<PAGE>
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, 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 November 10, 1997
12,231,811 Shares of Common Stock, $0.01 par value
Page 1 of 15
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
--------------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.................. $10,271 $ 3,169
Short-term investments..................... 17,430 27,266
Accounts receivable, net of allowance
for doubtful accounts of $650 and
$598, respectively........................ 10,365 9,350
Other current assets....................... 1,201 617
------ ------
Total current assets..................... 39,267 40,402
------ ------
EQUIPMENT, at cost:
Network equipment.......................... 27,999 21,472
Office equipment........................... 4,601 2,688
Less--Accumulated depreciation............. (13,406) (10,074)
------ ------
19,194 14,086
------ ------
INTANGIBLE ASSETS:
Software and intangibles................... 13,864 13,772
Less--Accumulated amortization............. (4,342) (3,186)
------ ------
9,522 10,586
------ ------
OTHER ASSETS................................. 857 909
LONG-TERM INVESTMENTS........................ 4,699 2,568
------ ------
Total assets............................. $73,539 $68,551
------ ------
------ ------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses...... $7,499 $5,551
DEFERRED INCOME TAX, net of current amount... 774 809
------ ------
Total liabilities........................ 8,273 6,360
------ ------
STOCKHOLDERS' EQUITY
Common Stock, $0.01 par value, 20,000
shares authorized, 12,441 and 12,328
shares issued, respectively............... 124 123
Additional paid-in capital................. 50,602 49,844
Treasury Stock, 211 shares, at cost........ (2,491) --
Unearned compensation...................... (54) (76)
Retained Earnings.......................... 17,139 12,272
Foreign currency translation............... (54) 28
------ ------
Total stockholders' equity............... 65,266 62,191
------ ------
Total liabilities and stockholders'
equity.................................. $73,539 $68,551
------ ------
------ ------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues.............................................................. $ 17,170 $ 14,840 $ 45,729 $ 38,941
Cost of network services.............................................. 9,540 8,166 25,562 21,539
--------- --------- --------- ---------
Gross profit.......................................................... 7,630 6,674 20,167 17,402
--------- --------- --------- ---------
Other operating expenses:
Engineering & development........................................... 921 642 2,534 2,022
Selling, general & administrative................................... 1,998 1,913 6,196 5,650
Depreciation........................................................ 1,225 1,053 3,501 2,970
Amortization of intangibles......................................... 388 382 1,156 1,100
--------- --------- --------- ---------
Total other operating expenses........................................ 4,532 3,990 13,387 11,742
--------- --------- --------- ---------
Income from operations................................................ 3,098 2,684 6,780 5,660
Interest income....................................................... 542 397 1,383 1,247
--------- --------- --------- ---------
Income before provision for income taxes.............................. 3,640 3,081 8,163 6,907
Provision for income taxes............................................ 1,384 1,214 3,296 2,668
--------- --------- --------- ---------
Net income............................................................ $ 2,256 $ 1,867 $ 4,867 $ 4,239
--------- --------- --------- ---------
--------- --------- --------- ---------
Net income per common and equivalent share............................ $ 0.18 $ 0.15 $ 0.39 $ 0.34
--------- --------- --------- ---------
--------- --------- --------- ---------
Weighted average common and equivalent shares outstanding............. 12,755 12,618 12,641 12,605
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
<PAGE>
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income................................................................................. $ 4,867 $ 4,239
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................................ 4,657 4,070
Stock option compensation................................................................ 22 22
Loss on disposals of equipment........................................................... 55 16
Deferred income taxes.................................................................... (35) --
Changes in assets and liabilities:
Accounts receivable.................................................................... (1,015) (2,425)
Other current assets................................................................... (584) 35
Other assets........................................................................... 52 419
Accounts payable and accrued expenses.................................................. 1,948 618
--------- ---------
Net cash provided by operating activities............................................ 9,967 6,994
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment................................................................... (8,664) (5,148)
Purchases of intangible assets........................................................... (100) (1,636)
Proceeds from disposals of equipment..................................................... -- 33
Collection of note receivable............................................................ -- 3,600
Maturities (purchases) of short-term investments......................................... 9,836 (14,840)
Purchases of long-term investments....................................................... (2,131) (211)
--------- ---------
Net cash used in investing activities.................................................. (1,059) (18,202)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from options and employee stock purchase plan................................... 759 570
Purchases of treasury stock.............................................................. (2,491) --
Repayment of equipment notes and capital leases.......................................... -- (18)
--------- ---------
Net cash (used in) provided by financing activities.................................... (1,732) 552
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH...................................................... (74) --
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS................................................................................. 7,102 (10,656)
CASH AND CASH EQUIVALENTS, beginning of period............................................... 3,169 15,539
--------- ---------
CASH AND CASH EQUIVALENTS, end of period..................................................... $ 10,271 $ 4,883
--------- ---------
--------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Common Stock issued for 401k matching contribution....................................... $ -- $ 165
Cash paid for income taxes............................................................... 3,231 2,250
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
4
<PAGE>
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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-Registered Trademark-network
services, (2) the domestic telephone call billing validation and fraud control
market through its CARD*TEL-Registered Trademark- 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-Registered Trademark- Data Services.
