UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

 

 

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission file number 0-51027

 

 

 

(703) 660-6677

(Registrant’s telephone number, including area code)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE

SECURITIES EXCHANGE ACT OF 1934:

None

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE

SECURITIES EXCHANGE ACT OF 1934:

 

Class A Common Stock Par Value $0.0001 Per Share

(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   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” in Rule 12b-2 of the Securities Exchange Act of 1934. (Check one):

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

 

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

 

The aggregate market value of the common stock held by non-affiliates of the Registrant was $723,415,397 based on the closing price of $29.36 per share on the NASDAQ National Market on June 30, 2005.

 

The number of shares of Registrant’s common stock outstanding on May 19, 2006 was 27,346,978.

 

 

TABLE OF CONTENTS

 

Forward-Looking Statements

 

This annual report contains forward-looking statements and information relating to USA Mobility, Inc. and its subsidiaries 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 below under the captions “Business”, “Risk Factors” and “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. 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 or to persons acting on the Company’s behalf are expressly qualified in their entirety by the discussion under Item 1A “Risk Factors”.

 

General

 

USA Mobility, Inc., a Delaware corporation (“USA Mobility,” the “Company” or “we”), is a leading provider of local, regional and nationwide one-way messaging and two-way messaging services. Through its nationwide wireless networks, the Company provides messaging services to over 1,000 U.S. cities, including the top 100 Standard Metropolitan Statistical Areas (“SMSAs”). At December 31, 2005, the Company had approximately 4.4 million and 0.5 million one and two-way messaging units in service, respectively.

 

The Company’s principal office is located at 6677 Richmond Highway, Alexandria, Virginia 22306, and its telephone number is 866-662-3049. USA Mobility’s Internet address is www.usamobility.com. The Company makes available free of charge through the web site its annual, quarterly and current reports, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after such reports are filed or furnished to the Securities and Exchange Commission. The information on the web site is not incorporated by reference into this Annual Report on Form 10-K and should not be considered a part of this report.

 

Merger of Arch Wireless, Inc. and Metrocall Holdings, Inc.

 

USA Mobility is a holding company that was formed on March 5, 2004 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. 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 diluted basis.

 

The merger was accounted for under the purchase method of accounting pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations , (“SFAS No. 141”). Arch was deemed to be the accounting acquirer of Metrocall. Accordingly, the basis 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. Since Arch was deemed the acquiring entity, Arch’s historical financial results prior to the merger are presented throughout this Form 10-K.

 

Industry Overview

 

The mobile wireless telecommunications industry consists of multiple voice and data providers that compete among one another, both directly and indirectly, for subscribers. Messaging carriers like USA Mobility provide customers with services such as numeric and alphanumeric messaging. Customers receive these messaging services through a small, handheld device. The device, often referred to as a pager, signals a subscriber when a message is received through a tone and/or vibration and displays the incoming message on a small screen. With numeric messaging services, the device displays numeric messages, such as a telephone number. With alphanumeric messaging services, the device displays numeric and/or text messages.

 

Some messaging carriers also provide two-way messaging services using devices that enable subscribers to respond to messages or create and send wireless email messages to other messaging devices, including pagers, personal digital assistants (“PDAs”) and personal computers. These two-way messaging devices, often referred to as two-way pagers, are similar to one-way devices except that they have a small QWERTY keyboard that enables subscribers to type messages which are sent to other devices as noted above. USA Mobility provides two-way messaging and other short messaging based services and applications using its narrowband personal communication services networks.

 

Mobile telephone service, such as cellular and broadband personal communication services (“PCS”) carriers provide telephone voice services as well as wireless messaging services that compete with USA Mobility’s one and two-way messaging services. Customers subscribing to cellular, broadband PCS or other mobile phone services

utilize a wireless handset through which they can make and receive voice telephone calls. These handsets are commonly referred to as cellular or PCS telephones or personal data devices and are generally also capable of receiving numeric, alphanumeric and e-mail messages as well as information services, such as stock quotes, news, weather and sports updates, voice mail, personalized greetings and message storage and retrieval.

 

Technological improvements in PCS telephones and PDAs, including their interoperability with the users’ electronic mail systems, declining prices, and the degree of similarity in messaging devices, coverage and battery life, have resulted in competitive messaging services continuing to take market share from USA Mobility’s paging subscriber base.

 

Although the U.S. traditional paging industry has hundreds of licensed paging companies, the overall number of one and two-way messaging subscribers has been declining as the industry faces intense competition from “broadband”/voice wireless services and other forms of wireless message delivery. As a result demand for USA Mobility’s one and two-way messaging services has declined over the past several years, and the Company believes that it will continue to decline for the foreseeable future. The decline in demand for messaging services has largely been attributable to competition from cellular and broadband PCS carriers.

 

2006 Business Strategy

 

USA Mobility believes that one-way messaging is a cost-effective, reliable means of delivering messages and a variety of other information rapidly over a wide geographic area directly to a mobile person. One-way messaging is a method to communicate at lower cost than current two-way communication methods, such as cellular and PCS telephones. For example, the messaging equipment and airtime required to transmit an average message costs less than the equipment and airtime for cellular and PCS telephones. Furthermore, one-way messaging devices operate for longer periods due to superior battery life, often exceeding one month on a single battery. Numeric and alphanumeric subscribers generally pay a flat monthly service fee. In addition, these messaging devices are unobtrusive and mobile.

