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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2of the Exchange Act.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2of 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: 27,347,224 shares of the Registrant’s Common Stock ($0.0001 par value per share) were outstanding as of November 3, 2006.

 

 

 

 

 

 

 

 

 

 

(4) Goodwill and Other Intangible Assets — Goodwill of $149.5 million at September 30, 2006 resulted from the purchase accounting related to the November 2004 merger of Arch Wireless, Inc. and subsidiaries (“Arch”) and Metrocall Holdings, Inc. and subsidiaries (“Metrocall”). The Company’s operations consist of one reporting unit to evaluate goodwill. Goodwill is not amortized, but is evaluated for impairment annually. 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, 2005 and 2006 was $19.3 million and $11.4 million, respectively.

 

The Company did not record any impairments of long-lived assets, intangible assets or goodwill in the first, second and third quarters of 2005 or 2006, respectively. The Company is required to evaluate goodwill of a reporting unit for impairment at least annually and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. (For this evaluation the Company as a whole is considered the reporting unit.) Declines in the Company’s stock price or changes in expected cash flows impact the calculation of fair value of the reporting unit for purposes of this evaluation. Should the Company’s stock price declineand/or other circumstances arise that would reduce the fair value of the reporting unit, there is a reasonable possibility that a material impairment to goodwill could occur.

 

Amortizable intangible assets are comprised of the following at September 30, 2006 (dollars in thousands):

 

 

(5) Accounts Payable and Accrued Liabilities — Accounts payable and accrued liabilities consist of the following (dollars in thousands):

 

 

Accrued taxes are based on the Company’s estimate of outstanding state and local taxes. This balance may be adjusted in the future as the Company settles with various taxing jurisdictions.

 

(6) Asset Retirement Obligations — 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 $17.4 million at both December 31, 2005 and September 30, 2006. Network assets have been increased to reflect these costs and depreciation is being recognized over their estimated lives, which range between one and eight years.

 

 

Depreciation, amortization and accretion expense for the nine months ended September 30, 2005 and 2006 included $2.6 million and $1.0 million, respectively, related to depreciation of these assets. 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 through 2013.

 

The components of the changes in the asset retirement obligation balances for the nine months ended September 30, 2006 were as follows:

 

 

The balances above were included in accrued other and other long-term liabilities, respectively, at September 30, 2006.

 

(7) Other Long-Term Liabilities — Other long-term liabilities consist of the following (dollars in thousands):

 

 

(8) 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

(9) Revenue Recognition — Revenue consists primarily of monthly service and rental fees charged to customers on a monthly, quarterly, semi-annual or annual basis. Revenue also includes the sale of messaging devices directly to customers and other companies that resell the Company’s services. In accordance with the provisions of Emerging Issues Task Force (“EITF”) IssueNo. 00-21,Revenue Arrangements with Multiple Deliverables, (“EITFNo. 00-21”),the Company evaluated these revenue arrangements and determined that two separate units of accounting exist, messaging service revenue and product sale revenue, and that objective reliable evidence exists to recognize revenue separately for each element. Accordingly, the Company recognizes messaging service revenue over the period the service is performed and revenue from product sales is recognized at the time of shipment. The Company recognizes revenue when four basic criteria have been met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services rendered, (3) the fee is fixed or determinable and (4) collectibility is reasonably assured. Amounts billed but not meeting these recognition criteria are deferred until all four criteria have been met. The Company has a variety of billing arrangements with its customers resulting in deferred revenue in advance billing and accounts receivable for billing in-arrears arrangements.

 

USA Mobility’s 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 lossand/ormaintenance 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.

 

In June 2005, the Company announced an alliance with Advanced Metering Data Systems, LLC (“AMDS”) and Sensus Metering Systems (“Sensus”) to provide meter-monitoring services over a narrow-band PCS network. The Company agreed to sell one of its FCC licenses and to provide tower space and other custom network services to AMDS. On August 29, 2005, the FCC approved the license sale. Closing occurred on October 12, 2005. Proceeds from these sales included a note receivable of $1.5 million and a royalty of 1% to 3% of net monitoring revenue derived from the use of the FCC license. The Company did not consider collectibility of the proceeds to be reasonably assured. As such, the Company recognized the gain on sale of the license through Other Income, as the monthly payments were made. Proceeds of $0.3 million were recognized as received in Other Income during the

 

 

period October 12, 2005 to May 31, 2006. Revenue relating to the ancillary services agreement is recognized as earned as part of Service, Rental and Maintenance revenue.

