Earnings Call Transcript - GOGO Q3 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the Q3 2023 Gogo Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Will Davis, VP of Investor Relations. Please go ahead.

Will Davis, VP of Investor Relations

Thank you, Bella, and good morning everyone. Welcome to Gogo’s third quarter 2023 earnings conference call. Joining me today to talk about our results are Oakleigh Thorne, Chairman and CEO; and 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 the conference call. Those risk factors are described in our earnings release filed this morning and are more fully detailed under our 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 November 7, 2023. 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 will 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 third quarter earnings release. This 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 will 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 welcome to our Q3 2023 earnings call. Gogo achieved solid bottomline results in the third quarter, despite aviation industry headwinds and a slowing of orders as customers await the launch of Gogo 5G and Galileo, both of which will reaccelerate our growth starting in the second half of 2024. On the positive side, several of the headwinds I discussed last quarter, like suspensions and deactivations, which are mostly temporary in nature, have started to normalize, and in fact, we achieved the highest third quarter ever for new activations. On the flipside, supply chain issues and labor shortages continue to impact our OEM and aftermarket partners, delaying new aircraft deliveries and extending maintenance cycles, which in turn have reduced equipment revenue and slowed the growth of service revenue for Gogo. Despite that, we have maintained our profitability levels partly due to our shift to 5G investment dollars to 2024 and partly due to strong cost management. As a result, we are lowering our revenue guidance for 2023, but raising guidance for adjusted EBITDA and free cash flow to the high end of our prior ranges. The change in guidance is very disappointing. These near-term headwinds do not change our view that Gogo is poised for explosive growth in 2025 and beyond, and we are not changing our long-term targets. First, we serve a highly unpenetrated market, with 78% of the world’s business aircraft flying without a broadband solution today. Second, we see unprecedented demand with a surge of travelers choosing to fly private aviation post-COVID and those travelers demanding connectivity. Third, we have an attractive business model based on recurring service revenue that drives strong cash flow. Fourth, we are incorporating new technologies into our platform to deliver order of magnitude improvements in service, to dramatically increase our TAM by having products that meet the needs of every segment of the global BA market and to enhance our competitive position. And finally, we have a strong balance sheet that enables us to make the investments necessary to deliver those new technologies. The price for reaching that explosive growth and driving substantial returns for shareholders is a heavy investment cycle we are now in, to build Gogo 5G, develop Gogo Galileo and execute the FCC rip and replacement project, all of which I will deep dive in a few minutes. This morning, I am going to start by highlighting the demand we see in the BA market, I will then go through the data from the quarter and I will close by touching on Gogo’s progress against our key strategic initiatives. Jessi will then walk through the numbers and the rationale behind our guidance update. So let me start with industry demand. Industry observers typically use flight count as a proxy for private aviation demand, and in Q3, Gogo flight counts were down only 2% from the very high counts in 2022, which is an improvement from the 5% decline we experienced in Q2. More importantly, flight counts remain significantly elevated from pre-COVID 2019 at plus 28%, signaling to many in the industry that stronger demand is here to stay. Those numbers are supported by the surge in OEM order books and the sale of fractional ownerships that we have seen over the past few years. Meanwhile, data usage per flight hour for Q3 increased 15% over Q3 2022 and increased 77% from Q3 2019. In global market research conducted by Gogo, when offered all current and currently announced IFC offerings from Gogo and its competitors, 74% of all business aviation industry participants will opt to add connectivity to those aircraft today. That stands in stark contrast to broadband connectivity in the global fleet, which stands at only 23%. Some of this demand is driven by a generational shift and who is flying. Among the silent generation of older flyers, only 65% would opt for connectivity; among baby boomers that goes up to 78%; Gen X and Y that goes up to 87%; and for Gen Z that jumps to 98%. We believe those demographic trends bode very well for broadband connectivity penetration of business aircraft over the next 10 years. Now let me turn to Q3 results. Overall revenue was down 7% from the prior year, with equipment revenue down 24% and our high-margin recurring service revenue up 6%. The biggest drivers of this performance were part shortages, labor shortages, and frantically busy maintenance schedules at the OEMs and dealers. Part shortages have caused OEMs to push out deliveries, which combined with a fair amount of Gogo inventory in that channel has caused them to push out equipment orders from us, which has hurt equipment sales and by extension dampened the aircraft online and slow growth in service revenue. Parts shortages have also forced dealers to hold aircraft for extended maintenance times as they wait for critical parts, which has delayed reactivation times for Gogo, which in turn has dampened aircraft online and slowed service revenue growth. And finally, labor shortages combined with heavy demand for critical maintenance have forced dealers to prioritize needed to fly maintenance over discretionary spending like IFC, which has dampened equipment revenue and by extension, you guessed it, growth in aircraft online and service revenue. On that last point, as 5G technology and LEO satellite technology are poised to dramatically improve our product performance and potential new offerings from others, customers have