<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 June 30, 1998
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 August 5, 1998
12,690,091 Shares of Common Stock, $0.01 par value
1
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 6,579 $ 18,516
Short-term investments 5,809 9,899
Accounts receivable, net of allowance for doubtful
accounts of $618 and $530, respectively 14,619 10,618
Other current assets 1,843 1,453
----------- -----------
Total current assets 28,850 40,486
----------- -----------
EQUIPMENT, at cost:
Network equipment 36,742 30,101
Office equipment 5,822 4,802
Less - Accumulated depreciation (17,157) (14,314)
----------- -----------
25,407 20,589
----------- -----------
INTANGIBLE ASSETS:
Software and intangibles 23,507 14,119
Less - Accumulated amortization (5,968) (4,742)
----------- -----------
17,539 9,377
----------- -----------
OTHER ASSETS 814 877
LONG-TERM INVESTMENTS 5,784 4,780
INVESTMENT IN UNCONSOLIDATED AFFILIATE 1,999 --
ASSETS AVAILABLE FOR SALE 8,250 --
----------- -----------
Total assets $ 88,643 $ 76,109
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 9,857 $ 7,256
DEFERRED INCOME TAX, net of current amount 378 378
----------- -----------
Total liabilities 10,235 7,634
----------- -----------
STOCKHOLDERS' EQUITY
Common Stock, $0.01 par value, 20,000 shares authorized,
12,670 and 12,476 shares issued, respectively 127 125
Additional paid-in capital 55,034 51,292
Treasury Stock, none and 211 shares, at cost -- (2,491)
Unearned compensation (31) (46)
Retained Earnings 23,404 19,658
Foreign currency translation (126) (63)
----------- -----------
Total stockholders' equity 78,408 68,475
----------- -----------
Total liabilities and stockholders' equity $ 88,643 $ 76,109
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
2
<PAGE>
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
------- ------- ------- --------
<S> <C> <C> <C> <C>
Revenues $20,433 $15,444 $38,510 $28,559
Cost of network services 11,167 8,614 21,874 16,022
------- ------- ------- --------
Gross profit 9,266 6,830 16,636 12,537
------- ------- ------- --------
Other operating expenses:
Engineering & development 1,141 827 2,168 1,613
Selling, general & administrative 2,670 2,121 5,185 4,198
Depreciation 1,593 1,173 2,987 2,276
Amortization of intangibles 641 384 1,092 768
------- ------- ------- --------
Total other operating expenses 6,045 4,505 11,432 8,855
------- ------- ------- --------
Income from operations 3,221 2,325 5,204 3,682
Interest income 365 432 856 841
------- ------- ------- --------
Income before provision for income taxes 3,586 2,757 6,060 4,523
Provision for income taxes 1,430 1,148 2,395 1,912
Earnings in unconsolidated affiliate 81 -- 81 --
------- ------- ------- --------
Net income $ 2,237 $ 1,609 $ 3,746 $ 2,611
------- ------- ------- --------
------- ------- ------- --------
Diluted earnings per common share $ 0.17 $ 0.13 $ 0.29 $ 0.21
------- ------- ------- --------
------- ------- ------- --------
Basic earnings per common share $ 0.18 $ 0.13 $ 0.30 $ 0.21
------- ------- ------- --------
------- ------- ------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
<PAGE>
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 3,746 $ 2,611
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,079 3,044
Stock option compensation 15 15
Loss on disposals of equipment -- 55
Equity in earnings of affilliate (81) --
Changes in assets and liabilities, net of effects of acquisition:
Accounts receivable (3,841) 134
Other current assets (358) (624)
Other assets 63 (137)
Accounts payable and accrued expenses 1,621 585
-------- --------
Net cash provided by operating activities 5,244 5,683
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment (6,925) (5,534)
Purchases of intangible assets (20) (495)
Acquisition, net of cash acquired (12,243) --
Investment in affilliates, net (1,999)
Maturities of short-term investments 4,090 1,972
(Purchases) maturities of long-term investments (1,006) 1,519
-------- --------
Net cash used in investing activities (18,103) (2,538)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from options and employee stock purchase plan 985 265
Purchases of treasury stock -- (2,491)
-------- --------
Net cash provided by (used in) financing activities 985 (2,226)
-------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (63) 23
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (11,937) 942
CASH AND CASH EQUIVALENTS, beginning of period 18,516 14,735
-------- --------
CASH AND CASH EQUIVALENTS, end of period $ 6,579 $ 15,677
-------- --------
-------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes $ 2,548 $ 1,800
Fair value of assets acquired $ 19,639 --
Less: cash paid (12,243) --
value of stock issued (5,250) --
-------- --------
Liabilities assumed $ 2,146 $ -
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
4
<PAGE>
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(Unaudited)
1. GENERAL
- -----------
Transaction Network Services, Inc. (the "Company" or "TNS") 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 1994,
the Company acquired Fortune Telecommunications, Inc. ("FTI") of Ft. Lauderdale,
Florida, which provides customers in the telecommunications industry with
telephone call fraud control, billing validation, and other services. In June
1996, the Company formed Transaction Network Services Limited ("TNSL"), a
majority-owned subsidiary located in Dublin, Ireland. TNSL provides POS network
services in Ireland and serves as TNS' European technology and marketing center
to support current and future European operations.
