Spok Holdings - 10-Q quarterly report FY

     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 requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes þ          No o

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o          No þ

      Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.     Yes þ          No o

      Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 27,269,277 shares of the Registrant’s Common Stock ($0.0001 par value per share) were outstanding as of November 4, 2005.

      (b) Merger of Arch and Metrocall — The merger of Arch Wireless, Inc. and subsidiaries (“Arch”) and Metrocall Holdings, Inc. and subsidiaries (“Metrocall”) occurred on November 16, 2004. Under the terms of the merger agreement, holders of 100% of the outstanding Arch common stock received one share of the Company’s common stock for each common share held of Arch. Holders of 2,000,000 shares of Metrocall common stock received cash consideration totaling $150 million and the remaining 7,236,868 shares of Metrocall’s common stock were each exchanged for 1.876 shares of USA Mobility common stock. Upon consummation of the merger exchange, former Arch and Metrocall common shareholders held approximately 72.5% and 27.5%, respectively, of USA Mobility’s common stock on a fully diluted basis.

      The merger was accounted for using the purchase method of accounting. Arch was the accounting acquirer. Accordingly, the bases of Arch’s assets and liabilities as of the acquisition date are reflected in the balance sheet of USA Mobility at their historical basis. Amounts allocated to Metrocall’s assets and liabilities were based upon the total purchase price and the estimated fair values of such assets and liabilities. The results of operations of Metrocall have been included in the USA Mobility results from November 16, 2004, therefore, the results presented for the three and nine months ended September 30, 2004 do not include results associated with Metrocall.

      USA Mobility expects to achieve operating and other synergies through elimination of redundant overhead and duplicative network structures. Subsequent to the merger, the Company began an extensive review of all operating systems, the rationalization of the one-way and two-way messaging networks, and the composition of the sales force. The Company expects to continue its reviews through 2005 and beyond as it deconstructs networks and standardizes its systems. In this process, the Company expects to incur additional costs.

      The following unaudited pro forma summary presents the consolidated results of operations as if the merger had occurred at the beginning of the period presented, after giving effect to certain adjustments, including depreciation and amortization of acquired assets and interest expense on merger-related debt. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the merger been completed at the beginning of the period presented, or of results that may occur in the future.

      (c) Business — USA Mobility is a leading provider of wireless messaging in the United States. Currently, USA Mobility provides one-way and two-way messaging services. One-way messaging consists of numeric and alphanumeric messaging services. Numeric messaging services enable subscribers to receive messages that are composed entirely of numbers, such as a phone number, while alphanumeric messages may include numbers and letters, which enable subscribers to receive text messages. Two-way messaging services enable subscribers to send and receive messages to and from other wireless messaging devices, including pagers, personal digital assistants and personal computers. USA Mobility also offers voice mail, personalized greeting, message storage and retrieval and equipment loss and/or maintenance protection to both one-way and two-way messaging subscribers. These services are commonly referred to as wireless messaging and information services.

      (d) Risks and Other Important Factors — Based on current and anticipated levels of operations, USA Mobility’s management believes the Company’s net cash provided by operating activities, together with cash on hand, should be adequate to meet its cash requirements for the foreseeable future.

      In the event that net cash provided by operating activities and cash on hand are not sufficient to meet future cash requirements, USA Mobility may be required to reduce planned capital expenditures, sell assets or seek additional financing. USA Mobility can provide no assurance that reductions in planned capital expenditures or proceeds from asset sales would be sufficient to cover shortfalls in available cash or that additional financing would be available or, if available, offered on acceptable terms.

      USA Mobility believes that future fluctuations in its revenue and operating results may occur due to many factors, particularly the decreased demand for its messaging services. If the rate of decline for the Company’s messaging services exceeds its expectations, revenues may be negatively impacted, and such impact could be material. USA Mobility’s plan to consolidate its networks may also negatively impact revenues as customers experience a reduction in, and possible disruptions of, service in certain areas. Under these circumstances, USA Mobility may be unable to adjust spending in a timely manner to compensate for any future revenue shortfall. It is possible that, due to these fluctuations, USA Mobility’s revenue or operating results may not meet the expectations of investors, which could reduce the value of USA Mobility’s common stock.

