UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Arch Wireless, Inc.

(508) 870-6700
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

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

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 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 [X] No [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: no shares of the Registrant’s Common Stock ($.001 per value per share) and 19,657,094 shares of the Registrant’s Class A Common Stock ($0.0001 par value per share) were outstanding as of October 21, 2004.

ARCH WIRELESS, INC.
QUARTERLY REPORT ON FORM 10-Q
Index

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ARCH WIRELESS, INC.

ARCH WIRELESS, INC.

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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ARCH WIRELESS, INC.

     (a) Preparation of Interim Financial Statements - The consolidated financial statements of Arch Wireless, Inc. (“Arch” or the “Company”) have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission. The financial information included herein, other than the consolidated balance sheet as of December 31, 2003, has been prepared without audit. The consolidated balance sheet at December 31, 2003 has been derived from, but does not include all the disclosures contained in, the audited consolidated financial statements for the year ended December 31, 2003. In the opinion of management, these unaudited statements include all adjustments and accruals consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of all interim periods reported herein. These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in Arch’s Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for a full year.

     (b) Risks and Other Important Factors — Based on current and anticipated levels of operations, management anticipates net cash provided by operating activities, together with the $45.3 million of cash on hand at September 30, 2004, will be adequate to meet Arch’s anticipated 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, Arch may be required to reduce planned capital expenditures, sell assets or seek additional financing. Arch can provide no assurances 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.

     Arch 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 of messaging units in service exceeds Arch’s expectations, its revenues will be negatively impacted, and such impact could be material. Arch’s plan to consolidate its networks may also negatively impact revenues as customers may experience a reduction in, and possible disruptions of, service in certain areas. Arch 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, Arch’s revenue or operating results may not meet the expectations of investors and creditors, which could impair the value of its equity securities.

     (c) Proposed Merger — On March 29, 2004, Arch announced the execution of a definitive merger agreement with Metrocall Holdings, Inc. (“Metrocall”). Pursuant to the terms of the merger agreement, a new holding company was formed to own both Arch and Metrocall. In the aggregate, Metrocall common stockholders will receive $150 million in cash pursuant to a cash election and approximately 27.5% of the shares of the new holding company’s common stock on a fully diluted basis. Under the cash election, Metrocall shareholders will be entitled to elect to receive cash in the amount of $75.00 per Metrocall share for up to two million Metrocall shares. The remaining approximately four million fully diluted Metrocall shares will be converted into approximately 27.5% of the new holding company’s outstanding common stock on a fully diluted basis. To the extent that cash elections are made in respect of a number greater than or less than two million shares, the merger consideration will be adjusted on a pro rata basis so that two million of Metrocall’s outstanding shares are exchanged for cash.

     Arch shareholders will receive one share of new holding company common stock for each share of Arch common stock they own. Based on Arch’s outstanding shares and options as of October 22, 2004, 20,151,773 shares and options of the new holding company would be issued to Arch stakeholders. This amount consists of 19,657,094 shares currently outstanding, 278,683 shares remaining to be issued pursuant to Arch’s plan of reorganization and options to purchase 215,996 shares of Arch common stock issued to certain members of the

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board of directors which fully vested on May 29, 2004. The current balance of outstanding shares above includes 316,002 shares of restricted stock issued to certain members of management that are currently subject to repurchase and other restrictions. If all 316,002 shares were repurchased, Arch shareholders would receive 19,835,771 shares of the new holding company’s common stock and Metrocall’s shareholders would receive 7,560,515 shares of the new holding company’s common stock, reflecting an exchange ratio of 1.876 new holding company shares for each Metrocall share.

     Arch and Metrocall have received opinions from tax counsel indicating the merger will qualify as a tax-free reorganization to the extent that shareholders receive stock rather than cash. Upon completion of the merger, Arch shareholders will own approximately 72.5% and Metrocall shareholders will own approximately 27.5% of the new company on a fully diluted basis.