The Company currently operates four divisions: (1) The POS Division
which includes the Company's TransXpress(R) network services for the POS
transaction processing industry, (2) The Telecom Services Division ("TSD") which
includes FTI's CARD*TEL(R) telephone call billing validation and fraud control
services and other services targeting primarily the telecommunications industry,
(3) The Financial Services Division ("FSD") which provides TNS FastLink(R) Data
Services in support of the Financial Information eXchange ("FIX") messaging
protocol and other transaction oriented trading applications primarily to the
financial services community, and (4) The International Systems Division ("ISD")
which markets the Company's products and services internationally.
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 the Company, 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, 1998 and 1997 are not necessarily
indicative of the results to be expected for the full year.
2. ACQUISITIONS AND OTHER INVESTMENTS
- --------------------------------------
OmniLink Communications Corporation ("OmniLink")
On July 1, 1998, the Company acquired substantially all of the assets
and assumed certain liabilities (composed principally of trade accounts payable
and accrued liabilities of approximately $700,000) of OmniLink, a Michigan
corporation. The consideration paid to OmniLink, after arm's-length
negotiations, was $2.5 million which was composed of (a) approximately $600,000
in cash paid by the Company and (b) approximately $1.9 million by cancellation
of a note payable from OmniLink to the Company. A limited partnership controlled
by the Company's Chief Executive Officer and a venture capital firm, one of
whose partners is a Company director, each are minority shareholders in
OmniLink. The terms of the acquisition also include a royalty payment from the
Company to OmniLink of up to approximately 5% per unit based upon future
OmniLink product sales. The royalty agreement will terminate upon the earlier of
the date that OmniLink has received royalties aggregating $5,000,000 or June 30,
2001. The OmniLink acquisition is being accounted for as a purchase. Amounts
allocated to intangible assets (primarily goodwill) in the purchase accounting
are being amortized on a straight-line basis over a period of 10 years. The
purchase price allocations have been completed on a preliminary basis and are
subject to adjustment, should new or additional facts about the business become
known.
5
<PAGE>
Atos Ireland Limited
- --------------------
In April 1998, the Company, through TNSL, acquired a 50% interest in
Atos Ireland Limited ("Atos") for approximately $2.0 million. Prior to the
acquisition Atos was a wholly owned subsidiary of Sligos Payment Services PLC
("SPS"), which in turn is a majority-owned subsidiary of the Atos Group, a
computer services company based in France. Atos provides processing services,
primarily for cash withdrawals, made from a network of automated teller machines
("ATMs") located throughout Ireland. The Company believes that Atos, focusing
initially on the Irish market, will exploit opportunities to provide transaction
processing services to banks, other financial institutions and government
agencies. SPS has an option to sell its 50% interest in Atos to the Company for
approximately $1.0 million. The option may be exercised between February 1, 1999
and March 31, 1999. Atos is accounted for under the equity method of accounting.
Accordingly, the Company records its 50% share of Atos' net income as "Equity in
Unconsolidated Affiliate".