extra impetus to wait and see what gets delivered and avoid discretionary spending in IFC in the short run. We saw the same phenomenon in Q1 2015 to Q1 2017 timeframe when aftermarket quarterly shipments fell 28% in the two years before we launched AVANCE and SmartSky was making their first big marketing splash. Despite those headwinds, AOL grew 86 units in Q3, down from 123 units last year, but up substantially from the 18 units we grew Q2 this year. The stronger AOL performance was driven by continuing strong new activations and a normalization of our suspension rate, all of which was partially offset by continuing weaker reactivation rates due to the elongated maintenance events, I mentioned a moment ago. New activations and upgrades from Classic to AVANCE were particularly encouraging, as short of expectations, we had our highest third quarter ever for new activations at 214, up 11% from the prior year, and our highest quarter ever for upgrades at 60, up 28% from the prior year. Strategically because AVANCE allows customers to upgrade with Gogo to new technologies like 5G and lower earth orbit satellites much more quickly and economically than moving to a competitor, we believe the discontinued migration to AVANCE is very important. In total, AVANCE now accounts for 53% of our fleet, up from 45% at the end of Q3 last year, and that percentage will grow as our FCC rip and replacement program rolls out. What is important to note is that based on extensive interviews with customers, we are not losing planes to competitors. We are just losing time, parts, and labor shortage. Now let me turn to shipments and field inventory. Inventory in the field decreased by about 47 units in the quarter to roughly 857 units, of which only 140 units are not committed to a particular aircraft. Of those 140 units, only 32 units are at our dealers that do not install a high volume of Gogo systems. For the reasons I discussed a moment ago, we had a significant decrease in AVANCE shipments this quarter to 192 units versus 388 units in Q3 last year when we had a blockbuster quarter. To put the quarter in a little more perspective however, we still expect to have the second highest AVANCE shipment year ever in 2023, and we have seen encouraging signs as new orders were much stronger in October than earlier in the year. Now let me turn to an update on our strategic initiatives and how we intend to accelerate growth with our three-pronged strategy. First, we want to expand our addressable market by broadening the AVANCE platform, hardware and network offerings to meet the needs of each segment of the global BA market. Second, we want to drive customer loyalty by continually improving our networks and leveraging the AVANCE platform to provide easy upgrade paths to new technologies as new technologies emerge. And third, we are focused on offering the best product and customer support to each segment of the market at the lowest total cost of ownership. We are making great strides in our strategic initiatives to achieve those goals, including our FCC Secured Network Program, our 5G network, and our global broadband LEO offerings Galileo HDX and FTX. I will start with the FCC Secured Networks Program and an encouraging announcement from the Biden administration. You will recall that last year Gogo was awarded a $334 million grant under the FCC Secure and Trusted Communication Networks Program to reimburse it for expenses associated with accelerating the removal of Chinese telecom technology from our 4G network. Because there were more qualified grants than originally planned, funding for all grants were cut back to 39% of their original award, which in Gogo’s case was cut back to $132 million. The good news last week was that the White House included full funding for the program in its supplemental funding request to Congress. Given the full funding has broad bipartisan support in Congress, we feel that it has a good chance of passage this year. Full funding will help Gogo defray the cost of replacing all DTE ground equipment and moving Gogo Classic customers to airborne equipment that is compatible with the replacement ground equipment. Because the functionality of replacement ground-based equipment will be better than the equipment installed in our 4G network today, Gogo will get some significant benefits from this network refresh, including a 40% improvement in connectivity performance for AVANCE L3 customers and almost doubling the number of aircraft that the ATG 4G network can simultaneously manage and a significant acceleration of Gogo Classic customers upgrading to AVANCE, which as I described earlier has the strategic benefit of extending Gogo customer lifetimes and the lifetime of a very profitable ATG network. We have already started work on the network side of this project and expect to go live in early 2026. On the customer side of this transition, our goal is to convert all of the 3,300 tails flying with our Classic product today to new LRUs with LTE air cards over the next two years. We have been in touch with all of those customers and I have actually spoken to more than 90% of them, and of those that already have a preference, the overwhelming majority are leaning towards an AVANCE upgrade, but the majority of those are selecting the L5s. Jessi will provide more details on the FCC program in a few minutes and how the costs and reimbursements are coming in quicker than expected fit into our guidance. Now let me turn to our Gogo 5G air-to-ground network program. As a reminder, this product will have coverage limited to North America, but deliver mean performance around 25 megabits per second, 5 to 10 times the mean speed of Gogo’s current offerings, with peaks of up to 75 megabits to 80 megabits per second, all at a more affordable price than competitive satellite products. In global market surveys, business aviation professionals have indicated that the 5G packages are the number one pick ahead of all current and currently announced competitive ATG and GEO or LEO satellite offerings, which bodes well for the durability of Gogo’s high margin ATG revenue stream. This is partly driven by the fact that the North American medium and lighter aircraft market segments are by far the largest in the world, with more than 80% of all global flights beginning and ending in North America, and though they want quality connectivity, many operators