     Arch expects the new holding company will incur up to $140.0 million of indebtedness to provide the funds necessary to purchase the two million Metrocall shares subject to the cash election referred to above. Therefore, on October 11, 2004, Arch and Metrocall entered into a commitment letter with UBS Loan Finance LLC and UBS Securities LLC that provides for a senior secured term loan facility of up to $140.0 million for Arch Wireless Operating Company, Inc. and Metrocall, Inc., the operating subsidiaries of Arch and Metrocall. The facility will have a term of two years from the closing date and will amortize in eight equal quarterly installments with interest equal to (i) an interest margin of 150 basis points, plus the higher of the Federal Funds Rate, as published by the Federal Reserve Bank of New York, plus 1/2 of 1% and the prime commercial lending rate of UBS AG, as established from time to time, or (ii) an interest margin of 250 basis points, plus the rate equal to the London Interbank Offered Rate for corresponding deposits of U.S. dollars.

     The facility will be guaranteed on a joint and several basis by USA Mobility, Inc., the corporate entity formed to serve as the new publicly-traded parent company of Arch and Metrocall following consummation of the merger, and substantially all of its subsidiaries. The facility will be secured by pledges of the equity interests of Arch, Metrocall and substantially all of their respective subsidiaries and liens on most of their respective assets and will contain covenants that are customary for a facility of this type, including a minimum interest coverage ratio, maximum leverage ratio and maximum capital expenditure levels. While Arch expects to close the facility with UBS, there can be no assurance that negotiations on the facility will result in definitive agreements or that the facility, as negotiated, will be on the terms and conditions described herein or otherwise acceptable to it.

     The merger will be accounted for under the purchase method of accounting pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. Arch has been deemed the acquiring entity due primarily to its former shareholders holding a majority of the common stock of the new holding company. Accordingly, the basis of Arch’s assets and liabilities as of the acquisition date will be reflected on the new holding company’s balance sheet at their historical basis. Amounts allocated to Metrocall’s assets and liabilities will be based upon the total purchase price and the estimated fair values of such assets and liabilities as of the acquisition date.

     Arch expects the merger, which has been approved by the boards of directors of Arch and Metrocall, but is subject to regulatory review, shareholder approval and other third-party consents, to be completed in the fourth quarter of 2004. The special meetings of shareholders for Arch and Metrocall are scheduled for November 8, 2004.

     (d) Long-lived Assets — Intangible and other assets were comprised of the following at September 30, 2004 and December 31, 2003 (in thousands):

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     Aggregate amortization expense for intangible assets for the nine months ended September 30, 2004 and 2003 was zero and $2.1 million, respectively. The balance of Arch’s intangible assets were fully amortized in 2003, therefore there is no additional amortization expense to recognize in future periods.

     (e) Restructuring Charges - In the year ended December 31, 2003 and the nine month period ended September 30, 2004, Arch recorded restructuring charges of $11.5 million and $3.0 million, respectively, related to certain lease agreements for transmitter locations. Under the terms of these agreements, Arch is required to pay minimum amounts for a designated number of transmitter locations. However, Arch determined the designated number of transmitter locations was in excess of its current and anticipated needs. At September 30, 2004, the balance of the restructuring reserve was as follows (in thousands):

     The remaining obligations associated with these agreements are expected to be paid over the next three quarters.

     (f) Income Taxes - Arch accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109"). Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, given the provisions of enacted laws.

     On May 29, 2004, 316,999 shares of restricted stock previously issued to certain members of senior management vested. The value of the shares when they vested was higher than the compensation expense recorded in accordance with generally accepted accounting principles, which will result in an incremental deduction for tax purposes. In accordance with SFAS No. 109, the tax effect of this incremental deduction of $3.6 million was recognized as an increase to Arch’s long-term deferred tax assets and additional paid-in capital.

     SFAS No. 109 requires Arch to evaluate the recoverability of its deferred tax assets on an ongoing basis. The assessment is required to consider all available positive and negative evidence to determine whether, based on such evidence, it is more likely than not that some portion or all of Arch’s net deferred assets will be realized in future periods.

     During the quarter ended December 31, 2003, management determined the available positive evidence carried more weight than the historical negative evidence and concluded it was more likely than not that the net deferred tax assets would be realized in future periods. The positive evidence management considered included operating income and cash flows for 2002 and 2003, Arch’s repayment of debt ahead of scheduled maturities and anticipated operating income and cash flows for future periods in sufficient amounts to realize the net deferred tax assets. Results for the nine months ended September 30, 2004 and anticipated future results remain consistent with the assessment made in 2003; therefore, management continues to believe no valuation allowance is required.