 

USA Mobility believes that the combination of Arch and Metrocall 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.

 

The Company’s business objectives and operating strategy for 2006 will focus on maximizing cash flows provided by its operating activities through:

 

 

Customer and Revenue Retention  — USA Mobility’s customer and revenue retention efforts focus on customer service and sales efforts to existing and prospective business, medical and government customers. Retention efforts are supported through the Company’s national sales force and customer service model designed to provide support to customers based on their account size. The Company’s customer service representatives assist customers in managing their account activity. In addition, they address customer inquiries from existing or potential customers. To address the demands and expectations of its customers, USA Mobility provides customer service primarily at a national level with field customer service limited to a select group of customers. Despite this emphasis on customer and revenue retention, the Company expects that its customers and revenue will continue to decline for the foreseeable future, due to technological competition from the mobile phone/PDA service providers as they continue to lower cost while adding functionality.

 

Sales of New Products and Services  — The Company sells wireless phones, through alliance and dealer agreements with several carriers including Sprint Nextel Corporation and Cingular Wireless LLC, to subscribers that require wireless services that are complimentary to ours and/or exceed the capabilities of narrow band PCS messaging networks. These offerings partially offset revenue losses associated with subscriber erosion and enable the Company to satisfy customer demands for a broader range of wireless products and services. However, this represents a very small percentage of total revenues.

Continued Cost Efficiencies  — Throughout 2006 USA Mobility expects to improve its underlying cost structure. These reductions will come from all areas of operations but most significantly from the Company’s continuing network rationalization efforts that impacts its lease and telecommunications expenses.

 

Paging and Messaging Services, Products and Operations

 

USA Mobility provides one and two-way wireless messaging services including information services throughout the United States and Puerto Rico. These services are offered on a local, regional and nationwide basis employing digital networks that cover more than 90% of the United States population.

 

The Company’s customers include businesses with employees who need to be accessible to their offices or customers, first responders who need to be accessible in emergencies, and third parties, such as other telecommunications carriers and resellers that pay the Company to use its networks. Customers include businesses, professionals, management personnel, medical personnel, field sales personnel and service forces, members of the construction industry and construction trades, real estate brokers and developers, sales and service organizations, specialty trade organizations, manufacturing organizations and government agencies.

 

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 December 31, 2005, USA Mobility sales personnel were located in approximately 100 offices in 34 states throughout the United States. In addition, the Company maintains 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 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 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 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 indirect customers at specified dates:

 

 

 

 

Messaging Networks and Licenses

 

USA Mobility holds licenses to operate on various frequencies in the 150 MHz, 450 MHz and 900 MHz bands. The Company is licensed by the Federal Communications Commission (the “FCC”) to operate Commercial Mobile Radio Services (“CMRS”) messaging services. These licenses are utilized to provide one-way and two-way messaging services over the Company’s networks.

 

USA Mobility operates local, regional and nationwide one-way networks, which enable subscribers to receive messages over a desired geographic area. The majority of the messaging traffic that is transmitted on the Company’s 150 MHz and 450 MHz frequency bands utilize the Post Office Code Standardization Advisory Group (“POCSAG”) messaging protocol. This technology is an older and less efficient air interface protocol due to slower transmission speeds and minimal error correction. One-way networks operating in 900 MHz frequency bands predominantly utilize the FLEX ^tm protocol developed by Motorola along with some legacy POCSAG traffic that is broadcast in this band as well. The FLEX ^tm protocol is a newer technology having the advantage of functioning at

higher network speeds that increases the volume of messages that can be transmitted over the network as well as having more robust error correction, which facilitates message delivery to a device with fewer transmission errors.

 

The Company’s two-way messaging networks utilize the ReFLEX 25 ^tm protocol, also developed by Motorola. ReFLEX 25 ^tm promotes spectrum efficiency and high network capacity by dividing coverage areas into zones and sub-zones. Messages are directed to the zone or sub-zone where the subscriber is located allowing the same frequency to be reused to carry different traffic in other zones or sub-zones. As a result, the ReFLEX 25 ^tm protocol allows the two-way network to transmit substantially more messages than a one-way network using either the POCSAG or FLEX ^tm protocols. The two-way network also provides for assured message delivery. The network stores messages that could not be delivered to a device that is out of coverage for any reason, and when the unit returns to service, those messages are delivered. The two-way messaging network operates under a set of licenses, called narrowband PCS, which as noted above, use 900 MHz frequencies. These licenses require certain minimum five and ten-year build-out commitments established by the FCC, which have been satisfied.

 

Although the capacities of the Company’s networks vary by market, USA Mobility has a significant amount of excess capacity. The Company has implemented a plan to manage network capacity and to improve overall network efficiency by consolidating subscribers onto fewer, higher capacity networks with increased transmission speeds. This plan is referred to as network rationalization. Network rationalization will result in fewer networks and therefore fewer transmitter locations, which the Company believes will result in lower operating expenses.

