Gogo Inc.

Good day, ladies and gentlemen, and welcome to the fourth quarter 2018 GOGO Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Will Davis, Vice President, Investor Relations. Sir, you may begin.

Thank you and good morning, everyone. Welcome to GOGO's fourth quarter 2018 earnings conference call. Joining me today to talk about our results are Oakley Thorne, President and CEO, and Barry Rowan, Executive Vice President and CFO. Before we get started, I would like to take this opportunity to remind you that during the course of this call, we may make forward-looking statements regarding future events and the future financial performance of the company. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements on this conference call. These risk factors are described in our press release filed this morning and are more fully detailed under the caption risk factors in our annual report on Form 10-K and 10-Q and other documents we have filed with the SEC. In addition, please note that the date of this conference call is February 21, 2019. Any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we'll present both GAAP and non-GAAP financial measures. We included a reconciliation Thank you. Thank you. It is now my great pleasure to turn the call over to Oakley.

Thanks, Will. Good morning and welcome, everyone. I'm only a few weeks shy of my first anniversary serving as CEO, and though this past year has largely been focused on fixing operational issues, I thought I'd take a minute to provide an overview of the fundamental promise of our business and what attracted me to GOGO as an early investor. We provide broadband connectivity products and services for the aviation industry and monetize that bandwidth through passenger connectivity, in-flight entertainment and connected aircraft solutions. We have a simple business model to provide connectivity products and services that grow revenue as in-flight bandwidth consumption grows. At this point, I don't think there's much argument about the fact that airborne bandwidth consumption is growing and will continue to do so. Passengers expect it, aircraft operators want it, and aircraft owners are committed to providing it. We provide connectivity through two solutions, satellite solutions for larger aircraft and air-to-ground solutions for smaller aircraft. The satellite ecosystem is going through unprecedented change, so we serve the global large jet market with an open architecture that can adapt to technology innovations that come to market that improve capacity, lower costs, enhance reliability, and expand coverage. Over the next few years, We see tremendous advances coming in the satellite world and in the KU satellite world in particular. We believe our 2KU platform is uniquely positioned to capitalize on those advances. In the air-to-ground world, we have a competitive advantage by owning and operating our own spectrum, which we leverage through a nationwide network of towers and a state-of-the-art network operations center to provide the highest quality service available. We'll enhance that capacity through additional bandwidth in order to continue improving the quality of our product. Today, GOGO is the largest provider of in-flight connectivity in both the commercial and business aviation markets. And that size gives us scale advantages and operating leverage in bandwidth procurement, product development, customer support, research and development, engineering, and network support. and we believe scale will be the most important determinant of who the winners will be in the IFC space. I'm proud of the entire GOGO team's effort in making us the industry leader. Our customers, the OEMs and our suppliers all tell me one of the major differences between GOGO and its competitors is the quality of its people and the fact that our people are passionate about making the internet and the sky work. Even though we're the leader Gogo has significant runway ahead of it as both our markets are largely under-penetrated. Business aviation is roughly 25% penetrated in North America and only 15% globally. And commercial aviation, though fairly well penetrated in North America, is only about 35% penetrated on a global basis. Our ultimate vision is to seamlessly integrate the passenger's airborne connected experience with their on-the-ground experience. by providing immersive connectivity and entertainment on the aircraft. Between now and that seamless vision, our goal is to future-proof our customers' investments in in-flight connectivity equipment by developing hardware and software that can be modified and upgraded cost-effectively as future technologies emerge. We took major steps forward in this direction in 2018. We achieved a milestone of more than 1,000 2KU-installed aircraft in our commercial aviation division flying at very close to 98% availability in Q4, and we have roughly 1,000 2KU aircraft in our backlog. We believe 2KU is uniquely positioned to take advantage of new satellite technologies as they emerge, whether Leos or some newer and potentially even more interesting technology on the drawing board today. We also took major steps in our business aviation division with the successful launch of our Avance product line. This software-defined product platform gives us the ability to upgrade and support our product from the ground, making upgrades easier and more cost-efficient than installing new hardware at a dealer or maintenance and repair facility. On my first quarterly earnings call in May, I laid out four priorities, quality, focus, getting profitable, and driving shareholder value. While 2018 was a transitional year, We made significant strides in several of these and laid the foundation for solid achievement in all four in 2019. We significantly improved quality as exhibited by our progress in de-icing and on numerous other internal metrics. We focused our investments on products and services with the highest return for shareholders and we drove cost savings to position our business for long term success. We look forward to demonstrating continued momentum in 2019 including a significant reduction in our cash burn