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

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

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     For the three and nine months ended September 30, 2004 and 2003, no shares were excluded from the calculations above due to the shares being anti-dilutive.

     (h) Treasury Stock - On May 29, 2004, Arch received 98,223 shares of its class A common stock with a value of approximately $3.1 million surrendered from certain members of senior management as consideration for Arch remitting certain payroll withholding taxes related to the vesting of 316,999 shares of restricted stock on that date. Arch accounted for this treasury stock at cost.

     (i) Long-term Debt - On May 28, 2004, Arch completed the final redemption of its 12% notes and has no other borrowings outstanding.

     (j) Recently Issued Accounting Pronouncements — In January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB 51(“FIN No. 46”) and issued a revision to that guidance, FIN No. 46-R, in December 2003. FIN No. 46 and FIN No. 46-R provide guidance on the identification of entities for which control is achieved through means other than through voting rights called “variable interest entities” or “VIEs” and how to determine when and which business enterprise should consolidate the VIE (the “primary beneficiary”). This model for consolidation applies to an entity in which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, these interpretations require both the primary beneficiary and all other enterprises with a significant variable interest in a VIE to make additional disclosures. The provisions of FIN No. 46 were applicable to Arch for any interests entered into after January 31, 2003 and the provisions of FIN No. 46-R were effective on January 1, 2004. Arch does not have any interests that would change its current reporting entity or require additional disclosures outlined in FIN No. 46 or FIN No. 46-R.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

     This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, also known as the Exchange Act. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes”, “anticipates”, “plans”, “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated or suggested by such forward-looking statements. These factors include, without limitation, those set forth below under the caption “Factors Affecting Future Operating Results.”

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Pending Metrocall Merger

     On March 29, 2004, we announced the execution of a definitive merger agreement with Metrocall Holdings, Inc., also known as Metrocall. Pursuant to the terms of the merger agreement, a new holding company was formed to own both Arch and Metrocall. In the aggregate, Metrocall common stockholders will receive $150 million in cash pursuant to a cash election and approximately 27.5% of the shares of the new holding company’s common stock on a fully diluted basis. Under the cash election, Metrocall shareholders will be entitled to elect to receive cash in the amount of $75.00 per Metrocall share for up to two million Metrocall shares. The remaining approximately four million fully diluted Metrocall shares will be converted into approximately 27.5% of the new holding company’s outstanding common stock on a fully diluted basis. To the extent that cash elections are made in respect of a number greater than or less than two million shares, the merger consideration will be adjusted on a pro rata basis so that two million of Metrocall’s outstanding shares are exchanged for cash.

     Our shareholders will receive one share of new holding company common stock for each share of our common stock they own. Based on our outstanding shares and options as of October 22, 2004, 20,151,773 shares and options of the new holding company will be issued to our stakeholders. This amount consists of 19,657,094 shares currently outstanding, 278,683 shares remaining to be issued pursuant to our plan of reorganization and options to purchase 215,996 shares of our common stock issued to certain members of the board of directors which became fully vested on May 29, 2004. The current balance of outstanding shares above includes 316,002 shares of restricted stock issued to certain members of our management that are currently subject to repurchase and other restrictions. If all 316,002 shares were repurchased, our shareholders will receive 19,835,771 shares of the new holding company’s common stock and Metrocall’s shareholders would receive 7,560,515 shares of the new holding company’s common stock, reflecting an exchange ratio of 1.876 new holding company shares for each Metrocall share.

     Arch and Metrocall have received opinions from tax counsel indicating the merger will qualify as a tax-free reorganization to the extent that shareholders receive stock rather than cash. Upon completion of the merger, Arch shareholders will own approximately 72.5% and Metrocall shareholders will own approximately 27.5% of the new company on a fully diluted basis.

     We expect the new holding company to incur up to $140.0 million of indebtedness to provide the funds necessary to purchase the two million Metrocall shares subject to the cash election referred to above. See “Liquidity and Capital Resources-Source of Funds” for a description of the financing commitment.