 

Sources of Equipment

 

USA Mobility does not manufacture any of the messaging devices its customers need to take advantage of its services or any of the network equipment it utilizes to provide messaging services. The Company does have relationships with several vendors for new equipment, and additionally, used equipment is available in the secondary market from various sources. The Company believes existing inventory, returns of devices from lease customers that cancel service and purchases from other available sources of new and reconditioned devices will be sufficient to meet expected device requirements for the foreseeable future.

 

The Company currently has network equipment that it believes will be sufficient to meet equipment requirements for the foreseeable future.

 

Competition

 

The wireless messaging industry is highly competitive. Companies compete on the basis of price, coverage area, services offered, transmission quality, network reliability and customer service.

 

USA Mobility competes by maintaining competitive pricing for its products and services, by providing broad coverage options through high-quality, reliable messaging networks and by providing quality customer service. Direct competitors for USA Mobility’s messaging services include Verizon Wireless Messaging, LLC (a subsidiary of Verizon Wireless), American Messaging Service, Inc., Skytel Corp. (a division of Verizon Communications, Inc.) and a variety of other regional and local providers. The products and services offered by the Company also compete with a broad array of wireless messaging services provided by mobile telephone companies. This competition has intensified as prices for these services have declined, and these providers have incorporated messaging capability into their mobile phone devices. Many of these companies possess financial, technical and other resources greater than USA Mobility’s. Such providers currently competing with the Company in one or more markets include Cingular Wireless LLC, Sprint Nextel Corporation, Verizon Wireless Inc., and T-Mobile USA, Inc.

 

While cellular, PCS and other mobile telephone services are, on average, more expensive than the one and two-way messaging services the Company provides, such mobile telephone service providers typically provide one and two-way messaging service as an element of their basic service package. Most PCS and other mobile phone devices currently sold in the United States are capable of sending and receiving one and two-way messages. Most subscribers that purchase these services no longer need to subscribe to a separate messaging service. As a result, one and two-way messaging subscribers can readily switch to cellular, PCS and other mobile telephone services. The decrease in prices and increase in capacity and functionality for cellular, PCS and other mobile telephone services

has led many subscribers to select combined voice and messaging services as an alternative to stand alone messaging services.

 

Regulation

 

Federal Regulation

 

The FCC issues licenses to use radio frequencies necessary to conduct the USA Mobility’s business and regulates many aspects of the Company’s operations. Licenses granted to the Company by the FCC have varying terms, generally of up to ten years, at which time the FCC must approve renewal applications. In the past, FCC renewal applications generally have been granted upon showing compliance with FCC regulations and adequate service to the public. Other than those still pending, the FCC has thus far granted each license renewal USA Mobility has filed.

 

The Communications Act of 1934, as amended (the “Act”), requires radio licensees such as USA Mobility to obtain prior approval from the FCC for the assignment or transfer of control of any construction permit or station license or authorization of any rights there under. The FCC has thus far granted each assignment or transfer request the Company has made in connection with a change of control.

 

The Act also places limitations on foreign ownership of CMRS licenses, which constitute the majority of licenses held by the Company. These foreign ownership restrictions limit the percentage of stockholders’ equity that may be owned or voted, directly or indirectly, by aliens or their representatives, foreign governments or their representatives, or foreign corporations. USA Mobility’s Amended and Restated Certificate of Incorporation permits the redemption of its equity from stockholders where necessary to protect compliance with these requirements.

 

Failure to follow the FCC’s rules and regulations can result in a variety of penalties, ranging from monetary fines to the loss of licenses. Additionally, the FCC has the authority to modify licenses, or impose additional requirements through changes to its rules.

 

As a result of various FCC decisions over the last few years, the Company no longer pays fees for the termination of traffic originating on the networks of local exchange carriers providing wire-line services interconnected with the Company’s services and in some instances the Company received refunds for prior payments to certain local exchange carriers. USA Mobility has entered into a number of interconnection agreements with local exchange carriers in order to resolve various issues regarding charges imposed by local exchange carriers for interconnection. The Company may be liable to local exchange carriers for costs associated with delivering traffic that does not originate on that local exchange carrier’s network, referred to as transit traffic, resulting in some increased interconnection costs for the Company, depending on further FCC disposition of these issues and the agreements reached between USA Mobility and the local exchange carriers. If these issues are not ultimately decided through settlement negotiations or via the FCC in the Company’s favor, USA Mobility may be required to pay past due contested transit traffic charges not addressed by existing agreements or offset against payments due from local exchange carriers and may also be assessed interest and late charges for amounts withheld.

 

Other legislative or regulatory requirements may impose additional costs on USA Mobility’s business. For example, the FCC requires companies such as this one to pay levies and fees, such as “Universal Service” fees, to cover the costs of certain regulatory programs and to promote various other societal goals. These requirements increase the cost of the services provided. By law, USA Mobility is permitted to pass through most of these regulatory costs to customers and typically does so. Additionally, the Communications Assistance to Law Enforcement Act, and certain rules implementing that Act, requires some telecommunications companies, including USA Mobility, to design and/or modify their equipment in order to allow law enforcement personnel to “wiretap” or otherwise intercept messages on its networks. Other regulatory requirements restrict how the Company may use customer information and prohibit certain commercial electronic messages, even to the Company’s own customers. Although these requirements have not, to date, had a material adverse effect on the Company’s operating results, these or similar requirements could have a material adverse effect on USA Mobility’s operating results in the future.

