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 o     Accelerated filer þ     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: 27,315,102 shares of the Registrant’s Common Stock ($0.0001 par value per share) were outstanding as of July 27, 2007.

 

 

 

 

 

 

 

 

 

 

 

 

(1) Preparation of Interim Financial Statements— The condensed consolidated financial statements of USA Mobility, Inc. (“USA Mobility” or the “Company”) have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Amounts shown on the condensed consolidated income statements within the Operating Expense categories of cost of products sold; service, rental and maintenance; selling and marketing; and general and administrative are recorded exclusive of depreciation, amortization and accretion, and severance and restructuring charges. These items are shown separately on the condensed consolidated income statements within Operating Expenses.

 

The financial information included herein, other than the condensed consolidated balance sheet as of December 31, 2006, has been prepared without audit. The condensed consolidated balance sheet at December 31, 2006 has been derived from, but does not include all the disclosures contained in, the audited consolidated financial statements for the year ended December 31, 2006. In the opinion of management, these unaudited statements include all adjustments and accruals that are necessary for a fair presentation of the results of all interim periods reported herein. All adjustments are of a normal recurring nature.

 

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in USA Mobility’s Annual Report onForm 10-Kfor the year ended December 31, 2006. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for a full year.

 

(2) 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 lossand/ormaintenance protection to both one-way and two-way messaging subscribers. These services are commonly referred to as wireless messaging and information services.

 

(3) Risks and Other Important Factors — See “Item 1A. Risk Factors” of Part II of this quarterly report, which describes key risks associated with USA Mobility’s operations and industry.

 

Based on current and anticipated levels of operations, USA Mobility’s management believes that 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 revenues 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 the Company’s 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.

 

(4) New Accounting Pronouncements — In June 2006, the Financial Accounting Standards Board (“FASB”) issued Financial Interpretation No. 48,Accounting for Uncertainty in Income Taxes, (“FIN 48”), an interpretation of

 

Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes,(“SFAS No. 109”). In May 2007, FASB Staff Position 48-1 amended FIN 48. The disclosure requirements and cumulative effect of adoption of FIN 48, as amended, are presented in Note 12.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair-value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the first fiscal year beginning after November 15, 2007. SFAS No. 159 should not have a material impact on the Company’s consolidated financial position or results of operations.

 

Other new pronouncements issued during the first and second quarters of 2007 are not applicable to the Company and have no effect on the Company’s consolidated financial position or results of operations.

 

(5) Goodwill and Other Intangible Assets — Goodwill of $199.8 million at June 30, 2007 resulted from the purchase accounting of the November 2004 merger of Arch Wireless, Inc. and subsidiaries (“Arch”) and Metrocall Holdings, Inc. and subsidiaries (“Metrocall”). Based on the requirements of Emerging Issues Task Force (“EITF”) IssueNo. 93-7,Uncertainties Related to Income Taxes in a Purchase Business Combination, (“EITFNo. 93-7”),goodwill increased by $10.0 million during the fourth quarter of 2006 due to a change in management’s estimate of the ultimate tax basis of the deferred income tax assets acquired in the purchase of Metrocall.

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an increase to goodwill of $40.3 million for uncertain tax positions directly related to the merger of Arch and Metrocall. The Company anticipates that between $15.0 to $17.0 million of this $40.3 million increase to goodwill recognized for uncertain tax positions may be resolved in 2007 and result in a corresponding reduction to goodwill.

 

Goodwill is not amortized. 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 determination, the Company as a whole is considered the reporting unit. If the fair-value of the reporting unit is less than its carrying value, an impairment loss is required to be recorded to the extent that the implied value of goodwill within the reporting unit is less than the carrying value. The fair-value of the reporting unit is determined based on discounted cash flows, market multiples or appraised values as appropriate.

 

Declines in the Company’s stock priceand/or other prevailing circumstances that would reduce the fair-value of the reporting unit could indicate that a potential impairment has occurred. Such a decline could require evaluation of impairment more frequently than annually.

