Earnings Call Transcript - GOGO Q1 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the Gogo Inc.'s First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Mr. William Davis, Vice President of Investor Relations. Sir, please go ahead.

William Davis, Vice President of Investor Relations

Thank you, and good morning, everyone. Welcome to Gogo's first quarter 2022 earnings conference call. Joining me today to talk about our results are Oakleigh Thorne, Chairman 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 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. Those risk factors are described in our earnings release filed this morning and are more fully detailed under the 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 May 5, 2022. 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 more information or future events. During the call, we'll present both GAAP and non-GAAP financial measures. We've included a reconciliation and explanation of adjustments and other considerations of our non-GAAP measures to the most comparable GAAP measures in our first quarter earnings release. This call is being broadcast on the Internet and is available on the Investor Relations website. 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 Oakleigh.

Oakleigh Thorne, Chairman and CEO

Thanks, Will, and thank you all for joining us this morning. The first quarter results we announced today reflect our continued strong momentum, as we execute on our strategy and capitalize on the unprecedented demand for broadband connectivity solutions and business aviation. I'll focus my remarks today on three areas: the BA industry demand for connectivity, Gogo's strong first quarter results, and our progress in two of Gogo's key strategic initiatives. Barry will then walk through the details of our quarterly performance and update our 2022 outlook. In the first quarter, Gogo delivered record top-line revenue of nearly $93 million, up 26% year-over-year, fueled by strong service and equipment revenue. Our results demonstrate that demand for BA travel and connectivity continues to accelerate. The three variables driving that demand are: first, the growth over the last decade of the number of high-net-worth individuals who can afford to fly privately. Second, the COVID pandemic, which led many in that cohort to try private aviation. And third, the acceleration of the digital transformation brought on partly by COVID, as demonstrated by growing usage of video-intensive social and work-related applications like TikTok and Zoom. These are all trends we believe will continue. In a recent survey, 91% of business jet passengers today plan to fly privately the same or more in 2022 compared to 2021, with 51% stating they will actually fly more flights in 2022 than in 2021. We also believe the propensity of these flyers to demand high-speed connectivity will continue to grow, driven partly by a shift in passenger demographics towards younger age groups. Traditionally, business aircraft passengers skewed towards older demographics, but in our recent Gogo brand survey, 67% of all respondents identified as members of Generations X, Y, and Z. We've seen the impact of these trends play out in usage as data consumed by business aircraft on our network in Q1 grew 50% year-over-year and more than doubled compared to pre-COVID Q1 2019. We've also witnessed these trends reflected in rate plans, with more than twice as many customers upgrading their plans as opposed to those who downgraded in the quarter, leading to an 8% year-over-year increase in Gogo's first quarter average revenue per user (ARPU). Additionally, we've seen these trends reflected in flight counts, with flights across our fleet up 33% from Q1 2021 and 29% from pre-COVID Q1 2019. Corporate aircraft flights surged, up 23% from Q1 2019 and 47% from Q1 2021, signaling a strong comeback in demand from that important segment. This demand for travel has substantial implications for the business aviation industry. Some fractional operators have suspended sales to meet service commitments to owners. The percentage of aircraft for sale is at an all-time low at 2% of the U.S. fleet. Many operators have turned to purchasing jets overseas to bolster supply. Fortunately for us, those jets almost always require the installation of an in-flight connectivity system. Order books at OEMs continue to grow; Textron, a significant partner for Gogo, announced a $5.1 billion backlog, up 53% from Q1 2021. This activity drives broader Gogo adoption. We ended Q1 with 6,526 ATG units online, an increase of 11% over Q1 2021, and we shipped 246 new advanced units during the quarter—an all-time high for a Q1, exceeding previous records by 64%. We entered this year projecting 25% growth in advanced unit sales, and during our last call, we indicated the potential to exceed that number if we could access sufficient supply. The good news is our supply chain team has managed to secure more supply, and we are now raising our committed deliveries for the year to approximately 1,300 units, nearly 50% higher than the previous year, with 95% of that demand already accounted for. Almost all units we ship are tied to specific customer orders from dealers or OEMs, resulting in a very high percentage being installed and activated even during economic downturns. Thus, this increase in unit shipments is a very positive indicator of future growth in high-margin service revenue. Despite the dire circumstances currently surrounding supply in the telecom industry, our supply chain team has displayed remarkable creativity and expertise. They've effectively leveraged our common component strategy, and our robust balance sheet enables us to collaborate with our suppliers to source the thousands of components required to meet this surge in demand. Thanks to their efforts, we've managed to boost our committed deliveries and build buffer stock to meet drop-in orders, ensuring we never lose opportunities for installations. As a result, we can now increase our revenue guidance from a range of $380 million to $390 million, to a new range of $390 million to $400 million. Notably, we continue to witness signs of even greater demand later in the year, and we are working to ensure sufficient supply. This uptick in equipment sales is a positive sign for our growth strategy. Equipment sales generate future high-margin service revenue, which serves as the primary engine of our ongoing value creation. The