Gogo Inc.

ATG Aircraft Online reached 7,150 units as of the end of the third quarter, representing 6% growth versus the prior year and 1% growth sequentially. While GOGO saw an improvement in incremental ATG Aircraft Online from 18 in the second quarter to 86 in the third quarter, these remained muted due to temporary suspensions driven by elongated maintenance cycles which took aircraft offline. In addition, We had record upgrades in the third quarter, and while strategically important, it also contributed to the muted aircraft online growth as it replaces existing aircraft online. Advanced aircraft online grew to 3,784 and now comprise 53% of our total fleet, up from 45% last year. Increasing aircraft online with the penetration of our advanced products remains critical to GOGO's strategy both in the North American market and globally as we prepare for GOGO 5G and Galileo. As we mentioned last quarter, we continue to expect the advanced aircraft online growth rate to accelerate over the next several quarters as maintenance events start to return to normal levels, reducing suspension time, and dealers work on addressing supply chain issues that are contributing to slower installation rates. Total ATG ARPA, of $3,373, slightly increased sequentially and slightly decreased versus the prior year, driven by a shift in product mix. The anticipated launch of GOGO 5G and Galileo next year will further expand our opera growth opportunity over time, partially offset by continued L3 sales into smaller aircraft and lower priced data plans to drive incremental revenue growth down market. Now turning to equipment revenue, GOGO generated $18.4 million in equipment revenue in the third quarter, a 39% decrease year-over-year and a 24% decrease sequentially as advanced equipment units shipped decreased to 192 in the third quarter. As Oak noted, the decrease in advanced equipment units shipped largely reflects the impact of lingering inventory in the channel. Shifts in OEM orders to 2024, as well as delays in customer purchases, as they wait for the expected launch of GOGO 5G and Galileo in 2024. GOGO remains confident that our strong position in a global market that is only 22% penetrated with in-flight connectivity, coupled with the expected launch of GOGO 5G in Q3 2024 and GOGO Galileo in the second half of next year, will continue to propel our equipment sales in the future. Turning to profitability, GOGO delivered service margins of 77% in the third quarter, which remains flat compared to the prior year quarter. We continue to expect long-term service margins in the 75-plus percent range, positioning service as the primary lever for free cash flow generation and long-term value creation. Equipment margins were 33% in the third quarter, three percentage points lower than prior year period, and six percentage points higher sequentially. The increase in our equipment margin compared to last quarter was primarily due to an accrual of $2.8 million for the expected FCC reimbursement of costs incurred to replace a large number of EVDO air cards in advanced equipped aircraft with dual modem air cards. Out of the $2.8 million accrual, $0.8 million related to Q3 shipments, while $2 million was related to prior quarters activity back to 2022. The positive impact of the accrual for expected FCC reimbursement was partially offset by an increase in production cost as a percentage of revenue due to lower equipment revenue in the quarter. We expect Q4 equipment margin to decline as there is no catch-up accrual for the FCC reimbursement. Moving on to operating expenses, third quarter combined engineering design and development sales and marketing, and general and administrative expenses of $25.5 million declined slightly year-over-year and decreased 3% on a sequential basis. Our operating expenses decreased sequentially primarily due to lower marketing-related costs. GOGO continues to expect 2024 will be a significant investment year as we complete our GOGO 5G program and RAMP spending for GOGO Galileo. We expect to see the benefit of these investments through sustained, strong top-line growth and an inflection point in free cash flow growth in 2025 and beyond in our core operating business. In terms of GOGO 5G in the third quarter, our $1.8 million of 5G spending was comprised of $0.5 million in OPEX and $1.3 million in CAPEX. As Oak mentioned, GOGO is working with our 5G network and chipset suppliers to resolve the 5G chip issue, and we now expect the commercial launch of GOGO 5G to take place in Q3 2024. We maintain our estimate of $100 million in total cost for our 5G program, but the delay will push approximately $10 million of CAPEX and $7 million of OPEX from our original plans in 2023 into 2024. GOGO expects this delay to dampen revenue, EBITDA, and free cash flow in 2024. Now onto our GOGO Galileo initiative. In the third quarter, GOGO recorded $2.6 million in operating expenses related to GOGO Galileo and $6.6 million year-to-date. We continue to expect external development costs for GOGO Galileo to be less than $50 million in total, of