as we progress toward becoming free cash flow positive. In the past, we've discussed strategic options including the potential of selling one of our divisions in order to de-lever the company. At this point, I think that is less likely as we have other approaches to dealing with our debt that we believe create more value for shareholders. Our top strategic priorities in the near term are to continue our strong operating performance drive to becoming free cash flow positive and to address the balance sheet, all so that we can control our own destiny and to maximize value and enhance our company's position in a rapidly evolving industry. Over time, we continue to believe that the IFC industry would benefit from consolidation, and we'd like to play a role in that consolidation from a position of strength. The first step in strengthening the balance sheet is to address the remaining portion of our $162 million convertible notes due March 2020. We have several good solutions that we're pursuing and believe that our improved performance and cash outlook will facilitate a less diluted solution. Before I turn to the quarter, I'd like to address the deinstallation and business term changes we are experiencing at American Airlines. As I'm sure many of you know, in 2016, We lost a bidding process to upgrade our legacy ATG product to a satellite product on 550 American Airlines aircraft. 374 of them were deinstalled in 2018, and the remainder are planned to be deinstalled in the first half of 2019. In conjunction with this decision to upgrade 550 aircraft to our competitor, American also elected to upgrade roughly 150 of our ATG aircraft to our 2KU product. most of which were installed last year. American made this decision in good faith as our satellite solution was not as advanced as our competitors at that time. We continue to have a good relationship with American and look forward to working together in the future. We're also proud that all of our other mainline ATG customers have selected to go with our 2KU product. We've shared this before and it's largely old news but we recognize that it's difficult to see our underlying growth rate given the noise from these de-installs. Throughout these comments, Barry and I will refer to, quote unquote, excluding de-installs when we mean to isolate our growth rate, excluding the de-installations and change in business terms with America. Now let me turn to the quarter. Q4 was strong and we finished well ahead of our EBITDA expectations due to strong consolidated CA service revenue Thank you. Thank you. Thank you. and modestly upsizing the convert refi we closed in December. We continue to shift our CA business model from upfront subsidies for equipment to full pricing, which should further improve the quality of our earnings and cash flow over the longer term. As Barry will discuss, we expect to approach cash flow positive results on an unlevered basis in 2019. We believe our stronger cash position and expectations for continuing strong operational performance significantly reduce and may obviate the future need for buffer capital that we have discussed in the past. With that overview, I'll dive down into the operating units for a minute, starting with business aviation. BA had a strong Q4 in an outstanding year. I'll leave the detailed numbers to Barry, but I'm going to steal a little thunder. 2018 revenue was up 21% over prior year and segment profit was up 41% with a 48% EBITDA margin. Service revenue grew 13% for the quarter year over year as our strong advanced shipments started getting activated and generating service revenue. In total, we shipped 796 advanced units for the year, making it our best product launch ever, which bodes well for future service activations. At the end of 2018, we had 5,224 ATG units online, up from 4,678 at the end of 2017. Our ATG monthly ARPU increased to $3,027 in 2018, up from $2,876 in 2017. And at year end, we had 5,124 satellite aircraft online versus 5,443 at the end of 2017. Our satellite monthly ARPU grew to $237 a month in 2018, I'm sorry, from $237 up to $243 a month in 2018. The decline in satellite units has been long predicted as the classic Iridium product nears end of life. As a value-added manufacturer and service reseller of the new Iridium service, Sirtis, we anticipate a slow transition from classic Iridium units online to the new SIRTIS service with a higher ARPA once the SIRTIS service is commercially available later next year. A big success in Q4 was the widespread adoption of our new DASH enhancement to our advanced platform. This software upgrade allows flight departments to monitor and manage the customer experience and advance aircraft while in flight and was signed on by 500 customers in the fourth quarter alone. Avance continued to deliver three times the throughput of our classic ATG products, and customer satisfaction ratings have risen dramatically. One exciting piece of news is that we're having great success selling GoGo Vision, our CA entertainment product, into the BA market. We gave a free 90-day trial for GGV to each Avance subscriber last year, and of those, 50%, or 341, ended up buying the product. taking us to 664 GGV subscribers in the BA segment at year end. As we warned on our Q3 call, Q4 advance shipments slowed to 162 units from 245 units in Q3 because some dealers had already purchased all the inventory they needed for the year. Now let me turn to commercial aviation. Probably the most important victory of the quarter was our defeat of the de-icing demons. As you'll recall, last winter, our system availability suffered tremendously as a result of de-icing fluid entering the ray dome and gumming up antenna raceways. Developing and deploying a de-icing solution has been the top priority of our operational and engineering teams. I'm grateful to the GOGO team for how well they responded to this challenge and grateful for the support we received from our airline partners throughout this process. As we discussed in our last call, After a painstaking process of identifying causes, identifying and testing solutions, and passing safety tests, we developed four different