SunTech Processing Systems, LLC
- -------------------------------
On February 27, 1998, the Company acquired certain assets and assumed
certain liabilities of SunTech Processing Systems, LLC ("SunTech"), a Texas
limited liability company. The total consideration paid after arm's-length
negotiations was $17.5 million, composed of (a) $12.25 million in cash, and (b)
287,474 shares of the Company's common stock valued at $5.25 million. Prior to
the acquisition, SunTech was primarily engaged in the business of providing
transaction processing services for ATMs and developing additional
communications technologies for ATMs. The Company acquired the dial-up ATM
transaction processing segment (the "Processing Business") of SunTech and
SunTech's proprietary host-interface processing ("HIP") technology segment,
which allows for leased line ATMs to be converted into dial-up ATMs.
Since the acquisition date, the Company intended to dispose of the
Processing Business. As a result, the net assets of the Processing Business are
segregated as "Assets Held for Sale" in the accompanying June 30, 1998 balance
sheet. The fair value allocated to the assets held for sale includes the
anticipated net operating results to be derived from these operations while
owned by the Company. The results of the HIP technology segment are included in
the consolidated financial statements since the date of acquisition. The SunTech
acquisition is being accounted for as a purchase. Amounts allocated to
intangible assets (including customer contracts, non-compete agreements,
software and goodwill) in the purchase accounting are being amortized on a
straight-line basis over periods ranging from 2 to 10 years.
On July 23, 1998, the Company sold the Processing Business to Money
Access Service Inc., a wholly-owned subsidiary of Electronic Payment Services,
Inc. ("EPS"). The consideration received after arm's-length negotiations was
$6.0 million in cash, with $3.0 million payable at closing and $3.0 million
payable 30 days from the closing date. In connection with this transaction, the
Company retained the right to certain equipment and accounts receivable of the
Processing Business. The terms of the acquisition also included: (a) a software
license whereby the Company was granted a non-exclusive, perpetual right to use
certain software associated with the Processing Business at locations outside
the United States; and (b) an agreement with EPS whereby EPS committed, under
certain circumstances, to purchase certain modems from the Company during a
three year period.
The unaudited pro forma information for the periods set forth below
give effect to the SunTech transaction as if it had occurred at the beginning of
each period. The pro forma information is presented for informational purposes
only and is not necessarily indicative of the results of operations that
actually would have been achieved had the acquisition been consummated as of
that time (unaudited, 000's omitted):
<TABLE>
<CAPTION>
Six Months Ended Year Ended
June 30, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Revenues $ 38,360 $ 62,885
Net income 3,435 6,086
Diluted earnings per share $ 0.26 $ 0.47
Basic earnings per share $ 0.27 $ 0.49
</TABLE>
AMNEX, Inc.
- -----------
6
<PAGE>
On March 29, 1996, the Company completed an asset purchase from AMNEX,
Inc. ("AMNEX") of AMNEX's proprietary fraud-control system and related databases
used to provide fraud control and billing validation services. The transaction
also included 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. The Company
paid approximately $1.5 million in cash for these assets. The Company amortizes
the cost of these assets over five to ten years. The transaction also included a
ten year exclusive service agreement.
In December 1997, the Company entered into a consulting agreement
with AMNEX in exchange for certain revisions made to the exclusive service
agreement. The consulting agreement included an initial payment of
approximately $180,000 and monthly payments of approximately $33,000 through
June 30, 2002. The consulting agreement provides that, in the case of a
material breach by AMNEX, the remaining unpaid monthly payments become
immediately due and payable as liquidated damages. To ensure payment of
amounts under both the exclusive service agreement and consulting agreement
(collectively, the "Agreements"), AMNEX executed instruction letters whereby
AMNEX directed its billing agent to pay the Company directly all amounts owed
by AMNEX under the Agreements (the "Directions to Pay"). The Directions to
Pay are held in escrow by an escrow agent. In May 1998, the Company delivered
a notice of default to AMNEX for non-payment of fees under the exclusive
service agreement and consulting agreement. The Company subsequently directed
the escrow agent to deliver the Directions to Pay to the billing agent. By
notice served upon the escrow agent pursuant to the escrow agreements, AMNEX
objected to the release of the Directions to Pay to the billing agent. On
July 29, 1998, the Company instituted arbitration proceedings with the
American Arbitration Association against AMNEX. The statement of claim
alleges that AMNEX breached various agreements with the Company and seeks
damages and injunctive relief. Management believes it is likely to prevail in
the arbitration proceedings on its merits. The statement of claim also seeks
to have the escrow agent release the Directions to Pay to the Company for
delivery to AMNEX's billing agent.