State Regulation

 

As a result of the enactment by Congress of the Omnibus Budget Reconciliation Act of 1993 in August 1993, states are now generally preempted from exercising rate or entry regulation over any of USA Mobility’s operations. States are not preempted, however, from regulating “other terms and conditions” of the Company’s operations, including consumer protection and similar rules of general applicability. Zoning requirements are also generally permissible; however, provisions of the Act prohibit local zoning authorities from unreasonably restricting wireless services. States that regulate the Company’s services also may require it to obtain prior approval of (1) the acquisition of controlling interests in other paging companies and (2) a change of control of USA Mobility. At this time, USA Mobility is not aware of any proposed state legislation or regulations that would have a material adverse impact on its existing operations.

 

Arch Chapter 11 Proceeding

 

Certain holders of 12 3 / 4 % senior notes of Arch Wireless Communications, Inc., a wholly-owned subsidiary of Arch Wireless, Inc., filed an involuntary petition against it on November 9, 2001 under Chapter 11 of the bankruptcy code in the United States Bankruptcy Court for the District of Massachusetts, Western Division. On December 6, 2001, Arch Wireless Communications, Inc. consented to the involuntary petition and the bankruptcy court entered an order for relief under Chapter 11. Also on December 6, 2001, Arch and 19 of its wholly owned domestic subsidiaries filed voluntary petitions for relief under Chapter 11 with the bankruptcy court. These cases were jointly administered under the docket for Arch Wireless, Inc., et al., Case No. 01-47330-HJB. After the voluntary petition was filed, Arch and its domestic subsidiaries operated their businesses and managed their properties as debtors-in-possession under the bankruptcy code until May 29, 2002, when Arch emerged from bankruptcy. Arch and its domestic subsidiaries are now operating their businesses and properties as a group of reorganized entities pursuant to the terms of the plan of reorganization.

 

Trademarks

 

USA Mobility owns the service marks “USA Mobility”, “Arch”, “Arch Paging”, and “Metrocall”, and holds federal registrations for the service marks “Metrocall”, “Arch Wireless” and “PageNet” as well as various other trademarks.

 

Employees

 

At May 19, 2006, USA Mobility had 1,557 full time equivalent employees. The Company has no employees that are represented by labor unions. USA Mobility believes that its employee relations are good.

 

The following important factors, among others, could cause USA Mobility’s actual operating results to differ materially from those indicated or suggested by forward-looking statements made in this Form 10-K or presented elsewhere by management from time to time.

 

The rate of revenue erosion may not improve, or may deteriorate.

 

USA Mobility and the paging industry continues to face intense competition for subscribers due to technological competition from the mobile phone and personal digital assistant service providers as they continue to lower device prices while adding functionality. A key factor in the Company’s ability to be profitable and produce net cash flow from operations is realizing improvement in the rate of revenue erosion from historical levels. USA Mobility is dependent on net cash provided by operations as its principal source of liquidity. If no improvement is realized, or if revenue erosion accelerates, it would have a material adverse effect on the Company’s ability to be profitable and produce positive cash flow.

USA Mobility may fail to achieve the cost savings necessary to maintain positive cash flow from operations.

 

USA Mobility expects its revenue to continue to decline substantially in the future, therefore maintaining positive cash flow is dependent on substantially reducing operating costs. To achieve cost reductions of the magnitude necessary requires the Company to continually rationalize its own internal costs, as well as continually negotiate lower costs from its outside vendors. There can be no assurance that the Company will be successful in reducing its costs to the level necessary to maintain positive net cash flow. If the Company is not successful at continuing to reduce operating costs it would have a material adverse effect on the Company’s ability to be profitable and product positive cash flow.

 

If the Company is unable to retain key management personnel, it might not be able to find suitable replacements on a timely basis or at all and the Company’s business could be disrupted.

 

USA Mobility’s success will depend, to a significant extent, upon the continued service of a relatively small group of key executive and management personnel. USA Mobility has an employment agreement with its president and chief executive officer. The board of directors has implemented a long-term incentive plan for senior management utilizing the equity incentive program approved by the Company’s shareholders in connection with the merger. USA Mobility has issued restricted stock to its key executives that vests on January 1, 2007 and January 1, 2008. The loss or unavailability of one or more of the Company’s executive officers or the inability to attract or retain key employees in the future could have a material adverse effect on the Company’s future operating results, financial position and cash flows.

 

USA Mobility may be unable to find vendors willing to supply it with paging equipment based on future demands.

 

The Company purchases paging equipment from third party vendors. This equipment is sold or leased to customers in order to provide wireless messaging services. The reduction in industry demand for paging equipment has caused various suppliers to cease manufacturing this equipment. USA Mobility believes that its current multiple vendor relationships, its current on-hand inventories of paging equipment and its repair and maintenance programs will ensure an adequate supply of paging equipment for the foreseeable future; however, the Company is unable to predict if the existing third party vendors will continue to supply paging equipment. A lack of paging equipment could impact the Company’s ability to provide certain wireless messaging services and could materially adversely affect its cash flows, results of operations, and ultimately, the value of USA Mobility’s common stock.

 

Future changes in ownership of the Company’s stock could prevent USA Mobility from using its tax assets to offset future taxable income, which would materially reduce the Company’s expected after-tax net income and cash flows from operations. Actions available to the Company to preserve its consolidated tax assets could result in less liquidity for its common stock and/or depress the market value of its stock.