gross margins from this service revenue provide capital for investments in leveraging the advanced platform to enter adjacent markets and deliver improved bandwidth solutions, which in turn drives more equipment sales and high-margin service plans. Despite being an investment year, we reported nice growth in Q1, delivering adjusted EBITDA of $42.8 million, a 26% increase over Q1 2021, driven by rising service revenue and gross profit. Q1 came in better than expected thanks to some timing-related issues, which Barry will elaborate on later, along with higher average equipment selling prices and increased scale benefits in manufacturing as we ramp production. Though we are not raising our adjusted EBITDA guidance range of $150 million to $160 million, we now expect to reach the high end of that range, which includes estimated legal fees of $5 million in Q3 related to our patent litigation with SmartSky networks. Now turning to our strategic initiatives aimed at deepening our competitive moat and driving long-term shareholder value. Firstly, enhancing our ATG network to meet customers' ground connectivity expectations, and secondly, driving adoption of our flexible future-proof AVANCE platform among the approximately 70% of U.S. business aircraft that do not yet have connectivity and ultimately among the 14,000 business aircraft outside the United States. The first step toward successfully executing this objective is the commercial launch of our Gogo 5G network in the second half of this year. We remain on track, on time, and on budget. We have passed all development risks and are now focused on tracking 5G chipset production and building towers. Our Gogo 5G chipset supplier previously delayed delivery, but they are now nearing completion and expect to deliver on schedule for our launch. On the tower side, we are managing through supply chain challenges in Southeast Asia but remain on track. As of this morning, we have completed 35 of the 150 tower sites planned, and we are accelerating our pace. You can monitor our progress on a map at our website. Later this summer, once we have the chipset and most of our towers deployed, we will begin end-to-end testing and fine-tuning of the network. From a regulatory perspective, we are on track as well. We recently announced the receipt of our parts manufacturing authorization from the FAA for our 5G NB3-antenna, which enables us to sell that equipment on customers' aircraft. We're also continuing to take orders for 5G and making progress towards getting line-fit with major OEMs. We're encouraged by the responses from existing customers and dealers. Gogo 5G will be a significant advancement for BA in-flight connectivity as it will achieve average speeds of approximately 25 megabits per second with peaks up to 75 to 80 megabits per second, surpassing any other IFC product available for Business Aviation today, and at a lower cost than competing GEO satellite solutions. Gogo 5G will enable multiple streaming and video conference applications to operate simultaneously on the same aircraft, providing a connectivity experience comparable to home or office in-flight. This brings me to our second strategic objective, driving advanced penetration. Our advanced platform presents opportunities to enhance equipment stickiness, introduce adjacent products, and expand into adjacent markets. Consequently, growing the advanced installed base is central to our strategy. To date, we have been successful, reaching an exciting milestone this quarter. Gogo's advanced system has seen over 1 million business aviation flights since its launch in August 2017. It's the most successful broadband product launch in business aviation history, with over 2,700 aircraft online as of the end of Q1, outperforming our two largest competitors combined. Today, I want to highlight one important feature of Advance: its multi-bearer capability allows Gogo to partner with a global LEO provider under a managed services model to create a global broadband offering. Gogo Global Broadband will enable us to pursue the 14,000 business aircraft outside North America, target large North American jets that fly global missions, and drive stickiness in our core North American medium-sized and smaller aircraft segments by providing a unique dual ATG-LEO solution. This solution will aggregate our ATG capacity with the LEO network satellite capacity in the North American market, making it very competitive with offerings relying solely on LEO capacity. For existing customers, upgrading to add LEO will be straightforward—just install an electronically steerable antenna and run two wires inside, one for data and one for power. They will then access all the functionality that Advanced offers, along with LEO. To capitalize on this excellent opportunity, Gogo will design and fund the necessary airport and hardware to access the LEO network and partner with a LEO operator for network access. We expect the external development costs to be less than half the investment required for our Gogo 5G network, and this investment is anticipated to be spread over three years. We also believe our Global Broadband Initiative will significantly boost our revenue and free cash flow after it launches, generating a very high return on capital relative to our other investment priorities. We are actively engaged in discussions with LEO and antenna partners, and once we are ready to proceed, we'll share more details about this important project. In conclusion, these two key strategic initiatives, ATG network enhancements and advanced penetration, will significantly improve our network performance for customers. They will open up opportunities for adjacent products, create new market opportunities, and enhance Gogo's competitive advantage and shareholder value in the future. Before turning it over to Barry, I want to thank the entire Gogo team for their exceptional work and dedication to the company and our continued success. I also want to express my deep sympathy for those affected by the war in Ukraine, particularly acknowledging and supporting the ten Ukrainian software engineers working at Gogo. One is serving in the army, while the others have continued working almost every day since the conflict began, despite the surrounding turmoil. Their resilience and sacrifice inspire us, and we will continue to support them and their families throughout this crisis. Now, I will turn it over to Barry. Thank you.