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 nine month periods ended September
30, 1997 and 1996 are not necessarily indicative of the results to be
expected for the full year.
2. 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 Company. 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 1997, the Company purchased a total of 211,500 shares for
approximately $2.5 million.
3. OTHER INVESTMENTS
In the third quarter of 1997, in connection with obtaining
new customers for the Company's service offerings, the Company made certain
strategic investments.
The Company obtained a five year exclusive network data mover
agreement and joint marketing agreement from a customer. The Company
invested $2.0 million in this customer in the form of subordinated
convertible debt. Interest is payable each August, beginning in August 1998.
Alternatively, the customer may issue an additional note equal to the
accrued interest on terms and with rights identical to the original $2.0
million note. At any time, the Company may convert all or any portion of the
principal plus accrued interest into a minority interest in the customers'
common stock. The customer may redeem up to 50% of the debt at any time up
until August 1999 at a specified annual internal rate of return. The
principal and any unpaid accrued interest matures in August 2005, and as a
result, the investment is recorded as a long-term investment in the
accompanying consolidated balance sheet.
5
<PAGE>
The Company obtained agreements to provide
CARD*TEL-Registered Trademark-services for a five year period from a
customer. The Company paid this customer $500,000 for a software license to
use the customers' proprietary call monitoring and screening system and
related databases along with an option (the "Option") to purchase a minority
ownership interest in the customer. The Option is exercisable beginning in
June 1998 and expires in June 2002. The customer may cancel a portion of the
Option at an escalating call price. The Company is amortizing the cost of
the software license over five years. The Company also loaned the customer
$250,000 as a term loan (the "Term Loan") and $1.2 million under a secured
revolving credit agreement (the "Revolver"). All amounts due under the
Revolver were repaid with accrued interest in October 1997 when the Revolver
was canceled. As a result, the Revolver is classified as a short-term
investment in the accompanying consolidated balance sheet. The Term Loan is
secured by certain collateral, interest is payable monthly, and principal
payments are due in three annual payments on the next three loan anniversary
dates.
The Company also loaned a customer $500,000 under a secured
term loan. Interest is payable monthly and principal is due no later than
February 1998. As a result, this investment is recorded as a short-term
investment in the accompanying consolidated balance sheet.
4. ACQUISITION
In October 1997, the Company acquired a majority interest in
Pronoma Systems AB through its majority owned Irish subsidiary for an
immaterial amount of cash in an acquisition to be accounted for as a
purchase. Accordingly, the operating results of Pronoma will be included in
the Company's operating results from the date of acquisition. The new
company will be named Transaction Network Services AB and will operate as a
TNS subsidiary located in Stockholm, Sweden.