 

If USA Mobility were to undergo an “ownership change”, as that term is defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “IRC”), the Company’s use of tax assets would be significantly restricted, which would reduce the Company’s after-tax net income and cash flow. This in turn could reduce the Company’s ability to fund its operations.

 

Generally, an ownership change will occur if a cumulative shift in ownership of more than 50% of USA Mobility’s common stock occurs during a rolling three-year period. The cumulative shift in ownership is a measurement of the shift in ownership of the Company’s stock held by stockholders that own 5% or more of such stock. In general terms, it will equal the aggregate of any increases in the percentage of stock owned by each stockholder that owns 5% or more of USA Mobility stock at any time during the testing period over the lowest percentage of stock owned by each such shareholder during the testing period. The testing period generally is the prior three years, but begins no earlier than May 30, 2002, the day after Arch emerged from bankruptcy.

 

As of December 31, 2005, the Company has undergone a combined cumulative change in ownership of approximately 36.2%. The determination of the Company’s percentage ownership change is dependent on provisions of the tax law that are subject to varying interpretations and on facts that are not precisely determinable

by USA Mobility at this time. Therefore, the Company’s cumulative shift in ownership may be more or less than approximately 36.2% and, in any event, may increase by reason of subsequent transactions in the Company’s stock by stockholders who own 5% or more of such stock, and certain other transactions affecting the direct or indirect ownership of stock.

 

There are transfer restrictions available to the Company in its Amended and Restated Certificate of Incorporation that permit it to generally restrict transfers by or to any 5% shareholder of USA Mobility common stock or any transfer that would cause a person or group of persons to become a 5% shareholder of USA Mobility common stock. The Company intends to enforce these restrictions in order to preserve its consolidated tax assets, and such enforcement may result in less liquidity for the Company’s common stock and/or depress the market price for USA Mobility shares.

 

Please refer to Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities , for a description of the transfer restrictions that are available to the Company in its Amended and Restated Certificate of Incorporation which permit USA Mobility to restrict transfers by or to any 5% shareholder of its common stock or any transfer that would cause a person or group of persons to become a 5% shareholder of its common stock. USA Mobility intends to enforce these restrictions in order to preserve its tax assets, and such enforcement may result in less liquidity for the Company’s common stock and/or depress the market price for USA Mobility shares.

 

USA Mobility has material weaknesses in internal control over financial reporting and can provide no assurance that additional material weaknesses will not be identified in the future. Our failure to implement and maintain effective internal control over financial reporting could result in material misstatements in the financial statements.

 

Management has identified material weaknesses in our internal control over financial reporting that affected USA Mobility’s financial statements for the periods ended December 31, 2002, 2003, 2004 and 2005 and the first three quarters of the years ended December 31, 2004 and 2005. See “Item 9A. Controls and Procedures.”

 

The material weaknesses in the Company’s internal control over financial reporting during the periods related to ineffective controls over the accuracy and valuation of income taxes and related deferred income tax balances; over the completeness and accuracy of transactional taxes, over the completeness and accuracy of depreciation expense and accumulated depreciation, and over the completeness, accuracy and valuation of asset retirement costs, asset retirement obligation liabilities and the related depreciation, amortization and accretion expense.

 

We can provide no assurance that additional material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties that may be encountered in their implementation, could result in additional material weaknesses, cause the Company to fail to meet its periodic reporting obligations or result in material misstatements in the Company’s financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor reports regarding the effectiveness of the Company’s internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated under Section 404. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements.

 

The Company had no unresolved staff comments as of May 19, 2006.

 

At December 31, 2005, USA Mobility owned four office buildings in the United States. In addition, the Company leased facility space, including its executive headquarters, sales, technical, and storage facilities in approximately 209 locations in 38 states.

USA Mobility leases transmitter sites on commercial broadcast towers, buildings and other fixed structures in approximately 10,500 locations in all 50 states and Puerto Rico. These leases are for various terms and provide for monthly lease payments at various rates.

 

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. USA Mobility and the other defendants entered into a settlement agreement with the plaintiffs which was approved by the court on May 18, 2005 and the case was dismissed.

 

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, and a previously agreed mitigation payment equal to nine months of base salary. This mitigation payment may be reduced based on income received from future employment. The Company recorded this $4.3 million settlement and $0.9 million mitigation payment as an increase to severance expenses for the years ended December 31, 2005 and 2004 respectively.

 

Certain holders of 12 3 / 4 % senior notes of Arch Wireless Communications, Inc., a wholly owned subsidiary of Arch Wireless, Inc., filed an involuntary petition against it on November 9, 2001 under Chapter 11 of the bankruptcy code in the United States Bankruptcy Court for the District of Massachusetts, Western Division. On December 6, 2001, Arch Wireless Communications, Inc. consented to the involuntary petition and the bankruptcy court entered an order for relief under Chapter 11. Also on December 6, 2001, Arch and 19 of its wholly owned domestic subsidiaries filed voluntary petitions for relief under Chapter 11 with the bankruptcy court. These cases were jointly administered under the docket for Arch Wireless, Inc., et al., Case No. 01-47330-HJB. After the voluntary petition was filed, Arch and its domestic subsidiaries operated their businesses and managed their properties as debtors-in-possession under the bankruptcy code until May 29, 2002, when Arch emerged from bankruptcy. Arch and its domestic subsidiaries are now operating their businesses and properties as a group of reorganized entities pursuant to the terms of the plan of reorganization.