Barry Rowan, Executive Vice President and CFO

Thanks, Oak, and good morning, everyone. In my remarks today, I'll start by detailing Gogo's first quarter financial performance. Then I'll update our balance sheet and capital allocation strategy, concluding with additional context around our updated 2022 guidance. This quarter, we delivered record performance on multiple fronts: record service revenue, record total revenue, record equipment backlog, and record adjusted EBITDA. These records result from solid execution by the Gogo team in a vibrant market, where higher-than-expected equipment shipments led to high-margin service revenue growth and increased profitability. Total revenue of $92.8 million in the first quarter grew 26% year-over-year. This was the highest first-quarter revenue in the company's history, with robust trends in both service and equipment. We achieved record service revenue of $70.7 million, driven by an 11% year-over-year increase in ATG units online and a 2% sequential increase. Our ongoing growth in ATG units online reflects strong potential in a market that is only about 30% penetrated with Wi-Fi connectivity. Notably, we've continued to add new customers, with 61% of ATG activations in the quarter coming from new clients. Penetration of our advanced products across our installed base and among new customers is central to our strategy. These equipment installations drive rising service revenue and offer significant customer advantages through the extensible AVANCE platform Oak has highlighted. In the first quarter, AVANCE units online grew 42% year-over-year to 2,699, an 8% sequential increase. Our year-over-year AVANCE unit growth has averaged about 45% over the past six quarters, and we continue to expect AVANCE to constitute roughly 50% of our total ATG units online by the end of 2022. As we grow our ATG units online, our ATG ARPU rose by 8% year-over-year to $3,321, highlighting increased service utilization. Moreover, strong growth in passenger data demand is driving upgrades to Gogo's high-rate data plans, further supporting ARPU growth. The impending launch of Gogo 5G will enhance our ARPU growth opportunities. Regarding equipment revenue, Gogo delivered $22.1 million in equipment revenue, a remarkable 52% increase year-over-year, fueled by high demand for our AVANCE L3 and L5 products. We shipped 246 AVANCE units in the first quarter, exceeding our internal budget, setting a record for any first quarter in Gogo's history. Equipment shipments typically peak in the fourth quarter due to promotional activities and seasonal dynamics. Thanks to the outstanding work by our supply chain team, combined with our ability to leverage our strong balance sheet to acquire inventory in a buoyant market for our products, we now anticipate total ATG equipment shipments in 2022 to reach 1,300 units, up nearly 50% versus 2021, which is an increase from the initially budgeted growth of 25%. 95% of these 1,300 chipsets are already secured and committed to customers, underpinning our confidence in the raised 2022 revenue guidance shared today. Turning to profitability, we delivered robust service margins of 79% in Q1, slightly above our budget due to high operating leverage from our recurring revenue model. Equipment margins were 35% in Q1, a 1.7 percentage point decrease sequentially. We expect equipment margins to average around 30% for the remainder of the year, which corresponds with our strategic objective of increasing AVANCE penetration. However, this is higher than previously anticipated, since average selling prices have not declined as much as expected, and increased production scale has positively impacted our equipment revenue. Our updated expectations for equipment revenue and margins are key drivers of our revised 2022 guidance. Our growing record backlog also mitigates risk to long-term targets, as increased units installed lead to growth in high-margin recurring service revenue, enhancing cash flow. Proceeding to operating expenses, first-quarter combined expenses for engineering, design, development, sales, marketing, and general administration decreased 10% sequentially to $25.1 million. This reduction was primarily due to timing of expenses, including those associated with 5G, which I will elaborate on shortly, as well as lower G&A and sales and marketing costs. These factors were partially offset by increased stock-based compensation. In March, we filed an 8-K to disclose updated executive employee agreements, details of which will be filed with our 10-Q today. These will lead to increased non-cash stock-based compensation expenses throughout 2022 relative to 2021. As previously stated, 2022 is an investment year, particularly as we enhance spending on Gogo 5G. While our investment levels may fluctuate quarterly, spending on this strategically essential project will result in increased operating expenses throughout the year. We continue to expect our business model to reflect meaningful operating leverage over time, evidenced by our long-term target of an adjusted EBITDA margin approaching 50% by 2026. Now I'll provide additional details concerning our Gogo 5G program and spending profile. We remain on track to deploy our 5G ATG network in the second half of 2022, on time and within budget. Our $5.1 million of 5G spending in Q1 was lower than expected due to timing and consisted of $0.3 million in operating expenses and $4.8 million in capital expenditures. It’s essential to clarify that while expense tracking may vary from quarter to quarter, our deployment schedule and overall costs for Gogo 5G remain unchanged. For 2022, we've budgeted an increase of around $13 million versus 2021, encompassing external development and deployment costs, and additional 5G-related investments in marketing, production, and network expenses. This spending will dampen Gogo's adjusted EBITDA growth rate for 2022 compared to what it might have been without this investment. With respect to the capital expenditures side, we anticipate completing over 90% of our total 5G investment by the end of this year. After Gogo 5G launches, we forecast highly favorable adjusted EBITDA to free cash flow conversion rates in 2023 and beyond, anticipating a