in those segments want it at an affordable price. Last year, Gogo completed the build-out of its 150-tower 5G network with the Cisco core that provides nationwide coverage, and next year, we will complete our Canadian network. We have also completed every aspect of the airborne equipment except one, our 5G chip. As I am sure you are aware, we have had two significant delays in this program because of issues in bringing the 5G chip up after completing fabrication at the chip foundry. Important to note that the issue with the chip was not in the 5G block, but in the peripheral sub-block. Since July, we have been working with our 5G network and chipset suppliers on a remedy to bring up the problem. Sadly, that remedy involves a full re-spin, which establishes our ship date in the third quarter at the outside perimeter of our earlier guidance. That said, we are confident we will hit that timeframe, because, first, our team feels that our chipset supplier has conducted a much more thorough analysis and has fully identified the root cause of this issue and is currently implementing a complete remedy. Second, our chipset supplier has brought a new design house into the project, which has superior simulation and modeling capabilities to the old design house. Third, the design house has a very solid record of getting it right the first time. And fourth, we will be utilizing new higher-speed 50-megahertz Field Programmable Gate Array technology, better known as FPGAs, to test many aspects of the chip before we have the chip itself. Gogo expects to have the FPGA technology in place from our vendors in late Q1 and to begin flight testing with it in Q2, which will enable us to burn down all software testing risk, all 5G design testing risk, and our system integration risk, and it will allow us to fine-tune our network before ever receiving the actual 5G chip. Other milestones that Gogo will share as they occur next year include the startup and end of chip fabrication, Gogo receipt of the chip after bringing up, and Gogo flight test of the chip. Finally, we are having considerable commercial success with the product already. Not only have we had no cancellations due to the delay, we have orders from five OEMs and have built an $8.5 million backlog for chipsets. We are also having success with 5G pre-provision kits, which allow customers to install the AVANCE L5 with full 5G provisions and operate on Gogo’s 4G network while waiting for the LX5 5G box. Once the LX5 is ready, it can be installed quickly, and 5G service can begin immediately, saving downtime and expense. We shipped 133 of those kits, including 67 in Q3, and what's really exciting is that more than 30 of those chipsets have already been installed in the aftermarket alone. And what’s even more impressive is that two OEMs are already installing the 5G MB13 antennas on every plane in which they install an AVANCE L5. So those planes will be ready to move to 5G when the 5G chip is ready. Now, I will turn to our LEO-based global broadband initiative, Galileo, which adds a flat panel, fuselage-mounted electronically steerable antenna to the AVANCE platform and adds the EUTELSAT OneWeb low earth orbit satellite constellation to our network offerings. Galileo comes in two flavors: a smaller HDX terminal and a larger FDX terminal. The Galileo HDX terminal is a small antenna that fits on almost all business aircraft, targets mid-size and smaller jets, domiciled outside North America, and have no broadband solution today, and domiciled inside North America and often fly internationally. The Galileo FDX terminal is a large antenna that delivers significantly higher bandwidth and targets global super mid-size and larger heavy jets that fly transcontinental missions. The market surveys I mentioned a moment ago also tested Gogo HDX and FDX bundles against our current and currently announced competitive ATG and LEO/GEO offerings, and they show those bundles outperforming all competitor satellite offerings by a considerable margin. We demonstrated our Galileo technology this year at both the Geneva and Las Vegas NBAA-BACE conferences using the Eutelsat OneWeb network and Hughes antennas and achieved mean speeds consistently approaching 200 megabits per second. Worth noting that these speeds will increase dramatically when Eutelsat OneWeb launches its Gen 2 satellite constellation in just a few years. A huge advantage for Gogo in these markets is that Galileo is a simple upgrade from any AVANCE installed aircraft and only needs to add either our HDX or FDX antenna on the fuselage and route data and power cabling into the aircraft. Given that AVANCE is already a line-fit option at every OEM and has STCs on every currently flying model of aircraft in the aftermarket, this will make it easier from the engineering certification perspective for OEMs and dealers to offer Galileo as an option to their customers. We have already signed a line-fit agreement with one OEM and have discussions underway with several others. We plan to start shipping HDX terminals in the second half of 2024 and FDX terminals in the first half of 2025. Our satellite partner, Eutelsat OneWeb, and our internet partner, Hughes, continue to make great progress driving towards those dates. Eutelsat OneWeb has completed launch of its 648 satellite Gen 1 constellation and should complete its ground network and be ready for aero use in Q2 2024 before our launch in the second half of the year. We expect to receive pre-production test units of the HDX antenna from Hughes in the first quarter and production equivalent units for flight testing early Q3, and are targeting first shipments a few months after. With the addition of Galileo, Gogo will have the most complete product portfolio in the business aviation IFC industry, with products that offer the right performance, coverage, total cost of ownership, and great customer support for every segment of the highly unpenetrated 38,000 aircraft global business aviation market. Overall, we are excited for the future and believe Gogo has the right strategy in place to continue to capitalize on the significant opportunity in our market and deliver long-term value creation. I want to end by thanking the Gogo team on both the frontline and those who support the frontline. It’s because of you that we are in this position. With that, I will turn it over to Jessi to do the numbers.