 

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 was $3.8 million and $2.5 million for the three months ended June 30, 2006 and 2007, respectively; and $8.0 million and $5.2 million for the six months ended June 30, 2006 and 2007, respectively.

 

The Company did not record any impairment of long-lived assets, intangible assets or goodwill in the first and second quarters of 2006 or 2007, respectively.

 

Amortizable intangible assets are comprised of the following at June 30, 2007 (dollars in thousands):

 

 

(6) Depreciation, Amortization and Accretion— The components of depreciation, amortization and accretion expenses for the three and six months ended June 30, 2006 and 2007, respectively, are as follows (dollars in thousands):

 

 

(7) 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.

 

(8) Asset Retirement Obligations — The Company adopted the provisions of 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, principally transmitters that are located on leased locations. The underlying leases generally require the removal of equipment at the end of the lease term; therefore, a future obligation exists.

 

The Company had recognized cumulative asset retirement costs of $17.4 million at both December 31, 2006 and March 31, 2007. In the second quarter 2007, the Company recorded an additional $0.4 million resulting in a cumulative asset retirement costs of $17.8 million at June 30, 2007. Network assets have been increased to reflect these costs and depreciation is being recognized over their estimated lives, which range between one and nine 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.

 

The components of the changes in the asset retirement obligation balances for the six months ended June 30, 2007 were as follows (dollars in thousands):

 

 

The balances above were included with accounts payable and accrued liabilities and other long-term liabilities, respectively, at June 30, 2007.

 

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

 

 

(10) 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.

 

 

 

 

 

On January 1, 2006, the Company implemented the provisions of SFAS No. 123R, Share-Based Payment, (“SFAS No. 123R”). The implementation of SFAS No. 123R, including the cumulative effect of changes in expense attribution, did not have a material impact on the Company’s financial position or results of operations. The Company followed the modified prospective transition election.

 

At June 30, 2007, the Company has no stock options outstanding.

 

In connection with and prior to the November 2004 merger, the Company established the USA Mobility, Inc. Equity Incentive Plan (“Equity Plan”). Under the Equity Plan, the Company has the ability to issue up to 1,878,976 shares of its common stock to eligible employees and non-employee members of its Board of Directors in the form of common stock, stock options, restricted shares of common stock (“restricted stock”), stock grants or units. Restricted stock awarded under the Equity Plan entitles the stockholder to all rights of common stock ownership except that the shares may not be sold, transferred, exchanged, or otherwise disposed of during the restriction period, which will be determined by the Compensation Committee of the Board of Directors of the Company.

 

The following table summarizes the activities under the Equity Plan from inception through June 30, 2007:

 

 

 

 

Restricted Stock.  For the 2005 grant of restricted stock (“2005 Grant”), the Company used the fair-value based method of accounting for the award and will ratably amortize the $2.2 million to expense over the vesting period. A total of $0.7 million and $0.2 million was included in stock based compensation for the six months ended June 30, 2006 and 2007, respectively, in relation to these shares.

 

On January 1, 2007, 55,616 shares of restricted stock from the 2005 Grant vested, of which 22,403 shares were sold back to the Company in payment of required tax withholdings at a price per share of $22.37, the Company’s closing stock price on December 29, 2006. On April 2, 2007, 6,708 shares of vested restricted stock were issued, of which 2,165 shares were sold back to the Company in payment of required tax withholdings at a price per share of $19.93, the Company’s closing stock price on March 30, 2007. On July 2, 2007, 6,708 shares of vested restricted stock were issued, of which 2,144 shares were sold back to the Company in payment of required tax withholdings at a price per share of $26.76, the Company’s closing stock price on June 29, 2007. The shares purchased by the Company were retired and will not be reissued. The remaining 13,455 shares from the 2005 Grant are scheduled to vest ratably over the remainder of 2007, such that all shares awarded are scheduled to fully vest by December 31, 2007.