As of June 30, 1998, the Company has recorded net assets related to
AMNEX of approximately $1.8 million, including accounts receivable of
approximately $500,000 and intangible assets of approximately $1.3 million.
Any adjustment to the fair value of the recorded assets will result in a
non-cash accounting charge. The Company is currently evaluating the potential
impairment to the fair value of these assets but cannot determine the
impairment, if any, at this time. Due to the material breach by AMNEX, the
Company is entitled to liquidated damages under the consulting agreement of
approximately $1.6 million (none of which has been recorded by the Company),
in addition to the outstanding $500,000 of accounts receivable.
Other
In July 1997, the Company entered into a term loan with a customer
in the amount of $250,000. The Company also 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 to purchase a
minority interest in the customer. 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. In connection
with the term loan, the Company signed a debt subordination agreement with
the customer's senior creditor. In April 1998, the Company received notice of
events of default from the senior creditor. Under the debt subordination
agreement, the Company cannot accept payments from the customer until the
events of default are cured. Management believes that these assets are
recoverable through future cash flows. Any adjustment to the fair value of
the recorded assets will result in a non-cash accounting charge.
7
<PAGE>
3. EARNINGS PER SHARE
- ------------------------
The following reconciles the shares used in the calculations of basic and
diluted earnings per share:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
------------------ -----------------
<S> <C> <C> <C> <C>
Weighted average shares
outstanding - basic 12,647,299 12,244,826 12,518,978 12,289,716
Dilutive effect of Stock options 659,233 304,087 604,287 234,771
------------------------ ------------------------
Weighted average shares - dilutive 13,306,532 12,548,913 13,123,265 12,524,487
------------------------ ------------------------
Diluted earnings per share $ 0.17 $ 0.13 $ 0.29 $ 0.21
Basic earnings per share $ 0.18 $ 0.13 $ 0.30 $ 0.21
</TABLE>
4. COMPREHENSIVE INCOME
The total of net income and all other nonowner changes in equity as
required by consists of (unaudited, 000's omitted):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
------------------ --------------------
<S> <C> <C> <C> <C>
Net Income $ 2,237 $ 1,609 $ 3,746 $ 2,611
Other Comprehensive Income:
Currency Translation (6) 18 (63) (7)
------------------ --------------------
Comprehensive Income $ 2,231 $ 1,627 $ 3,683 $ 2,604
------------------ --------------------
</TABLE>
8
<PAGE>
Item 2.
TRANSACTION NETWORK SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
- --------------------------
Certain information included or incorporated by reference in this
document may be deemed to be "forward looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act. All statements, other than statements of historical facts, that address
activities, events or developments that the Company intends, expects, projects,
believes or anticipates will or may occur in the future are forward looking
statements. Such statements are characterized by terminology such as "believe,"
"anticipate," "should," "intend," "plan," "will," "expects," "estimates,"
"projects," "positioned," "strategy," and similar expressions. These statements
are based on assumptions and assessments made by the Company's management in
light of its experience and its perception of historical trends, current
conditions, expected future developments and other factors it believes to be
appropriate. These forward looking statements are subject to a number of risks
and uncertainties, including but not limited to continuation of the Company's
long standing relationship with major customers and vendors, the Company's
ability to integrate acquired businesses and purchased assets into its
operations and realize planned synergies, the extent to which acquired
businesses and assets are able to meet the Company's expectations and operate
profitably, the impact of future revisions to the cost of the Company's network
services under the Telecommunications Act of 1996, competition, technological
change, the ability to develop new services, dependence on proprietary rights,
dependence on key employees, changes in government regulation, seasonality and
fluctuations in quarterly results. In addition, the Company is subject to risks
and uncertainties that affect the technology sector generally including, but not
limited to, economic, competitive, governmental and technological factors
affecting the Company's operations, markets, products, services and prices. Any
such forward looking statements are not guarantees of future performances and
actual results, developments and business decisions may differ from those
envisaged by such forward looking statements. The Company disclaims any duty to
update any forward looking statements, all of which are expressly qualified by
the foregoing.
RESULTS OF OPERATIONS
- ---------------------
Revenues
Total revenues increased by 32% to $20,433,000 for the three month
period ended June 30, 1998 from $15,444,000 for the same period in 1997 and by
35% to $38,510,000 for the first six months of 1998 from $28,559,000 for the
same period in 1997.