which $10 million will be incurred in 2023 and approximately $30 million in 2024. We anticipate approximately 90% of GoGo Galileo's external development costs will be in OpEx. Moving on to our bottom line, GoGo's third quarter adjusted EBITDA of $43.2 million stayed relatively flat year over year. EBITDA margin expanded to 44.1%, up 140 basis points from last quarter, and up approximately 300 basis points year-over-year as we had growth in high margin service revenue while maintaining strong cost control. GOGO delivered net income at $20.9 million in the third quarter, up 4% year-over-year, translating to 16 cents in basic and diluted earnings per share. As a reminder, last quarter we reported net income that included an income tax benefit of $63.8 million, due to the partial release of the valuation allowance on our deferred tax assets related to the Section 163 interest limitation carry forward. As of December 31, 2022, GOGO had $562 million in federal net operating losses, $448 million in state net operating losses, and $292 million in Section 163 interest limitation carry forward. As a reminder, our financial statements reflect non-cash income tax expense as we continue to generate positive pre-tax income. Based on our substantial NOL position, we did not expect to pay meaningful cash taxes for an extended period, but we may pay a modest amount by the end of our five-year planning horizon. In addition, our shareholder rights plan that is designed to preserve NOLs expired in September. The shareholder rights plan was not renewed as changes in the shareholder base over a three-year period have lapsed. Thus, we still have access to our large NOL positions, but new shareholders are no longer restricted from purchasing over 5% of the outstanding shares of GOGO's common equity. In the third quarter, we generated $21 million in free cash flow, up $12.5 million versus prior year, primarily due to lower 5G capex. Free cash flow is also up $7.7 million sequentially, largely due to lower interest paid this quarter as we switched to a monthly cadence of interest payments on our term loan, resulting in five months of interest paid in the second quarter. Now I'll turn to a discussion of our balance sheet. We ended this quarter with $110.8 million in cash and short-term investments and $608.7 million in outstanding principal on our term loan. with our $100 million revolver remaining undrawn. GOGO's net leverage was slightly lowered to 2.9 times, in line with our target range of 2.5 to 3.5 times. As we previously mentioned, we have a hedge agreement in place, and we currently have 86% of our loans hedged. The next step down in the hedge to $350 million occurs in July 2024, with an increase in strike rate from 0.75% to 1.25%. As a reminder, GOGO's capital allocation priorities remain unchanged and are aligned with our strategic goals and include, first, maintaining adequate liquidity. Second, investing in strategic opportunities to drive competitive positioning and financial value, including GOGO, 5G, and Galileo. Third, maintaining an appropriate level of leverage for the economic environment with a target net leverage ratio of 2.5 to 3.5 times. And finally, returning capital to shareholders as appropriate in the future. With a strong cash balance, our GoGo 5G, Galileo, and other strategic projects well-funded, and our net leverage ratio at 2.9 times, including the $100 million debt pay down earlier this year, and our strong confidence in the business, we were comfortable moving to priority four in returning capital to shareholders. Our board of directors approved a share repurchase program in September with no set expiration date. that grants authority to repurchase up to $50 million of shares of common stock. This gives us the ability to opportunistically repurchase shares when we find that doing so offers an attractive value proposition. However, we need to continue to balance the use of cash over the next year across our capital allocation priorities, and especially in allocating funds between further pay down of debt, considering high interest rates and a step down in our hedge, and future share repurchases. I would now like to provide an update on the expected financial impact of the SEC Secure and Trusted Communication Networks Reimbursement Program. As Oak mentioned, we are encouraged that the White House recently issued a supplemental funding request that includes a call to Congress to fully fund the SEC program, which would significantly increase our total reimbursement value as we were granted up to $334 million. As mentioned in previous quarters, we currently expect to receive partial funding of $132 million. As a reminder, we submitted our first claim in July, which triggered the start of the one-year clock to complete the program by July 21, 2024. In our application, we stated that we will need to have multiple extensions to complete the program and are waiting to see if the FCC will grant a blanket extension or we will request an extension in the coming months on our own. GOGO has incurred and will continue to incur costs for this program in three areas. First, network equipment for cell sites and data centers. Second, airborne equipment for the swaps of LTE air cards to replace EVDO air cards, and partial rebates for customers' installation costs to enable existing customer aircraft to communicate to the new network. And third, operating expenses primarily for flight testing, network design, and professional services. We expect the spend will be partially offset by the FCC reimbursements. As of September 30th, we recorded a $16.2 million receivable from the FCC, which is included in prepaid expenses and other current assets in our balance sheet for the reimbursement of the cost I previously mentioned, with corresponding reductions to property and equipment, inventory, and contract assets, and with a pickup in the income statement. Going forward, since the program is currently partially funded, We have some optionality in what we request reimbursement for, which could impact where grant money received would be recorded between the income statement and balance sheets. Previously, GOGO expected 2023 and 2024 free cash flow to be negatively impacted by the FCC program and a benefit in 2025 due to the timing of reimbursement proceeds. However, we are currently seeing reimbursements coming in quicker than expected, potentially changing the swing effect on free cash flow over the years. For example, in 2023, we expect to spend approximately $20 million for the FCC program and recoup approximately $2 million in cash reimbursements. But with the reduced lag in the reimbursement process, we could receive more this year. Nonetheless, with partial funding, reimbursements are expected to be short of the total expected cost of the program through 2026. Turning to our financial outlook, GOGO updated its fiscal 2023 financial guidance to reflect current market dynamics. GOGO now expects 2023 total revenue to be in the range of $390 million to $400 million. The decrease is driven by a reduction in our equipment revenue, which is largely affected by shifts in OEM orders to 2024 and a delay in customer orders as they wait for the expected launch of GOGO 5G in Galileo, as I noted earlier. We now expect 2023 adjusted EBITDA to be in the high end of our previously guided $150 million to $160 million range. We are able to increase adjusted EBITDA guidance despite lower revenue as we continue to prudently manage costs down as well as push out additional 5G spend due to the delay. This guidance includes spending on operating expenses of approximately $15 million compared to $20 million previously for strategic and operational initiatives. which include approximately $3 million in expected GOGO 5G spending, approximately $10 million of GOGO Galileo development spend, and approximately $2 million in additional operational initiatives. Our adjusted EBITDA guidance also includes approximately $7 million of costs related to the FCC program, offset by $6 million of accruals for the expected FCC reimbursement. We now expect our 2023 CapEx to be in the range of $25 million to $30 million, including $12 million for the GOGO 5G program and approximately $2 million related to the FCC program. We also now expect our 2023 free cash flow guidance to be in the high end of the previously guided range of $60 million to $70 million, including FCC-related spend and the expected lag of FCC reimbursement. Even with our investments in strategic initiatives and the FCC program, we expect nearly 20% year-over-year free cash flow growth in 2023, and excluding the FCC impact, it would be nearly 50%. As we previously stated, 2024 will continue to be an investment year with an increase in Google Galileo expenses anticipated, but further burdened due to the push-out of 5G spend. These investments, coupled with the lower shipments and lower aircraft online this year versus our original expectations and delay in 5G launch, are expected to negatively impact our financials, causing 2024 to be a trust-free cash flow year. However, GOGO's long-term targets remain unchanged. They reflect our expectations for the launch of GOGO 5G in Q3 2024 and the launch of Google Galileo in the second half of 2024. We reiterate revenue growth at a compound annual growth rate of approximately 15 to 17% from 2022 through 2027. We continue to expect annual adjusted EBITDA margin in the mid 40% range by 2027 and free cash flow in the range of 150 to 200 million dollars in 2025 without the effect of the FCC program and growing thereafter. We plan to provide 2024 guidance metrics and update our long-term targets as appropriate on the fourth quarter earnings call as we typically do. In conclusion, we will continue to deliver solid bottom line financial performance, and we are committed to creating long-term value for our shareholders and customers. Before we open the call up to questions, I would like to join Oak in thanking our entire team for their continued commitment to GoGo and providing unparalleled service to our customers. Operator, this concludes our prepared remarks. We are now ready for your first question.

In order to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again.

Please stand by while we compile the Q&A roster.

And our first question comes from the line of Rick Prentice with Raymond James. Your line is now open.

Thanks. Good morning, everybody. Good morning, Rick. Hey. Appreciate all the details. I want to probe into, first, the competition side. I know you talked a little bit about testing your offers versus others. It's not on the VA side, but interesting with Hughes announcing the Delta Regional Jet contract. I wonder if you're thinking of will others start coming into the BA space as well, and then maybe an update on the Smart Sky lawsuit if there's been any changes.

Yeah. So, I mean, the Delta Hughes deal is a large antenna geo product at this point. So, they're using the ThinCom 1717 antenna set, which is about five feet long. It's not a BA aircraft type of antenna. And it's not ESA, and it does not use LEO satellites at present. I think it's KA, which is important. It's really meant to be a way for Hughes to sell Jupiter capacity. So, you know, they're our partner. This is consistent with our agreements, and, you know, we have no issue with it at all. Second, I think you were asking about potential entrants. Yeah. Yeah, I think our confidence against potential entrants has really grown. We spent a lot of time over the summer doing a lot of detailed market research and surveys around the world. And we did those on a branded and an unbranded basis. And the top four offers were always Gogo, our really cheap L3 product, the 5G product for North American flyers, generally medium-sized jets on down that want higher capacity, and then the FDX and HDX for planes flying, you know, outside the U.S. or, you know, medium-sized jets in the U.S. who want higher capacity, and then FDX for the global trans cons. And so that gave us added, you know, confidence that we're developing the right products, we have the right service, you know, we're looking at the right price points, the right coverage. And our, you know, our whole strategy is to understand the complexities of this pretty small vertical, the fact that there's a lot of different segments that have different needs and be able to create, take advantage of understanding all those different segments and create the right product, the right coverage, the right cost, et cetera, for each of those segments. So we feel very good about that. Most people worry about Starlink coming in. I think they're still trying to find their way. They keep changing their mind about what they're going to do. And of course that just doesn't, resonate very well with the, with the business aviation market, which has long lead times and where people want, you know, very steady, very steady partners that they know they can trust to actually deliver products, service products, et cetera. So we feel good about that. And then the last question was on the smart sky litigation. There's still no decision in their appeal of the lower court denial of a temporary injunction. And we view that as a good sign because it's been close to half a year now since that was heard. And if the court really felt that there was an urgent need to grant an injunction, one believes they would have granted that by now. Because, you know, when asking for a temporary injunction, one has to sort of assert that time is of the essence. So we feel good about that. And the general trial, which was to come later, I believe that goes to trial in April of 2025 or August of 2025. I can't remember which A month it was. So that still weighs out. And, you know, there will be a lot of Markman hearings and all that over the next year or so. So that'll go into discovery. And, you know, it'll be a time-consuming and somewhat expensive process.

Okay. And I just want to make sure I also understand the 5G Galileo operating initiatives, Jess, I think you said. The 15 million impact OpEx wise and 23 is like 3 million for 5G, 10 million for Galileo and 2 million for others. The 24 Galileo looks like it's going to be 30 million. Is the 5G, is that just 7 million? Has that got pushed out? Just trying to think what the total 24 impact is to compare to the 15 million EBITDA impact for those three items.

Yeah, so Galileo, as you mentioned, you have that right. It's expected to be around 30 million, approximately 30 million next year. 5G, so we pushed out 7 million of OPEX from this year to next year.

So we're expecting 7 million in OPEX next year. And then for CAPEX, we're expecting that to be more like 14 million, so we pushed out 10 million from CapEx this year to next year, but we had originally planned to have a little bit of additional CapEx next year, so total of 14 next year. So 5G spending total will be 20 million next year.

Okay. And the last one for me is, obviously the balance sheet's strong, the bottom line, you've been working to that. How much cash do you want to keep on the balance sheet to run the business? as we think about all the different components you're looking at, and also obviously the FCC reimbursement?

Yeah, so, you know, we like to be fairly conservative on this, and I think the range is around, you know, 50 to 75, which is, you know, higher than what we would need to run the business, but we like to be conservative. So when we talk about, you know, maintaining adequate liquidity, that's usually the amount that we're keeping in mind.

Makes sense. Thanks a lot for answering the questions.

One moment for your next question. And your next question comes from the line of Lance Vitonza with TD Cohen.

Your line is now open.

Hi, thanks, guys. Thanks for taking my questions. Just a couple around the new product launches, first on 5G. You know, what are the milestones that you can point us to that would help us get more comfortable around the certainty, if not the exact timing, of this launch? I mean, what specifically needs to happen between here and there?

Right. So I tried to run through some of those in the call. I'd say that the first would be the ship actually going into production in the foundry as that service, the clock starts then. I would say second would be our delivery in late Q1 of the FPGA technology to us because that new 50 megahertz capacity FPGA version of the chip, we will be able to burn down a lot of risk. You know, we'll be flying that in Q2. And because it's an exact software replication of the chip, we can burn down all software integration risk. We can burn down all integration testing across the network risk. So those are very significant. The only thing, the only risk we cannot burn down with that is an issue in the 5G chip from a hardware perspective. That you have to test it after it comes off the foundry. And then later dates would be when that chip comes off the foundry. And then when we take delivery, because there's a bring-up process between it coming off the foundry and being delivered to us, and then our start of flight testing. I think those are the major milestones.

That's really helpful. And how long does the flight testing component take, would you expect?

We start testing flying the whole network. It takes about two months once we have the chip, but we you know, we will burn down most of the risk around flight testing and fine-tuning with the FPGA.

Right. I'm not so much worried about the risk as I am just trying to think about the timeframe and calibrating there, but that's helpful. And then just sort of a related question, I guess, you know, with the Galileo launch set to launch relatively quickly on the heels of the 5G launch, do we have to worry about the 5G launch being softer than expected or pressured by aircraft operators basically saying, well, gee, you know what? I was going to go with 5G, but now Galileo is going to be here in a couple of months. Maybe I should hold off and wait for that.

Yeah, look, it's not ideal to have these two product launches land on top of each other, and that wasn't the design, as you well know. We were going to originally have 5G out last year. But I think that we don't see a conflict because we don't see – we see these products as being positioned to very different segments of the market. And while – While the delays have sort of confused that communication, I think we're starting to see it get straightened out. You know, the 5G is really aimed at North American market because that's its coverage. It's aimed at those sort of medium-sized jets on down that want a really good product but are still somewhat cost-conscious, right? They want an affordable product. And 5G will be cheaper than any satellite product. The HDX is aimed at sort of medium-sized jets on down outside the U.S., and those planes today have no connectivity option whatsoever, no broadband connectivity option whatsoever. And medium-sized jets on down that fly outside the U.S., like to the Caribbean or Canada or Mexico, et cetera, Hawaii, which is in the U.S., of course, but it's over a large piece of ocean. So that's where that's aimed. And then the FDX is a heavy jet product, and that's for, you know, the big jets that either, you know, fly around the U.S. and want a lot of connectivity or, you know, fly, you know, transcontinental routes. And it's going to be more, you know, more aimed probably at the transcontinental planes. So they're very different segments, and we're trying to be very clear with the market in terms of communicating, you know, which products, you know, should be the right product for each segment.

Thanks very much.

I appreciate your help.

one moment for the next question and your next question comes from the line is caught surly with roth and cam your line is now open hey good morning thanks for taking my questions i appreciate all the detail and maybe oh just to um dive in quickly in terms of the maintenance events, engine port availability, et cetera, that has been delaying AOL. The last quarter, you know, shipments or ATG units were down pretty significantly. I think they're about 100 units below where it averaged over the last six quarters or so. It sounds like despite that, you're having record activations And you're starting to see a pickup in terms of suspensions going away in the month of October. And I believe you indicated as well that there are only about 40 units in the channel that are unspoken for. So implied in the fourth quarter guidance is another weak ATG unit quarter. So the question is, as we get into 2024, are we completely burned down and normalized in terms of channel inventory and that balance now with prolongated maintenance events But now that's starting to work its way through the channel, and we start to see a reacceleration both of ATG units being shipped and AOL aircraft starting to ramp back up again.

You know, I think that the inventory burndown is definitely taking place. And when you really look at the 850 or so, there's an awful lot of those that have actually already been installed. We talked about 200 last quarter. This quarter, that's down to 187. And actually, it's much more dynamic than that. there were of the 279 were actually activated. That was then offset by, you know, increased shipments that took that number back up to 187. So we're feeling much better about that part of the inventory, if you will. And, yeah, like we said, all but 140 are spoken for. 32 of those really are at dealers that, you know, took inventory one or two units during COVID, hoping they'd get an order. They haven't. And that may be sitting there, but the rest are just a couple dealers that move a lot of inventory. So we feel that that is normalizing and that that will help order somewhat. I think that the countervailing force next year will be, you know, people wanting to make sure that they don't end up with a lot of L5 inventory after we launch LX5. So they'll order to fulfill, you know, current orders, but I don't think they will be stocking up for, you know,