     The merger will be accounted for under the purchase method of accounting pursuant to Statement of Financial Accounting Standards, known as SFAS, No. 141, Business Combinations. Arch has been deemed the acquiring entity due primarily to its former shareholders holding a majority of the common stock of the new holding company. Accordingly, the basis of our assets and liabilities as of the acquisition date will be reflected on the new holding company’s balance sheet at their historical basis. Amounts allocated to Metrocall’s assets and liabilities will be based upon the total purchase price and the estimated fair values of such assets and liabilities as of the acquisition date.

     Arch expects the merger, which has been approved by the boards of directors of Arch and Metrocall, but is subject to regulatory review, shareholder approval and other third-party consents, to be completed in the fourth quarter of 2004. The special meetings of shareholders for Arch and Metrocall are scheduled for November 8, 2004.

Overview

     The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes and the discussions under “Application of Critical Accounting Policies,” which describes key estimates and assumptions we make in the preparation of our consolidated financial statements and “Factors Affecting Future Operating Results,” which describes key risks associated with our operations and industry and the following subsections of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2003: “Overview,” “Results of Operations” and “Inflation.”

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

     Direct. Our direct sales force leases or sells devices and messaging services directly to customers ranging from small and medium-sized businesses to Fortune 500 companies, health care and related businesses and government

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agencies. Our direct sales force represents our most significant sales and marketing efforts and we intend to continue to market to commercial enterprises utilizing our direct sales force as these commercial enterprises have typically disconnected service at a lower rate than individual consumers.

     Indirect. Our indirect sales force sells devices and access to our messaging networks to third parties, or resellers, who then resell messaging services to consumers or small businesses. Resellers generally are not exclusive distributors of our services and often have access to the networks of more than one provider. Competition among network providers to attract and maintain resellers is based primarily upon price. We intend to continue to provide access to our messaging networks to resellers and to concentrate on relationships that are profitable and in which longer-term partnerships can be established and maintained.

     The following tables set forth units in service and revenue associated with our channels of distribution:

     We derive the majority of our revenues from fixed monthly or other periodic fees charged to subscribers for wireless messaging services. Such fees are not generally dependent on usage. As long as a subscriber maintains service, operating results benefit from recurring payment of these fees. Revenues are generally dependent on 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 and the number of gross placements relative to average units in service in a period, referred to as the gross placement rate, are monitored on a monthly basis. In addition, the ratio of gross placements for a period to the number of sales representatives for the same period, referred to as gross placements per sales representative, is also reviewed. This measurement together with the gross placement rate reflects the productivity of our direct sales force. 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 our success retaining subscribers which is important in order to maintain recurring revenues and to control operating expenses. The following table sets forth our gross placements and disconnects for the periods stated.

     The other factor that contributes to revenue, in addition to the number of units in service, is the monthly charge per unit. As previously discussed, the monthly charge is dependent on the subscriber’s service, extent of geographic coverage, whether the subscriber leases or owns the messaging device and the number of units the

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customer has on his or her account. The ratio of service revenues for a period to the average units in service for the same period, commonly referred to as average revenue per unit, is a key revenue measurement as it indicates whether monthly charges for similar services and distribution channels are increasing or decreasing. Average revenue per unit by distribution channel and messaging service are monitored regularly. The following table sets forth our average revenue per unit by distribution channel for the periods stated. The rates for the prior year periods below have been recalculated to reflect a 249,000 unit adjustment recorded at December 31, 2003 which is discussed in our annual report on Form 10-K for the fiscal year ended December 31, 2003.

     Average revenue per unit for similar services and distribution channels is indicative of changes in monthly charges; however, this measurement on a consolidated basis is affected by several factors, most notably the mix of units in service. The decrease in our consolidated average revenue per unit for the quarter ended September 30, 2004 from the quarters ended September 30, 2003 and June 30, 2004 was due primarily to the change in average revenue per unit in service in our direct distribution channel. We anticipate average revenue per unit for our direct units in service will decline in future periods and the decline will be primarily due to the mix of messaging services demanded by our customers, a decline in the percentage of customers with fewer units in service and, to a lesser extent, changes in monthly charges and competitive pricing pressure.