      (e) Long Lived Assets — The Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations,(“SFAS No. 143”) in 2002. SFAS No. 143 requires the recognition of liabilities and corresponding assets for future obligations associated with the retirement of assets. USA Mobility has network assets that are located on leased transmitter locations. The underlying leases generally require the removal of equipment at the end of the lease term, therefore a future obligation exists. The Company has recognized cumulative asset retirement costs of $10.4 million and $20.4 million through December 31, 2004, and September 30, 2005, respectively. Network assets have been increased to reflect these costs and depreciation is being recognized over their estimated lives, which range between one and ten years. The asset retirement costs, and the corresponding liabilities, that have been recorded to date generally relate to either current plans to consolidate networks or to the removal of assets at an estimated future terminal date.

      (f) Goodwill and Other Intangible Assets — Goodwill of $148.8 million at September 30, 2005 resulted from the purchase accounting related to the merger with Metrocall as previously discussed. Goodwill was reduced by $3.0 million during the nine months ended September 30, 2005. This reduction reflects $1.5 million of adjustments to the state and local tax contingencies identified at the merger date of Arch and Metrocall and $1.5 million of adjustments to the deferred tax assets resulting from information obtained during the preparation of the Company’s 2004 income tax returns. Additional changes to goodwill may occur during 2005 due to the Company’s purchase price allocation being preliminary with respect to the state and local tax contingencies.

      The Company’s operations consists of one reporting unit to evaluate goodwill. Goodwill is not amortized, but is evaluated for impairment annually or when events or circumstances suggest a potential impairment may have occurred. The Company has selected the fourth quarter to perform its annual impairment test. Other intangible assets were recorded at fair value at the date of acquisition and amortized over periods generally ranging from one to five years. Aggregate amortization expense for intangible assets for the nine months ended September 30, 2004 and 2005 was zero and $19.3 million, respectively.

      Amortizable intangible assets are comprised of the following at September 30, 2005 (dollars in thousands):

      (g) Long-term Debt — On November 16, 2004, Metrocall and Arch as Borrowers, along with USA Mobility and its bank lenders, entered into a credit agreement (the “credit agreement”) to borrow $140.0 million. Under the credit agreement, the Company may designate all or any portion of the borrowings outstanding at either a floating base rate or a Eurodollar rate advance with an applicable margin of 1.50% for base rate advances and 2.50% for Eurodollar advances. The cash proceeds under the credit agreement were used by USA Mobility to fund a portion of the cash consideration paid to Metrocall shareholders in accordance with the merger agreement. The borrowings were secured by substantially all of the assets of USA Mobility. During the third quarter of 2005, the Company paid the remaining balance of $26.5 million under the credit agreement in full satisfaction of its bank debt obligation.

      (i) Stockholders’ Equity — The authorized capital stock of the Company consists of 75 million shares of common stock and 25 million shares of preferred stock, par value $0.0001 per share.

      • Earnings per Share — Basic earnings per share is computed on the basis of the weighted average common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average common shares outstanding plus the effect of outstanding stock options and restricted stock using the “treasury stock” method. The components of basic and diluted earnings per share were as follows (in thousands, except share and per share amounts):

      Our customers may subscribe to one-way or two-way messaging services for a monthly service fee which is generally based upon the type of service provided, the geographic area covered, the number of devices provided to the customer and the period of commitment. Voice mail, personalized greeting and equipment loss and/or maintenance protection may be added to either one-way or two-way messaging services, as applicable, for an additional monthly fee. Equipment loss protection allows subscribers who lease devices to limit their cost of replacement upon loss or destruction of a messaging device. Maintenance services are offered to subscribers who own their device.