significant increase in free cash flow beginning in 2023. Now let’s turn to the bottom line. Gogo's adjusted EBITDA increased by 26% year-over-year to $42.8 million, with the primary driver being a 19% increase in service revenue. We reported net income of $22.2 million in Q1, translating to $0.20 in basic earnings per share and $0.18 in diluted earnings per share. We expect to incur non-cash income tax expenses in upcoming quarters, similar to this one, as we keep generating positive pre-tax income. We anticipate additional reversals of portions of our valuation allowance over the next 12 to 18 months. Importantly, given our considerable net operating loss position, we do not expect to pay meaningful cash taxes for an extended period, though we may incur a modest amount by the end of our planning horizon. We expect net income in future quarters to reflect an increase in stock-based compensation expenses due to the executive employment agreements I previously mentioned. Our employee equity program is notably important as it significantly contributes to our higher-than-average retention rates compared to peers, especially as we experience a surge in customer demand in this constrained labor market. Now discussing free cash flow, we generated $8.8 million in free cash flow during the quarter. This quarter’s free cash flow declined from last year’s figures, due to the timing of interest payments stemming from our refinancing last year, as well as higher CapEx and net working capital used, driven by changes in accounts receivable and increased inventory purchases. On a sequential basis, free cash flow decreased from $25.7 million in Q4 2021, primarily because of $8.9 million in employee bonus payments made in Q1 and shifts in accounts receivable. Despite 2022 being an investment year, we are raising our free cash flow guidance for 2022. Now, I’ll briefly discuss Gogo's balance sheet. Gogo is in a robust liquidity position, ending the quarter with $152.8 million in cash, while our $100 million revolver remains undrawn. As of the end of Q1, we had approximately $822.4 million in outstanding debt, including a $719.6 million Term Loan B and around $102.8 million in convertible notes, maturing on the 15th of this month unless converted earlier. As discussed, we will settle any conversions prior to maturity in stock. Let me quickly remind you of the timing and impact of this process. Given our current stock price relative to the $6 conversion price, we expect all holders of the remaining convertible notes to choose to convert. Holders must notify Gogo by May 12 to convert their notes. This process is expected to add approximately 17 million shares, increasing the total to about 134 million shares outstanding. This equitization will lower Gogo's net leverage ratio below four times based on adjusted EBITDA for the 12 months ending March 31, 2022, aligning with our target capital structure, which I will discuss shortly. The maturity of our convertible notes will further simplify our capital structure. Following this step in our comprehensive refinancing plan, our interest expense will decline from $111 million in April 2021 to approximately $33 million going forward, excluding the impact of changes in LIBOR rates, inflows from our hedging contract, and potential voluntary debt payments. Gogo's operational and financial advancements have strengthened our balance sheet, offering substantial strategic and financial flexibility, as demonstrated by our proactive supply chain management efforts and our continuing quest for bottom-line growth. We've shared our balanced capital allocation strategy focusing on four primary actions, prioritized as follows: first, launching Gogo 5G in the second half of this year, on time and on budget; second, reducing financial leverage; third, making strategic, value-enhancing investments in our business, including the LEO-based global broadband opportunity currently under evaluation; and fourth, returning capital to shareholders. We are making excellent strides on the first three priorities, with 5G on track and our balance sheet gearing up below four times this quarter. As I discussed in detail, we are actively assessing returns of capital to shareholders at the appropriate time and context. Now turning to our increased 2022 full-year financial guidance announced this morning, we now anticipate shipping roughly 1,300 ATG equipment units in 2022, an increase of nearly 50% from 2021 and a substantial improvement from our previous 2021 guidance of about 1,100 units. Gogo now expects to deliver full-year 2022 revenue in the range of $390 million to $400 million, compared to our earlier guidance of $380 million to $395 million. Furthermore, we expect to achieve full-year adjusted EBITDA nearing the high end of the previously announced range of $150 million to $160 million, factoring in the planned increase in 5G investments alongside an estimated $5 million in legal expenses related to the SmartSky patent litigation. We have also raised the lower end of our previously guided free cash flow range by $10 million and now expect it to be between $35 million and $45 million. Our free cash flow expectations incorporate approximately $65 million in capital expenditures, with around $50 million of that spend dedicated to Gogo 5G. Our five-year targets remain unchanged. As noted earlier, the 2022 guidance and long-term targets stem from our baseline 2022 forecast and long-term plan, which include planned Gogo 5G investments but exclude potential strategic investments under consideration such as the global broadband initiative. Our outlook suggests that momentum is building, positioning us for a brighter future fueled by strong tailwinds in the business aviation industry, our leading market position, our quality product and service platform, and the strength of our balance sheet. Before we transition to Q&A, I want to echo Oak's gratitude and commend the entire Gogo team for their relentless dedication and hard work. Your commitment to delivering industry-leading service and innovative solutions for our customers inspires us and adds value for our shareholders. Thank you. Operator, this concludes our prepared remarks, and we're now ready for our first question.