     As discussed earlier, customers with more units in service generally have lower monthly charges for similar services due to volume discounts and historically have had lower disconnect rates. Therefore, as the percentage of our direct units in service becomes more concentrated with customers that have more units in service, our average revenue per unit and disconnect rate should decline. The following table sets forth units in service for our direct channel of distribution grouped by the number of units in service on customer accounts for the quarter ended September 30, 2004. The ratio of contractual recurring fees to the average units in service for a period is referred to below as average contractual recurring fees per unit in service. Contractual recurring fees are derived from our billing system and represent the fees that would be billed to customers assuming all units in service were billed at their contractual amounts, but they are not our actual service revenues. Contractual recurring fees are generally lower than actual service revenues recognized due to usage and transaction based revenues which occur on a recurring basis, but are not included in the contractual recurring billing rate.

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     The following table sets forth our gross placements, disconnects and net gains (losses) of units in service for our direct channel of distribution grouped by the number of units in service on customer accounts for the quarter ended September 30, 2004. The gross placement, disconnect and net gain (loss) rates set forth below are calculated by dividing the relevant measure, gross placements, disconnects or net gains (losses) by average units in service and are presented on an average monthly basis.

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     The tables above illustrate the increasing concentration of customers with more units in service and how the net gain (loss) rate decreases as the number of units with a customer increases, thereby resulting in lower overall disconnect rates and average revenue per unit. We anticipate this trend to continue in future periods, which should result in lower revenues, although the rate of revenue decline should also decrease.

     As the tables above indicate, we have experienced significant reductions in units in service and revenues. The demand for our one and two-way messaging services has declined over the past several years and we believe demand will continue to decline for the foreseeable future largely attributable to competition from cellular and broadband PCS service providers. Reductions in the number of units in service significantly affects our results of operations since operations no longer benefit from the recurring revenue generated from these units in service. In order to continue to generate net cash provided by operating activities, given the anticipated decreases in revenues, reductions in operating expenses have been, and will continue to be, necessary. In particular, lease payments on transmitter locations and telephone expenses are the most significant costs associated with the operation of our messaging networks, accounting for 37.6% of our service, rental and maintenance, selling and general and administrative expenses thus far in 2004. Reductions in these expenses depend on our ability to successfully consolidate the number of messaging networks we operate, ultimately resulting in fewer locations on which we are required to pay monthly lease and telephone costs.

     We are dependent on net cash provided by operating activities as our principal source of liquidity. If our expected reductions in operating expenses are not met, or if revenues decline at a more rapid rate than anticipated and that decline cannot be offset with additional expense reductions, net cash provided by operating activities would be adversely affected. If we are not able to achieve anticipated levels of net cash provided by operating activities, we may be required to reduce desired capital expenditures, which could result in higher losses of units in service.

     Our revenues were $109.4 million and $143.6 million for the quarters ended September 30, 2004 and 2003, respectively. As noted above, the demand for one and two-way messaging services has declined over the past several years and, as a result, management of operating expenses is important to our financial results. Certain of our operating expenses are especially important to overall expense control. These operating expenses are categorized as follows:

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•		Service, rental and maintenance. These are the expenses associated with the operation of our networks and the provision of messaging services. These expenses consist largely of telephone charges to deliver messages over our networks and lease payments for locations on which we maintain transmitters.
•		Selling. These are the costs associated with our direct and indirect sales forces. These costs consist primarily of salaries and commissions and advertising expense.

•

General and administrative. These are costs associated with customer service, inventory management, billing, collections, bad debts and other administrative functions.

     We review the percentages of these operating expenses to revenues on a regular basis. These ratios indicate whether operating expenses are decreasing at the same rate as revenues which are key indicators of our operating efficiency. Even though operating expenses are classified as described above, expense controls are also performed on a functional expense basis. For the three months ended September 30, 2004, we incurred approximately 74% of the expenses referred to above in three functional expense categories: payroll and related expenses, lease payments for transmitter locations and telephone expenses.

     Payroll and related expenses include wages, commissions, incentives, employee benefits and related taxes. We review the number of employees in major functional work groups, such as direct sales, collections and customer service on a monthly basis. The ratio of the number of employees in each functional work group to the number of direct units in service or total units in service is reviewed to ensure that functional groups that are largely dependent on the number of units in service maintain or improve this ratio. We also review the design and physical locations of functional groups to continuously improve efficiency, simplify organizational structures and minimize physical locations.