Jessi Betjemann, Executive Vice President and CFO

Thanks, Oak, and good morning, everyone. Gogo delivered solid bottom-line financial performance, as we continued to invest in our strategic and operational initiatives, including Gogo 5G and Gogo Galileo, to enhance our competitive position for the future. In my remarks today, I will start by walking through Gogo’s third quarter financial performance, then I will turn to our balance sheet and capital allocation priorities, next I will provide an overview of the financial impact of the FCC program, and finally, I will provide additional context around our revised 2023 outlook and wrap up by reiterating our long-term targets. Total revenue for the third quarter was $97.9 million, down 7% from the prior year and down 5% sequentially. We delivered record service revenue of $79.5 million in the third quarter, a 6% increase year-over-year and a 1% increase sequentially. Our ATG aircraft online reached 7,150 units as of the end of the third quarter, representing 6% growth versus the prior year and 1% growth sequentially. While Gogo is showing improvement in incremental ATG aircraft online from 18 units in the second quarter to 86 units in the third quarter, these remain muted due to temporary suspensions, driven by elongated maintenance cycles, which took aircraft offline. In addition, we had record upgrades in the third quarter, and while strategically important, it also contributed to the muted aircraft online growth as it replaces existing aircraft online. AVANCE aircraft online grew to 3,784 and now comprise 53% of our total fleet, up from 45% last year. Increasing aircraft online with the penetration of our AVANCE products remains critical to Gogo’s strategy both in the North American market and globally as we prepare for Gogo 5G and Galileo. As we mentioned last quarter, we continue to expect the AVANCE aircraft online growth rate to accelerate over the next several quarters, as maintenance events start to return to normal levels, reducing suspension time and allowing dealers to work on addressing supply chain issues that are contributing to slower installation rates. Total ATG ARPA of $3,373 slightly increased sequentially and slightly decreased versus the prior year, driven by a shift in product mix. We anticipate the launch of Gogo 5G and Galileo next year will further expand our ARPA growth opportunity over time, partially offset by continued L3 sales into smaller aircraft and lower-priced data plans to drive incremental revenue growth down market. Now turning to equipment revenue. Gogo generated $18.4 million in equipment revenue in the third quarter, a 39% decrease year-over-year and a 24% decrease sequentially, as AVANCE equipment units shipped decreased to 192 units in the third quarter. As Oak noted, the decrease in AVANCE equipment units shipped largely reflects the impact of lingering inventory in the channel, shift in OEM orders for 2024, as well as delays in customer purchases as they wait for the expected launch of Gogo 5G and Galileo in 2024. Gogo remains confident in our strong position in the global market, which is only 22% penetrated with inflight connectivity, coupled with the expected launch of Gogo 5G in Q3 2024 and Gogo Galileo in the second half of next year. We will continue to propel our equipment sales in the future. Turning to profitability, Gogo delivered service margins of 77% in the third quarter, which remains flat compared to the prior year quarter. We continue to expect long-term service margins in the 75% plus range, positioning service as the primary lever for free cash flow generation and long-term value creation. Equipment margins were 33% in the third quarter, 3 percentage points lower than the prior year period and 6 percentage points higher sequentially. The increase in our equipment margin compared to last quarter was primarily due to an accrual of $2.8 million for the expected FCC reimbursement of costs incurred to replace a large number of EVDO aircards and AVANCE equipped aircraft with dual modem aircards. Out of the $2.8 million accrual, $0.8 million related to Q3 shipments, while $2 million was related to prior quarter’s activity back to 2022. The positive impact of the accrual for expected FCC reimbursement was partially offset by an increase in production costs as a percentage of revenue due to lower equipment revenue in the quarter. We expect Q4 equivalent margins to decline as there is no catch-up accrual for the FCC reimbursement. Moving on to operating expenses. Third quarter combined engineering design and development, sales and marketing, and general and administrative expenses of $25.5 million declined slightly year-over-year and decreased 3% on a sequential basis. Our operating expenses decreased sequentially primarily due to lower marketing-related costs. Gogo continues to expect 2024 will be a significant investment year, as we complete our Gogo 5G program and ramp spending for Gogo Galileo. We expect to see the benefit of these investments through sustained strong top-line growth and an inflection point in our free cash flow growth in 2025 and beyond in our core operating business. In terms of Gogo 5G, in the third quarter, our $1.8 million of 5G spending was comprised of $0.5 million in OpEx and $1.3 million in CapEx. As Oak mentioned, Gogo is working with our 5G network and chipset suppliers to