Operator, Operator

Thank you, sir. We have our first question from Lance Vitanza with Cowen. Your line is now open.

Lance Vitanza, Analyst

Hi. Thanks, guys. Thanks for taking my questions, and congratulations on the great quarter. To begin, I guess on the air-to-ground unit shipments, 1,300 for the full year, if I'm looking at the press, it seems to suggest pretty substantial acceleration from the pace. I'm just wondering, can you talk a little bit about what gives you the confidence that you can reach that 1,300 number? How much of that is contractually in backlog, and how much is just your gut feeling about where the business is headed? And then I have one follow-up question, if I could. Thanks.

Oakleigh Thorne, Chairman and CEO

Yeah, Lance, the real limiting factor on our unit shipments this year is supply, not demand. The demand is tremendous. So, my confidence comes from successfully securing all the components needed to reach the 1,300 number, and that is well positioned. On the demand side, 95% of that number already has a name attached to it concerning where it's headed and what it's being installed in. We are nearly sold out of the increased 200 units in that context. Furthermore, we're gaining signals indicating that there could be even greater demand later this year than the previously stated 1,300 number. Thus, we are currently trying hard to secure more supply.

Lance Vitanza, Analyst

Okay, thanks. And then my follow-up is on the LEO global broadband strategy. It seems there has been an increasing conversation regarding this on earnings calls. Is this something that is moving faster than previously expected? If so, what should we anticipate in terms of the timing related to finding partners and ultimately launching a global broadband product? Is the timeline still expected towards the end of this decade, or could it be sooner?