      In June 2005, the Company announced an alliance with Advanced Metering Data Systems, LLC (“AMDS”) and Sensus Metering Systems to provide meter monitoring services over a narrow-band PCS

      (k) Stock Based Compensation — Compensation expense associated with options and restricted stock was recognized in accordance with the fair value provisions of SFAS No. 123, Accounting for Stock Based Compensation (“SFAS No. 123”), over the instruments’ vesting period. Pursuant to SEC Staff Accounting Bulletin 107, Share-Based Payment,(“SAB 107”), the following table reflects the classification of $6.2 million and $2.2 million in stock based compensation for the nine months ended September 30, 2004 and 2005, respectively (dollars in thousands).

      (l) Severance Expenses — In the nine months ended September 30, 2004 and 2005, USA Mobility recorded severance charges of $5.4 and $16.0 million, respectively. During the second quarter 2005, the Company announced a reorganization plan to adjust its management structure and consolidate three sales divisions of five regions into two sales divisions of six regions. This plan was subsequently adjusted to reflect one national sales organization consisting of eleven regions. Under this plan and in an effort to continue to integrate operations of Arch and Metrocall, the Company will eliminate approximately 100 additional positions through the end of 2005. As a result, as of September 30, 2005, the Company has $6.3 million accrued for postemployment benefits, including severance and health benefits, for more than 400 employees that were or will be terminated. In addition, a $4.3 million settlement agreement with three former Arch executives was paid during second quarter 2005.

      At September 30, 2005, the balance of the liability was as follows (dollars in thousands):

      Reclassifications represent reclassification of accrued liabilities for vacation and long-term incentives to be paid to severed employees.

      On November 10, 2004, three former Arch senior executives (the “Former Executives”) filed a Notice of Claim before the JAMS/ Endispute arbitration forum in Boston, Massachusetts asserting they were terminated from their employment by Arch pursuant to a “change in control” as defined in their respective executive employment agreements (the “Claims”). On May 9, 2005, the Former Executives agreed to dismiss the Claims with prejudice against all parties in exchange for a settlement payment of $4.3 million. The Company recorded this settlement as an increase to severance expenses for the nine months ended September 30, 2005.

      (n) Income Taxes — USA Mobility accounts for income taxes under the liability method of SFAS No. 109, Accounting for Income Taxes.Deferred income tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, given the provisions of enacted laws. The Company would provide a valuation allowance against deferred income tax assets if, based on available evidence, it is more likely than not that the deferred income tax assets would not be realized.

      USA Mobility evaluates the recoverability of its deferred income tax assets on an ongoing basis. The assessment is required to determine whether based on all available evidence, it is more likely than not that all USA Mobility’s net deferred income tax assets will be realized in future periods. Management continues to believe no valuation allowance is required.

      The evaluation of the recoverability of the deferred assets is based on historical evidence of profitability since emerging from bankruptcy and the Company’s projections of increased profitability as a result of anticipated cost synergies made available through the November 2004 merger. To the extent that these anticipated cost synergies are not realized, or the Company is unable to generate sufficient revenue and projections of future revenue are adjusted downward, a partial, or full, valuation allowance of these assets may be required.

      In the quarter ended September 30, 2005, USA Mobility revised its expected applicable tax rate reducing the rate from 40.2% to 38.8%. The reduction in the expected applicable tax rate is primarily due to updating the state apportionment factors utilized in determining the expected applicable tax rate and the recently completed merger of the Company’s operating entities. The Company performed an analysis of the expected future applicable tax rate as if the merger of operating companies had occurred on January 1, 2005 in order to determine the effect of the mergers and the updated state apportionment factors on the future expected applicable tax rate. The reduction in the expected applicable tax rate requires that the Company’s deferred income tax assets be revalued based on the new expected applicable tax rate. For the nine months ending as of September 30, 2005, the deferred tax assets were reduced by $8.6 million as a result of the change in the expected applicable tax rate.

      (o) Related Party Transactions — Two of our directors, effective November 16, 2004, also serve as directors for entities from which the Company leases transmission tower sites. During the nine months ended September 30, 2005, the Company paid $18.6 million and $2.5 million, respectively, to these landlords for rent expenses. Each director has recused himself from any discussions or decisions made on matters relating to the respective vendor for which he serves as a director.

      (p) Segment Reporting — USA Mobility believes it currently has one operating segment.

