Gogo Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the fourth quarter 2019 GoGo Incorporated earnings conference call. At this time, all participants are now listed in only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to turn the conference over to your speaker today, Will Davis, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Sonia. And good morning, everyone. Welcome to GOGO's fourth quarter 2019 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 the 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 March 13, 2020. 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 explanation of adjustments and other considerations of our non-GAAP measures to the most comparable GAAP measures in our fourth quarter earnings press release. This call is being broadcast on the internet and available in the investor relations section of the GoGo website at ir.gogoair.com. The earnings press release is also available on the website. After management comments, we'll host a Q&A session with the financial community only. It is now my great pleasure to turn the call over to Oakley.

Thanks, Will. Good morning, all. Welcome. We had a great fourth quarter and a great full year, but with the stock down substantially in recent weeks, with the uncertainty around the coronavirus and the Delta Airlines free Wi-Fi program, people are less interested in past performance than they are in trying to understand future unknowns. So I'm just going to start with the coronavirus today and then discuss in order the Delta free program and then get back to some of the fundamentals of our business trends in the satellite industry that are driving down our costs, then discuss industry consolidation and how we might fit into that consolidation and discuss a change we're making to our equity compensation plans. And finally, I'll discuss the quarter and the year and provide some high level thoughts on what will be a very difficult to predict 2020. So let me start with the news of the day, the coronavirus. This is a very, very, very fast moving situation in our industry. and in fact, a great deal has just changed in the last 48 hours. Needless to say, our primary concern is the health and safety of our employees and our customers. But our next concern is with the financial health of GOGO. As I discuss the impact of coronavirus on our different CA regions, I think it would be helpful to give you the regional breakout of our 2019 in-air sales revenue so you have a frame of reference. Roughly 73% of our in-air revenue from flights originating in North America, 19% originating in Asia, 5% in Europe, and 3% somewhere else. In January and February, we were on track for a great start to the year at both our business aviation division and our commercial aviation division. And two weeks ago, we started to see a significant decline in Asia for our CA division as US Airlines canceled flights to the region and domestic travel in Japan declined significantly. In the first week of March, we saw a decline in international travel more broadly, which lowered our total CA in air sales by 6.7% versus trend for the prior two months. This week, we're seeing a more pronounced decline in U.S. traffic, with some of our larger commercial airline customers down as much as 15%, and we expect a further decline in European traffic with the flight ban that goes into effect tonight. In the CA division, it's very hard for us to predict exactly how this will play out. And different airlines are predicting a wide variety of different potential outcomes. We'll obviously be negatively impacted as airlines take planes out of service. How badly we're hit will depend on what happens with load factors and on how long travel is impacted by the virus. We also anticipate that there could be a reduction in installations and equipment revenue as airlines cut back on capital spending, though perversely, that could help cash flow if those are older, subsidized equipment deals. We had $204 million of cash on hand in the bank as of last night. We're planning through a variety of scenarios and taking immediate steps to match our revenue declines with cash expense reductions in order to preserve our liquidity. That starts today with the CEO deferring his 2019 bonus until GOGO is in half-year times. We'll provide more guidance on our coronavirus actions as events in our plans unfold. The only good news in all this is that we see no impact yet on our business aviation segment. Some analysts believe that this could drive demand for private aviation in the future. Now let me turn to Delta Free. As I said before, we'll leave it to Delta to announce their plans. Our role is to provide the operational support to make those plans happen. Under today's turnkey contract, we subsidize the installation of Delta's jets, we charge Delta's passengers for connectivity, and then we pay Delta a royalty for access to their aircraft. In a free model, that will completely change, and assuming we come to terms, Delta would pay for equipment and pay us for passenger connectivity. However, as Delta will now have to pay for connectivity, Delta will want to make sure it is getting competitive pricing and competitive service levels. Hence, may want to move to a multi-supplier model for domestic mainline aircraft. Though we would not relish the idea of having a competitor join us at Delta, we coexist with competitors at most of the airlines we serve, and we compete very well on price and customer satisfaction at those airlines. We expect demand to grow significantly when Delta goes free, and though no agreement has been reached, we and Delta expect us to grow our revenue from Delta in a post-free environment, even