Oakleigh Thorne, Chairman and CEO

Yes. We are engaged in active conversations with potential partners, and we will share more details once we have those partnerships finalized. In terms of timing, it will likely take around two years to develop the equipment that we will deploy on the aircraft, which represents one critical path. Additionally, the completion of LEO Networks, which can service us, is another major part of the critical path, also projected to take about two years. Use that timeline as your reference for when we could potentially launch a product. We view this as a crucial opportunity, particularly as a competitive response to other LEO providers attempting to enter our market. Our aim is to lead the way rather than lag behind. It's important to note that these constellations are still being launched, which is another governing factor. So, I would say mid-decade onward, we anticipate a positive impact on our growth—both on the revenue and the bottom line. Most of the financial benefits will probably start coming in around 2025 or 2026.

Lance Vitanza, Analyst

Thanks again for taking the question. I'll yield the floor.

Operator, Operator

Thank you. Our next question is from Landon Park with Morgan Stanley. Please go ahead.

Landon Park, Analyst

Great. Thank you. Good morning, everyone. Just a follow-up on the backlog question: can you provide more details in terms of the L3 versus L5 equipment and what types of aircraft you're seeing demand from, in terms of size? Additionally, could you touch on the SEC funding that you applied for earlier this year and how you are viewing the potential for receiving significant funds?

Oakleigh Thorne, Chairman and CEO

Yes, certainly. Regarding the mix of L3 and L5, I don't have that information readily available, but L3 has been gaining a larger share of our advanced sales this year. I'll let Barry address the specifics regarding the breakdown in a moment. As for aircraft size, we’re experiencing growth across all segments. Notably, we have considerable success penetrating the general aviation market with Cerus and are seeing significant activity in that area. We've observed growth across light, medium, and large jets, with no significant skew in demand. Regarding the FTC funding, the government subsidies aim at encouraging actions that may not be economically viable otherwise. If the subsidy we receive is substantial enough, we may quicken the pace of phasing out ZTE equipment over an extended timeframe. We will know more about the results of that funding initiative when the decisions are announced in June. There is considerable competition for these funds, so it's hard to predict exactly where we’ll land.

Barry Rowan, Executive Vice President and CFO

To provide further detail on the backlog, we expect a split between L5 and L3 to be about 50-50 for all of 2022, potentially skewed slightly toward L5. So think of it in terms of roughly a 50-50 division.

Landon Park, Analyst

Should we still expect overall equipment margin to compress year-over-year, or are you guys taking a different stance?

Barry Rowan, Executive Vice President and CFO

As I mentioned, we do expect equipment margins to be in the 30% range for the rest of the year. That projection is higher than we previously expected due to the fact that average selling prices aren't decreasing as much, and we aren’t required to discount our products as much as initially anticipated. This aligns with our strategy to drive advanced penetration.

Operator, Operator

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

Ric Prentiss, Analyst

Hello, everyone. I have a couple of follow-up questions. First, I appreciate the color on the earlier program timing. Oak, you mentioned that external development might be about half of your total 5G investment. Please remind us of the total projected Gogo 5G investment so that we can estimate what half of this might be. Also, when you mention external development, how do you envision splitting these costs between operational expenses and capital expenditures?

Oakleigh Thorne, Chairman and CEO

Yes. We've consistently indicated that the 5G external costs will be about $100 million. Barry can correct me if I’ve misstated that, but I'm confident that is a fair estimate. External costs include equipment, R&D, and similar expenses. The remaining costs are internal resources already baked into our OpEx and CapEx projections detailed in our guidance.

Barry Rowan, Executive Vice President and CFO

For further understanding regarding the split, 5G costs will be primarily in CapEx—approximately two-thirds of that $100 million will be capital expenditures. On the other hand, for the global broadband product, which represents less than half that total $100 million, most expenses will be in OpEx, as it leans much more towards development.

Ric Prentiss, Analyst

When you contemplate potential partners on the LEO side and the antenna side, what key factors do you consider important when selecting partners? With so many LEO constellations out there, how do you differentiate between them?

Oakleigh Thorne, Chairman and CEO

Firstly, the probability of the LEO's launch readiness is crucial to us, so that stands as the foremost consideration on our minds. All remaining factors revolve around finding partners capable of building our desired products within our specified timeframe.

Ric Prentiss, Analyst

I have one housekeeping question remaining. You both mentioned litigation fees of $5 million this year. Are those figures included in your EBITDA guidance, or how do you account for them?