resolve the 5G chip issue, and we now expect the commercial launch of Gogo 5G to take place in Q3 2024. We maintain our estimate of $100 million in total cost for our 5G program, but the delay would push approximately $10 million of CapEx and $7 million of OpEx from our original plans in 2023 into 2024. Gogo expects this delay to dampen revenue, EBITDA, and free cash flow in 2024. Now onto our Gogo Galileo initiative. In the third quarter, Gogo recorded $2.6 million in operating expenses related to Gogo Galileo and $6.6 million year-to-date. We continue to expect external development costs for Gogo Galileo to be less than $50 million in total, of which $10 million will be incurred in 2023 and approximately $30 million in 2024. We anticipate approximately 90% of Gogo Galileo’s external development costs will be in OpEx. Moving onto our bottom line, Gogo’s third quarter adjusted EBITDA of $43.2 million stayed relatively flat year-over-year. EBITDA margin expanded to 44.1%, up 140 basis points from last quarter and up approximately 300 basis points year-over-year, as we had growth in high-margin service revenue while maintaining strong cost control. Gogo delivered net income of $20.9 million in the third quarter, up 4% year-over-year, translating to $0.16 in basic and diluted earnings per share. As a reminder, last quarter we reported net income that included an income tax benefit of $63.8 million due to the partial release of the valuation allowance on our deferred tax assets related to the Section 163(j) interest limitation carried forward. As of December 31, 2022, Gogo had $562 million in federal net operating losses, $448 million in state net operating losses, and $292 million in Section 163(j) interest limitation carry forwards. As a reminder, our financial statements reflect non-cash income tax expense as we continue to generate positive pre-tax income. Based on our substantial NOL position, we do not expect to pay meaningful cash taxes for an extended period. But we may pay a modest amount by the end of our five-year planning horizon. In addition, our shareholders’ rights plan that is designed to preserve NOLs expired in September. The shareholder rights plan was not renewed as changes in the shareholder base over a three-year period have lapsed. Thus we still have access to our large NOL position, but new shareholders are no longer restricted from purchasing over 5% of the outstanding shares of Gogo common equity. In the third quarter, we generated $21 million in free cash flow, up $12.5 million versus prior year primarily due to lower 5G CapEx. Free cash flow is also up $7.7 million sequentially, largely due to lower interest paid this quarter as we switched to a monthly cadence of interest payments on our term loan, resulting in five months of interest paid in the second quarter. Now I will turn to a discussion of our balance sheet. We ended the quarter with $110.8 million in cash and short-term investments and $608.7 million in outstanding principal on our term loan, with our $100 million revolver remaining undrawn. Gogo’s net leverage was slightly lower to 2.9 times, in line with our target range of 2.5 times to 3.5 times. As we previously mentioned, we have a hedge agreement in place and we currently have 86% of our loans hedged. The next step down in the hedge to $350 million occurs in July 2024, with an increase in strike rate from 0.75% to 1.25%. As a reminder, Gogo’s capital allocation priorities remain unchanged and are aligned with our strategic goals and include; first, maintaining adequate liquidity; second, investing in strategic opportunities to drive competitive positioning and financial value, including Gogo 5G and Galileo; third, maintaining an appropriate level of leverage for the economic environment with a target net leverage ratio of 2.5 times to 3.5 times; and finally, returning capital to shareholders as appropriate in the future. With a strong cash balance, our Gogo 5G, Galileo, and other strategic projects should be well-funded, and our net leverage ratio at 2.9 times including the $100 million debt pay down earlier this year, and our strong confidence in the business, we are comfortable moving to prioritize returning capital to shareholders. Our Board of Directors approved a share repurchase program in September with no set expiration date that grants authority to repurchase up to $50 million of shares of common stock. This gives us the ability to opportunistically repurchase shares when we find that doing so offers an attractive value proposition. However, we need to continue to balance the use of cash over the next year across our capital allocation priorities, and especially in allocating funds between further pay down of debt considering high interest rates and the step down in our hedge and future share repurchases. I would now like to provide an update on the expected financial impact of the FCC Secure and Trusted Communication Networks Reimbursement program. As Oak mentioned, we are encouraged that the White House recently issued a supplemental funding request that includes a call to Congress to fully fund the FCC program, which will significantly increase our total reimbursement value as we were granted up to $334 million. As mentioned in previous quarters, we currently expect to receive partial funding of $132 million. As a reminder, we submitted our first claim in July, which