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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 March 31, 1997
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 April 28, 1997
12,347,017 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. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
----------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 12,344 $ 3,169
Short-term investments 16,289 15,700
Reverse repurchase agreements 6,102 11,566
Accounts receivable, net of allowance for doubtful
accounts of $658 and $598, respectively 7,702 9,350
Other current assets 999 617
-------- --------
Total current assets 43,436 40,402
-------- --------
EQUIPMENT, at cost:
Network equipment 22,596 21,472
Office equipment 3,601 2,688
Less - Accumulated depreciation (11,095) (10,074)
-------- --------
15,102 14,086
-------- --------
INTANGIBLE ASSETS:
Software and intangibles 13,769 13,772
Less - Accumulated amortization (3,570) (3,186)
-------- --------
10,199 10,586
-------- --------
OTHER ASSETS 862 909
LONG-TERM INVESTMENTS 50 2,568
-------- --------
Total assets $ 69,649 $ 68,551
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 5,607 $ 5,551
DEFERRED INCOME TAX, net of current amount 809 809
-------- --------
Total liabilities 6,416 6,360
-------- --------
STOCKHOLDERS' EQUITY
Common Stock 123 123
Additional paid-in capital 49,902 49,844
Unearned compensation (69) (76)
Retained Earnings 13,274 12,272
Foreign currency translation 3 28
-------- --------
Total stockholders' equity 63,233 62,191
-------- --------
Total liabilities and stockholders' equity $ 69,649 $ 68,551
======== ========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
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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
MARCH 31,
----------------------
1997 1996
-------- --------
<S> <C> <C>
Revenues $ 13,115 $ 10,933
Cost of network services 7,408 6,226
-------- --------
Gross profit 5,707 4,707
-------- --------
Other operating expenses:
Engineering & development 786 689
Selling, general & administrative 2,077 1,716
Depreciation 1,103 913
Amortization of intangibles 384 339
-------- --------
Total other operating expenses 4,350 3,657
-------- --------
Income from operations 1,357 1,050
Interest income 409 400
-------- --------
Income before provision for income taxes 1,766 1,450
Provision for income taxes 764 551
-------- --------
Net income $ 1,002 $ 899
======== ========
Net income per common and
equivalent share $ 0.08 $ 0.07
======== ========
Weighted average common and
equivalent shares outstanding 12,556 12,603
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
3
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TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
1997 1996
--------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,002 $ 899
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,487 1,252
Stock option compensation 7 7
Loss on disposal of equipment 49 -
Changes in assets and liabilities:
Accounts receivable 1,648 (528)
Other current assets (382) 94
Other assets 47 62
Accounts payable and accrued expenses 57 2,519
--------- ----------
Net cash provided by operating activities 3,915 4,305
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment (2,181) (2,680)
Sale (purchases) of intangible assets 3 (1,450)
Proceeds from disposal of equipment 12 7
Purchases of short-term investments (589) (1,644)
Net maturities (purchases) of reverse repurchase agreements 5,464 (1,081)
Maturities (purchases) of long-term investments 2,518 (6,083)
--------- ----------
Net cash provided by (used in) investing activities 5,227 (12,931)
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from options and employee stock purchase plan 58 164
Repayment of equipment notes and capital leases - (4)
--------- ----------
Net cash provided by financing activities 58 160
--------- ----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (25) -
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 9,175 (8,466)
CASH AND CASH EQUIVALENTS, beginning of period 3,169 15,539
--------- ----------
CASH AND CASH EQUIVALENTS, end of period $ 12,344 $ 7,073
========= ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Common Stock issued for 401k matching contribution $ - $ 161
Cash paid for income taxes 470 768
</TABLE>
The accompanying notes are an integral part of these statements.
4
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TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 three 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, and (3) international markets for the
Company's products and services. The Company provides participants in these
markets with 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 consolidated financial statements include the accounts of
Transaction Network Services, Inc., Fortune Telecommunications, Inc. ("FTI") and
Transaction Network Services Limited ("TNSL"). FTI was a wholly owned
subsidiary from the date of its acquisition, June 6, 1994, through February 28,
1995, when it was merged into TNS. TNSL, formed in June 1996, is a majority-
owned subsidiary located in Ireland. 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 month periods ended
March 31, 1997 and 1996 are not necessarily indicative of the results to be
expected for the full year.
STOCK SPLIT
In April 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. 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 an original maturity
of three months or less at the date of purchase to be cash equivalents.
At March 31, 1997 and December 31, 1996, the Company's securities
consisted primarily of money market accounts (classified as cash equivalents),
U.S. government and government agency securities, investment
5
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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.
REVENUE RECOGNITION
The Company recognizes POS and Telecom services revenue as the related
services are performed. Advance payments for services are deferred and
recognized as revenue when earned. POS services revenue 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 consulting
fees and equipment sales revenue. Revenue from maintenance and software licenses
will be recognized ratably over the term of the agreement. Revenue from
royalties will be recognized when earned.