Oakleigh Thorne, Chairman and CEO

After discussing it, we concluded that we've always included legal fees associated with litigation in the past. We've had instances such as shareholder lawsuits and various patent suits, and we haven't excluded those expenses before, so we decided against pulling it out now for consistency.

Barry Rowan, Executive Vice President and CFO

We did want to share the $5 million number so that everyone is aware of how we plan to account for it. Adjustments can be easily made based on everyone’s EBITDA calculations.

Ric Prentiss, Analyst

Thanks for the clarification. I have one more question. With inflation being a hot topic nowadays, how does your company perceive the impact of current financial markets on your operations and outlook?

Oakleigh Thorne, Chairman and CEO

Barry, could you address that question regarding our operations?

Barry Rowan, Executive Vice President and CFO

When assessing inflation, we categorize it into three primary areas. It has been factored into our forecasts and guidance: firstly, regarding wage increases, we've budgeted for higher increases than prior periods due to observed market trends; secondly, component cost increases—while we have long-term purchase contracts locking in future pricing, we do anticipate gradual rises in component costs but at a rate that won’t overly impact our forecasts; finally, the cost of service provision, where we see a large portion of our costs won't be subject to inflation. In fact, our overall ATG cost per megabyte is expected to remain flat or decrease over our five-year plan.

Oakleigh Thorne, Chairman and CEO

To further elaborate the implications of a recession amid high interest rates, our experience has shown resilience during previous economic downturns. We performed well during the 2008-2009 financial crisis and even during COVID. In 2008-2009, the business aviation industry faced steep declines, yet we continued to sell effectively. During COVID, we saw a dip in equipment orders for a short period, but full-year service revenue only fell by 4%. As we look forward, there could be a moderation in our red-hot equipment sales; however, we haven't seen that yet and expect service revenue remains largely unchanged amid potential recessionary pressures. Our previous experiences justify this expectation.

Ric Prentiss, Analyst

I appreciate your insights. Thank you, gentlemen. Stay well.

Barry Rowan, Executive Vice President and CFO

Thanks, Ric.

Operator, Operator

Thank you. Our next question comes from the line of Scott Searle with ROTH Capital. Your line is now open.

Scott Searle, Analyst

Good morning. Thanks for taking my questions. Oak, Barry, great job on the quarter, especially concerning operational gains.

Barry Rowan, Executive Vice President and CFO

Thanks, Scott.

Scott Searle, Analyst

It's likely premature, but given your visibility into 2022 at this point, are your early thoughts for 2023 similar in terms of targeting another 1,300 ATG units? Or should we expect some moderation moving forward? How do you view this?

Oakleigh Thorne, Chairman and CEO

We’ll provide an update on ’23 during the second quarter call. We haven’t fully figured that through yet. In our long-term model, we anticipate about 11% unit growth yearly.

Barry Rowan, Executive Vice President and CFO

Correct. Expect about 12% growth in aircraft online, considering that combined with ARPU increases.

Oakleigh Thorne, Chairman and CEO

We are already taking orders for 2023. There’s significant order volume already in the pipeline. The average orders look very promising. We’ll provide an update for 2023 by our second-quarter call after forecasting.

Scott Searle, Analyst

Regarding the 5G network, it’s great to see that everything stays on track from a technological and network standpoint for a launch in the second half. Can you offer insights on the interest level regarding 5G and what you anticipate for the penetration adoption upgrade cycle? Additionally, can you provide cost-related details for upgrades using existing AVANCE systems and timing for aircraft upgrades? Lastly, how does the potential for 5G impact your ARPU estimates, considering your recent performance has shown it at around 8%?

Oakleigh Thorne, Chairman and CEO

We anticipate initiating meaningful shipments in 2023, likely with an announcement by the end of this year. The ramp will be somewhat slow as clients devise upgrades over time. To give context, our advanced product line is the most successful launch in business aviation history and currently sits at roughly 25% after four years. Thus, while the ramp for 5G won’t be quite as swift, we do foresee it building momentum. Importantly, it will drive substantial ARPU increases. Early indications suggest strong customer interest with a willingness to pay more for 5G due to its anticipated performance enhancements. So, early signs are encouraging relative to what we’re modeling.

Scott Searle, Analyst

Thanks for the insights.

Operator, Operator

Thank you. Our next question is from Louie DiPalma with William Blair. Please go ahead.

Louie DiPalma, Analyst

Good morning, Barry and Will.

Barry Rowan, Executive Vice President and CFO

Good morning.