RECENT AUTHORITATIVE PRONOUNCEMENTS
On March 3, 1997 the Financial Accounting Standards Board
("FASB") released Statement No. 128, "Earnings Per Share." Statement No. 128
requires a 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. Diluted earnings
per share is computed similarly to fully diluted earnings per share pursuant
to Accounting Principles Bulletin No. 15. The Company has not presented fully
diluted earnings per share as the difference between these amounts and
primary earnings per share was not material. 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 third quarter
1997 and 1996 earnings per share is shown below.
6
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average shares outstanding
(basic earnings per share)........... 12,229,186 12,283,227 12,325,394 12,239,453
Stock option equivalents.............. 525,671 334,873 315,320 365,908
---------- ---------- ---------- ----------
Weighted average shares and equivalents
(diluted earnings per share)......... 12,754,857 12,618,100 12,640,714 12,605,361
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic earnings per share............. . $0.18 $0.15 $0.39 $0.35
Diluted earnings per share............ $0.18 $0.15 $0.39 $0.34
</TABLE>
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.
6. LINE OF CREDIT ARRANGEMENT
In July 1997, the Company obtained a $5.0 million line of
credit arrangement which expires in 1998. Outstanding borrowings accrue
interest at the prime rate. The Company has had no borrowings under this
facility.
7
<PAGE>
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. 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 6.8 million in the third quarter of
1997. In June 1994, the Company acquired Fortune Telecommunications, Inc.
("FTI") of Ft. Lauderdale, Florida, which provides customers in the
telecommunications industry with telephone call fraud control and billing
validation services. In June 1996, the Company formed Transaction Network
Services Limited ("TNSL"), a majority-owned subsidiary, to provide POS
network services in Ireland. In October 1997, the Company acquired a majority
interest in Pronoma Systems AB through TNSL. This company will be renamed
Transaction Network Services AB ("TNSAB") and will operate as a TNS
subsidiary located in Stockholm, Sweden.
The Company is organized around its four primary markets/product offerings:
(1) POS services include the Company's domestic TransXpress-Registered
Trademark-network services for the POS transaction processing
industry.
(2) Telecom services include FTI's CARD*TEL-Registered Trademark-domestic
telephone call billing validation and fraud control services and other
services targeted primarily to the telecommunications industry.
(3) International activities - The Company continues to actively market
its products and services to potential international customers through
TNSL, TNSAB and its technology transfer arrangements.
(4) TNS FASTLink-Registered Trademark-Data Services- This new line of
services is currently being deployed and will initially offer domestic
network services in support of the Financial Interface eXchange
("FIX") messaging protocol between brokerage firms and financial
institutions. 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 15.7% to $17,170,000 for the three
month period ended September 30, 1997 from $14,840,000 for the same period in
1996 and by 17.4% to $45,729,000 for the first nine months of 1997 from
$38,941,000 for the same period in 1996. Of the increase for the three and
nine month periods, $1,285,000 and $4,148,000, respectively, was due to the
increased usage of the TNS network by the Company's POS services customers
and $1,971,000 and $3,606,000, respectively, was due to an increase in
revenues from telecommunications service customers. International revenues
declined to $200,000 from $1,205,000 from the comparable 1996 quarter, and to
$498,000 from $1,603,000 for the comparable nine month periods. The decrease
was mainly due to $1,100,000 of certain equipment sales completed in the
third quarter of 1996. TNS FASTLink-Registered Trademark- Data Services
revenues were relatively immaterial for all periods presented. TNS
FASTLink-Registered Trademark-Data Services revenues will consist of a
one-time installation fee and fixed monthly recurring revenues thereafter
based on the number of connections.
POS services revenue increased by 13.0% to $11,145,000 from
$9,860,000 for the three months ended September 30, 1997 versus the
comparable period in 1996 and by 15.4% to $31,016,000 from $26,868,000 for
the first nine 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 19.9% to 626 million transactions for the
third quarter of 1997 from 522 million transactions in the third quarter of
1996.
The POS transaction volume growth rate exceeded the revenue
growth rate for the comparable quarter primarily because the average revenue
per POS transaction declined by approximately 10% for the comparable three
month periods. 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. The
decline in POS revenue per transaction has stabilized in 1997 and revenue per
POS transaction has been relatively constant for all 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 and
increasing competition.