     Lease payments for transmitter locations are largely dependent on our messaging networks. We operate local, regional and nationwide one-way messaging networks and a two-way messaging network. These networks each require locations on which to place transmitters, receivers and antennas. 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 and are generally fixed in the short term. In order to reduce this expense, we have an active program to consolidate the number of networks and thus transmitter locations, referred to as network rationalization. We have identified frequencies in each geographic region onto which we are migrating customers as network capacity allows. We attempt to migrate customers in a manner which minimizes customer impact; however, in certain circumstances messaging coverage may not entirely replicate that of the network being consolidated, which may result in some customers experiencing differences in coverage patterns or possible disruptions of service. Network rationalization results in consolidated networks, and therefore fewer transmitter locations, which we believe will result in lower operating expenses. Due to the nature of the underlying contractual agreements for our transmitter locations, there can be no assurance that network rationalization will result in immediate, proportionate savings in lease payments.

     In 2003, we removed 4,520 transmitters from various networks and plan to remove approximately 1,200 additional transmitters in 2004, including approximately 660 that were removed during the nine months ended September 30, 2004.

     Telephone expenses are incurred to provide interconnection of our messaging networks, telephone numbers for customer use, points of contact for customer service and connectivity among our offices. These expenses are dependent on the number of units in service and the number of office and network locations we maintain. The dependence on units in service is related to the number of telephone numbers provided to customers and the number of telephone calls made to our call centers, though this is not always a direct dependency. For example, the number or duration of telephone calls to our call centers may vary from period to period based on factors other than the number of units in service, which could cause telephone expense to vary regardless of the number of units in service. In addition, certain telephone numbers we provide to our customers may have a usage component based on the number and duration of calls to the subscriber’s messaging device. Therefore, based on the factors discussed above, absent the efforts that have been underway to review telephone circuit inventories and capacities

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and to reduce the number of transmitter and office locations at which we operate, telephone expenses do not necessarily vary in a direct relationship to units in service.

     The total of our cost of products sold, service, rental and maintenance, selling and general and administrative expenses was $228.6 million and $317.9 million for the nine months ended September 30, 2004 and 2003, respectively. The decrease in these operating expenses is discussed in “Results of Operations.” Since it is anticipated that demand for one and two-way messaging will continue to decline, expense reductions will continue to be necessary for the foreseeable future.

Results of Operations

     Comparison of the Results of Operations for the Three Months Ended September 30, 2004 and 2003

Revenues

     Service, rental & maintenance revenues consist primarily of recurring fees associated with the provision of messaging services and rental of leased units. Product sales consists largely of revenues associated with the sale of devices and charges for leased devices that are not returned. We do not differentiate between service and rental revenues. The table below sets forth units in service and service revenue, the changes in each between the three months ended September 30, 2004 and 2003 and the change in revenue associated with differences in the numbers of units in service and the average revenue per unit, known as ARPU.

     As previously discussed, demand for messaging services has declined over the past several years and we anticipate that it will continue to decline for the foreseeable future, which will result in reductions in service revenue due to the lower volume of subscribers. In addition, as the percentage of customers with more than 100 units in service increases, our average revenue per unit and disconnect rate is expected to decline. We expect that the impact of these events should result in a lower rate of decline in revenues.

Operating Expenses

     Payroll and Related Expenses. Payroll and related expenses are our largest expense, representing 35.4% and 38.7% of the total of cost of products sold, service, rental and maintenance, selling and general and administrative for the three months ended September 30, 2004 and 2003, respectively. The payroll and related expenses in each significant category of expense are included in the following table:

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     As discussed earlier, we review the ratio of the number of direct units in service per employee in each functional work group to ensure that functional groups, which are largely dependent on the number of units in service, maintain or improve this ratio. The number of employees and the ratio of direct units in service per employee for each category of expense are included in the table below:

     The decrease in the number of employees resulted in $12.5 million lower payroll and related expense for the quarter ended September 30, 2004, and the ratio of direct units in service per employee improved in each functional work group.