Louie DiPalma, Analyst

Barry, congratulations on your upcoming retirement.

Barry Rowan, Executive Vice President and CFO

Thank you, Louie. I am still here, and I know Jesse will be taking over with great success. So you will have to put up with me for a while longer.

Louie DiPalma, Analyst

I have a question regarding the impending extinguishment of convertible debt. What share count should analysts be using for Gogo going forward?

Barry Rowan, Executive Vice President and CFO

After the conversion, it will be approximately 134 million shares.

Louie DiPalma, Analyst

In terms of capital allocation, are you considering stock buybacks or potential dividends following the achievement of your leverage target?

Barry Rowan, Executive Vice President and CFO

We think systematically and disciplined about capital allocation. As we've stated for several quarters, we consider this sequentially; first, launching 5G on time and within budget; second, reducing leverage; third, investing in strategic priorities enhancing business value like the Gogo broadband opportunity we’re assessing; and lastly, considering returning capital to shareholders. We’ve made excellent progress on the first three aspects, and we assess the possibility of returning capital to shareholders accordingly.

Louie DiPalma, Analyst

How fast is the 5G network in trials with ongoing work at the completed 35 cell sites? Does the channel-bonding configuration integrating the 850-megahertz signal with 2.4 gigahertz signal work? If the 5G network works optimally, will a LEO broadband product still be necessary over the continental US?

Oakleigh Thorne, Chairman and CEO

We view it as imperative to enhance network quality to stay competitive. The capacity to aggregate both 5G and LEO networks in the same router allows us to strengthen our customer base in the U.S. and continue expanding, ensuring competitiveness against any LEO providers attempting to enter the market. In terms of testing, with just one tower, we confirmed that the blending of 850 with 2.4 GHz works fine. The remaining towers haven’t been lit up yet, but we will have more insights once the testing continues.

Louie DiPalma, Analyst

So that system would be additive?

Oakleigh Thorne, Chairman and CEO

Correct. It's inherent within the AVANCE system. Its multi-bearer capability allows for integrating multiple networks with a seamless user experience.

Louie DiPalma, Analyst

Thanks, gentlemen.

Barry Rowan, Executive Vice President and CFO

Thank you, Louie.

Operator, Operator

Thank you. Our last question comes from Anthony Klarman with Deutsche Bank. Your line is now open.

Anthony Klarman, Analyst

Thanks. Just two follow-ups to conclude. First, regarding the potential for a global LEO broadband partnership, I'm assuming that expenses related to such a partnership are not included in your long-term financial targets. Should we expect some incremental spend associated with that? Moreover, are revenues from this venture reflected in the 15% CAGR you mentioned for 2021 through 2026?

Oakleigh Thorne, Chairman and CEO

Correct, the global broadband initiative is not included in our baseline projections that are the foundation of our long-term guidance. They are considered as an overlay. We’ll disclose more detailed information once we announce the project. The business model with the LEO provider will be structured around a managed services model, so we will have costs linked to usage without incurring significant expenditures upfront.

Anthony Klarman, Analyst

That makes sense. I was curious specifically about costs related to R&D and equipment for customer premises. Would these still be considered back-ended investments as we get closer to actual service?

Oakleigh Thorne, Chairman and CEO

Indeed, this primarily pertains to our development of antennas and wiring needed for the aircraft. However, these investments will be made ahead of initiating revenue generation.

Anthony Klarman, Analyst

Finally, Barry, regarding adjusted EBITDA's treatment of litigation expenses—I'm assuming that's cash expense rather than an accrual for potential future liabilities? It's more in line with recognizing current cash flow outlays for defending entities, correct?

Barry Rowan, Executive Vice President and CFO

Yes, it’s important to view this as an earmarked cash outlay for legal expenses associated with defending against the current suit, explicitly netted against EBITDA figures. As I mentioned earlier, the projected EBITDA range of $150 million to $160 million has already taken that $5 million expense into account.

Anthony Klarman, Analyst

Thank you very much for the clarification.

Operator, Operator

Thank you. We have no further questions at this time. Presenters, please continue.

William Davis, Vice President of Investor Relations

Thank you, everyone, for joining our first quarter earnings call. We look forward to speaking with you next quarter. Thank you.

Oakleigh Thorne, Chairman and CEO

Thank you. We appreciate your time.

Barry Rowan, Executive Vice President and CFO

Thank you all.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.