      In December 2004 the FASB issued a revision of SFAS No. 123, Accounting for Stock Based Compensation (“SFAS No. 123R”). SFAS No. 123R supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS No. 123 as originally issued and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

      The SEC adopted a rule that defers the effective date of SFAS No. 123R until the beginning of the first fiscal year beginning after June 15, 2005. The Company has elected to postpone adoption of SFAS No. 123R until 2006. Management does not expect SFAS No. 123R to materially affect the reported results of operations, cash flows or financial position of the Company.

      In March 2005, the FASB issued Financial Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (“FIN 47”). FIN 47 clarifies the application of certain aspects of SFAS No. 143,Asset Retirement Obligations. Management does not expect the adoption of FIN 47 to materially affect the reported results of operations, cash flows or financial position of the Company.

      (r) Commitments and Contingencies — USA Mobility was named as a defendant, along with Arch, Metrocall and Metrocall’s former board of directors, in two lawsuits filed in the Court of Chancery of the State of Delaware, New Castle County, on June 29, 2004 and July 28, 2004. The Company and the other defendants entered into a settlement agreement with the plaintiffs prior to the merger which was approved by the court on May 18, 2005 and the case was dismissed. As noted in note (m),Settlement Agreements, on May 9, 2005, three former executives of Arch agreed to dismiss all claims against Arch and its subsidiaries in exchange for a settlement payment of $4.3 million.

      In August 2005, USA Mobility, through a subsidiary, entered into a Master Antenna Site Lease agreement (the “Master Leases”) with a subsidiary of Global Signal, Inc. (“Global Signal”) under which USA Mobility and/or its affiliates may lease space for their equipment on communications sites currently and subsequently owned, managed or leased by Global Signal. The new Master Leases were effective as of July 1, 2005 and expire on December 31, 2008. Under the Master Leases, USA Mobility may locate up to a specified maximum number of transmitters on Global Signal’s sites for a fixed monthly fee. The fixed monthly fee decreases periodically over time from approximately $1.6 million in July 2005 to approximately $1.0 million per month in 2008. USA Mobility expects to consolidate up to 50% of its transmitters onto Global Signal sites by the end of 2008.

      USA Mobility, from time to time, is involved in lawsuits arising in the normal course of business. USA Mobility believes that its pending lawsuits will not have a material adverse effect on its reported results of operations, cash flows or financial position.

      This quarterly report contains forward-looking statements and information relating to USA Mobility, Inc. and its subsidiaries (“USA Mobility” or the “Company”) that are based on management’s beliefs as well as assumptions made by and information currently available to management. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “anticipate”, “believe”, “estimate”, “expect”, “intend” and similar expressions, as they relate to USA Mobility or its management are forward-looking statements. Although these statements are based upon assumptions management considers reasonable, they are subject to certain risks, uncertainties and assumptions, including but not limited to those factors set forth within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein as anticipated, believed, estimated, expected or intended. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. We undertake no obligation to update or revise any forward-looking statements. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the discussion under “Risk Factors Affecting Future Operating Results” section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.

      The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes and “Risk Factors Affecting Future Operating Results,” which describe key risks associated with our operations and industry and the following subsections of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004: “Overview,” “Results of Operations,” “Liquidity and Capital Resources”, “Inflation”, and “Application of Critical Accounting Policies.”

      USA Mobility is a holding company that was formed to effect the merger of Arch Wireless, Inc. and subsidiaries (“Arch”) and Metrocall Holdings, Inc. and subsidiaries (“Metrocall”) which occurred on November 16, 2004. Prior to the merger, USA Mobility had conducted no operations other than those incidental to its formation. For financial reporting purposes, Arch was deemed to be the accounting acquirer of Metrocall. The historical information for USA Mobility includes the historical financial information of Arch for 2004 and the acquired operations of Metrocall from November 16, 2004. Accordingly, the results of operations reflect increases in revenues and costs due to the inclusion of Metrocall during the three and nine month periods ended September 30, 2005 as compared to the three and nine month periods ended September 30, 2004, which included the results of Arch only.