POS services revenue increased by 14% to $12,009,000 from $10,518,000
for the three months ended June 30, 1998 versus the comparable period in 1997
and by 16% to $22,990,000 from $19,871,000 for the first six months of 1998
versus the same period in 1997. 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 16% to 681
million transactions for the second quarter of 1998 from 584 million
transactions in the second quarter of 1997. POS revenue per transaction was
$0.016 for the three and six months ended June 30, 1998 and for the comparable
periods in 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 competitive factors.
9
<PAGE>
Telecommunications services revenue increased by 53% to $7,274,000 from
$4,766,000 for the three months ended June 30, 1998 versus the comparable period
in 1997 and by 66% to $13,815,000 from $8,332,000 for the first six months of
1998 versus the same period in 1997. The growth in revenue was primarily due to
growth in queries processed for the Company's telecommunications customers and
from an increase in other telecommunications services revenues, including
LEConnect, SS-7 and dial-around compensation.
The Financial Services Division was formed in March 1997 and
contributed $390,000 of revenue for the three months ended June 30, 1998 versus
$46,000 for the same period in 1997 and $623,000 for the first six months of
1998 compared to $57,000 for the same period in 1997.
International revenue contributed $760,000 in the second quarter of
1998 compared to $114,000 for the same period in 1997 and $1,082,000 for the
first six months of 1998 compared to $299,000 for the same period in 1997. The
significant increase is due to increases in royalties, equipment sales and
software license revenues. In April 1998, the Company, through TNSL, acquired a
50% interest in Atos Ireland Limited ("Atos") for approximately $2.0 million.
Atos provides processing services, primarily for cash withdrawals, made from a
network of automated teller machines ("ATM's") located throughout Ireland.
Management believes that Atos, focusing initially on the Irish market, will
exploit opportunities to provide transaction processing services to banks, other
financial institutions and government agencies. Atos is accounted for under the
equity method of accounting. Accordingly, the Company records its 50% share of
Atos' net income as "Equity in Unconsolidated Affiliate".
The Company's majority owned Irish subsidiary - Transaction Network
Services Limited ("TNSL") provides POS network services in Ireland and serves as
TNSL's European technology and marketing center. Currently, TNSL's consolidated
losses are being absorbed and consolidated with the Company's operating results.
TNSL's consolidated losses were approximately $270,000 for the second quarter of
1998 compared to $224,000 for the same period in 1997 and $517,000 for the first
six months of 1998 compared to $440,000 for the same period in 1997.
The Company is in the process of negotiations for the formation of a
joint venture in the United Kingdom. The venture is expected to be 60% owned by
the Company and will be named Transaction Network Services (UK) Limited
("TNSUK"). TNSUK will utilize the Company's network technology, along with
technology acquired in the acquisition of certain assets of SunTech and
OmniLink, to provide point-of-sale and transaction services in the United
Kingdom. The formation of TNSUK is anticipated to be completed in the third
quarter of 1998. The Company anticipates that the acquisition price of its 60%
share of TNSUK will require a payment of cash of approximately $4.0 million.
Cost of Network Services
Cost of network services increased by 30% to $11,167,000 from
$8,614,000 for the three months ended June 30, 1998 versus the comparable period
in 1997 and by 37% to $21,874,000 from $16,022,000 for the first six months of
1998 versus the same period in 1997. This growth resulted primarily from
increases in usage charges and charges for billing validation information
resulting from increased transaction and query volumes.
10
<PAGE>
In May 1997, pursuant to the Telecommunications Act of 1996 (the "1996
Act"), the FCC implemented rules and regulations referred to as Access Charge
Reform ("Access Reform") that seek to reform the system of interstate access
charges and make it compatible with the competitive paradigm established by the
1996 Act. The initial phase of Access Reform was implemented in July 1997. The
initial phase of Access Reform resulted in a decrease in certain components of
the Company's variable cost per transaction and as a result, lowered the
Company's network costs. The second and third phases of Access Reform were
implemented in January and July 1998. The second and third phases of Access
Reform resulted in an additional decrease in certain components of the Company's
variable cost per transaction; however, both phases increased certain of the
Company's fixed monthly recurring charges and instituted certain new fixed
charges. Further changes to access charges due to Access Reform are scheduled to
be implemented in January 1999 and January 2000. The Company believes that
future revisions may reduce its network costs because the Company believes that
it is not subject to certain of the new charges instituted by Access Reform and
that in any event the increased charges are not in accordance with the spirit of
Access Reform which is intended to reduce overall access charges. However, there
can be no assurance that the future phases of Access Reform will result in
reductions to the Company's network costs and, in fact, they may increase. The
ultimate impact of Access Reform is dependent upon, among other things 1) the
ability to increase transaction volumes, which benefits the Company when lower
variable costs are instituted, 2) the nature and amount of fixed charges based
upon the number of connections in the Company's network, which increases network
costs, 3) any other future actions by the FCC, 4) the ability of the Company to
modify its network design to react to pricing revisions, and 5) the ability of
the Company to successfully defend and receive credits for improperly billed
charges. Accordingly, the impact of Access Reform on the Company's future
network access costs is unknown, and the Company cannot predict the timing,
outcome or effects of the FCC's regulations or of any future tariff matters.