triggered the start of the one-year clock to complete the program by July 21, 2024. In our application, we stated that we will need to have multiple extensions to complete the program and are waiting to see if the FCC will grant a blanket extension or we will request an extension in the coming months on our own. Gogo has incurred and will continue to incur costs for this program in three areas; first, network equipment for cell sites and data centers; second, airborne equipment for the swaps of LTE air cards to replace EVDO air cards and partial rebates for customers’ installation costs to enable existing customer aircraft to communicate with the new network; and third, operating expenses primarily for flight testing, network design, and professional services. We expect to spend that will be partially offset by the FCC reimbursements. As of September 30th, we recorded a $16.2 million receivable from the FCC, which is included in prepaid expenses and other current assets in our balance sheet for the reimbursement of the costs I previously mentioned, with corresponding reductions to property and equipment inventory, and contract assets, and with the pickup in the income statement. Going forward, since the program is currently partially funded, we have some optionality in what we request reimbursement for, which could impact when grant money received would be recorded between the income statement and balance sheets. Previously, Gogo expected 2023 and 2024 free cash flow to be negatively impacted by the FCC program's progress and the benefit in 2025 due to the timing of reimbursement proceeds. However, we are currently seeing reimbursements quicker than expected, potentially changing the swing effect on free cash flow over the years. For example, in 2023, we expect to spend approximately $20 million for the FCC program and recoup approximately $2 million in cash reimbursements, but with the reduced lag in the reimbursement process, we could receive more this year. Nonetheless, the partial funding reimbursements are expected to be short of the total expected cost of the program through 2026. Turning to our financial outlook, Gogo updated its fiscal 2023 financial guidance to reflect current market dynamics. Gogo now expects 2023 total revenue to be in the range of $390 million to $400 million. The decrease is driven by a reduction in equipment revenue, which was largely affected by a shift in OEM orders to 2024 and a delay in customer orders as they wait for the expected launch of Gogo 5G and Galileo, as I noted earlier. We now expect 2023 adjusted EBITDA to be at the high end of our previously guided range of $150 million to $160 million. We were able to increase adjusted EBITDA guidance despite lower revenue as we continue to prudently manage costs as well as push out additional 5G spending due to the delay. This guidance includes spending on operating expenses of approximately $15 million compared to $20 million previously for strategic and operational initiatives, which include approximately $3 million in expected Gogo 5G spending, approximately $10 million of Gogo Galileo development spend, and approximately $2 million in additional operational initiatives. Adjusted EBITDA guidance also includes approximately $7 million of costs related to the FCC program offset by $6 million of accruals for the expected FCC reimbursements. We now expect our 2023 CapEx to be in the range of $25 million to $30 million, including $12 million for the Gogo 5G program and approximately $2 million related to the FCC program. We also now expect our 2023 free cash flow guidance to be at the high end of the previously guided range of $60 million to $70 million, including FCC-related spend and the expected lag of FCC reimbursements. Even with our investments in strategic initiatives and the FCC program, we expect nearly 20% year-over-year free cash flow growth in 2023, and excluding the FCC impact it would be nearly 50%. As we previously stated, 2024 will continue to be an investment year with an increase in Gogo Galileo expenses anticipated for further burdened due to the push out of 5G spending. These investments, coupled with the lower shipments and aircraft online this year versus our original expectations, and the delay in the 5G launch, are expected to negatively impact our financials causing 2024 to be a tough free cash flow year. However, Gogo’s long-term targets for me haven’t changed. They reflect our expectations for the launch of Gogo 5G in Q3 2024 and the launch of Gogo Galileo in the second half of 2024. We reiterate revenue growth at a compound annual growth rate of approximately 15% to 17% from 2022 through 2027. We continue to expect annual adjusted EBITDA margin in the mid-40% range by 2027 and free cash flow in the range of $150 million to $200 million in 2025 without the effect of the FCC program and growing thereafter. We plan to provide 2024 guidance metrics and update our long-term targets as appropriate on the fourth-quarter earnings call as we typically do. In conclusion, we will continue to deliver solid bottom-line financial performance and we are committed to creating long-term value for our shareholders and customers. Before we open the call up to questions, I would like to join Oak in thanking our entire team for their continued commitment to Gogo and providing unparalleled service to our customers.