      We continue to believe that the combination of Arch and Metrocall provides us with the potential to generate stronger operating and financial results than either company could have achieved separately, by reducing overall costs while the Company’s revenue continues to decline sequentially. During the third quarter of 2005, our integration and cost reduction efforts continued to focus on:

     Technical Infrastructure and Network Operations — We continued decommissioning and deconstructing one of our two-way networks. That process is expected to be completed by late November 2005. We are also focused on rationalizing our one-way networks. This consolidation and rationalization will be an ongoing process as we attempt to match our network capacity to the requirements of our customers. These activities include reducing the costs of lease payments for transmitter locations and telecommunications related expenses associated with our networks.

     Selling and Marketing — We continued the process to eliminate redundant and unnecessary sales offices to match the staff reductions that were taken in the fourth quarter of 2004 and which have occurred to date.

     Billing System Consolidation — The conversion of the Metrocall stand alone billing system into the Arch billing system was completed during July 2005.

     Inventory Fulfillment — We consolidated our remaining three distribution centers to one distribution center by the end of the third quarter 2005.

     Back-office Operations — We are consolidating our customer service operations, from five to two centers by the end of 2006. Other administrative and support functions such as accounting, finance, human resources, credit and collections, information technology and other overhead functions are also being consolidated throughout 2005.

      Since the merger on November 16, 2004, the Company has reduced its employee base from 2,844 around the time of the merger to 1,731 at September 30, 2005. While these staff reductions have resulted in significant severance expenses, the Company’s ongoing cost of payroll and related costs will be reduced.

      We market and distribute our services through a direct sales force and a small indirect sales force.

     Direct. Our direct sales force rents or sells products and messaging services directly to customers ranging from small and medium-sized businesses to Fortune 1000 companies, health care and related businesses and government agencies. We intend to continue to market to commercial enterprises utilizing our direct sales force as these commercial enterprises have typically disconnected service at a lower rate than individual consumers. As of September 30, 2005, our sales personnel were located in approximately 109 offices in 35 states throughout the United States. In addition, we maintain several corporate sales groups focused on national business accounts; federal government accounts; advanced wireless services; systems sales applications; telemetry and other product offerings.

     Indirect. Within our indirect channel we contract with and invoice an intermediary for airtime services. The intermediary or “reseller” in turn markets, sells and provides customer service to the end-user. There is no contractual relationship that exists between us and the end subscriber. Therefore, operating costs per unit to provide these services are lower than those required in the direct distribution channel. Indirect units in service typically have lower average monthly revenue per unit than direct units in service. The rate at which subscribers disconnect service in our indirect distribution channel has been higher than the rate experienced with our direct customers and we expect this to continue in the foreseeable future.

      The following table sets forth units in service associated with our channels of distribution:

      During our billing system conversion, which was completed in early July 2005, we became aware of errors in the Metrocall units in service counts and differences in the definition of units in service between Metrocall

and Arch. As a result, as of June 30, 2005, we reduced our units in service by 238,000 units to correct the errors and to conform to the Arch billing system standard unit definition. There was no impact on revenue.

      Our customers may subscribe to one-way or two-way messaging services for a monthly service fee which is generally based upon the type of service provided, the geographic area covered, the number of devices provided to the customer and the period of commitment. Voice mail, personalized greeting and equipment loss and/or maintenance protection may be added to either one or two-way messaging services, as applicable, for an additional monthly fee. Equipment loss protection allows subscribers who lease devices to limit their cost of replacement upon loss or destruction of a messaging device. Maintenance services are offered to subscribers who own their device.

      A subscriber to one-way messaging services may select coverage on a local, regional or nationwide basis to best meet their messaging needs. Local coverage generally allows the subscriber to receive messages within a small geographic area, such as a city. Regional coverage allows a subscriber to receive messages in a larger area, which may include a large portion of a state or sometimes groups of states. Nationwide coverage allows a subscriber to receive messages in major markets throughout the United States. The monthly fee generally increases with coverage area. Two-way messaging is generally offered on a nationwide basis.