RECLASSIFICATIONS
Certain reclassifications of prior period amounts have been made to
conform with current period presentation.
2. 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 accompanying balance sheets. The Company will amortize
the cost of these assets over five to 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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3. INCOME TAXES
- ----------------
The Company recorded a provision for income taxes of $764,000 and
$551,000 for the three month periods ended March 31, 1997 and 1996. During 1996,
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 anticipated annual effective income taxes for the three month period
ended March 31, 1997 is based upon the anticipated annual effective income tax
rate of 43.3%. 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 4.8
-----
Anticipated effective income tax rate 43.3%
=====
4. EARNINGS PER SHARE
- ----------------------
Earnings per common and equivalent share are based on the weighted-
average number of common equivalent shares outstanding during the periods.
Common equivalent shares includes the dilutive effect of all options
outstanding. Fully diluted earnings per share are not presented because the
difference between these amounts and the amounts presented is not material.
On March 3, 1997 the Financial Accounting Standards Board released
Statement No. 128, "Earnings Per Share." Statement 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 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 128, diluted
earnings per share will approximate previously reported primary earnings per
share under the Company's current capital structure. The pro-forma impact on
previously reported first quarter 1996 and 1997 earnings per share would be as
shown below.
<TABLE>
<CAPTION>
Quarter Ended March 31,
1997 1996
----------- ----------
<S> <C> <C>
Average shares outstanding 12,343,117 12,187,296
(basic earnings per share)
Stock option equivalents 212,735 416,017
---------- ----------
Average shares and equivalents
(diluted earnings per share) 12,555,852 12,603,313
========== ==========
Basic earnings per share $0.08 $0.07
Diluted earnings per share $0.08 $0.07
</TABLE>
7
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6. STOCK REPURCHASE
- --------------------
In December, 1996 the Board of Directors authorized the Company to
repurchase 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. On April 25, 1997
the Company purchased 15,000 shares at $10.50 per share. On May 2, 1997 the
Company purchased 1,500 shares at $11.75 per share and 50,000 shares at $11.87
per share.
8
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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 5.8 million in the first 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 three key service/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. 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 the sale of products and services in international
markets. In Ireland, the Company has formed a majority-owned
subsidiary which intends to provide POS network services in
Ireland in the future. The Company continues to actively market
its products and services to potential international customers.
In March 1997, the Company announced a new product line - TNS
FASTLink(R) data services. This new line of services is currently being deployed
and will offer a secure private network for transmitting securities trading
orders electronically between brokerage firms and financial institutions. TNS
FASTLink(R) services revenues consist of a one-time installation fee and fixed
monthly recurring revenues thereafter based on the number of connections. The
FASTLink(R) service offering will require the Company to build and support a
TCP/IP 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 customers,
dependence on market expansion, competition, technological change and necessity
of developing new services, dependence on proprietary rights, changes in
government regulation, seasonality and fluctuations in quarterly results.
9
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RESULTS OF OPERATIONS
- ---------------------
REVENUES
Total revenues increased by 20% to $13,115,000 for the three month
period ended March 31, 1997 from $10,933,000 for the same period in 1996. Of the
$2,182,000 increase for the three month period, 88% was due to the increased
usage of the TNS network by the Company's POS services customers and 12% was
contributed by Telecom service customers. 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 26% to $9,353,000 from $7,426,000 for
the first quarter of 1997 versus the comparable 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 52% to 519 million from 341 million transactions
for the first 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
21% for the three month period as compared to the same period in 1996. This
decline in average revenue per transaction occurred as a result of several
factors. 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 8% to $3,566,000 for the three
months ended March 31, 1997 from $3,309,0000 for 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 for the three month
periods, and from the inclusion of the revenues derived from the March 29, 1996
purchase of intangible assets, including an exclusive services agreement, from
AMNEX, Inc.
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 Commissions ("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
telephone proprietor
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("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 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 was $185,000 in the first quarter of 1997 and
$198,000 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. In Ireland, the Company has formed a majority-owned
subsidiary, Transaction Network Services Limited ("TNSL") which intends to
provide POS network services in Ireland in the future. TNSL is in a start-up
phase and has not generated revenue to date. TNSL losses to date are
approximately $540,000 including approximately $216,000 during the first quarter
of 1997. These losses are consolidated with the Company's operating results.
COST OF NETWORK SERVICES
Cost of network services increased by 19% to $7,408,000 for the three
months ended March 31, 1997 from $6,226,000 for 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 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 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.
11
<PAGE>
GROSS PROFIT
Gross profit increased by 21% to $5,707,000 for the three months ended
March 31, 1997 from $4,707,000 for the same period of 1996. This represents 44%
and 43% of total revenues for the first quarter of 1997 and 1996, respectively.