Operator, Operator

Operator, this concludes our prepared remarks; we are now ready for your first question.

Richard Prentiss, Analyst

Hey. Good morning, everybody.

Oakleigh Thorne, Chairman and CEO

Good morning, Ric.

Will Davis, VP of Investor Relations

Ric.

Jessi Betjemann, Executive Vice President and CFO

Hi.

Richard Prentiss, Analyst

Appreciate all the details. I want to probe into first the competition side, as we have talked a little bit about testing your offers versus others. It’s not on the BA side but interesting the Hughes announcing the Delta version of jet contract. I am wondering if you are thinking of others starting to come into the BA space as well and then maybe an update on the SmartSky lawsuit, if there’s been any changes?

Oakleigh Thorne, Chairman and CEO

The Delta Hughes deal involves a large antenna GEO product. They are utilizing the ThinKom 1717 antenna set, which is approximately 5 feet long. It is neither a BA aircraft antenna nor an ESA and currently does not use LEO satellites. It primarily operates on Ka band, which is significant. This setup is intended for Hughes to sell Jupiter capacity, and it aligns with our agreements without any issues on our part. Additionally, I believe you were inquiring about potential new entrants.

Richard Prentiss, Analyst

Yeah.

Oakleigh Thorne, Chairman and CEO

I think our confidence regarding potential entrants has significantly increased. We devoted a lot of time over the summer to detailed market research and surveys globally, both for branded and unbranded assessments, and Gogo consistently ranked as the top choice. Our cost-effective L3 product and 5G offering, tailored for North American travelers in medium-sized jets, cater to those requiring higher capacity. Additionally, the FDX and HDX models serve international flights and medium-sized jets within the U.S. that also have similar capacity needs, while FDX targets global transcontinental flights. This information has reinforced our belief that we are creating the right products, delivering appropriate services, and setting the right price points and coverage. Our overall strategy is to grasp the complexities of this relatively small vertical, acknowledging that various segments have unique needs, and to develop tailored products, coverage, and pricing for each segment. We feel very positive about this approach. While many express concerns about Starlink entering the market, it seems they are still figuring out their direction and frequently changing their plans, which does not align well with the business aviation sector that requires reliable partners with established track records. Therefore, we remain optimistic. Regarding the SmartSky litigation, there is still no decision on their appeal following the lower court's denial of a temporary injunction, which we see as a positive indicator since it has been nearly six months since the case was heard. If the court believed there was an urgent need for an injunction, it is likely they would have issued one by now. The general trial is scheduled for either April or August 2025, which is still some time away. There will be numerous Markman hearings and a lengthy discovery process over the next year, making it a time-consuming and potentially costly endeavor.

Richard Prentiss, Analyst

Okay. I just want to make sure I also understand the 5G, Galileo operating initiatives. Jessi, I think you said the $15 million impact OpEx-wise and 2023 is like $3 million for 5G, $10 million for Galileo and $2 million for others, the 2024 Galileo looks like it’s going to be $30 million. Is the 5G is that just $7 million, is that gap push out, I was just trying to think about the total 2024 impact is to compare to the $15 million EBITDA impact for those three items?

Jessi Betjemann, Executive Vice President and CFO

Galileo is expected to be around $30 million next year. For 5G, we have pushed out $7 million of operating expenses from this year to next year, so we are expecting $7 million in operating expenses next year. For capital expenditures, we anticipate that to be around $14 million next year. We pushed out $10 million from capital expenditures this year to next year, as we had initially planned for a little more capital expenditures next year. Therefore, the total 5G spending will be $20 million next year.