 

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.

 

None.

PART II

 

USA Mobility’s sole class of common equity is its $0.0001 par value common stock, which is listed on the NASDAQ National Market and is traded under the symbol “USMO.”

The following table sets forth the high and low intraday sales prices per share of USA Mobility’s common stock for the period indicated, which corresponds to its quarterly fiscal periods for financial reporting purposes. Prices for the Company’s common stock are as reported on the NASDAQ National Market from November 17, 2004 through December 31, 2005.

 

 

The Board of Directors of USA Mobility declared a special one-time cash distribution of $1.50 per share on November 2, 2005, with a record date of December 1, 2005, and a payment date of December 21, 2005. This cash distribution was paid from available cash on hand.

 

USA Mobility sold no unregistered securities during 2005 and made no repurchases of its common stock during 2005.

 

As of May 19, 2006, there were 1,586 holders of record of USA Mobility common stock.

 

Transfer Restrictions on Common Stock  — In order to reduce the possibility that certain changes in ownership could impose limitations on the use of the Company’s tax attributes, USA Mobility’s Amended and Restated Certificate of Incorporation contains provisions which generally restrict transfers by or to any 5% shareholder of the Company’s common stock or any transfer that would cause a person or group of persons to become a 5% shareholder of the Company’s common stock. After a cumulative indirect shift in ownership of more than 45% since its emergence from bankruptcy proceedings in May 2002 (as determined by taking into account all relevant transfers of the stock of Arch prior to its acquisition, including transfers pursuant to the merger or during any relevant three-year period) through a transfer of the Company’s common stock, any transfer of USA Mobility’s common stock by or to a 5% shareholder of the Company’s common stock or any transfer that would cause a person or group of persons to become a 5% shareholder of such common stock, will be prohibited unless the transferee or transferor provides notice of the transfer to the Company and the Company’s board of directors determines in good faith that the transfer would not result in a cumulative indirect shift in ownership of more than 47%.

 

Prior to a cumulative indirect ownership change of more than 45%, transfers of the Company’s common stock will not be prohibited except to the extent that they result in a cumulative indirect shift in ownership of more than 47%, but any transfer by or to a 5% shareholder of the Company’s common stock or any transfer that would cause a person or group of persons to become a 5% shareholder of the Company’s common stock requires a notice to USA Mobility. Similar restrictions apply to the issuance or transfer of an option to purchase the Company’s common stock if the exercise of the option would result in a transfer that would be prohibited pursuant to the restrictions described above. These restrictions will remain in effect until the earliest of (a) the repeal of Section 382 of the IRC (or any comparable successor provision) and (b) the date on which the limitation amount imposed by Section 382 of the IRC in the event of an ownership change would not be less than our tax attributes subject to these limitations. Transfers by or to USA Mobility and any transfer pursuant to a merger approved by the Company’s board of directors or any tender offer to acquire all of USA Mobility’s outstanding stock where a majority of the shares have been tendered will be exempt from these restrictions.

 

USA Mobility is a holding company formed to effect the merger of Arch and Metrocall, which occurred on November 16, 2004. Prior to these acquisitions, USA Mobility had conducted no operations other than those that were incidental to its formation. For financial reporting purposes, Arch was deemed the acquiring entity and is the predecessor registrant of USA Mobility. Accordingly, the consolidated historical information and operating data for the year ended December 31, 2005 reflects that of Arch and Metrocall; and the consolidated historical information and operating data for the year ended December 31, 2004 reflects that of Arch for the twelve months ended December 31, 2004 and Metrocall for the period November 16, 2004 to December 31, 2004. Historical financial

information and operating data as of December 31, 2001, 2002, and 2003, and for the three years ended December 31, 2003 reflect that of Arch. The table below sets forth the selected historical consolidated financial and operating data for each of the five years ended December 31, 2005.

 

On May 29, 2002, Arch emerged from proceedings under Chapter 11 of the bankruptcy code. The consolidated financial statements of Arch, prior to its emergence from Chapter 11 on May 29, 2002 (the “Predecessor Company”), have been prepared in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code (“SOP 90-7”) and on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. Although May 29, 2002 was the effective date of Arch’s emergence from bankruptcy, for financial reporting convenience, Arch accounted for consummation of the plan as of May 31, 2002. Substantially all of the Predecessor Company’s pre-petition debt was in default. As required by SOP 90-7, the Predecessor Company recorded the pre-petition debt instruments at the allowed amount, as defined by SOP 90-7.

 

Upon emergence from Chapter 11, (the “Reorganized Company”) restated its assets and liabilities, in accordance with SOP 90-7, on the fresh start basis of accounting, which requires recording the assets on a fair value basis similar to those required by SFAS No. 141, Business Combinations (’SFAS No. 141”).

 

As a result of the application of fresh start accounting, Arch’s financial results during the year ended December 31, 2002 include two different bases of accounting and, accordingly, the operating results and cash flows of the Reorganized Company and the Predecessor Company are presented separately. The Reorganized Company’s financial information is not comparable with those of the Predecessor Company.