The 1% increase 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 offset by local access rate reductions and network efficiencies. The gross
margin on equipment sales was not significantly different from the gross margin
on network services during either quarter. 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. 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.
ENGINEERING AND DEVELOPMENT
Engineering and development expense increased by 14% to $786,000 for
the three months ended March 31, 1997 from $689,000 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 also increased as a result of 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 21% to
$2,077,000 for the three months ended March 31, 1997 from $1,716,000 for the
same period of 1996. 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. In March 1996, the Company
relocated to a new headquarters facility and began incurring increased lease
expense and other relocation expenses, as compared to its prior facilities.
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 21% to $1,103,000 for the three months
ended March 31, 1997 from $913,000 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 new 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. Depreciation expense
12
<PAGE>
relating to network and office equipment is recorded using the straight line
method over estimated useful lives ranging from three to five years.
Depreciation expense relating to leasehold improvements is recorded over the
lesser of the term of the lease or useful life of the improvement.
AMORTIZATION OF INTANGIBLES
The amortization of intangible assets increased by 13% to $384,000 for
the three months ended March 31, 1997 from $339,000 for the same period of 1996.
The increase resulted primarily from the asset purchase from AMNEX. In March
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 $764,000 for the three months ended
March 31, 1997 and $551,000 for the same period in 1996. The effective tax rate
has increased to approximately 43% 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 11% to $1,002,000 for the three months ended
March 31, 1997 from $899,000 for the same period in 1996. In April 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. All share and per share data have been
retroactively adjusted to reflect the stock split. Earnings per share grew to
$0.08 from $.0.07 during the first quarter of 1997. The weighted average number
of shares outstanding used to calculate earnings per share decreased to
12,556,000 from 12,603,000 during the first quarter of 1997 as compared to the
same period in 1996. Shares outstanding decreased primarily because of a lower
average stock price used in the Company's calculation of common equivalent
shares under the treasury stock method in the first quarter of 1997, than in
1996.
13
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The following table summarizes sources and uses of cash from the
Company's Consolidated Statement of Cash Flows for the three month period ended
March 31, 1997.
<TABLE>
<CAPTION>
<S> <C> <C>
Cash & equivalents as of December 31, 1996 $ 3,169,000
Net cash provided by operations $ 3,915,000
Investing activities:
Purchases of equipment (2,181,000)
Maturity of long-term investments 2,518,000
Purchases of short-term investments (589,000)
Net maturities of reverse repurchase agreements 5,464,000
Other investing activities 15,000
-----------
5,227,000
Financing activities: 58,000
Effect of exchange rate changes on cash (25,000)
Net decrease in cash & equivalents $ 9,175,000
-----------
Cash & equivalents as of March 31, 1997 $12,344,000
===========
</TABLE>
At March 31, 1997, principal sources of liquidity were cash and cash
equivalents of $12,344,000, short term investments of $16,289,000, 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 March 31,
1997.
At March 31, 1997 the Company had long term commitments to purchase
capital equipment in the amount of approximately $2.6 million over an 18 month
period, 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.
During the three months ended March 31, 1997 operations provided
$3,915,000 in cash.
Investing activities provided $5,227,000 in cash during the three months
ended March 31, 1997. For the three month period in 1997, purchases of equipment
used $2,181,000, maturity of long term investment-grade fixed-income securities
with original maturities of more than one year provided $2,518,000, purchases of
short-term investments with original maturities of less than one year but more
than three months used $589,000, maturities of reverse repurchase agreements
provided $5,464,000 and other investing activities provided $15,000.
During the three months ended March 31, 1997, financing activities
provided net cash of $58,000 and the effect on exchange rate changes on cash
was $25,000.
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.
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: May 13, 1997 By: /s/ John J. McDonnell, Jr.
----------------------------
John J. McDonnell, Jr.
President and Chief
Executive Officer
Date: May 13, 1997 By: /s/ Elizabeth A. Crawford
----------------------------------
Elizabeth A. Crawford
Chief Accounting Officer
(Principal Financial Officer)
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 12,334
<SECURITIES> 16,339
<RECEIVABLES> 8,360
<ALLOWANCES> 658
<INVENTORY> 0
<CURRENT-ASSETS> 43,436
<PP&E> 26,197
<DEPRECIATION> 11,095
<TOTAL-ASSETS> 69,649
<CURRENT-LIABILITIES> 5,607
<BONDS> 0
0
0
<COMMON> 123
<OTHER-SE> 63,110
<TOTAL-LIABILITY-AND-EQUITY> 69,649
<SALES> 13,115
<TOTAL-REVENUES> 13,115
<CGS> 0
<TOTAL-COSTS> 7,408
<OTHER-EXPENSES> 4,350
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,766
<INCOME-TAX> 764
<INCOME-CONTINUING> 1,357
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,002
<EPS-PRIMARY> .08
<EPS-DILUTED> .08
</TABLE>