when you include the impact of some planes potentially moving to a competitor. We further believe that Delta's move to free service will be a catalyst for other airlines to provide free service, thereby driving more demand for our product and more revenue and cash flow for GoGo. Now I'm going to talk about some trends in our business because we believe we're going to survive coronavirus, and I think it's important that investors understand the underlying strategic issues and trends in our industry. So let me start with developments in the satellite industry. I want to start with a few comments on what we're seeing in SATCOM pricing and the impact that has on our CA, rest of world segment, future profitability. As we replace expiring rest of world satellite contracts with new contracts, on average, we're seeing a 67% decline in per unit pricing. If all of our current capacity in rest of world were priced at those levels today, our rest of world segment would break even on a segment profit basis in 2021 and be profitable in 2022. Of course, not all those contracts are at those prices today, but two thirds of the current contracts in rest of world will expire in the next three years and we'll have the opportunity to replace them with much cheaper capacity. Two other positive trends are non-geosynchronous orbit satellites, NGSOs, which we expect to start coming online in 2022, and the emergence of managed services, which give us much more flexibility in terms of what we can provide our airline customers. Let me start with why NGSOs are important. As we study the most frustrating aspects of in-flight connectivity to passengers, Many of them are a result of the high latency inherent in geostationary satellites. NGSOs, such as Medium Earth Orbit Satellites, MEOs, and Low Earth Orbit Satellites, LEOs, are much closer to Earth, so packets from the teleport to the satellite to the aircraft travel a much shorter distance, hence arrive much faster than with a geosatellite. In our lab testing, complex web pages downloaded more than three times faster with a MEO satellite than with a GEO satellite. This type of responsiveness is not only important for web pages, but also for cloud-based applications like Microsoft 360, for VPN connectivity, for gaming, for interactive chat and IM apps, and the like. So very important for driving passenger satisfaction in the future. and since a number of airlines tell us that quality IFC is now their number one driver of customer satisfaction, we believe airlines will value low latency solutions. We're working with potential NGSO partners on a variety of fronts and hope to soon demonstrate that our Fincom 2KU antenna can work with LEO constellations and hope to have an announcement in that regard shortly. I should note that all of our competitors use traditional gimbal antennas, They won't work with LEO constellations, so airlines installing that equipment will have to go through an expensive upgrade if they want the benefits of LEO low latency. The other innovation is around managed services. Many years ago, when we decided to expand into satellite-based ISC, we had to either become a reseller of our competitors' network or build our own network, what I'll call the network ownership model. We chose to build our own in KU band spectrum at that time because it was the only spectrum with enough global coverage, capacity, and redundancy to meet our global airline partners' needs. In the network ownership model, we must buy capacity wherever our airlines fly, and we pay for it no matter how little we use it. The new trend is that some satellite operators are developing enough of their own coverage that they can begin to offer us a managed service where we buy by the drink instead of in bulk. This model has the benefits of reducing our fixed costs, increasing the burstable capacity we can bring to airlines, improving our capacity utilization, and enabling us to tailor solutions to individual airlines' needs. Though we remain committed to supporting our current customers with KU connectivity, we also see opportunities to reduce regional managed service KA solutions that will require very little capital investment upfront from us. The point of my discussion of MGSOs and managed services is that because of our asset-light model and the open architecture flexibility we've built into our solutions, we're able to quickly pick best-of-breed solutions provided by our partners and deliver them to our customers. In contrast, our vertically integrated competitors have committed their next several years of capital investment to KA band geo solutions and will have a hard time augmenting those investment plans to compete with all the innovation our satellite partners are bringing to market. Now, let me turn to some of the dynamics inside the IFC industry itself. At Govo, we have two businesses, business aviation and commercial aviation. And we believe our current enterprise value significantly underestimates the value of those two parts. Our business aviation segment is a solid franchise. It produces solid growth in a relatively under-penetrated market. It produces strong recurring cash flows. It has proprietary technology and intellectual property, a compelling product roadmap, and a very strong position in a relatively price-insensitive market. Our commercial aviation segment also represents real value. It has leading share in a fast-growing industry, a very attractive customer base, a very strong product roadmap, and strong product integration, engineering and distribution capabilities. The issue in the commercial aviation IFC space is that there are too many competitors and nobody yet has enough