 

On June 2, 2006, Sensus acquired substantially all of the assets and assumed certain liabilities of AMDS. Due to this change in control, the balance outstanding on the AMDS note receivable has been paid. Sensus assumed AMDS’ obligation to pay the balance of AMDS’ royalty fees in accordance with the original agreement and agreed to pay the full amount of the note in July 2006. With subsequent collection of total proceeds in July, all four of the criteria for revenue recognition were met and the Company recognized in June 2006 $1.2 million in Other Income with respect to the AMDS note receivable.

 

(10) Stock Based Compensation Expense — Compensation expense associated with options and restricted stock was recognized in accordance with the fair value provisions of SFAS No. 123R, over the instruments’ vesting period. The following table reflects the income statement line items that include the $2.3 million and $2.1 million of stock based compensation for the nine months ended September 30, 2005 and 2006, respectively (in thousands):

 

 

(11) Severance and Restructuring —The balance of this accrued liability will be paid during 2006. Severance cost charges in 2006 primarily relate to the sale of an internally managed call center to an outside provider during the second quarter of 2006.

 

(12) Settlement Agreements — During the three months ended March 31, 2005, the Company reached a settlement agreement with a vendor for roaming credits held by USA Mobility and recorded a $1.5 million reduction to service, rental and maintenance expenses for this cash consideration. The Company will also utilize additional benefits of $0.5 million over the next 58 months as USA Mobility customers incur roaming charges on the vendor’s network.

 

(13) Income Taxes — USA Mobility accounts for income taxes under the liability method of SFAS No. 109, Accounting for Income Taxes,(“SFAS No. 109”). Deferred income tax assets and liabilities are determined based on the difference between the financial statement and the income tax bases of assets and liabilities, given the provisions of enacted laws. The Company provides 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 of USA Mobility’s net deferred income tax assets will be realized in future periods.

 

The evaluation of the recoverability of the deferred income tax assets is based on historic and continued 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 may not be realized in the future, or if the Company is unable to generate sufficient revenue and projections of future revenue are adjusted downward, a partial or full valuation allowance against deferred tax assets may be required.

 

The anticipated effective tax rate is expected to continue to differ from the statutory federal tax rate of 35%, primarily due to the effect of state income taxes.

 

 

(14) Related Party Transactions — Two of USA Mobility’s 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 and 2006, the Company paid $18.6 million and $2.5 million, and $13.1 million and $13.8 million, respectively, to these two landlords for rent expenses that are included in service, rental and maintenance expenses. Each director has recused himself from any discussions or decisions by the Company on matters relating to the respective vendor for which he serves as a director.

 

(15) Segment Reporting — USA Mobility believes it currently has two operating segments: domestic operations and international operations, but no reportable segments, as international operations are immaterial to the consolidated entity.

 

(16) New Accounting Pronouncements — In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements(“SFAS No. 157”). SFAS No. 157 establishes a formal framework for measuring fair value under generally accepted accounting principles. Although SFAS No. 157 applies (amends) the provisions of existing FASB and AICPA pronouncements, it does not require any new fair value measurements nor does it establish valuation standards. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Management has determined that SFAS No. 157 will have no material impact to the Company.

 

In September 2006, the FASB issued SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans(“SFAS No. 158”). SFAS No. 158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. SFAS No. 158 is effective as of the end of the fiscal year ending after December 15, 2006, for entities with publicly traded securities and at the end of fiscal year ending after June 15, 2007 for all other entities. Management has determined that SFAS No. 158 will have no material impact to the Company.

 

In June 2006, the FASB issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes(“FIN 48”). FIN 48 addresses the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently evaluating the impact FIN 48 will have on the Company.

 

In June 2006, the FASB ratified the EITF IssueNo. 06-3,How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (“EITFNo. 06-3”).EITFNo. 06-3requires an entity to disclose transactional tax amounts assessed by government authorities that are considered significant. EITFNo. 06-3is effective for interim and annual reporting periods beginning after December 15, 2006. Management has determined that EITFNo. 06-3will have no impact to the Company’s disclosures.

 

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 , “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”(“SAB No. 108”). SAB No. 108 requires quantification of errors using both a balance sheet approach and an income statement approach in the determination of materiality in relation to a misstatement. SAB No. 108 is effective the first fiscal year ending after November 15, 2006. Management is currently evaluating the impact, if any, SAB No. 108 will have on the Company.