 

For the 2006 grant of restricted stock (“2006 Grant”), the Company used the fair-value based method of accounting for the award and will ratably amortize the $3.5 million to expense over the vesting period. A total of $0.5 million and $0.6 million was included in stock based compensation for the six months ended June 30, 2006 and 2007, respectively, in relation to these shares.

 

For the six months ended June 30, 2007, no shares were forfeited. As of June 30, 2007, there were 125,179 shares scheduled to fully vest by January 1, 2009.

 

Cash Award.  Also on February 1, 2006, the Company provided long-term cash performance awards to the same certain eligible employees. The vesting date for these long-term cash performance awards is January 1, 2009 and payment will be made after the vesting date. The Company will ratably amortize the $3.6 million to expense over the vesting period. A total of $0.5 million and $0.6 million was included in payroll and related expenses for the six months ended June 30, 2006 and 2007, respectively, for these long-term cash performance awards. Any unvested long-term cash performance awards are forfeited if the participant terminates employment with USA Mobility.

 

Restricted Stock Units.  On May 3, 2006, the Board of Directors granted the non-executive directors restricted stock units (“RSUs”) in addition to cash compensation for service on the Board of Directors as well as any standing committees of the Board of Directors on which they serve. On April 2, 2007, the Company issued 4,030 RSUs to the Company’s non-executive directors for service performed in the first quarter 2007, of which 391 RSUs represent distributions on previously granted RSUs. On July 2, 2007, the Company issued 3,908 RSUs to the Company’s non-executive directors for service performed in the second quarter 2007, of which 1,197 RSUs represent distributions on previously granted RSUs. These RSUs are fully vested on the date of grant.

 

No shares of common stock are issued for the RSUs until the earlier of (i) the date the participant is no longer an eligible director, or (ii) immediately prior to a change in the ownership of the Company. Prior to the issuance of shares of common stock underlying the RSUs, the RSUs represent unsecured obligations of the Company. USA Mobility used the fair-value based method of accounting for the award. As the RSUs are fully vested on the date of grant and relate to service performed in the first and second quarters of 2007, the Company recognized expense of $0.1 million for the six months ended June 30, 2007 in relation to these RSUs.

 

On August 1, 2007 the Board of Directors approved an acceleration in the conversion date for existing RSUs. Existing RSUs will be converted into shares of common stock on the earlier of: (1) a director’s departure from the Board of Directors; (2) a change in control of the Company (as defined in the Equity Plan); or (3) the second trading day following the day that the Company files its 2007 Annual Report on Form 10-K with the SEC.

 

The Board of Directors also approved that future cash distributions on the existing RSUs will be set aside and paid in cash to each non-executive director when the RSUs are converted into shares of common stock.

 

Finally, on August 1, 2007 with an effective date of July 1, 2007 the Board of Directors approved that, in lieu of RSUs, each non-executive director will be granted in arrears on the first business day following the quarter of service restricted stock in addition to cash compensation for service on the Board of Directors as well as standing committees of the Board of Directors on which they serve. The restricted stock will vest on the earlier of a change in control of the Company (as defined in the Equity Plan) or one year from the date of grant provided the non-executive director maintains continuous service on the Board of Directors. Future cash distributions on restricted stock will be set aside and paid in cash to each non-executive director as the restricted stock vests.

 

Common Stock.  In lieu of cash payments of $20,000 for directors’ fees earned since October 1, 2006 through March 31, 2007, one director elected to receive a total of 948 shares of common stock in January and April 2007, based upon the fair market value of a share of common stock at the date of award. A total of 373 shares of common stock will be issued in July 2007 for fees of $10,000 earned in the second quarter 2007.

 

Cash Distributions to Stockholders.  On February 7, 2007, the Board of Directors declared the regular quarterly cash distribution of $0.65 per share, with a record date of February 22, 2007, and a payment date of March 15, 2007. This cash distribution of approximately $17.8 million was paid from available cash on hand.