Gross Profit
Gross profit represented approximately 45% of total revenues for the
second quarter of 1998 compared to 44% for the same period in 1997 and 43% of
total revenues for the first six months of 1998 compared to 44% for the same
period in 1997. The approximate 1% increase in gross profit as a percentage
of total revenues for the comparable three month periods reflects the impact
of the SunTech acquisition and increases in revenues from certain new service
offerings including LEConnect, financial services revenue and other services.
The increase in gross margin percentage was partially offset by costs
associated with the Company's development of its own on-network "800" access
service, costs incurred in connection with the TNS Financial Services Network
and increases in the number of employees hired in the Company's network
control center in order to support increasing transaction volumes and to
support new service offerings. The future level of the gross profit margin
percentage 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 success of the
Company's new service offerings including recent acquisitions, 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 significant portions 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.
11
<PAGE>
Engineering and Development
Engineering and development expense increased by 38% to
$1,141,000 for the three months ended June 30, 1998 versus $827,000 for the
comparable period in 1997 and by 34% to $2,168,000 for the first six months
of 1998 from $1,613,000 for the same period in 1997. Engineering and
development expenses increased in order to support the Company's revenue
growth. Engineering and development expenses represented approximately 6% of
revenues for the first six months of 1998 and 1997 and represented
approximately 6% of revenues for the three months ended June 30, 1998 and
June 30, 1997.
On July 1, 1998, the Company acquired substantially all of the assets
of OmniLink Communications Corporation ("OmniLink"), a Michigan corporation.
Prior to the acquisition, OmniLink developed, manufactured and marketed modems
for electronic commerce, Internet access, telecommuting and advanced office
communications. The Company has transferred its dial-up modem technology
acquired in the February 1998 acquisition of certain assets of SunTech
Processing Systems, LLC ("SunTech") to OmniLink. OmniLink will integrate the
SunTech modem technology into the OmniLink modems. This development effort is
intended to support the Company's strategy to offer dial-up ISDN access services
to both domestic and international customers. These customers have traditionally
relied upon more expensive leased line communications to process transactions
originated at both point-of-sale locations as well as automated teller machines.
The Company intends to devote the acquired OmniLink assets to these lines of
business for the forseeable future. The Company believes that engineering and
development expenses will increase as a result of the acquisition of OmniLink,
however, the Company does not anticipate that these expenses, as a percentage of
revenues, will materially differ from historical percentages.
Year 2000
- ---------
The Company has conducted a review of the impact of the Year 2000 on
its products and services, as well as reviewing its impact on relationships with
key customers and vendors. Based on this review, a plan to ensure minimal
disruption to Company operations has been developed and is being implemented.
The Company does not anticipate incurring material costs associated with its
products and services to accommodate the Year 2000 issue.
Selling, General and Administrative
Selling, general and administrative expenses increased by
26% to $2,670,000 for the three months ended June 30, 1998 from $2,121,000
for the same period of 1997 and by 24% to $5,185,000 for the first six months
of 1998 from $4,198,000 for the same period of 1997. Selling, general and
administrative expenses increased in order to support the Company's revenue
growth. Selling, general and administrative expenses represented 13% of
revenues for the first six months ended June 30, 1998 and 15% for the same
period of 1997. Selling, general and administrative expenses represented 13%
of revenues for the three months ended June 30, 1998 and 14% for the same
period of 1997. These decreases are attributed to certain economies of scale
related to revenue growth. The Company believes that selling, general and
administrative expenses will increase as a result of the acquisition of
OmniLink; however, the Company does not anticipate that these expenses, as a
percentage of revenues, will materially differ from historical percentages.