•

Service, rental and maintenance consists largely of field technicians and their managers. This functional work group does not vary as closely to direct units in service as other work groups since these individuals are related to the number of networks we operate rather than the number of units in service on our networks. In the quarter ended September 30, 2004, we maintained, and will continue to maintain, higher staffing levels to support our efforts to consolidate our networks.

•

The decrease in payroll expenses related to selling was due primarily to a decrease in the number of sales representatives and sales management which resulted from our continuing efforts to maintain or improve sales force productivity; consequently, as units in service decline, fewer sales personnel are required.

•

The decrease in payroll and related expenses included in general and administrative expenses was due to 493 fewer employees in this category at September 30, 2004. The improvement in the ratio of direct units in service per general and administrative employee was due primarily to additional outsourcing of customer service activities. In addition, bonus expense was $1.9 million less in 2004 compared to the same period in 2003 due to changes in the 2004 plan and a lower number of participants.

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     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 $9.8 million from the quarter ended September 30, 2003, however the percentage of these costs to revenues increased marginally, primarily due to lease payments for transmitter locations and other expenses. Following is a discussion of each significant item listed above:

•		As discussed earlier, we have reduced the number of transmitters in service in conjunction with our plan to consolidate our networks. In 2003, transmitter consolidation activity was significantly higher in the latter half of the year resulting in lower lease payments in 2004. In addition, the restructuring charges recorded in the fourth quarter of 2003 and the first quarter of 2004 resulted in approximately $3.0 million lower lease expense in the current year period compared to the same period in 2003.
		Our efforts to consolidate our networks should continue to result in lower lease payments for transmitter locations, however these payments are subject to underlying obligations contained in each lease agreement, some of which do not allow for immediate savings when our equipment is removed and most of which require annual payment increases. Leases may also consist of payments for multiple sets of transmitters, antenna structures or network infrastructures on a particular site. In some cases, we remove only a portion of the equipment to which the lease payment relates. Under these circumstances, reduction of future rent payments is often subject to negotiation and our success is dependent on many factors, including the number of other sites we lease from the lessor, the amount and location of equipment remaining at the site and the remaining term of the lease. Therefore, lease payments for transmitter locations are generally fixed in the short term.

•

The decrease in telephone expenses resulted from savings associated with the consolidation of network facilities, lower usage-based charges due to declining units in service and rationalization of telephone trunk capacities. The costs associated with network facilities and telephone trunks are generally fixed in nature and the usage-based charges generally vary with units in service.

•

The change in payroll and related expenses was discussed above.

•

The decrease in operator dispatch fees was due primarily to lower units in service and, to a lesser extent, the utilization of other means to contact alphanumeric subscribers, such as the Internet.

•

Other expenses consist largely of repairs and maintenance expenses. Repairs and maintenance expenses relate to two primary activities, device repairs and transmission sites. These expenses do not vary directly with units in service or revenue and therefore, the percentage of these expenses to revenue increased in the current year period.

     We believe the primary service, rental and maintenance expense reduction in 2004 will relate to lease payments for transmitter locations. In 2003, we recognized a beneficial trend in these payments as a result of our ongoing program to consolidate the number of networks we operate. We expect this trend to continue in future periods, although we cannot guarantee the level and specific timing of savings because these expenses are based on

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underlying contracts which, depending on the particular contract, may or may not result in immediate expense savings.

     Selling. Selling expense consists primarily of payroll and related expense which was discussed above.

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

     As illustrated in the table above, general and administrative expenses decreased $12.1 million from the quarter ended September 30, 2003 and the percentage of these costs to revenue also decreased. Following is a discussion of each significant item listed above:

•

The change in payroll and related expenses was discussed above.

•

The decrease in bad debt expense was due to lower levels of overall accounts receivable, which resulted from decreases in revenues and strong collections, and lower amounts of write-offs. We anticipate bad debt expense as a percentage of revenue to remain flat or increase in the future since we do not anticipate similar decreases in future accounts receivable balances.

•

The $1.3 million decrease in facilities expense was due to the closure of various office facilities in conjunction with our efforts to reduce the number of physical locations at which we operate.