 

(17) Commitments and Contingencies — In November 2004, USA Mobility entered into a contract under which the Company is committed to purchase $10.0 million in telecommunication services over a two-year period ending in October 2006.

 

In August 2005, the Company, 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 the Companyand/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, the Company 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.

 

In January 2006, USA Mobility entered into a new Master Lease Agreement (“MLA”) with American Tower Corporation (“ATC”). Under the new MLA, USA Mobility will pay ATC a fixed monthly amount in exchange for the rights to a fixed number of transmitter equivalents (as defined in the MLA) on transmission towers in the ATC portfolio of properties. The new MLA was effective January 1, 2006 and expires on December 31, 2010. The fixed monthly fee decreases periodically over time from $1.5 million per month in January 2006 to $0.9 million per month in 2010.

 

In June 2006, as a result of the sale of an internally managed call center to an outside provider, USA Mobility entered into a Master Service Agreement (“MSA”) with TPUSA, Inc. (“TPUSA”). Under this MSA, USA Mobility will pay a minimum monthly amount for call center services. The MSA was effective June 8, 2006, and the minimum monthly commitment expires on December 31, 2006. The minimum monthly commitment during this period is $500,000.

 

In September 2006, USA Mobility re-negotiated an existing contract with a vendor under which the Company is committed to purchase $24.0 million in telecommunication services through September 2008.

 

USA Mobility has various Letters of Credit (“LOCs”) outstanding with multiple state agencies. The LOCs typically have three-year contract requirements but are renewed annually. The deposits related to these LOCs are classified within Other Assets on the balance sheet.

 

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 financial position or results of operations.

 

USA Mobility was named as a defendant in a breach of contract suit filed in the U.S. District Court for the Northern District of Texas, (Ad Valorem Services Company v. USA Mobility, Inc.,No. 4-06CV-742-Y),alleging that the Company owes a property tax filing services firm monetary damages of up to $3.3 million in addition to amounts already paid by the Company to the firm under the contract. The Company was served with the complaint in this action on October 26, 2006, and intends to deny all claims and seek to have this suit dismissed. In the Company’s view, this suit is without merit and will have no material effect on the Company’s financial results or operations.

 

On August 2, 2006, Nationwide Paging, Inc. (“Nationwide”) filed a two-count civil action in Massachusetts Superior Court against defendants USA Mobility, Inc., Arch Wireless Inc., Arch Operating Company, Inc., and Paging Network, Inc. (collectively “Arch”) titledNationwide Paging, Inc. v. Arch Wireless, Inc. and Paging Network, Inc. MICV2006-02734, Middlesex County Superior Court, Massachusetts (the “2006 Superior Court Case”). Nationwide alleged that, in 2000 and 2001, Arch breached its contract with Nationwide by supplying defective pagers and by over billing Nationwide for paging services. In addition, Nationwide alleged that Arch breached the implied covenant of good faith and fair dealing and destroyed or injured Nationwide’s right to receive the fruits of its contract with Arch. Nationwide’s complaint alleges damages in the amount of $6.9 million.

 

Nationwide served the 2006 Superior Court Case on USA Mobility on October 27, 2006. The Company denies liability to Nationwide and intends to vigorously defend the allegations of the complaint.

 

There are two related cases that are outstanding, Nationwide Paging, Inc. v. Arch Wireless, Inc. and Paging Network, Inc., MICV2002-02329, Middlesex County Superior Court, Massachusetts (the “2002 Superior Court Case”) andIn re Arch Wireless, Inc., U.S. Bankruptcy Court, District of Massachusetts, Western Division, Chapter 11, CaseNo. 01-47330-HJB(the “Arch Bankruptcy Case”). The 2002 Superior Court Case has been stayed due to Nationwide’s filing in October 2005 of a voluntary Chapter 11 bankruptcy proceeding. The Arch Bankruptcy Case involves Arch’s motion for contempt against Nationwide and alleges that Nationwide’s claims in the 2002 Superior Court Case are barred by the discharge injunction in the Arch Bankruptcy Case. The bankruptcy court denied that motion. The Company has appealed that decision. The appeal has not been decided.

 

 

USA Mobility intends to pursue the appeal of the bankruptcy court’s denial of Arch’s motion for contempt against Nationwide. In addition, USA Mobility intends to defend the 2006 Superior Court Case, and also to defend the claims by Nationwide in the 2002 Superior Court Case, if the appeal in the Arch Bankruptcy Case is denied and the stay is lifted. Further, if the stay is lifted, Arch intends to prosecute vigorously its counterclaims against Nationwide. In the Company’s view these suits are without merit and will have no material effect on the Company’s financial results or operations.