 

On May 2, 2007, the Board of Directors declared the regular quarterly cash distribution of $0.65 per share and also declared an additional special one-time cash distribution to stockholders of $1.00 per share. Both distributions had a record date of May 17, 2007 and a payment date of June 7, 2007. The total cash distribution of approximately $45.0 million was paid from available cash on hand.

 

Cash distributions paid as disclosed in the statement of cash flows for the six months ended June 30, 2007 include previously declared cash distributions on shares of vested restricted stock issued in January and April 2007 in relation to the 2005 Grant.

 

Future Cash Distributions to Stockholders.  On August 1, 2007, the Board of Directors declared the regular quarterly cash distribution of $0.65 per share, with a record date of August 16, 2007 and a payment date of September 6, 2007. This cash distribution of approximately $17.8 million is expected to be paid from available cash on hand.

 

Additional Paid-in Capital.  For the six months ended June 30, 2007, additional paid-in capital decreased by $41.0 million due to the recognition of uncertain tax positions, the correction of the deferred income tax assets established in 2003, cash distributions to stockholders, and the vesting and repurchases of shares of restricted stock under the 2005 Grant. This was offset by the issuance of RSUs, distributions and common stock to the non-executive directors discussed above.

 

Net Income per Common Share.  Basic net income per common share is computed on the basis of the weighted average common shares outstanding. Diluted net income per common share is computed on the basis of the weighted average common shares outstanding plus the effect of outstanding stock options and outstanding restricted stock using the “treasury stock” method plus the effect of outstanding RSUs, which are treated as contingently issuable shares. As noted above, the Company acquired a total of 24,568 shares of the Company’s common stock from the Company’s executives in payment of required tax withholdings. The shares of common stock acquired were retired and excluded from the Company’s reported outstanding share balance as of June 30, 2007. The components of basic and diluted net income per common share were as follows (in thousands, except share and per share amounts):

 

 

(11) Stock Based Compensation— Compensation expense associated with stock 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 for stock based compensation expense for the three and six months ended June 30, 2006 and 2007, respectively (dollars in thousands):

 

 

(12) Income Taxes — USA Mobility adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an additional liability of approximately $32.8 million for uncertain tax positions for a total liability of approximately $55.8 million at June 30, 2007. This increase in the liability was reflected as a corresponding increase to goodwill of $40.3 million for uncertain tax positions directly related to the merger of Arch and Metrocall, a decrease to long-term deferred income tax assets of $10.5 million with the remaining $3.0 million accounted for as a reduction to additional paid-in capital. In addition, the Company recognized a $1.4 million reduction in its deferred income tax assets that was primarily accounted for as reduction in the January 1, 2007 balance of additional paid-in capital due to the correction of the deferred income tax assets established in 2003. As of June 30, 2007 the Company had approximately $368.8 million of unrecognized tax benefits (net of the federal and state tax).

 

The Company anticipates that between $23.0 to $25.0 million of the $55.8 million liability recognized for uncertain tax positions may be resolved in 2007 due to the expiration of assessment statutes. Of this amount, $6.0 to $8.0 million would likely decrease the Company’s income tax expense and the remainder would likely decrease goodwill.

 

The Company recognizes accrued interest related to uncertain tax positions in income tax expense. For the six months ended June 30, 2007, the Company accrued approximately $1.1 million for the payment of tax-related interest. The total accrued tax-related interest as of June 30, 2007 is approximately $3.7 million.

 

The Company files its tax returns as prescribed by the tax laws of the jurisdictions in which it operates. The Company is not currently under audit by the Internal Revenue Service (“IRS”). The Company’s 2003 through 2005 tax years are still subject to examination by the IRS. Various state jurisdiction tax years remain open to examination.

 

The Company 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 historical 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 the Company is unable to generate sufficient revenue and projections of future revenue are adjusted downward, a partial, or full valuation allowance against the deferred income tax assets may be required.

 

The Company has established a valuation allowance account against deferred income tax assets of approximately $0.6 million. This relates to charitable contributions carry-forward, which the Company currently anticipates will not be utilized.

 

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.