Depreciation
Depreciation expense increased by 36% to $1,593,000 for the three
months ended June 30, 1998 from $1,173,000 for the same period of 1997 and by
31% to $2,987,000 for the first six months of 1998 from $2,276,000 for the same
period of 1997. Depreciation expense increased primarily as a result of the
acquisition of capital equipment for network expansion to support growth in the
Company's business.
12
<PAGE>
Amortization of Intangibles
The amortization of intangible assets increased by 67% to $641,000 for
the three months ended June 30, 1998 from $384,000 for the same period in 1997
and by 42% to $1,092,000 for the first six months of 1998 from $768,000 for the
same period in 1997. The increase is attributable to the amortization of
intangible assets associated with the February 27, 1998 SunTech acquisition.
Amounts allocated to intangible assets (including customer contracts,
non-compete agreements, software and goodwill) in the purchase accounting are
being amortized on a straight-line basis over periods ranging from 2 to 10
years. The purchase price allocations have been completed on a preliminary basis
and are subject to adjustment should new or additional facts about the business
become known. Amortization expense is expected to be approximately $750,000 per
quarter over the next several years. This amount includes the amortization of
goodwill associated with the July 1, 1998 acquisition of certain assets of
OmniLink and any necessary adjustment of SunTech goodwill associated with the
July 23, 1998 disposition of the SunTech processing business. See Note 2 to Item
1. - Financial Statements for a discussion of events related to AMNEX and a
customer.
Income Taxes
The quarterly effective tax rate decreased from 42% for the three and
six month period ended June 30, 1997 to 40% for the three and six month period
ended June 30, 1998 primarily as a result of the relative reduction in TNSL's
losses relative to the Company's annual results. 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 39% to $2,237,000 for the three months
ended June 30, 1998 from $1,609,000 for the same period in 1997 and by 44% to
$3,746,000 for the first six months of 1998 from $2,611,000 for the same period
in 1997. Earnings per share grew 31% to $0.17 during the second quarter of 1998
from $0.13 in the comparable 1997 quarter and by 38% to $0.29 for the first six
months of 1998 from $0.21 for the comparable period of 1997. The weighted
average number of shares outstanding used to calculate diluted earnings per
share increased to 13,307,000 during the second quarter of 1998 from 12,549,000
in the same period in 1997 and to 13,123,000 for the first six months of 1998
from 12,524,000 for the same period in 1997. Diluted shares outstanding
increased primarily because of the 287,474 shares issued on February 27, 1998 in
connection with the SunTech acquisition and from an increase in stock options
outstanding. See Note 2 to Item 1. - Financial Statements for a discussion of
events related to AMNEX and a customer.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At June 30, 1998, principal sources of liquidity were cash and cash
equivalents of $6,579,000 and short term investments of $5,809,000. In
connection with the July 1, 1998 acquisition of OmniLink, approximately $1.9
million of short term investments was exchanged along with $600,000 in cash for
certain OmniLink assets. On July 23, 1998 the Company sold the SunTech
processing business for $6.0 million in cash and other consideration. The
Company received $3.0 million at the closing of the sale of the SunTech
processing business and will receive $3.0 million 30 days from the closing date.
The Company is in the process of negotiations for the formation of a joint
venture in the United Kingdom. The venture is expected to be 60% owned by the
Company and named Transaction Network Services Limited ("TNSUK"). TNSUK will
utilize the Company's network technology, along with technology acquired in the
acquisition of certain assets of SunTech and OmniLink, to provide point-of-sale
and transaction services in the United Kingdom. The formation of TNSUK is
anticipated to be completed in the third quarter of 1998. The Company
anticipates that the acquisition price of its 60% share of TNSUK will require a
payment of cash of approximately $4.0 million.
13
<PAGE>
Net cash provided by operating activities was $5,244,000 for the six
month period ended June 30, 1998, a decrease from $5,683,000 for the comparable
period in 1997. The decrease is primarily from increases in net income and
depreciation and accounts payable being more than offset by a relative increase
in accounts receivable.
Investing activities used $18,103,000 for the six month period ended
June 30, 1998 as compared to a use of $2,538,000 for the same period in 1997.