potential modifications to solve the de-icing problem, and we began installing the first modification in October. That modification has worked, and as of today, we've installed it on 100% of our 2KU aircraft in North America. As of yesterday, we've flown more than 15,000 flights that had been de-iced. And there has not been one incident of de-icing fluid entering the radome and causing degraded system availability. The best proof of the efficacy of this modification is that last winter our system availability ran roughly in the mid 80% range versus the upper 90% ranges this winter. Q4 CA North America service revenue was down 13% year over year as a result of the de-installs I described earlier, but up 6% when you exclude those de-installs. Q4 CANA equipment revenue came in below expectations, mostly due to customer and certification delays in installation programs. However, we installed 327 aircraft for the year in CANA, of which 254 were 2KU. and ended the year with CANA aircraft of 2,551. Though equipment revenue was down in CANA in Q4, we did have several important new inductions, including the Alaska B737-900ER, the Alaska A322-200, the Delta 737-700, and of course the new Delta A220-100, which has gotten a lot of media attention and was our first line fit installation. and also both the new seatback wireless IFV system we developed with Delta Airlines. CANA take rates showed nice improvement in the quarter, up to 12.9% from 12% in the prior quarter and 9.9% a year earlier. CANA also showed very positive improvements in customer satisfaction and in the net promoter scores our airline partners share with us. CAO, CA rest of world revenue showed nice growth over the prior year period and on a subsequent basis for both service and equipment revenue. Installations accelerated as we started to gain some traction on take rates with our newer rest of world fleets. We're excited about the growth prospects for rest of world, especially as we see several of the world-class airlines we've been installing turn from focusing on installations to thinking about 2KU marketing and distributions. In 2018, our rest of world segment added 199 2KU aircraft online, adding 76 of those in Q4, and finished just shy of 600 aircraft online for the year. In the year, we had a significant number of installations at IAG, Virgin Australia, Air France, Cathay Pacific, and Air Canada. In Q4, we also had one new induction, the KLM 777-300. Now I'd like to make a few comments on things that impact both commercial aviation divisions, including NA and the rest of the world. First, we increased total 2KU aircraft online globally by 453 aircraft in the year, 254 of which were in CANA and 199 in the rest of the world. 174 of the NA 2KU installs were ATG retrofits. across all CEA fleets. We started the year with 3,231 aircraft online, and we ended with 3,140 down as a result of the de-installs I discussed earlier. Second, data usage is moving quickly from ATG to satellite, with 72.5% of our data traffic now on our satellite network versus 47% a year ago. Third, we're making progress with the OEMs. Thank you very much. and we could restart the AIS service bulletin installations on the A330s and A340 families last month. As a result of the ELT holdup, we lost one fleet of 16 aircraft and 10 aircraft that have been delayed for installation. In 2018, we also achieved AIS service bulletin installations on the A350 and we believe we're on target to achieve our first Airbus line fit installs in 2020. In general, 2018 was a slow year for airline IFC awards, with approximately 815 aircraft awards announced versus roughly 1,700 the year before and roughly 3,800 the year before that. We were awarded 60 aircraft with Air Canada and another 30 aircraft with other customers. And as I've said before, we're involved in several bidding processes that we hope will deliver some very strong new airline partners. Another trend that we've mentioned is the shift of some airlines from the airline directed model back to the turnkey model. One airline is about to sign a revised contract that does that, and another one appears to be heading in that direction. The immediate impact of a switch from airline directed back to turnkey is to depress reported equipment revenue. However, the longer term impact is to increase service revenue, which should improve our quality of earnings and margins in the future. It's important to note that apples to apples, this transition has no impact on cash flow. Now let me turn to our business outlook. We've just completed our planning and budgeting process for 2019 and have set a few critical objectives for the year. Those objectives include first, Continuing our drive towards achieving cash flow positive results in our CA segments as soon as possible without jeopardizing the business or hurting quality. Second, investing in business aviation to protect our customer base and attack new business segments. Third, strengthening our balance sheet by dealing with our convertible stub and perhaps refinancing our senior notes to get a lower interest rate. Fourth, investing in our people. because GoGo has employees with unique technical and industry knowledge that are very, very valuable to our business. Fifth, continuing GoGo's cultural migration to process compliance and accountability while maintaining the creative problem-solving skills that are our unique competitive advantage. And finally, once we have our house in order, get out and tell our story. The image of us on Wall Street and the media is pretty negative. and though I think we've improved our image with airlines, we have a lot of work to do in the rest of the world. So given those objectives, let me provide a high level outlook for the year. I think the most important aspect of our outlook is that we expect a substantial improvement in our free cash flow. I also think it's worth noting that despite the negative effect of the de-installs I discussed earlier, we expect consolidated service revenue to grow in 2019. In fact, If you exclude the negative impact of the de-installs, we plan to grow consolidated CA service revenue 10 to 15% for the year.