 

 

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” (“MD&A”) and within “Item 1A. Risk Factors” of Part II of this quarterly report. 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. USA Mobility undertakes no obligation to update or revise any forward-looking statements. All subsequent written or oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the discussion under “Item 1A. Risk Factors” section of Part II of this quarterly report.

 

The following discussion and analysis should be read in conjunction with USA Mobility’s consolidated financial statements and related notes and “Item 1A. Risk Factors”, which describe key risks associated with the Company’s operations and industry, and the following subsections of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of the Company’s Annual Report onForm 10-Kfor the fiscal year ended December 31, 2005: “Overview,” “Results of Operations,” “Liquidity and Capital Resources,” “Inflation” and “Application of Critical Accounting Policies.”

 

USA Mobility believes that the combination of Arch Wireless, Inc. and subsidiaries (“Arch”) and Metrocall Holdings, Inc. and subsidiaries (“Metrocall”) in November 2004 provided the Company with 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.

 

Since the merger, the Company has undertaken significant integration and consolidation activities. These activities have included management and staff reductions and reorganizations, network rationalization and consolidation and changes in operational systems, processes and procedures. Such changes are described below.

 

USA Mobility markets and distributes its services through a direct sales force and a small indirect sales force.

 

Direct.  The 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. USA Mobility intends to continue to market to commercial enterprises utilizing its direct sales force as these commercial enterprises have typically disconnected service at a lower rate than individual consumers. As of September 30, 2006, USA Mobility sales personnel were located in approximately 86 offices in 35 states throughout the United States. In addition, the Company maintains several corporate sales groups focused on medical sales; federal government accounts; large enterprise; advanced wireless services; systems sales applications; telemetry and other product offerings.

 

Indirect.  Within the indirect channel the Company contracts with and invoices 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 USA Mobility 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 the indirect distribution channel has been higher than the rate experienced with direct customers and USA Mobility expects this to continue in the foreseeable future.

 

The following table sets forth units in service associated with the Company’s channels of distribution:

 

 

Customers may subscribe to one- 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 lossand/ormaintenance 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.

 

Subscribers 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 the Company’s one-way and two-way units in service at specified dates:

 

 

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

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

 

 

USA Mobility derives the majority of its 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 average units in service for the same period, called the disconnect rate, is an indicator of the Company’s success in retaining subscribers, which is important in order to maintain recurring revenues and to control operating expenses.

 

The following table sets forth the Company’s 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, 2006, and USA Mobility believes 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 USA Mobility’s 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 applicable to new subscribers, this measurement on a consolidated basis is affected by several factors, most notably the mix of units in service. Gross revenues decreased year over year, and the Company expects future sequential quarterly revenues to decline. The decrease in consolidated ARPU for the quarter ended September 30, 2006 from the quarters ended September 30, 2005 and June 30, 2006, was due primarily to the change in composition of the Company’s customer base as the percentage of units in service attributable to larger customers continues to increase. The change in ARPU in the direct distribution channel is the most significant indicator of rate-related changes in the Company’s revenues. USA Mobility expects that ARPU for its direct units in service will decline in future periods.

 

Certain of the Company’s operating expenses are especially important to overall expense control; these operating expenses are categorized as follows:

 

 

USA Mobility reviews 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, 2006, approximately 73.9% of the expenses referred to above were incurred 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. USA Mobility reviews 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. The Company also reviews the design and physical locations of functional groups to continuously improve efficiency, to simplify organizational structures and to minimize the number of physical locations. Since the merger on November 16, 2004, the Company has reduced its employee base from 2,844 full time equivalent employees (“FTEs”) at the time of the merger to 1,279 FTEs at September 30, 2006. During the second quarter 2006, USA Mobility sold an internally managed call center to an outside provider, resulting in a reduction of 203 FTEs. While certain staff reductions have resulted in significant severance expenses, the Company’s on-going cost of payroll and related expenses will be reduced.

 

Lease payments for transmitter locations are largely dependent on the Company’s messaging networks. USA Mobility operates 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 the Company’s operating margin as revenues decline. In order to reduce this expense, USA Mobility has an active program to consolidate the number of networks and thus transmitter locations, which the Company refers to as network rationalization.