The significant increase primarily relates to $12,250,000 paid for the
acquisition of SunTech. The Company purchased $6,925,000 of equipment for the
six month period ended, June 30, 1998 up from $5,534,000 for the comparable
period in 1997. The increase was primarily due to the requirements of new
service offerings including the build-out of the TNS FASTLink(R) Data Services
backbone network and the Company's own on network "800" service. In April 1998,
he Company paid approximately $2.0 million for a 50% interest in Atos. The net
proceeds from the maturities of short and long term investments were $3,084 for
the six month period ended June 30, 1998 and $3,491 for the six months ended
June 30, 1997.
Financing activities provided $985,000 for the six month period ended
June 30, 1998 as compared to use of $2,226,000 in the same period in 1997. In
1997, the Company purchased 211,500 shares of its common stock for approximately
$2.5 million. There were no such purchases in 1998. Proceeds from the exercise
of stock options and the Company's employee stock purchase plan increased from
$265,000 for the first six months of 1997 to $985,000 for the first six months
of 1998.
The Company believes that its existing cash, investment balances,
and cash flows generated by operations will be sufficient to meet the capital
needs of its current business activities for the foreseeable future.
NEW ACCOUNTING STANDARDS
- ------------------------
In July 1997, the FASB issued Statement No. 131 "Disclosures About
Segments of an Enterprise and Related Information." Statement No. 131 will
require the Company to disclose segment information using a "management
approach" beginning with its December 31, 1998 financial statements.
INFLATION
- ---------
Inflation is not a material factor affecting the Company's business and
has not had a significant effect on the Company's operations to date.
14
<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 "FCC") 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
FCC's rules. TAS Group competes with the Company's
TransXpress(R) network services. The complaint seeks an order
requiring AT&T to cease and desist from engaging in the
contested conduct and seeks monetary damages for lost business
opportunities. At the request of the parties, the FCC has
extended the deadline for filing briefs in this proceeding
while the parties continue to discuss the terms of a
settlement.
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 14, 1998
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 I directors, Henry R. Nichols and Joseph Squarzini,
Jr., to three-year terms expiring at the annual meeting of
stockholders in 2001. The voting tabulation for each nominee
was as follows:
Henry R. Nichols - 10,409,747 votes in favor of election and
696,191 votes withheld.
Joseph Squarzini, Jr. - 10,409,747 votes in favor of election
and 696,191 votes withheld.
The Company has a staggered board. In addition to the two
Class I directors elected at the annual meeting of
stockholders, the board has three Class II directors whose
terms expire at the annual meeting in 1999: John S. McCarthy,
John J. McDonnell, Jr.,and Jurgen Manchot; and two Class III
directors whose terms expire at the annual meeting in 2000:
William N. Melton and Paolo L. Guidi.
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 1,800,000 to 2,300,000 shares. The voting
tabulation was as follows: 8,524,569 votes in favor of the
increase; 2,456,669 votes against the increase; 124,700
abstentions; and no votes withheld.
3. Increase in the Common Stock Subject to the 1994
Employee Stock Purchase Plan. The stockholders approved an
increase in the aggregate number of shares of Common Stock
authorized for issuance under the Company's 1994 Employee
Stock Purchase Plan, as amended, from 150,000 to 250,000
shares. The voting tabulation was as follows: 10,965,213
votes in favor of the increase; 15,625 votes against the
increase; 125,100 abstentions; and no votes withheld.
4. 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: 11,059,697
votes in favor of the ratification; 5,911 votes against the
ratification; 40,330 abstentions; and no votes withheld.
15
<PAGE>
Item 6. Exhibits and Reports on Form 8-K .
The Company filed a Current Report on Form 8-K on July 15,
1998 reporting pursuant to Item 2 the acquisition of certain
assets and the assumption of certain liabilities of OmniLink
Communications Corporation.
The Company filed a Current Report on Form 8-K on August 7,
1998 reporting pursuant to Item 5 the disposition of certain
assets of SunTech Processing Systems, LLC.
(a.) Exhibits.
Financial Data Schedule.
16
<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 11, 1998 By: /s/ John J. McDonnell, Jr.
--------------------------
John J. McDonnell, Jr.
President and Chief
Executive Officer
Date: August 11, 1998 By: /s/ Thaddeus G. Weed
--------------------------
Thaddeus G. Weed
Chief Financial Officer and Treasurer
17
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