 

The selected financial and operating data as of December 31, 2001, 2002, 2003, 2004 and 2005 and for the year ended December 31, 2001, for the five months ended May 31, 2002, the seven months ended December 31, 2002 and the three years ended December 31, 2005 have been derived from the audited consolidated financial statements of USA Mobility or its predecessor, Arch. The selected financial and reporting data as of December 31, 2002, 2003 and 2004 and for the seven months ended December 31, 2002, and for years ended December 31, 2003 and 2004 reflect restated amounts. The consolidated financial statements of Arch for the year ended 2001 were audited by Arthur Andersen LLP, which has ceased operations.

 

As described in USA Mobility’s Annual Report on Form 10 K/A for the year ended December 31, 2004, the Company restated its financial statements for the seven months ended December 31, 2002 and for the years ended December 31, 2003 and 2004.

The following consolidated financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes set forth below.

 

 

 

 

 

The following discussion and analysis should be read in conjunction with USA Mobility’s consolidated financial statements and related notes and the discussions under “Application of Critical Accounting Policies,” which describes key estimates and assumptions the Company makes in the preparation of its financial statements and Item 1A “Risk Factors”, which describes key risks associated with the Company’s operations and industry.

 

Restatement

 

As described in USA Mobility’s Annual Report on Form 10-K/A for the year ended December 31, 2004 and in the Company’s Quarterly Reports on Forms 10-Q/A for the first, second and third quarters of 2005 and in this Annual Report on Form 10-K, the Company restated certain financial statements and other information for the seven months ended December 31, 2002 upon the adoption of fresh start reporting and for the years 2003 and 2004 and each of the quarters ended March 31, June 30, and September 30, 2004 and 2005.

 

The determination to restate those consolidated financial statements and other financial information was made as a result of management’s assessment of accounting errors that existed as of June 1, 2002 and December 31, 2002, 2003 and 2004. The financial statements and other information for the seven months ended December 31, 2002 and for the years 2003 and 2004 and each of the quarters ended March 31, June 30, and September 30, 2004 and 2005 included in this Form 10-K reflect the adjustments associated with this restatement. (See Note 2 to the Consolidated Financial Statements.)

 

Merger of Arch and Metrocall

 

USA Mobility is a holding company that was formed to effect the merger of Arch and 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 2002, 2003 and 2004 through November 15, 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 year ended December 31, 2005, as compared to the year ended December 31, 2004, which included the results of Metrocall from November 16, 2004 only.

 

USA Mobility believes that the combination of Arch and Metrocall 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 on November 16, 2004, 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.

 

Overview

 

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 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 years ended December 31, 2005, and USA Mobility believes demand will continue to decline for the foreseeable future in line with recent trends. During 2003, units in service decreased by 1,452,000 units as a result of operations. This decrease does not include the addition of 249,000 units which resulted from the reversal of the remaining portion of the one-time, 1,000,000 unit reduction recorded in the fourth quarter of 2000 for definitional differences and potential unit reductions associated with the conversion and cleanup of accounts acquired in the PageNet acquisition. Since Arch completed the conversion and final review of these accounts, the remainder of this prior unit reduction was recorded as a one-time increase in the fourth quarter, which increased units in service at December 31, 2003. During 2004, units in service increased 1,765,000 units due to the addition of 2,744,000 units associated with the Metrocall merger partially offset by the decrease of 979,000 units as a result of operations.

 

During 2005, units in service decreased 1,316,000. During the billing system conversion, which was completed in early July 2005, the Company 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, the Company reduced its units in service by 238,000 units to correct the errors and to conform to the Arch billing system standard unit definition. The remaining decrease of 1,078,000 units results from operations.

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 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 increased in 2005 over 2004 due to the Metrocall merger, but the Company expects future sequential annual revenues to decline in line with recent trends. Consolidated ARPU decreased $0.68 in 2004 from 2003. The 249,000 unit adjustment Arch made in the fourth quarter of 2003 contributed $0.45 of this decrease. The remainder of the decrease 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. Consolidated ARPU decreased $0.26 in 2005 from 2004. The majority of this decrease 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.

 

USA Mobility’s revenues were $597.5 million, $490.2 million, and $618.6 million for the years ended December 31, 2003, 2004 and 2005, respectively. The 2004 revenue includes $38.5 million of Metrocall revenue for the period from November 16 to December 31, 2004.

 

The Company’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:

 

 

In addition to the functional categories described above, expense controls are also performed by expense category. In 2005, approximately 76% 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 1,617 FTEs at December 31, 2005. While these 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. In addition, in August 2005 and January 2006, USA Mobility executed agreements with its two largest site lease vendors. The agreements will reduce the Company’s future lease payments for transmitter locations. (See Note 9). During 2005, the Company decommissioned the former Arch 2-way network. This network rationalization resulted in an increase in depreciation expense, but is an important element of the Company’s integration and cost reduction strategy.

 

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.

 

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 $231,000 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 USA Mobility’s cost of products sold; service, rental and maintenance; selling and marketing, and general and administrative expenses was $407.5 million, $330.6 million and $440.7 million for the years ended December 31, 2003, 2004 and 2005, respectively. As discussed previously the Company expects revenue from one-way and two-way messaging services to continue to decline for the foreseeable future in line with recent trends. Additionally, the Company believes that the rate of revenue decline will likely outpace the Company’s ability to reduce costs, therefore the Company expects it’s margins to decline for the foreseeable future. There can be no assurance that in the face of declining revenue the Company can remain profitable, or generate positive cash flow from operating activities.