Telecommunications services revenue increased by 52.2% to
$5,746,000 from $3,775,000 for the three months ended September 30, 1997 and
by 34.4% to $14,076,000 from $10,470,000 for the first nine months of 1997
versus the same period in 1996. The growth in revenue was primarily 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 through the addition of new customers, increasing queries
from existing customers, the acquisition of contract rights and other
intangible assets, and the provision of new service offerings. 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 originating 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 a result, "dial-around" offerings may continue
to have a negative impact on Telecom Services Division revenues.
9
<PAGE>
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 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 1997, the FCC
established a rate of $0.284 as the default per-call compensation rate for
subscriber 800 and access code calls made from payphones during the next two
years. After the first two years of per-call compensation, a payphone's
market-based local coin rate adjusted for certain costs will become the
default rate. While it is uncertain what impact the new rules will have on
"dial-around" usage and therefore on demand for traditional TNS 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. 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 $200,000 in the third quarter of
1997 and $1,205,000 for the same period in 1996. International revenue was
$498,000 for the first nine month period of 1997 and $1,603,000 for the same
period in 1996. International revenue primarily consisted of royalties,
equipment sales and software sales. The significant decline in
International revenue was due to $1,100,000 of equipment sales in 1996 which
did not occur in 1997. The Company currently has significant international
activities in Ireland, Canada and the United Kingdom ("UK"). In Canada and
the UK, 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 royalties, software license fees, and
maintenance fees.
TNSL will provide POS network services in Ireland and will
serve as a technology center for certain international activities. TNSL is in
a start-up phase and has not generated significant revenue to date. TNSL
losses were approximately $160,000 during the third quarter of 1997 and
$600,000 for the nine months ended September 30, 1997. These losses are
consolidated with the Company's operating results.
Cost of Network Services
Cost of network services increased by 16.8% to $9,540,000 from
$8,166,000 for the three months ended September 30, 1997 versus the same
period in 1996, and by 18.7% to $25,562,000 from $21,539,000 for the first
nine months of 1997 versus the same period in 1996. This growth resulted
primarily from increases in usage charges and charges for billing validation
information resulting from increased transaction and query volumes.
10
<PAGE>
On May 7, 1997, the FCC, pursuant to the 1996 Act, adopted
changes to the current system of interstate access charges ("Access Charge
Reform"). The first phase of the multi-phase process of Access Charge Reform
was implemented on July 1, 1997. These changes resulted in a reduction in
the variable component of certain of the Company's network costs. The
remaining phases of Access Charge Reform are scheduled to go into effect
during 1998. 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.
Gross Profit
Gross profit represented approximately 44% of total revenues
for the three and nine month periods of 1997 and approximately 45% for the
same periods in 1996. The approximate 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. 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.
As a result, maintaining historical gross margin levels depends in part on
growth in transaction volume generating economies of scale and on the impact
of Access Charge Reform.
Engineering and Development
Engineering and development expenses increased by 43.5% to
$921,000 for the three months ended September 30, 1997 from $642,000 for the
same period of 1996 and by 25.3% to $2,534,000 for first nine months of 1997
from $2,022,000 for the same period of 1996. Engineering and development
expenses increased as a result of the growth of the Company. 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. 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 services. The Company does not
anticipate incurring material costs associated with its computer systems to
accommodate the year 2000 issue.
Selling, General and Administrative
Selling, general and administrative expenses increased by 4.4%
to $1,998,000 for the three months ended September 30, 1997 from $1,913,000
for the same period of 1996 and by 9.7% to $6,196,000 for the first nine
months of 1997 from $5,650,000 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.
11
<PAGE>
Depreciation
Depreciation expense increased by 16.3% to $1,225,000 for the
three months ended September 30, 1997 from $1,053,000 for the same period in
1996 and by 17.9% to $3,501,000 for the first nine months of 1997 from
$2,970,000 for the same period in 1996. Depreciation expense includes the
depreciation of network and office equipment as well as leasehold
improvements. Depreciation expense increased primarily as a result of the
acquisition of capital equipment for network expansion to support growth in
the Company's business.