      The following table summarizes the breakdown of our one-way and two-way units in service at specified dates:

      We provide wireless messaging services to subscribers for a monthly fee, as described above. In addition, subscribers either lease a messaging device from us for an additional fixed monthly fee or they own a device, having purchased it either from the Company or from another vendor. We also sell devices to resellers who lease or resell devices to their subscribers and then sell messaging services utilizing our networks.

      The following table summarizes the number of units in service owned by us, our subscribers and our indirect customers at specified dates:

      We derive the majority of our revenues from fixed monthly or other periodic fees charged to subscribers for wireless messaging services. Such fees are not generally dependent on usage. As long as a subscriber maintains service, operating results benefit from recurring payment of these fees. Revenues are generally driven by the number of units in service and the monthly charge per unit. The number of units in service changes based on subscribers added, referred to as gross placements, less subscriber cancellations, or disconnects. The net of gross placements and disconnects is commonly referred to as net gains or losses of units in service. The absolute number of gross placements as well as the number of gross placements relative to average units in service in a period, referred to as the gross placement rate, is monitored on a monthly basis. Disconnects are also monitored on a monthly basis. The ratio of units disconnected in a period to beginning units in service for the same period, called the disconnect rate, is an indicator of our success retaining subscribers which is important in order to maintain recurring revenues and to control operating expenses.

      The following table sets forth our gross placements and disconnects for the periods stated.

      The demand for one-way and two-way messaging services declined during the nine months ended September 30, 2005, and we believe demand will continue to decline for the foreseeable future.

      The other factor that contributes to revenue, in addition to the number of units in service, is the monthly charge per unit. As previously discussed, the monthly charge is dependent on the subscriber’s service, extent of geographic coverage, whether the subscriber leases or owns the messaging device and the number of units the customer has on his or her account. The ratio of revenues for a period to the average units in service for the same period, commonly referred to as average revenue per unit (“ARPU”), is a key revenue measurement as it indicates whether monthly charges for similar services and distribution channels are increasing or decreasing. ARPU by distribution channel and messaging service are monitored regularly. The following table sets forth our ARPU by distribution channel for the periods stated.

      While ARPU for similar services and distribution channels is indicative of changes in monthly charges and the revenue rate that we add new subscribers, this measurement on a consolidated basis is affected by several factors, most notably the mix of units in service. Gross revenues have increased year over year due to the Metrocall merger, but we expect future sequential quarterly revenues to decline. The change in our consolidated average revenue per unit for the quarter ended September 30, 2005 from the quarters ended September 30, 2004 and June 30, 2005, was due primarily to the change in mix in customers and considered the 238,000 unit adjustment referred to above. The change in ARPU in our direct distribution channel is the most significant indicator of rate-related changes in our revenues. We expect ARPU for our direct units in service will decline in future periods.

      Our revenues were $109.4 million and $152.0 million for the three months ended September 30, 2004 and 2005, respectively, and $348.9 million and $475.2 million for the nine months ended September 30, 2004 and 2005, respectively. The 2004 revenues include historical information for Arch only. Certain of our operating expenses are especially important to overall expense control; these operating expenses are categorized as follows:

      We review the percentages of these operating expenses to revenues on a regular basis. Even though the operating expenses are classified as described above, expense controls are also performed by expense category. For the quarter ended September 30, 2005, we incurred approximately 74% of the expenses referred to above in three expense categories: payroll and related expenses, lease payments for transmitter locations and telecommunications expenses.

      Payroll and related expenses include wages, commissions, incentives, employee benefits and related taxes. We review the number of employees in major functional categories such as direct sales, engineering and technical staff, customer service, collections and inventory on a monthly basis. We also review the design and physical locations of functional groups to continuously improve efficiency, to simplify organizational structures and to minimize the number of physical locations.

      Lease payments for transmitter locations are largely dependent on our messaging networks. We operate local, regional and nationwide one-way and two-way messaging networks. These networks each require locations on which to place transmitters, receivers and antennae. Generally, lease payments are incurred for each transmitter location. Therefore, lease payments for transmitter locations are highly dependent on the number of transmitters, which in turn is dependent on the number of networks. In addition, these expenses generally do not vary directly with the number of subscribers or units in service, which is detrimental to our operating margin as revenues decline. In order to reduce this expense, we have an active program to consolidate the number of networks and thus transmitter locations, which we refer to as network rationalization.