Results of Operations

 

As previously discussed, Arch and Metrocall merged on November 16, 2004. The results of operations and cash flows discussed below for 2005 include the operating results and cash flows of Arch for the twelve months ended December 31, 2005 and 2004, and Metrocall for the period November 16, 2004 to December 31, 2005. For periods prior to 2004, the operating results and cash flows of Arch are presented. Accordingly, the apparent growth in operations is due to the merger of Arch and Metrocall and is not indicative of future operating trends or results.

 

 

 

Revenues

 

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 increase in revenues in each revenue type is the result of including revenues of Metrocall during the entire year of 2005 as compared to only 45 days in 2004. The combined Company has experienced, and expects to experience, revenue declines for the foreseeable future.

 

 

 

The table below sets forth units in service and service revenues, the changes in each between 2004 and 2005 and the change in revenue associated with differences in the numbers 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.

 

Operating Expenses

 

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 $0.1 million increase in 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 components:

 

 

As illustrated in the table above, service, rental and maintenance expenses increased $55.4 million or 34.6% from 2004. The percentage of these costs to revenues also increased, primarily due to the acquisition of 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 expense. Selling and marketing payroll and related expenses increased $7.1 million or 19.6% over 2004. This increase was due primarily to an increase in the number of sales representatives and sales management that resulted from the Metrocall merger. As of December 31, 2005, the Company had 460 FTEs responsible for selling and marketing its services.

 

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

 

 

As illustrated in the table above, general and administrative expenses increased $47.4 million from the year ended December 31, 2004 due to the inclusion of Metrocall operations. The percentages of these costs to revenue also increased, primarily due to the following:

 

 

 

Depreciation, Amortization and Accretion.   Depreciation, amortization and accretion expenses increased to $131.3 million for the year ended December 31, 2005 from $107.6 million for the same period in 2004. Part of this increase was due to depreciation and amortization expense of the tangible and intangible assets acquired from Metrocall, of $50.5 million, partially offset by a decrease of $26.8 million related to groups of assets becoming fully depreciated in legacy Arch operations. Depreciation expense for the year ended December 31, 2005, 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 and the board of directors, and the compensation cost associated with a long-term management incentive plan. USA Mobility uses the fair-value based method of accounting for stock based compensation. Stock based compensation decreased to $2.8 million for the year ended December 31, 2005 from $4.9 million for the same period in 2004, primarily due to lower compensation costs associated with the long-term management incentive plan, offset by the compensation expense of the grant of 103,937 shares of restricted common stock to eligible employees on June 7, 2005.

 

Severance and Restructuring.   Severance and restructuring expenses increased to $16.6 million for the year ended December 31, 2005 from $11.9 million for the same period in 2004. The increase consists primarily of both actual and planned reductions in headcount due to the reorganization plan to adjust the management structure and consolidate three sales divisions of five regions into one national sales organization consisting of eleven regions. Also included is the $4.3 million settlement agreement with three former Arch executives that was paid during second quarter 2005.

 

Restructuring charges of $3.0 million and $1.1 million for 2004 and 2005, respectively, relate to lease termination penalty expenses.

 

Impairments.   The Company did not record any impairments of long-lived assets, intangible assets or goodwill in 2004 or 2005, 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 is below its carrying amount. For this determination the Company as a whole is considered the reporting unit. Declines in the Company’s stock price impact the calculation of the fair value of the reporting unit for purposes of this determination. Should the Company’s stock price continue to decline and/or the carrying value of the reporting unit increase there is a reasonable possibility that a material impairment to goodwill could occur.

 

Interest Expense.   Net interest expense decreased to $1.3 million for the year ended December 31, 2005 from $5.9 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 $2.4 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 in 2005.

 

Income Tax Expense.    For the year ended December 31, 2005, the Company recognized $10.6 million of income tax expense, or an effective tax rate of 45.0%. The Company anticipates the recognition of income tax expense to be required for the foreseeable future.

Comparison of the Results of Operations for the Years Ended December 31, 2003 and 2004

 

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 for the twelve months ended December 31, 2004 and Metrocall for the period November 16, 2004 to December 31, 2004. For periods prior to 2004, the operating results and cash flows of Arch or its predecessor company are presented.

 

 

Revenues

 

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 decrease in total revenues consisted of a $137.5 million decrease in recurring fees associated with the provision of messaging services and a $8.3 million decrease in revenues from device transactions related to the operations of Arch partially offset by recurring fees associated with the provision of messaging services of $36.3 million and revenues from device and other sales transactions of $2.2 million related to the operations of Metrocall from November 16, 2004 to December 31, 2004.

 

 

 

 

The table below sets forth units in service and recurring fees, the changes in each between 2003 and 2004 and the change in revenue associated with differences in the numbers 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.

Operating Expenses

 

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 $1.2 million decrease in 2004 was due primarily to lower numbers of device transactions due to lower units in service in 2004; partially offset by $938,000 of costs of products sold related to Metrocall operations.

 

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