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
The quarterly effective tax rate has decreased from 39.4% to
38.0% primarily as a result of a reduction in the losses related to the
Company's activities in Ireland. The Company has not recorded a tax asset for
these losses due to TNSL's brief operating history.
Net Income and Earnings Per Share
Net income increased by 20.8% to $2,256,000 for the three
months ended September 30, 1997 from $1,867,000 for the same period in 1996
and by 14.8% to $4,867,000 for the first nine months of 1997 from $4,239,000
from the same period in 1996. Earnings per share grew 20% to $0.18 during
the third quarter of 1997 from $0.15 in the comparable 1996 quarter. The
weighted average number of shares outstanding used to calculate earnings per
share increased to 12,755,000 during the third quarter of 1997 from
12,618,000 in the same period in 1996. Shares outstanding increased primarily
because of a higher average stock price and an increase in common stock
equivalents used in the Company's calculation of common equivalent shares
under the treasury stock method. This effect was partially offset by the
Company's purchase of 211,500 shares of its common stock during the second
quarter of 1997.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, principal sources of liquidity were
cash and cash equivalents of $10,271,000, short term investments of
$17,430,000 and a bank line of credit of up to $5,000,000. The line of credit
bears interest at the prime rate and has not been used in 1997.
Net cash provided by operating activities was $9,967,000 for
the nine month period ended September 30, 1997 up from $6,994,000 for the
comparable period in 1996. The increase is primarily from increases in net
income and depreciation, a decrease in the rate of increase in accounts
receivable, and an increase in accounts payable.
12
<PAGE>
Investing activities used $1,059,000 for the nine month period
ended September 30, 1997 as compared to a use of $18,202,000 for the
comparable period in 1996. The Company purchased $8,664,000 of equipment for
the nine month period ended September 30, 1997, up from $5,148,000 for the
comparable period in 1996. The increase was primarily due to the build-out
of the TNS FASTLink-Registered Trademark-Data Services backbone network.
Investing activities in 1996 included the receipt of $3,600,000 in proceeds
from the maturity of a note receivable. Investing activities in 1997 included
approximately $4,000,000 of investments made in certain customers. The
remaining net difference between 1997 and 1996 results primarily from
significant ($14,840,000) purchases of short-term investments and purchases
of intangible assets of $1,636,000 in 1996. Short-term investments maturing
in 1997 totaled $9,836,000.
Financing activities used $1,732,000 for the nine month period
ended September 30, 1997 as compared to $552,000 of cash provided for the
same period in 1996. The Company purchased 211,500 shares of its common
stock in 1997 for $2,491,000. Proceeds from the exercise of stock options
and the employee stock purchase plan provided $759,000 in 1997 and $570,000
in 1996.
At September 30, 1997 the Company had long-term commitments to
purchase capital equipment in the amount of approximately $2.5 million over
an 18 month period, of which approximately $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 any 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. -
On October 28, 1997, the Company filed a formal complaint with the
Federal Communications Commission (the "Commission") against AT&T
Corp. ("AT&T"). The complaint alleges that AT&T, through the
provision of common carrier services to its Transaction Access
Services Group ("TAS Group") on terms and conditions more favorable
than those listed in AT&T's tariffs, violates several provisions of
the Communications Act of 1934 and the Commission's rules. TAS Group
competes with the Company through its TransXpress-Registered
Trademark-network services. The complaint seeks an order requiring
AT&T to cease and desist from engaging in the contested conduct and
money damages for lost business opportunities.
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
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: November 10, 1997 By: /s/ John J. McDonnell, Jr.
---------------------------------
John J. McDonnell, Jr.
President and Chief
Executive Officer
Date: November 10, 1997 By: /s/ Thaddeus G. Weed
---------------------------------
Thaddeus G. Weed
Chief Financial Officer
(Principal Financial Officer)
15
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<NAME> TRANSACTION NETWORK SERVICES, INC.
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