      Telecommunications expenses are incurred to interconnect our messaging networks and to provide telephone numbers for customer use, points of contact for customer service and connectivity among our offices. These expenses are dependent on the number of units in service and the number of office and network locations we maintain. The dependence on units in service is related to the number of telephone numbers provided to customers and the number of telephone calls made to our call centers, though this is not always a direct dependency. For example, the number or duration of telephone calls to our call centers may vary from period to period based on factors other than the number of units in service, which could cause telecommunica-

tions expense to vary regardless of the number of units in service. In addition, certain phone numbers we provide to our customers may have a usage component based on the number and duration of calls to the subscriber’s messaging device. Telecommunications expenses do not necessarily vary in direct relationship to units in service. Therefore, based on the factors discussed above, efforts are underway to review and reduce telephone circuit inventories and capacities and to reduce the number of transmitter and office locations at which we operate.

      USA Mobility did experience limited damage to transmission equipment located in the Gulf of Mexico region of the United States from Hurricanes Katrina and Rita in the third quarter of 2005. Expenses related to storm-related recovery efforts have been included in service, rental and maintenance expenses, and were immaterial for the third quarter of 2005. In addition, the Company recorded losses of $208,000 to reflect the loss of damaged assets. To date, the impact to revenues or bad debt expense has been immaterial. The Company has an insurance policy that affords recovery for operational expenses, asset losses and business interruption, and is working to assemble its claims; at this time, however, the Company cannot estimate the amount and timing of insurance recoveries, if any.

      The total of our cost of products sold, service, rental and maintenance, selling and marketing, and general and administrative expenses was $72.9 million and $111.6 million for the three months ended September 30, 2004 and 2005, respectively, and $228.6 million and $344.1 million for the nine months ended September 30, 2004 and 2005, respectively. Since we believe the demand for and our revenues from one-way and two-way messaging will continue to decline in future quarters, expense reductions will be necessary in order for us to mitigate the financial impact of such revenue declines. However, there can be no assurance that the Company will be able to maintain margins or generate net cash from operating activities.

      As previously discussed, Arch and Metrocall merged on November 16, 2004. The results of operations and cash flows discussed below for 2004 include the operating results and cash flows of Arch only for the three and nine months ended September 30, 2004, while the 2005 period includes the operating results of Arch and Metrocall. Accordingly, the apparent growth in operations is due to the merger.

      Service, rental and maintenance revenues consist primarily of recurring fees associated with the provision of messaging services and rental of leased units. Product sales consist largely of revenues associated with the

sale of devices and charges for leased devices that are not returned. The increase in revenues in each revenue type is the result of including revenues of Metrocall during 2005 as compared to Arch only during 2004. The combined Company has experienced, and expects to continue to experience, revenue declines for the foreseeable future.

      The table below sets forth units in service and service revenues, the changes in each between the three months ended September 30, 2004 and 2005 and the change in revenue associated with differences in the number of units in service and the ARPU.

      As previously discussed, demand for messaging services has declined over the past several years and we anticipate that it may continue to decline for the foreseeable future, which would result in reductions in service revenue due to the lower number of subscribers and related units in service.

     Cost of Products Sold. Cost of products sold consists primarily of the cost basis of devices sold to or lost by our customers. The increase for the three months ended September 30, 2005 was due primarily to an increase in the number of device transactions due to the Metrocall merger.

     Service, Rental and Maintenance. Service, rental and maintenance expenses consist primarily of the following significant items:

      As illustrated in the table above, service, rental and maintenance expenses increased $17.7 million or 48.0% from 2004. The percentage of these costs to revenues also increased, primarily due to the acquisition of the Metrocall one-way and two-way networks that resulted in increased lease and telecommunications-related expenses.