•

The decrease in telephone expense was due primarily to fewer calls to our call centers as a result of fewer units in service and the reduction of physical locations at which we operate.

•

Outside services expense consists primarily of costs associated with printing and mailing invoices, outsourced customer service, temporary help and various professional fees. The decrease in these expenses is due primarily to lower professional fees during the third quarter of 2004.

•

Taxes and permits consists primarily of property, franchise and gross receipts taxes. The decrease for the three months ended September 30, 2004 was due primarily to lower revenue, since certain of these charges are levied on revenue. We expect these taxes as a percentage of revenue to remain flat or increase in the future since certain of these taxes are not dependent on revenues.

•

Other expenses consist primarily of postage and express mail costs associated with the shipping and receipt of messaging devices, repairs and maintenance associated with computer hardware and software, insurance and bank fees associated with lockbox and other activities. The largest component of the reduction in other expense in 2004 related to insurance in the amount of $722,000. This reduction was due to lower premiums in the current year and receipt of a $257,000 refund related to an audit of prior year premiums.

     Depreciation and Amortization. Depreciation and amortization expenses decreased to $22.3 million for the quarter ended September 30, 2004 from $28.0 million for the same period in 2003. This decrease was due primarily to lower depreciation on messaging devices since certain asset layers became fully depreciated in the quarter ended June 30, 2004.

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     Stock Based and Other Compensation. Stock based and other compensation consists primarily of severance payments to persons we previously employed, amortization of compensation expense associated with common stock and options issued to certain members of management and the board of directors and compensation cost associated with a long-term management incentive plan. Stock based and other compensation was $3.1 million for the third quarter of 2004, compared to $2.8 million in the third quarter of 2003. The increase in this expense was due primarily to higher expense associated with the long-term incentive plan.

     Interest Income (Expense). The decrease in interest expense was due to lower average outstanding debt balances in the quarter ended September 30, 2004 due to the redemption of our 12% notes on May 28, 2004. We expect interest expense to increase in future periods in conjunction with our merger with Metrocall since we expect to incur up to $140 million of indebtedness to finance the cash election contemplated in the merger agreement.

     Income Tax Expense. For the quarter ended September 30, 2004, we recognized $4.5 million of deferred income tax expense based on an effective tax rate of approximately 40%. The expense for the three months ended September 30, 2003 of $4.3 million was recorded at an effective tax rate of approximately 41%. We anticipate recognition of income tax expense to be required for the foreseeable future, but we do not anticipate these provisions to result in current tax liabilities. See “Factors Affecting Future Operating Results - Deductions for tax purposes from future activities and from retained tax attributes may be insufficient to offset future federal taxable income and/or significant changes in the ownership of our common stock may increase income tax payments” and “Application of Critical Accounting Policies — Income Taxes” for further discussion.

     Comparison of the Results of Operations for the Nine Months Ended September 30, 2004 and 2003

Revenues

     Service, rental and maintenance revenues consist primarily of recurring fees associated with the provision of messaging services and rental of leased devices. Product sales consists largely of revenues associated with the sale of devices and charges for leased devices that are not returned. We do not differentiate between service and rental revenues. The table below sets forth units in service and service revenue, the changes in each between the nine months ended September 30, 2004 and 2003 and the change in revenue associated with differences in the numbers of units in service and the average revenue per unit, known as ARPU.

     As previously discussed, demand for messaging services has declined over the past several years and we anticipate that it will continue to decline for the foreseeable future, which will result in reductions in service revenue due to the lower volume of subscribers. In addition, as the percentage of customers with more than 100

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units in service increases, our average revenue per unit and disconnect rate is expected to decline. We expect that the impact of these events should result in a lower rate of decline in revenues.

Operating Expenses

     Payroll and Related Expenses. Payroll and related expenses are our largest expense, representing 36.7% and 38.0% of the total of cost of products sold, service, rental and maintenance, selling and general and administrative expenses for the nine months ended September 30, 2004 and 2003, respectively. The payroll and related expenses in each significant category of expense are included in the following table:

     The decrease in the number of employees resulted in $36.8 million lower payroll and related expense for the nine months ended September 30, 2004 for largely the same reasons as discussed in the comparison of the three months ended September 30, 2004.

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