scale to build a sustainable business for the long term. We believe that some consolidation will occur in the CAA IFC space and we're working hard to leverage our leading market position to make sure that our shareholders are among the beneficiaries of that consolidation. In order to make the value of the parts of our business more evident, in the 10K we'll file today, we've broken out our corporate expenses from the BA and CA segment expenses so investors can see the performance of our operating segments on a standalone basis. Now, I'd like to touch briefly on some changes to our stock-based compensation that our Compensation Committee has approved. It's important to understand that GOGO's most important asset are its employees. We work in an industry that demands very specific knowledge and skills. Our employee equity compensation plans were put in place years ago and no longer act as the retention vehicle we need. 84% of our stock options are more than 300% out of the money and more than 99% or at least 180% out of the money. Given the issues we face with coronavirus and other challenges, We think it's time to bite the bullet and offer an options exchange to our employees that receive equity compensation so that we have a real retention tool and employees have a piece of paper with real value. The exchange, which will be in the proxy, has the added benefit of returning roughly 3 million shares into our employee omnibus incentive plan pool, thereby reducing the need for us to come back to shareholders to replenish the pool in the near future. I think this is very important. because retaining our highly skilled employees will be very important to realizing the strategic value for GoGo that I discussed a moment ago. Now let me turn to the quarter of the year. As I mentioned, we had a really solid quarter and a great year. We exceeded our revenue, adjusted EBITDA and free cash flow expectations by wide margins. Perhaps the most important metrics are first, free cash flow, where we improved dramatically despite having an extra interest payment in the year. and second, Unlevered Free Cash Flow, which improved from a very negative number in 2018 to a very positive number in 2019, demonstrating the underlying earnings power of the business. As always, I'm very proud of my GoGo teammates for delivering such a great year. We've worked hard to improve our operations, execute on our strategy, and achieve our financial goals. I think we're making great progress, so thank you. Our business aviation division had a really solid quarter with record revenue for both service and equipment and good cost control, which in turn delivered record segment profit. The BA division added 142 APG aircraft online in the quarter to reach just under 5,700 a year and up 9% from prior year and achieved accelerating average service revenue for aircraft throughout the year to end at $3,200 per unit in Q4, up 5.4 from prior year. Shipments were strong, especially for the Avantel 5 product, which shipped 171 units in the quarter, tied for our highest quarter ever. Turning to our CA segments, if you add the two segments together, we crossed an important threshold with positive combined annual segment profit for the first time. In our commercial aviation North America segment, we achieved quarter-over-quarter growth in aircraft online with a positive for the quarter. In CA, rest of the world, we installed a growth 77, net 71 planes in the quarter, which was up over prior quarter and flat with prior year. Row service revenue was flat with prior quarter because planes installed this quarter have yet to produce solid take rates, but was up 21% over prior year. Some planes in newer fleets began to mature. Across CA segments, we installed exactly 400 aircraft online, which was at the bottom of our guidance as a result of the max grounding, the federal government shutdown, and internal operating issues at certain airlines. We crossed a major product mix threshold in the quarter, with more than 50% of all CA aircraft now on satellite IFC as opposed to ATG IFC. We also finished the quarter with a strong 2KU backlog of nearly 950 aircraft, as we picked up 150 aircraft new commitments from existing customers on top of the 70 aircraft on order from Qatar. With that, let me turn to 2020. Needless to say, it's a year of considerable uncertainty due to the coronavirus. So we're going to share what our guidance would have been without the coronavirus and update as the situation solidifies. In order to manage growth expectations, as it would have been, I think it's important to remind you that over the course of 2019, we highlighted approximately $35 million of non-recurring revenue benefits, which equated to a benefit of $31 million of non-recurring adjusted EBITDA. When you adjust to these items, 2019 adjusted EBITDA would have been roughly $115 million, still well ahead of guidance and prior year, but less than our reported adjusted EBITDA of $146 million. If you think of our trajectory, we had 71 million of adjusted EBITDA in 2018. Excluding the non-recurring revenue, we had adjusted EBITDA of 115 in 2019. And our pre-coronavirus budget continued that trend in 2020. The point of sharing what our 2020 plan would have been is to show that ex-coronavirus, we have a healthy business that is now going to suffer a setback. But I believe we can fight our way through this and preserve GOGO's franchise values. We'll continue to serve our employees and customers well. We're going to focus on maintaining our liquidity. And when we get through this pandemic, I believe we'll be stronger than we were before. With that, I'm going to turn it over to Barry for the numbers.