 

(13) Related Party Transactions — Effective November 16, 2004, two members of the Company’s Board of Directors also serve as directors for entities that lease transmission tower sites to the Company. During the six months ended June 30, 2006 and 2007, the Company paid $9.0 million and $9.3 million, and $6.6 million and $7.5 million, respectively, to these two landlords for site rent expenses that are included in service, rental and maintenance expenses.

 

(14) 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.

 

(15) Commitments and Contingencies — During the second quarter 2007, the Company contracted with a managedservice-hostingprovider for certain computer support services in order to eliminate a data center and to migrate the customer billing/provisioning system. The commitment is estimated to be approximately $7.5 million over thefive-yearterm.

 

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 and its subsidiaries 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 below and under the captions “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”),” and “Item 1A. Risk Factors” in the Company’s 2006 Annual Report onForm 10-K.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. The Company undertakes no obligation to update or revise any forward-looking statements. All subsequent written or oral forward-looking statements attributable to USA Mobility, Inc. and its subsidiaries or persons acting on their behalf are expressly qualified in their entirety by the discussion under “Item 1A. Risk Factors” section.

 

The following discussion and analysis should be read in conjunction with USA Mobility’s condensed 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, 2006: “Overview,” “Results of Operations,” “Liquidity and Capital Resources,” “Inflation,” and “Application of Critical Accounting Policies.”

 

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, healthcare 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 June 30, 2007, USA Mobility sales personnel were located in approximately 76 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. Generally, 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 periodic (monthly, quarterly or annual) 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.

 

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

 

 

USA Mobility provides wireless messaging services to subscribers for a periodic 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 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 based upon 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 at 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 three and six months ended June 30, 2007, and USA Mobility believes demand will continue to decline for the foreseeable future in line with recent trends.

 

The following table sets forth information on the Company’s direct units in service by account size for the period stated.

 

 

The following table sets forth information on the percentage of account size net unit loss for the Company’s direct customers for the period stated.

 

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 per unit 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 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 in line with recent trends. The decrease in consolidated ARPU for the quarter ended June 30, 2007 compared to the quarter ended March 31, 2007 and June 30, 2006, respectively, was primarily due 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.

 

The following table sets forth information on the account size ARPU for the period stated.

 

 

USA Mobility’s operating expenses are presented in functional categories. Certain of the Company’s functional categories 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. In the quarter ended June 30, 2007, approximately 70% of the operating expenses referred to above were incurred in three expense categories: payroll and related expenses, site rent expenses, and telecommunications expenses.

 

Payroll and related expenses include wages, 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 1,151 FTEs at June 30, 2007. The Company anticipates continued staffing reductions during 2007; however the most significant reductions occurred throughout 2006.

 

Site rent expenses 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, site rent expenses are incurred for each transmitter location. Therefore, site rent expenses 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 these expenses, 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 from which the Company operates.

 

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 resulting from storm-related recovery efforts and loss of damaged assets were immaterial and were recorded in 2005 and 2006. The Company received $0.7 million in May 2007 as settlement of related insurance claims. The settlement was included in other income, net in the second quarter 2007.

 

The total of USA Mobility’s cost of products sold; service, rental and maintenance; selling and marketing; and general and administrative expenses was $89.3 million and $74.1 million for the three months ended June 30, 2006 and 2007, respectively; and $185.3 million and $150.5 million for the six months ended June 30, 2006 and 2007, 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 continue to 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 continuing 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 and is net of service credits. 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 $127.2 million and $107.5 million for the three months ended June 30, 2006 and 2007, respectively.

 

The table below sets forth units in service and service revenues, the changes in each between the three months ended June 30, 2006 and 2007 and the changes in revenue associated with differences in ARPU and the number of units in service.

 

 

 

 

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, rental and maintenance revenues 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.

 

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 $5.4 million or 12.1% from 2006. The percentage of expense to revenue increased, primarily due to the following:

 

 

 

Selling and Marketing.  Selling and marketing expenses consist of the following major items: