fully offset by local access rate
reductions and network efficiencies. The future level of the gross profit margin
depends on a 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. On May 7, 1997, the
FCC, pursuant to the 1996 Act, adopted changes to the current system of
interstate access charges. The final impact of Access Reform on the Company's
future network costs is unknown but could have a material effect on the
Company's gross profit margin.
ENGINEERING AND DEVELOPMENT
Engineering and development expenses increased by 20% to $827,000 for the
three months ended June 30, 1997 from $691,000 for the same period of 1996 and
by 17% to $1,613,000 for first six months of 1997 from $1,380,000 for the same
period of 1996. 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. Engineering and development
expenses increased as a result of the growth of the Company and the formation of
TNSL in July 1996. Failure to successfully implement the Ireland POS services in
a timely manner may result in increased engineering and development costs as a
percentage of total revenue. The Company has not capitalized any costs
associated with software or other development performed by its engineering and
development groups. Future engineering and development costs may increase due to
additional resource requirements associated with the introduction of new product
services.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased by 5% to $2,121,000
for the three months ended June 30, 1997 from $2,021,000 for the same period of
1996 and by 12% to $4,198,000 for the first six months of 1997 from $3,737,000
for the same period in 1996. Selling, general and administrative expenses
include sales, marketing, finance, accounting and administrative costs. The
increase in these expenses is attributable to growth of the Company and an
increase in sales staff. Selling, general and administrative expenses also
increased as a result of the formation of TNSL. Failure to successfully
implement the Ireland POS services in a timely manner may result in increased
selling, general and administrative costs as a percentage of total revenue.
DEPRECIATION
Depreciation expense increased by 17% to $1,173,000 for the three months
ended June 30, 1997 from $1,004,000 for the same period in 1996 and by 19% to
$2,276,000 for the first six months of 1997 from $1,917,000 for the same period
in 1996. Depreciation expense includes network and office equipment as well as
leasehold improvements associated with the build-out of the Company's
headquarters and network site facilities. Depreciation expense increased
primarily as a result of the acquisition of capital equipment for network
expansion to support growth in the Company's business.
11
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AMORTIZATION OF INTANGIBLES
The amortization of intangible assets was relatively unchanged for all
periods presented. 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 $1,912,000 for the first six months of 1997
and $1,454,000 for the same period in 1996. The effective tax rate has increased
from 38% to 42% as a result of the Company's activities in Ireland. Continued
losses experienced by TNSL may continue to increase the Company's future
effective tax rate. The Company has not recorded a tax asset for these losses
due to TNSL's brief operating history. If TNSL becomes profitable, TNSL may
cause a reduction in the effective tax rate due to a lower effective tax rate in
Ireland than in the United States.
NET INCOME AND EARNINGS PER SHARE
Net income increased by 9% to $1,609,000 for the three months ended June
30, 1997 from $1,473,000 for the same period in 1996 and by 10% to $2,611,000
for the first six months of 1997 from $2,372,000 for the same period in 1996.
Earnings per share grew to $0.13 from $.0.12 during the second quarter of 1997.
The weighted average number of shares outstanding used to calculate earnings per
share decreased to 12,560,000 from 12,710,000 during the second quarter of 1997
as compared to the same period in 1996. Shares outstanding decreased primarily
because of the acquisition of 211,500 treasury shares during the second quarter
of 1997 and a lower average stock price used in the Company's calculation of
common equivalent shares under the treasury stock method in the second quarter
of 1997, than in 1996.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The following table summarizes sources and uses of cash from the Company's
Consolidated Statement of Cash Flows for the six month period ended June 30,
1997.
Cash & equivalents as of December 31, 1996 $ 3,169,000
Net cash provided by operations $ 5,683,000
Investing activities:
Purchases of equipment (5,534,000)
Maturities of investments 10,036,000
Other investing activities (495,000)
-----------
4,007,000
Financing activities:
Purchases of treasury stock (2,491,000)
Other financing activities 265,000
-----------
(2,226,000)
Effect of exchange rate changes on cash 23,000
Net increase in cash & equivalents $ 7,487,000
-----------
Cash & equivalents as of June 30, 1997 $10,656,000
===========
At June 30, 1997, principal sources of liquidity were cash and cash
equivalents of $10,656,000, short term investments of $13,728,000, reverse
repurchase agreements of $5,021,000, 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 has not been used in 1997.
12
<PAGE>
At June 30, 1997 the Company had long term commitments to purchase capital
equipment in the amount of approximately $4.7 million over an 18 month period,
of which $1.2 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 of its
vendors.
The Company believes that its existing cash, investment balances, line of
credit and cash flows generated by operations will be sufficient to meet the
capital needs of its current business activities for the foreseeable future.
13
<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.
The Annual Meeting of Stockholders was held on April 22, 1997 at TNS
Headquarters, 1939 Roland Clarke Place, Reston, Virginia 20191.
The stockholders voted on the following matters as set forth in the
proxy statement:
1. Election of Directors. The stockholders voted to elect two
---------------------
Class III directors, William N. Melton and Paolo L. Guidi, to three-
year terms expiring at the annual meeting of stockholders in 2000.
The voting tabulation for each nominee was as follows:
William N. Melton - 10,285,824 votes in favor of election and
593,287 votes withheld.
Paolo L. Guidi - 10,324,611 votes in favor of election and 554,500
votes withheld.
The Company has a staggered board. In addition to the two Class III
directors elected at the annual meeting of stockholders, the board
has two Class I directors whose terms expire at the annual meeting
in 1998: John S. McCarthy and Henry R. Nichols; and two Class II
directors whose terms expires at the annual meeting in 1999: John J.
McDonnell, Jr., and Jurgen Manchot.
2. Increase in the Common Stock Subject to the 1994 Stock Option
-------------------------------------------------------------
Plan. The stockholders approved an increase in the aggregate number
of shares of Common Stock authorized for issuance under the
Company's 1994 Stock Option Plan, as amended, from 600,000 to
1,800,000 shares. The voting tabulation was as follows: 7,286,661
votes in favor of the increase; 2,047,716 votes against the
increase; 30,258 abstentions; and 1,514,476 votes withheld.
3. Ratification of Independent Accountants. The stockholders
---------------------------------------
ratified the selection of Arthur Andersen LLP as the Company's
independent accountants for the current fiscal year. The voting
tabulation was as follows: 10,874,001 votes in favor of the
ratification; 2,750 votes against the ratification; 2,350
abstentions; and no votes withheld.
Item 6. Exhibits and Reports on Form 8-K .
(a.) Exhibits.
Financial Data Schedule.
(b.) Reports on Form 8-K. - None
14
<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: August 9, 1997 By: /s/ John J. McDonnell, Jr.
-----------------------------
John J. McDonnell, Jr.
President and Chief
Executive Officer
Date: August 9 , 1997 By: /s/ Thaddeus Weed
----------------------------------
Thaddeus Weed
Chief Financial Officer
(Principal Financial Officer)
15
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