      Following is a discussion of each significant item listed above:

     Selling and Marketing. Selling and marketing expenses consist primarily of payroll and related expenses. Selling and marketing payroll and related expenses increased $3.4 million or 43.4% over 2004. This increase was due primarily to an increase in the number of sales representatives and sales management which resulted from the Metrocall merger.

     General and Administrative. General and administrative expenses consist of the following significant items:

      As illustrated in the table above, general and administrative expenses increased $17.3 million from the three-month period ended September 30, 2004 due to the inclusion of Metrocall operations. The percentages of these expenses to revenue also increased, primarily due to the following:

     Depreciation and Amortization. Depreciation and amortization expenses increased to $27.3 million for the three month period ended September 30, 2005 from $22.3 million for the same period in 2004. This increase was due primarily to depreciation and amortization expense of the tangible and intangible assets acquired from Metrocall, of $11.6 million, partially offset by a decrease of $6.6 million related to groups of assets becoming fully depreciated in legacy Arch operations. Depreciation expense for the three months ended September 30, 2005, also includes $0.2 million for assets damaged and lost due to Hurricanes Katrina and Rita.

     Stock Based Compensation. Stock based compensation consists primarily of amortization of compensation expense associated with restricted common stock and options issued to certain members of management. USA Mobility uses the fair-value based method of accounting for stock based compensation. Stock based compensation decreased to $0.08 million for the three month period ended September 30, 2005 from $1.9 million for the same period in 2004 since the outstanding options vested in May 2005, offset by the compensation expense of the grant of 103,937 shares of restricted common stock to eligible employees on June 7, 2005.

     Severance Costs and Related Termination Costs. Severance decreased to $1.0 million for the three month period ended September 30, 2005 from $1.2 million for the same period in 2004. The decrease consists primarily of both actual and planned reductions in headcount due to the reorganization plan to adjust management structure and consolidate three sales divisions of five regions into one national sales organization consisting of eleven regions. The majority of costs associated with these planned reductions were accrued as of June 30, 2005. Lease termination penalty expenses were $0.3 million for the three month period ended September, 30, 2005.

     Interest Expense. Net interest expense decreased to $0.02 million for the three month period ended September 30, 2005 from net interest income of $0.07 million for the same period in 2004. This decrease was due to the repayment of Arch’s 12% notes on May 28, 2004 partially offset by $0.2 million of expense associated with the $140.0 million of debt incurred to partially fund the cash election to former Metrocall shareholders in accordance with the terms of the merger agreement. All of the debt incurred as a result of the merger with Metrocall was repaid during the quarter.

     Income Tax Expense. For the three month period ended September 30, 2005, the Company recognized $11.3 million of income tax expense. Included in the current quarter income tax expense for the three months was $4.6 million based on an effective tax rate of approximately 40%. Additionally in the three month expense is a charge of approximately $7.3 million to revalue the deferred tax assets from a statutory effective tax rate of 40.2% to 38.8%. The Company reduced its income tax expense by $0.6 million to reflect the filing of its 2004 income tax returns. The Company anticipates the recognition of income tax expense to be required for the foreseeable future, but we do not anticipate these expenses to result in current federal tax liability.

      Service, rental and maintenance revenues consist primarily of recurring fees associated with the provision of messaging services and rental of leased units. Product sales consist largely of revenues associated with the sale of devices and charges for leased devices that are not returned. The increase in revenues in each revenue type is the result of including revenues of Metrocall during 2005 as compared to Arch only during 2004.

      The table below sets forth units in service and service revenues, the changes in each between the nine months ended September 30, 2004 and 2005 and the change in revenue associated with differences in the number of units in service and ARPU.

      As previously discussed, demand for messaging services has declined over the past several years and we anticipate that it will continue to decline for the foreseeable future, which would result in reductions in service revenue due to the lower number of subscribers.

     Cost of Products Sold. Cost of products sold consists primarily of the cost basis of devices sold to or lost by our customers. The increase for the nine months ended September 30, 2005 was due primarily to an increase in the number of device transactions due to the Metrocall merger.

     Service, Rental and Maintenance. Service, rental and maintenance expenses consist primarily of the following significant items: