Earnings Call Transcript - GOGO Q2 2024

Operator, Operator

Good day! And welcome to Gogo Inc’s Second Quarter Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question and answer session. Instructions will be given at that time. As a reminder, this call may be recorded. I would like to turn the call over to Will Davis, Vice President, Investor Relations. Please go ahead.

Will Davis, VP, Investor Relations

Thank you, Michelle. Good morning everyone. Welcome to Gogo's second quarter of 2024 earnings conference call. Joining me today to talk about our results are Oakleigh Thorne, Chairman and CEO; Jessi Betjemann, 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 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. Those risk factors are described in our earnings release filed this morning and are more fully detailed under Risk Factors in our annual report on 10-K and 10-Q and other documents that we have filed with the SEC. In addition, please note that the date of this conference call is August 7, 2024. Any forward-looking statements that we make today are based on assumptions as of this date, and we undertake no obligation to update these statements as a result of more information or future events. During this call, we'll present both GAAP and non-GAAP financial measures. We have included a reconciliation and explanation of adjustments and other considerations of our non-GAAP measures to the most comparable GAAP measures in our second quarter earnings release. The call is being broadcast on the Internet and available on the Investor Relations 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's now my great pleasure to turn the call over to Oakleigh.

Oakleigh Thorne, Chairman and CEO

Thanks Will. Good morning everyone and thank you for joining us today. Gogo's second quarter performance showcases the strength of our recurring cash-generative service revenue model. Despite navigating a product lifecycle transition and investing in our next generation Gogo Galileo LEO satellite product and Gogo 5G service, we are approaching an exciting inflection point in our product lineup. In the near future, we will have the most extensive product portfolio in the business aviation IFC industry, offering the optimal performance, coverage, total cost of ownership, and exceptional customer support for each segment of the under-penetrated global business aviation market of over 40,000 aircraft. We anticipate that 5G and Galileo will fuel our revenue growth next year as they significantly enhance the speed of Gogo services, increase our total addressable market by 60%, and extend customer lifetimes through simple and attractive upgrade paths for our AVANCE install base. It's notable that record upgrade activity in the second quarter has led to AVANCE now composing 60% of Gogo's fleet. Each AVANCE installation is viewed as a strategic win, providing customers easier and more affordable paths to upgrade to emerging technologies like 5G and LEO, instead of switching to another connectivity provider. As we approach the launch, our aftermarket customers are adjusting their purchasing decisions in expectation of the Gogo 5G and Galileo products, which is evident in our second quarter equipment revenue and revised 2024 guidance. This behavior is not unique to Gogo; it’s common across various companies launching next generation products. A parallel can be drawn to Apple, where older models see diminished sales as customers eagerly await newer, superior offerings. This morning, I will discuss current demand trends in the business aviation market that inform our optimistic outlook, provide an overview of our Q2 results, and examine the progress we've made on strategic initiatives aimed at renewing our growth by introducing products that align with different segments of the market. Jessi will then present the figures and discuss our guidance for 2024 and the long term, which now reflects our most accurate expectations for the 5G launch timing. Overall demand for business aviation flights and connectivity within those flights remains strong, supporting our growth trajectory. Changing demographics are favorable for connectivity penetration as younger flyers enter the market. While all age groups seek better in-flight connectivity, demand significantly increases among younger flyers. Fortunately, Gogo has diverse products to cater to varying connectivity needs. In the second quarter, Gogo equipped BA flight counts increased slightly by 1.1% year-over-year, and flights remain substantially above pre-COVID levels, with Q2 flight hours per day rising by 35% from Q2 2019. Regarding data demand, average megabyte consumption per day on our networks has surged by 165% since Q2 2019, indicative of a notable shift in passenger demand, and average megabytes consumed per flight hour have increased by 96% over that same period, demonstrating a 17% annual growth in Q2. We are witnessing significant demand growth at the high end of the market where cloud data storage and video conferencing necessitate higher bandwidth than our traditional products, positioning Gogo Galileo and 5G to meet that demand effectively. Additionally, OEM order books and fractional aircraft sales look robust, a trend that will further drive growth in Gogo units online. The increasing appetite for data usage on aircraft significantly benefits Gogo in two ways. It creates a compelling demand tailwind for our products while underscoring the wisdom of our decision to divest the commercial aviation business four years ago to heavily invest in new technologies that greatly enhance our product capacity and quality for customers. Gogo’s ongoing commitment to future-proofing our technology and infrastructure has proven to be strategically sound and will remain crucial to our long-term success. Now let’s review our second quarter performance. Revenue saw a slight decline of about 1% year-over-year as record service revenue was counterbalanced by a drop in equipment revenue, which fell by 17% year-over-year and 11% sequentially in the second quarter. This decline is largely due to the product lifecycle dynamics I mentioned earlier, as customers are postponing purchases in anticipation of Gogo 5G and Gogo Galileo. Nevertheless, we expect our second highest year for AVANCE shipments ever and saw total AVANCE units online grow by 17% year-over-year to 4,215 aircraft, making up approximately 60% of our ATG install base. This base will grow even faster as we encourage our nearly 3,000 Gogo CLASSIC customers to transition to LTE as part of our FCC Secure Networks program over the next 20 months. As previously mentioned, we indicated on our last call that the usual trend of higher second half shipments might be reversed this year due to a surge in equipment orders last quarter, driven by NetJets pull-through demand and the shifting of some OEM annual bulk shipments into Q1 from later in the year. In service, we achieved record revenue, which is the foundation of our long-term business model, propelled by AVANCE upgrades, despite a slight decline in total ATG units online caused by modest net deactivations in our CLASSIC product line. In terms of earnings, Q2 EBITDA fell by 30% sequentially, mainly attributable to lower equipment revenues and rising operating expenses, predominantly legal fees from the SmartSky litigation and various vendor financing issues, nearly all of which we expect to resolve over the next year. However, it's important to note that while we invest significantly in the 5G and Galileo projects, our free cash flow remains strong. Regarding our strategic initiatives, Gogo is prioritizing growth acceleration through a three-pronged strategy. We aim to expand our addressable market globally by leveraging the versatility of our AVANCE platform to offer products that fit the pricing needs of different segments within the large, unpenetrated global business aviation market of 40,000 aircraft. Second, we focus on enhancing customer loyalty by consistently improving our ATG networks to facilitate the transition of CLASSIC customers to the AVANCE platform, enabling them to easily upgrade to new technologies like 5G, Ku-band, and LEO networks as they emerge. Third, we are dedicated to providing the best products and customer support to each market segment while maintaining the lowest total cost of ownership. We are making significant progress in these strategic initiatives. Beginning with Gogo Galileo, we are in an exciting phase as we finalize our go-to-market strategies, regulatory approval processes, and production for the launches of the Galileo HDX and FDX products. This product category emerged from insights gathered during a thorough strategic planning process in 2020 and 2021 following the sale of our commercial aviation division. We recognized that ESA antennas and LEO satellite constellations would revolutionize business aviation connectivity, enabling fast connectivity with low latency essential for applications like video conferencing, supporting high-capacity heavy data applications, allowing for small antennas suitable for all business aviation aircraft, simplifying installation compared to geostationary antennas, providing global broadband coverage for the first time, and allowing competitive pricing against geosatellite options. Most importantly, we believed that the enhanced value from these offerings would substantially increase IFC penetration in the global business aviation market. We also anticipated that StarLink would become a major competitor, which has been evident as they ramped up installations in Q2. While we will launch slightly after StarLink, our product will address a broader market than their offering and they have heightened awareness in the business aviation sector of how superior ESA LEO technology is compared to traditional geo satellite solutions. Our head of sales aptly illustrated this competitive edge with a metaphor about two mice, with Gogo strategically positioned to capture the market. Business aviation clients tend to be discerning; reliability is paramount, space on aircraft is limited, installation ease is critical, and robust customer support is essential. StarLink's offering is essentially a repackaged consumer product for aviation, which does not meet these demands, opening the door for us to differentiate ourselves in three key aspects. Our equipment is aviation-grade, designed from the aircraft up and satellite down to fulfill the specific requirements of the business aviation sector, while theirs is a consumer-grade product. Our business model is tailored for business aviation, providing the kind of personal customer support that a client who invests in an $80 million aircraft expects. In contrast, StarLink has a web-based, appointment-only chat service that doesn't provide direct access to aviation technicians. Additionally, our partner, OneWeb Network, is an enterprise-grade network with service level guarantees, unlike their consumer-grade network that targets a vast number of users with variable speed and no assurance of consistent pricing. Galileo will be available in two versions: a smaller HDX terminal and a larger FDX terminal. It’s important to note that our FDX terminal is still significantly smaller than the StarLink terminal. The Galileo HDX terminal, designed for mid-size and smaller aircraft, will deliver a consistent nearly 60 megabits per second, which is 12 to 60 times our current offerings. It primarily targets about 12,000 mid-size jets, small jets, and turboprops registered outside North America with no broadband solutions, as well as those aircraft in the mid-size and smaller range that often fly international routes or seek faster connectivity than the 25 megabits per second offered by our 5G product. The Galileo FDX terminal is a top-tier antenna aimed at roughly 9,700 super mid-size and bigger jets that fly global routes, delivering speeds of 145 to 195 megabits per second, which is 40 to 200 times faster than our existing product offerings. A significant advantage for us, which our AVANCE customers value, is that upgrading to Galileo is straightforward for any aircraft already equipped with AVANCE; it involves simply adding the HDX or SDX antenna and connecting data to the existing AVANCE box, which conservatively reduces installation costs by about $100,000. Another benefit is that AVANCE is both a line fit option for all OEMs and an STC option for all currently produced aircraft, making it relatively easy for OEMs and dealers to offer Galileo from an engineering and certification viewpoint. We have secured eight STC agreements for Galileo that cover 11 popular aircraft models, with an additional 21 agreements verbally confirmed, spanning another 17 unique aircraft models. Collectively, these represent a global service addressable market of 17,585 aircraft. Additionally, we have begun accepting orders from numerous dealers committed to developing STCs. We have successfully signed one OEM for line fit on four aircraft models, with cut-in dates set for three of those models for next year, amounting to over 100 deliveries annually. We are actively negotiating line fit deals with other OEMs and remain on track to start shipping HDX terminals by Q4 and FDX terminals in the first half of 2025. We have achieved several significant milestones since our previous conference call. We've announced our pricing for equipment and services, which is slightly higher than our competitor’s offerings, justified by our superior aviation-grade equipment, our reliable network, and enhanced customer support. Our go-to-market campaign is nearing completion, and we will launch our sales force this month, focusing on aggressively penetrating the market to capture the lifetime value of each Galileo customer and create long-term value for Gogo. In July, we began installations on our Challenger 300, with key certification milestones approaching, including engineering flight testing in August and Parts Manufacturing Authority in Q4. In summary, we are incredibly excited about Galileo as it promises to be a transformative force in the business aviation industry and a powerful catalyst for Gogo's growth. Now, shifting to Gogo 5G, this service is designed for segments of the 21,000 mid-sized and smaller business aircraft market that primarily operate in North America and seek a quality connectivity experience at a lower price than satellite options. Gogo 5G is expected to reach average speeds around 25 megabits per second, which is 5 to 25 times faster than our current products, with peak speeds of 75 to 80 megabits per second. On the aircraft, it comprises two belly-mounted MB13 antennas connected to an internal box containing a 5G AirCord. On the ground, it includes 150 Gogo-installed 5G base stations across the United States and Southern Canada. During our Q1 call, we mentioned a minor hardware redesign issue that would slightly delay our 5G launch. We are now providing an updated timeline for the launch during this call, with the chip set for patent and mass production, and we have revised our milestones to aim for shipping 5G in the second quarter of 2025. We are working closely with our vendor partners to streamline fabrication and launch processes. Encouragingly, the market continues to react positively to the 5G value proposition, with ongoing pre-provisioning efforts and a surge of STC programs positioning us for an effective launch. We have already shipped 292 pre-provisioning kits with MB13 5G antennas, up from 240 kits last quarter, of which 105 have been installed and are currently operating using our 4G network with an L5 4G LRU. We have commitments from five OEMs, one of which is already fitting the MB13 with the L5 line fit today. Since the L5 and LX5 share the same form factor, once the 5G chip receives certification, those customers who've installed L5s can easily replace the LX5 for access to the 5G network. On the certification front, we have completed 16 STCs for MB13s, one version of which covers 18 unique aircraft models, while 16 additional STCs are underway, covering 15 unique models, representing a total of 8,700 North American registered aircraft. We are confident that through our FPGA flights and a virtual simulator replicating our entire 5G network, we can test and validate 90% of our 5G network functionality before the arrival of the final 5G chip. Briefly touching on the SEC Secured Networks program, known as Gogo Evolution, Gogo has received a $334 million grant from the SEC to expedite the removal of Chinese telecom equipment from our 4G network. We are making significant headway in transitioning customers from our older CLASSIC product line to LTE variants of the hardware and our modern AVANCE L3 and L5 products. This program benefits both Gogo and our customers considerably; it will enhance the speed of our 4G network by 40% for those using the economical AVANCE L3 product, double the number of aircraft our ATG 4G network can manage simultaneously, and foster an increase in Gogo CLASSIC customer upgrades to AVANCE. This strategic shift will extend Gogo customer lifetimes due to the ease of upgrading to 5G, Galileo, and other emerging technologies. There are nearly 3,000 customers still utilizing our old CLASSIC product that need to transition from EVDO to LTE hardware by the end of 2025, with around 900 in fleet and over 2,000 among smaller customers. We’ve engaged with approximately 150 customers regarding their conversion plans, and most have expressed intent to switch to various AVANCE products. We currently have promotional offers to incentivize conversions, and our dealers are effectively adapting their operations to facilitate large-scale transitions. Additionally, we plan to introduce a special product named C1 later this year, which will house both an EVDO and an LTE air card in a form factor identical to our classic product. While this will not enhance service levels as much as transitioning to AVANCE would, it will provide customers delaying the switch with extra time to convert to AVANCE post-transition. As I stated earlier, Gogo is delivering exceptional service and solid performance while we continue to invest in and prepare for the launches of Gogo 5G and Galileo. I wish to commend the Gogo team for their outstanding efforts in getting us to this point. Our long-term outlook is reinforced by robust demand trends, and we are strategically, operationally, and technologically well-equipped to continuously meet and exceed the connectivity needs of passengers for the foreseeable future, offering the most comprehensive product portfolio in the business aviation market. Gogo’s strategy positions us to capitalize on a significant opportunity in our sector and create long-term value. Now, I’ll turn it over to Jessi for the numbers.

Jessi Betjemann, Executive VP and CFO

Service revenue and solid free cash flow in the second quarter. We believe our performance continues to demonstrate the strength of our core business, driven by recurring service revenue as we invest in our new products, Gogo 5G and Galileo. With the influx of OEM equipment orders and timing shift of expenses, which led to high adjustable EBITDA in the first quarter, our second quarter adjustable EBITDA declined sequentially, but was above expectations. We continue to believe that 2024 is the low point for our growth and profitability within our long-term plan that extends through 2028. As most of our current strategic investments conclude by early 2025, we aim for a significant acceleration in our free cash flow in 2025. I will start by reviewing Gogo's second quarter financial performance, then I will discuss our balance sheet and capital allocation priorities, and finally, I will provide additional context on our revised 2024 guidance and long-term targets, which now reflect the expected timing for the Gogo 5G launch. For the second quarter, Gogo's total revenue was $102.1 million, a decrease of about 1% year-over-year and 2% sequentially, driven largely by a decline in equipment revenue. Gogo achieved record service revenue of $81.9 million, up 4% from the previous year, and slightly higher than in the first quarter. Our ATG aircraft online totaled 7,031, a 0.5% decline year-over-year and down 1% sequentially, primarily due to increased CLASSIC deactivations and lower new activations. This decline is partially due to product lifecycle dynamics, as customers defer purchases in anticipation of the Gogo 5G and Galileo launches. Total AVANCE aircraft online increased to 4,215, a 17% rise year-over-year and 3% sequentially, now representing 60% of our total fleet. Our progress in AVANCE penetration is reflected in record upgrade activity in the second quarter from CLASSIC to AVANCE within our existing fleet. Converting our CLASSIC base to AVANCE remains a priority, and we expect these conversions to pick up in 2025. We maintain a conservative view on improvements in maintenance cycle times that have delayed installations. Every upgrade to AVANCE is a strategic win for Gogo, extending customer retention by providing a seamless upgrade path to Gogo 5G and Galileo once launched. However, the upgrade process and product lifecycle dynamics are expected to continue to pressure ATG aircraft online in the coming quarters. Total ATG ARPU rose 3% year-over-year to $3,468, and increased 0.3% sequentially, reflecting the price increase we implemented in the first quarter. The launches of Gogo 5G and Galileo are anticipated to further enhance our ARPU growth potential over time. For equipment revenue, Gogo delivered $20.1 million with 231 AVANCE shipments in the second quarter. Equipment revenue was in line with expectations, down 17% year-over-year and 11% sequentially, which we attribute to a combination of pull-forward OEM shipments in the first quarter and the current product lifecycle stage. Gogo's equipment revenue typically increases toward the latter half of the year; however, following strong first quarter shipments and the product lifecycle dynamics, we anticipate that trend will reverse in 2024. In terms of profitability, Gogo achieved service margins of 77% in the second quarter, exceeding our expectations due to reduced network and data center costs. We continue to expect service margins to be around 75% this year, with a slight decline in future years as Gogo Galileo service revenue grows as a larger portion of the mix. Service revenue and service profit margin are key drivers for free cash flow generation and long-term value creation. Equipment margins were 18% in the second quarter, meeting expectations but lower than both the previous year and quarter, primarily due to reduced revenue from fewer shipments. We foresee a decline in equipment margins in the latter half of 2024 due to lower shipments, largely as a result of product lifecycle dynamics. Now regarding operating expenses, combined engineering, design and development, sales and marketing, and general and administrative expenses in the second quarter rose 36% year-over-year and 28% sequentially to $41.2 million. The year-over-year increase was largely driven by legal expenses. External legal costs in the second quarter accounted for $9.5 million out of the total general and administrative spend of $22 million, driven by litigation matters, vendor financing support, and global expansion efforts. As discussed, 2024 is a significant investment year as we continue to invest in our Gogo 5G and Galileo programs. Our free cash flow target for 2025 assumes that many of these costs will decrease as we move into next year. We expect that these product investments will help accelerate revenue growth and lead to significant free cash flow growth in 2025 and beyond. For Gogo 5G, in the second quarter, our spending of $3.2 million consisted of $1 million in operating expenses and $2.2 million in capital expenditures. We now project approximately $5 million in operating expenses and $8 million in capital expenditures for 2024, with total Gogo 5G spending estimated at approximately $13 million. This is a revision from our earlier projections of $6 million in operating expenses and $14 million in capital expenditures. This adjustment reflects the rescheduling of Gogo 5G's timing to the second quarter of 2025 and a more efficient allocation of resources, as well as the timing of expected milestone payments to our vendor partner. We maintain our estimate of $100 million for total external development and deployment costs related to our 5G program and do not anticipate any negative impact on overall program costs due to the recent delay. In relation to our Gogo Galileo initiative, in the second quarter, Gogo recorded $2.2 million in operating expenses and $1 million in capital expenditures related to Gogo Galileo. We now forecast that 2024 will include approximately $15 million in Gogo Galileo operating expenses due to expense timing shifts to 2025, and about $4 million in capital expenditures. We still anticipate that external development costs for both the HDX and FDX solutions will total less than $50 million, including $13 million incurred in 2022 and 2023, with $19 million projected for 2024 and the remainder expected in 2025. Additionally, we expect about 90% of Gogo Galileo's external development costs to occur in operating expenses. Moving on to our bottom line, Gogo reported $30.4 million in adjusted EBITDA in the second quarter, which is a 31% decline year-over-year and a 30% decrease sequentially. This decrease was primarily due to reduced equipment revenue and increased operating expenses, as anticipated. Net income of $0.8 million in the second quarter fell 99% year-over-year and 97% sequentially, primarily resulting from an $11 million after-tax unrealized loss related to a market value adjustment of the convertible note investment in our key chipset supplier to support progress on our 5G chip, as mentioned in our first quarter earnings call. Future fluctuations in share price will continue to affect our net income as we adjust to the market value of this investment. Based on our significant net operating loss balances at the end of 2023, which include $446 million in federal net operating losses and $377 million in state net operating losses, we reported a net deferred income tax asset of $207 million at the end of the quarter. We do not expect to incur substantial cash taxes through our five-year planning horizon. I will now provide an update on our FCC Reimbursement Program. In the second quarter, we received $5.7 million in FCC grant funding, bringing our total funding received to $19.2 million. As of June 30, 2024, we recognized a receivable of $17.5 million from the FCC, and we incurred $8 million in reimbursable expenses during the quarter. This receivable is recorded under prepaid expenses and other current assets in our balance sheet, with corresponding reductions in property and equipment, inventory and contract assets, and an effect on the income statement. In line with our plan submitted to the FCC, we received our first six-month extension last quarter, moving the program completion deadline to January 21, 2025. In our application, we indicated the necessity of multiple extensions to complete the program and plan to request another extension in the fourth quarter. With partial funding of the program, we project to deplete reimbursement funds by late 2025 and will need to continue spending to support the program through 2026, which is expected to negatively affect free cash flow in 2025 and 2026. Regarding free cash flow, we generated $24.9 million in free cash flow during the second quarter, up from $13.3 million in the same period last year, driven by lower cash interest and improved working capital. Free cash flow decreased from $32.1 million last quarter, mainly due to lower EBITDA and the timing of the FCC reimbursement from our Rip and Replace program this quarter. Now I will discuss our balance sheet. Gogo finished the quarter with $161.6 million in cash and short-term investments, alongside $603 million in outstanding principal on our term loan, with our $100 million revolver remaining undrawn. Gogo's net leverage of 2.9 times remains in line with our target range of 2.5 to 3.5 times. Our cash interest paid for the second quarter, after netting hedge cash flow, was $7.8 million. As mentioned in previous quarters, we have a hedge agreement in place, currently hedging 58% of our loan, with a decrease in the hedge amount from $350 million at the end of July. Starting in the fourth quarter, hedge cash flow is expected to decline by approximately $3 million per quarter. Assuming no further debt repayment, we anticipate cash interest paid for 2024 to be about $34 million after hedging. Now let me summarize Gogo's capital allocation priorities. First, we focus on maintaining adequate liquidity. Second, we continue to invest in strategic opportunities to enhance our competitive position and financial value, including Gogo 5G and Galileo. Third, we aim to keep an appropriate leverage level considering the economic environment, targeting a net leverage ratio of 2.5 to 3.5 times. Lastly, we prioritize returning capital to shareholders. In the second quarter, we repurchased approximately 1.5 million shares for a total cost of $13 million, and over the last three quarters, we bought back more than 3.1 million shares at approximately $28 million. Gogo has around $22 million remaining of the $50 million repurchase authorization approved by our Board in September 2023. We believe we are positioned well to meet our product investment needs, assess further debt repayments, and opportunistically repurchase shares. Our capability to pay down additional debt and return capital to our shareholders is expected to grow as our free cash flow increases in 2025. Now I will turn to our financial outlook. We have revised our 2024 financial guidance and long-term targets due to two changes. First, the timing of the Gogo 5G launch, now expected in the second quarter of 2025. Second, we expect fewer aircraft online by the end of 2024 than originally estimated. It’s important to note that we have not yet finalized a complete bottoms-up long-term plan, as we typically do that annually in January. For our 2024 fiscal year, we now estimate revenue to be between $400 million and $410 million, down from our previous guidance of $410 million to $425 million. This reduction is mainly due to lower equipment revenue in the latter half of the year as a result of product lifecycle dynamics before the launches of Gogo 5G and Galileo. Additionally, we anticipate lower aircraft online than expected, impacting our service revenue growth. We now expect 2024 capital expenditures of about $35 million, reduced from our earlier guidance of $45 million. Our updated target includes approximately $20 million for strategic initiatives like Gogo 5G, Galileo, and LTE network build-out, down from $30 million for these initiatives mentioned last quarter. The decrease in strategic spending results primarily from the $6 million of 5G spending shifted to 2025, and shifts in LTE spending to 2025, along with some cost savings. For 2024 free cash flow, we anticipate a range of $35 million to $55 million, increasing from our previous guidance of $20 million to $40 million. This includes approximately $45 million in expected FCC spending, which accounts for non-reimbursable development costs, and around $40 million in FCC grant reimbursements received. The decrease in anticipated FCC reimbursement spend compared to prior expectations results from timing adjustments within the program. Our increase in free cash flow guidance reflects lower expected capital expenditures and reduced net FCC program spending. Moreover, we continue to target adjusted EBITDA at the higher end of the previously provided range of $110 million to $125 million. However, we now project operating expenses for strategic and operational initiatives, including Gogo 5G and Galileo, to decrease to around $26 million, down from $33 million previously. Despite reduced revenue, we maintain our adjusted EBITDA guidance, reflecting the timing shift in spending for strategic initiatives to 2025, offset by increased legal expenses incurred to date that are expected to continue throughout the year. For our long-term goals, we are now aiming for free cash flow of $150 million by 2025, excluding the impact from the FCC program, down from our previous target of $150 million to $200 million. This change in guidance connects to the impacts on both top and bottom lines due to the updated Gogo 5G launch timing in Q2 2025 and decreased aircraft online projections at the end of 2024. Over the long term, we reiterate our expectation for revenue to grow at a compound annual growth rate of around 15% to 17% from 2023 to 2028, with Gogo Galileo significantly contributing to revenue starting in 2025. We still anticipate annual adjusted EBITDA margins reaching 40% by 2028. In closing, despite this challenging period in our product lifecycle, Gogo’s outlook highlights the considerable value creation potential for our customers and shareholders, which we aim to unlock through executing our strategy and investing in critical initiatives to drive and sustain long-term growth. Before we open the floor for questions, I want to express my gratitude to the entire Gogo team for their hard work and commitment to our business, as well as their dedication to providing exceptional service to our customers.

Operator, Operator

Thank you. Our first question comes from Sebastiano Petti with JP Morgan. Your line is open.

Sebastiano Petti, Analyst

Hi. Thanks for taking the question. I was hoping you could help us maybe think about expected ARPUs or price points as it relates to Galileo? And then maybe kind of stepping back, 5G being a bit delayed here, but more broadly, any help on helping us think about the 5G pricing strategy that we should be thinking about as it pertains to next year and the long-term revenue guidance? Thank you.

Oakleigh Thorne, Chairman and CEO

Sorry, everybody. I was on mute. So, generally 5G ARPU would be about $2,000 on average, higher than our current ARPU. Then the HDX and FDX would be priced at higher price points. I don't know that we've shared the average ARPU yet, but you can actually see the pricing on our website now. So, they were reflecting greater coverage around the world and reflecting higher bandwidth. HDX and FDX are priced at premiums to 5G.

Sebastiano Petti, Analyst

Okay. And if I could maybe just – oh, sorry.

Oakleigh Thorne, Chairman and CEO

Jessi, I don't know if you want to go into any more detail in terms of the exact ARPU we're projecting for those.

Jessi Betjemann, Executive VP and CFO

Well, obviously, it depends upon a range, depending upon the plan that we would be providing, but we are expecting an increase in ARPU as Galileo starts to take off. As a reminder though, I mean in 2025 we won't necessarily see that much impact with regards to the service revenue. It will be more of the equipment revenue, and then you will see the service revenue really start to take off more in 2026.

Sebastiano Petti, Analyst

Got it. Thank you. And a quick follow-up. Just thinking about AVANCE, can you help us think about the new planes online, between maybe a migration perspective or net new customer standpoint? Just trying to think about the drivers there behind the nice increase we saw. Thank you.

Oakleigh Thorne, Chairman and CEO

Jessi, do you want to go into the activations?

Jessi Betjemann, Executive VP and CFO

Yeah. I mean, so this year we have been and in this quarter we noted, our units online was impacted by lower new activations than what we were expecting, and that is due to the product lifecycle dynamic that we talked about. We also had the higher deactivation. And I think that our expectation for the rest of the year is that will continue. But then come next year, we would expect, obviously with the launch of these two products, that our new activations would accelerate, as well as being able to kind of neutralize our net deactivation rate.

Sebastiano Petti, Analyst

Thank you.

Operator, Operator

Thank you. Our next question comes from Ric Prentiss with Raymond James. Your line is open.

Ric Prentiss, Analyst

Thanks. Good morning, everybody.

Oakleigh Thorne, Chairman and CEO

Hey Rick. How are you doing?

Ric Prentiss, Analyst

Hey, got a couple questions. Obviously, you've called out a couple times the customer behavior while they pause for the new stuff to come in. How many aircraft are you expecting, ATG aircraft, are you expecting as you look through the rest of this year into, let's say, second quarter next year?

Oakleigh Thorne, Chairman and CEO

Jessi can get into the more precise numbers. I think we expect that a little bit more degradation in the total units online count until we get our new products launched.

Jessi Betjemann, Executive VP and CFO

That's right.

Ric Prentiss, Analyst

So if you had 105 aircraft net on 2Q, that same kind of magnitude, 100 each quarter, or does it accelerate from there?

Jessi Betjemann, Executive VP and CFO

No. I mean, we're not anticipating it to reach, hopefully reach those levels, but there will be some deterioration, but not necessarily up to the 100.

Ric Prentiss, Analyst

Okay. So more coming off, but maybe not the pacing you saw in 2Q.

Jessi Betjemann, Executive VP and CFO

That's right. And as a reminder, in Q1, we had that unique situation in Q1 with the hourly deactivation.

Ric Prentiss, Analyst

Okay. You've called out a couple of times, I think, the vendor financing hitting some costs out. Give us a little color on that. What's happening there, and what kind of costs are being incurred?

Jessi Betjemann, Executive VP and CFO

Yeah. So in general, the legal expenses were very high in the quarter, so I wanted to highlight that, inflating our G&A expense. But with regards to the vendor financing issues, as noted, we had an investment in a convertible note in Q1 and Q2, and so the activity for that, the legal support of that, which is not normal business, that was one area. And then also in our 10-Q, you'll see a disclosure around the supporting a revolver commitment for Airspan. That is not necessarily effective until Airspan emerges from bankruptcy, but we have partnered with Fortress to support a revolver, and there's legal support for that as well. So we're really supporting our vendors in this and its unusual activities, so we wanted to call out that unique spend.

Oakleigh Thorne, Chairman and CEO

Got you, right. Okay. Yeah, I mean, in the case of Airspan, they went through a prepackaged bankruptcy, of course, so we ought – when that happens, you also have to spend money making sure that you defend your existing rights and your contracts, etc. So it was both, that we helped in terms of helping them with some financing to get through it all, but we also had to protect ourselves.

Ric Prentiss, Analyst

Okay. And the last one for me, following on Sebastiano’s question. Obviously, you've got the pricing on the website for the Galileo. Oak, you make a point about your network, your bandwidth, your customer service and customer support. What kind of anecdotal or outright detail do you have as far as how are customers valuing price versus coverage versus customer service?

Oakleigh Thorne, Chairman and CEO

You mean on a relative basis to each other?

Ric Prentiss, Analyst

Yeah.

Oakleigh Thorne, Chairman and CEO

I think that customers do value having a relationship with somebody that they can trust, who they've been doing business with for a long time, who has very responsive customer support, has been very consistent in terms of how they price and the customer feels that they can count on. I think that's probably the highest value of anything. And when you look at the products themselves, our network, and our network will perform about the same as StarLink's frankly, and I think ours will be more stable and reliable in terms of being pinned to a higher mean connectivity rate. So I think that'll be valued by customers. And then the equipment side, we manufacture equipment that can be put anywhere in the aircraft, inside the pressure vessel, outside the pressure vessel. It doesn't require any maintenance, etc., etc. You know StarLink's is consumer grade. It's what you would have in your home. That's what – it's not going to – it’s going to work for a while, but it's going to be a question about how long it's really going to be reliable and how long it can withstand the rigors of business aviation in terms of planes that go from 130 degrees inside the cabin before the passengers arrive to minus 60 at 40,000 feet. So there's reasons we build equipment aviation grade and they really haven't done that. So I think there's a million little things that are kind of wrong about how they are going at things, but right now people that have had it installed are using it and they are liking it a lot, because it's a much better experience than any of the current IFC products out there. In a way that kind of helps us. We don't have to be – I don't think we have to be crusaders for LEO. I think people in the market are already seeing that LEO is a real improvement. So, I think in the end that kind of helps us and I think then we'll win with all those little differentiators around service, aviation grade, our aviation focus that will sway a lot of the market towards our products.

Ric Prentiss, Analyst

Right. The last one for me is, the 5G launch now 2Q. Are we thinking early 2Q, mid 2Q’25, late 2Q’25 and what else might cause that to be at risk?

Oakleigh Thorne, Chairman and CEO

Well, I would say mid 2Q right now. A lot of the risk we will be able to retire or have been retiring, frankly, in two ways. One is our FPGA flights, where we've got all the chip software loaded on an FPGA that we're flying with. That's done a couple of things. First of all, it was one of the ways that we identified some of the issues that our chip provider has to provide. So, we've got to those early before they cause problems, after coming out of fabrication a year down the line or whatever. And second of all, that allowed us to validate our own software model of our network, which means that we can actually continue to test virtually now, and we are, and that will identify a lot of issues inside the network as well before we ever even get the chip. So those two things help a great deal. There's still some risk around the actual chip fabrication, which is slotted to begin early in September. And once it comes out, there will be some bringing up risk. So with the amount of scrutiny that's been paid to this chip at this point, I'd be shocked if there was a problem when it came out.

Ric Prentiss, Analyst

Great. Thanks everybody.

Oakleigh Thorne, Chairman and CEO

Thanks Rick.

Will Davis, VP, Investor Relations

Thank you, Rick.

Operator, Operator

Our next question comes from Scott Searle with Roth Capital Partners. Your line is open.

Scott Searle, Analyst

Hey, good morning. Thanks for taking the questions. Hey, good morning, Oak. Hey, a quick clarification for Jesse. Legal expenses were relatively high this quarter. I'm wondering what you are thinking about and factoring into your expectations in the second half of this year. And if you could remind us what they were in the first quarter. And then Oak, to follow-up on Rick's question around 5G, it seems like your comfort level of this launch in mid-second quarter is a lot higher than we had in prior conversations. I'm wondering if you could walk us through the steps and the milestones here. It sounds like now you are expecting chip delivery in September. Is there a new spin on that chip? I was wondering if you could just kind of lay out some of the milestones that we should expect over the next couple of quarters.

Jessi Betjemann, Executive VP and CFO

Yes, I can take the first one. The legal expenses, it was $9.5 million, and that was across litigation expenses, as well as the vendor financing we spoke about and also global expansion, just kind of our normal efforts that we're doing for global expansion. We do expect that to decrease. There was a bit of a high point in Q2, so we'll not be at that level of magnitude going forward in Q3 and Q4.

Oakleigh Thorne, Chairman and CEO

Okay, and then Scott, for milestones, I didn't say the chip would be delivered in September. It said it starts fabrication in September, so that's one milestone. Then coming out of fabrication is another. Bring up is a third, when they complete bring up, and then ship chips to us, and so arrival of chips with us would be another milestone. Obviously, we will install it and start flight testing with it right away. And then it really gets to PMA and STC, which are regulatory. PMA is regulatory and the STC is in terms of approvals for your aircraft getting done. I think those are the main milestones going forward.

Scott Searle, Analyst

Great. And lastly if I could, in terms of the competitive landscape, I was wondering if you could just give us an update on that front. We don't hear a lot about SmartSky. I'm wondering where they fit into the equation. And then specifically on StarLink, while they will be a competitor going forward, given their presence, given their network, there's been a lot of talk recently about the mini kind of factoring in somehow into the equation. I'm wondering if you could address specifically that issue in terms of FAA regulatory issues around something like that, in terms of that creeping into the market and/or impacting pricing. Thanks.

Oakleigh Thorne, Chairman and CEO

Well, SmartSky is really not a factor in the market at this point. They haven't – I'll just put it this way, I don't think they have any revenue generating customers. In terms of the litigation with us, we think that case in many ways is basically over at this point. As you might recall, Scott, there were two sets of patents, one set that expired in the 2030’s and one set of patents that expires in August of this year. In Discovery, and one of the reasons our legal expenses are so high is that Discovery ended up being quite extensive. We had four times as many documents to review as we had anticipated in initially budgeting for Discovery. However, in that Discovery, it was discovered that SmartSky knew about prior art to the patents that are expiring in 2030 and that they did not reveal that prior art to the patent trademark office. That has raised a very significant equitable conduct issue for them and will most likely lead to those patents being determined to be invalid. You might recall that we have often said that we thought they didn't have any valid patents that we infringed on and this is the reason why. So that, I think, eliminates frankly the risk of those long-term patents being an issue. Then the short-term ones, we have always did not infringe on patents. We think we will win on that. However, even if by some miracle we were to lose, 5G is not coming out until May now and those patents expire in August. So there’s not going to be a whole lot of damages in terms of the impacts on us. So, that's SmartSky. The mini, look, there’s all kinds of little toys people use in business aviation – I mean, sorry, general aviation, to get connectivity. There are people that fly low with their cell phones on, but that's not typically what people do in business aviation. You'll see a lot of guys goofing around, who I would consider general aviation flyers, not business aviation flyers, trying to put the mini in the windshield and the like. That is not going to be a solution that's going to satisfy business aviation flyers for a couple of reasons. For instance, really you've got to kind of get the speed through the fuselage of the aircraft, okay. In other words, the radio waves aren't going to penetrate the fuselage of the aircraft and hit the mini sitting inside the aircraft. You have to put it in the windshield essentially, on the dashboard if you will. These satellites are coming from flying at a very high speed and you've got to pick up one after another at a very high rate. That will work okay if you are flying your plane in the direction the satellites are coming from. But if you are not flying in that direction, your mini is not looking the right way, you are not going to have reception. It's going to lead to very unreliable connectivity and that's fine for some people, but it's not fine for the bulk of the business aviation market. There are also safety concerns and having an antenna fly around if there's a sharp banking or something like that, that doesn't make the FAA happy. The FAA would kind of have to catch you on the runway doing it and they probably wouldn't like that very much, but it's pretty unlikely, frankly, that that would happen. Frankly, the last thing is that StarLink doesn't want to sell you that at that price, and so when they detect that you are flying, they turn you off. So, that's the business model question maybe StarLink will do something about. All in, it's not going to be a very satisfactory performance. It could have safety implications, and right now you are not supposed to be able to do it from the vendor.

Simon Flannery, Analyst

Great. Very helpful. Thanks Oak.

Operator, Operator

Thank you. Our last question comes from Louie DiPalma with William Blair. Your line is open.

Louie DiPalma, Analyst

Jesse, Oak and Will, good morning.

Oakleigh Thorne, Chairman and CEO

Good morning. How are you doing?

Louie DiPalma, Analyst

Doing okay. The launch of HDX is a pivotal milestone for Gogo in this dynamic market. You mentioned your expectation to receive the Galileo HDX PMA in the fourth quarter. When do you expect to receive the STCs, and for the first customers to begin generating Galileo service revenue?

Oakleigh Thorne, Chairman and CEO

They'll start coming in first quarter, Louie.

Louie DiPalma, Analyst

Great. And those STCs and the PMA, that's a regulatory hurdle. Your Twitter account recently blogged how you had, I think, successful motion table testing with the HDX antenna. What are the major technical hurdles that remain, that could potentially delay receiving the PMA or just the general functionality of the antenna?

Oakleigh Thorne, Chairman and CEO

There's not a lot of technical risk with this technology, because this is not – like 5G, there's a whole new 5G chip being developed, which is where the risk has been and it's caused all of our issues. Right now, Hughes is already using different form factors of this antenna in aero, and so it's not unproven technology. The next step is, we finish installing our Challenger 300, which is happening right as we speak. It started in July. It should be done very shortly. Then we'll go into flight testing. The PMA process starts when you start developing a system. You've been in constant dialogue with the FAA for, in our case, a year plus in this. What they are trying to do in that is, is validate the authenticity of all the pieces and parts that go in there, to make sure that they are all aviation grade, as you originally stated they would be. That is something that I don't think has a lot of risk around it at this point. We're in touch with the FAA and proving to them that it's got the parts that we said it was going to have in there. So I don't think that that's going to be a huge risk. Then on the FTC side, once we start flying on the Challenger, I think we'd be able to show you can put it on a plane, you can fly it, and it works. So I don't think there's a ton of risk there, to be honest.

Louie DiPalma, Analyst

Great. And how far behind should the launch of the FDX be relative to the HDX, in terms of the launch?

Oakleigh Thorne, Chairman and CEO

Well, the FDX is, as we said, first half next year. I'll leave it at that on this call, and we'll give more details probably on the next call.

Louie DiPalma, Analyst

Great. And one final one for Jessie. If rip and replace funding is increased to cover your full $334 million, what would be the significance to your free cash flow generation in 2025 and 2026, potentially?

Jessi Betjemann, Executive VP and CFO

Right now, we've indicated that, one, we've mentioned that our current plans would not be to deliver all the way up to the $334 million. That was based off of our original application, so the total value has decreased a bit. But it would cover the negative hit that we're expecting in 2025 and 2026, but not all of it, because mainly there's probably going to be around $10 million or so that we would still need to spend in ‘25 that's not reimbursable. So that piece we would still need to cover. But then in 2026, it would fully cover everything that we would need to do there for the most part.

Louie DiPalma, Analyst

Great. And one final one, should service revenue stay flattish, even as aircrafts online trend lower over the next year? Like, you've recently had ARPU slightly pick up. Should that offset the decrease in aircraft online, or how should we think about that?

Jessi Betjemann, Executive VP and CFO

Yeah. So I think that that's the expectation through next year because again, we won't necessarily see an uplift from the new products coming in yet on service revenue. So they'll be either flattish to very modest growth next year.

Louie DiPalma, Analyst

Thanks everyone. We'll be looking forward to updates for the HDX on the Challenger as you do the flight testing over the next month.

Oakleigh Thorne, Chairman and CEO

All right. You bet. You bet. Thanks Louie.

Will Davis, VP, Investor Relations

Thank you.

Operator, Operator

Thank you. There are no further questions. I'd like to turn the call back over to Will Davis for a closing remark.

Will Davis, VP, Investor Relations

Thank you, everyone, for joining our second quarter earnings conference call. We look forward to talking with you soon. Thank you. You may disconnect.

Operator, Operator

Thank you for your participation. This does conclude the program. You may now disconnect. Everyone, have a great day.