 

Telecommunications expenses are incurred to interconnect USA Mobility’s messaging networks and to provide telephone numbers for customer use, points of contact for customer service and connectivity among the Company’s offices. These expenses are dependent on the number of units in service and the number of office and network locations the Company maintains. 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 the Company’s call centers, though this is

not always a direct dependency. For example, the number or duration of telephone calls to call centers may vary from period to period based on factors other than the number of units in service, which could cause telecommunications expenses to vary regardless of the number of units in service. In addition, certain phone numbers USA Mobility provides to its 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 the Company operates.

 

The total of USA Mobility’s cost of products sold; service, rental and maintenance; selling and marketing; and general and administrative expenses was $342.6 million and $271.0 million for the nine months ended September 30, 2005 and 2006, respectively. Since the Company believes the demand for, and the Company’s revenues from, one-way and two-way messaging will continue to decline in future quarters, expense reductions will be necessary in order for USA Mobility to mitigate the financial impact of such revenue declines on its cash from operating activities. However, there can be no assurance that the Company will be able to maintain margins or generate net cash from operating activities.

 

 

 

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 primarily of revenues associated with the sale of devices and charges for leased devices that are not returned. The decrease in revenues reflects the decrease in demand for the Company’s wireless services. USA Mobility’s total revenues were $152.0 million and $119.6 million for the three months ended September 30, 2005 and 2006, respectively.

 

 

The table below sets forth units in service and service revenues, the changes in each between the three months ended September 30, 2005 and 2006 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 the Company anticipates 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 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 USA Mobility’s customers. The $0.2 million increase for the three months ended September 30, 2006 was due primarily to an increase in system sales. The revenue for system sales is included as part of product sales revenue.

 

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 decreased $11.3 million or 21.0% from the same period in 2005.

 

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 decreased $0.4 million or 3.5% over the similar period in 2005. While total FTEs declined by 42 from 479 FTEs at September 30, 2005 to 437 FTEs at September 30, 2006, the

Company has launched a major initiative to reposition the Company and refocus its marketing goals. The sales and marketing staff are all involved in selling the Company’s paging products and services on a nationwide basis as well as reselling other wireless products and services such as cellular phones and email devices under authorized agent agreements.

 

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

 

 

As illustrated in the table above, general and administrative expenses decreased $12.4 million from the period ended September 30, 2005 due primarily to headcount reductions and office closures since the inclusion of Metrocall operations. The percentages of these expenses to revenue also decreased, primarily due to the following:

 

 

 

Depreciation, Amortization and Accretion.  Depreciation, amortization and accretion expenses decreased to $18.4 million for the quarter ended September 30, 2006 from $28.9 million for the same period in 2005. The decrease was primarily due to $6.7 million of fully depreciated paging infrastructure and other assets, $1.4 million in lower depreciation expense on paging devices resulting from lower purchases of paging devices and from fully depreciated paging devices, and $2.4 million in amortization expense.

 

Severance and Restructuring Charges.  These costs were $0.9 million and $0.7 million for the three months ended September 30, 2005 and 2006 respectively, and consist of charges resulting from staff reductions as the Company continues to match its employee levels to operational requirements.

 

Interest Income (Expense).  Net interest income is $0.7 million for the period ended September 30, 2006 compared to net expense of $0.02 million for the same period in 2005. This increase was due to the investment of available cash in short term interest bearing accounts for the three months ended September 30, 2006, versus interest expense for the same period in 2005 on the $13.3 million of average debt outstanding that was used to partially fund the cash consideration to Metrocall shareholders.

 

Income Tax Expense.  For the three-month period ended September 30, 2006, the Company recognized $7.1 million of income tax expense. The expense for the three months ended September 30, 2005 was $3.8 million. The increase in the provision for the current year was primarily due to higher income before income tax expense, and included a charge of $0.3 million resulting from recently enacted changes in income tax laws primarily in Michigan, and a $0.7 million charge to establish a valuation allowance against the portion of the Company’s charitable contributions carry forward estimated to expire prior to utilization. USA Mobility anticipates recognition of provisions for income taxes to be required for the foreseeable future.

 

 

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 primarily of revenues associated with the sale of devices and charges for leased devices that are not returned. The decrease in revenues reflects the decrease in demand for the Company’s wireless services. USA Mobility’s total revenues were $475.2 million and $381.7 million for the nine months ended September 30, 2005 and 2006, respectively.