Richard Prentiss, Analyst

Okay. And then last one for me is, and obviously, the balance sheet is strong, the bottomline you have been working through that. How much cash do you want to keep on the balance sheet to run the business as we think about all the different components you are looking at and also obviously the FCC reimbursement?

Jessi Betjemann, Executive Vice President and CFO

Yeah. So we would like to be fairly conservative on this. I mean, I think the range is around 50% to 75%, which is higher than what we would need to run the business, but we would like to be conservative. So when we talk about…

Richard Prentiss, Analyst

Make sense.

Jessi Betjemann, Executive Vice President and CFO

… maintaining adequate liquidity, that’s usually the amount that we are keeping in mind.

Richard Prentiss, Analyst

Makes sense. Thanks a lot for answering the questions.

Operator, Operator

One moment for your next question. And your next question comes from the line of Lance Vitanza with TD Cowen. Your line is now open.

Lance Vitanza, Analyst

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

Oakleigh Thorne, Chairman and CEO

I tried to outline some key milestones during the call. First, we expect the chip factory to begin production in the foundry, marking a significant starting point. Second, we anticipate receiving the FPGA technology delivery in late Q1, which will allow us to mitigate considerable risk with the new 50-megahertz capacity FPGA version of the chip. This will be operational in Q2, and since it's a precise software copy of the chip, we can alleviate all software integration risks and integration testing risks across the network. These factors are quite important. The only risk that remains is related to the hardware of the 5G chip, which will require testing after it exits the foundry. Additionally, future dates will include when the chip is completed at the foundry and when we take delivery, as the bring-up process from the foundry to delivery and the start of our flight testing is critical. I believe these are the main milestones to consider.

Lance Vitanza, Analyst

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

Oakleigh Thorne, Chairman and CEO

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

Lance Vitanza, Analyst

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

Oakleigh Thorne, Chairman and CEO

It's not ideal to have these two product launches coincide, and that wasn’t the original plan since we intended to roll out 5G last year. However, we don't anticipate a conflict because we envision these products serving very different market segments. Despite the delays that may have caused some confusion, we're starting to clarify that. The 5G service is designed mainly for the North American market, targeting medium-sized jets and below that require a reliable yet affordable product. 5G will be more cost-effective than any satellite alternatives. On the other hand, the HDX targets medium-sized jets flying outside the U.S., which currently lack any connectivity options, including broadband. These aircraft typically operate routes to the Caribbean, Canada, Mexico, and even Hawaii, which, while part of the U.S., requires over-ocean travel. The FDX is geared towards heavy jets, particularly those involved in domestic operations with significant connectivity demands or transcontinental flights, likely focusing more on long-haul services. Therefore, they cater to distinct segments, and we're making an effort to communicate clearly about which products are best suited for each market.

Lance Vitanza, Analyst

Thanks very much, I appreciate your help.

Oakleigh Thorne, Chairman and CEO

Yeah. Yeah. Thanks.

Operator, Operator

One moment for the next question. And your next question comes from the line of Scott Searle with ROTH MKM. Your line is now open.

Scott Searle, Analyst

Hey. Good morning. Thanks for taking my questions. I appreciate all the detail. And maybe, Oak, just to dive in quickly in terms of the maintenance events, engine part availability, etc., that has been delaying AOL. The last quarter shipments for ATG units were down pretty significantly, I think, they are about 100 units below where it had averaged over the last six quarters or so. It sounds like despite that you are having record activations, and you are starting to see a pickup in terms of suspension going away in the month of October. And I believe you indicated as well that there are only about 40 units in the channel that are unspoken for. So implied in the fourth quarter guidance is another weak ATG unit quarter. So the question is, as we get into 2024, are we completely burned down in normalized in terms of channel inventory and that balance now with prolonged maintenance events, but now that’s starting to work its way through the channel, we start to see a re-acceleration both of ATG units being shipped and AOL aircraft starting to ramp back up again?

Oakleigh Thorne, Chairman and CEO

I believe the inventory is definitely decreasing. When examining the approximately 850 units, many have already been installed. Last quarter, we mentioned 200 units, and this quarter, that number has decreased to 187, which is quite dynamic. Out of the 200, 79 were actually activated, but this was balanced out by increased shipments that raised the total back to 187. We feel more positive about that portion of the inventory. Additionally, 140 units are accounted for, with 32 of those being at dealerships that took one or two units during COVID, anticipating orders that haven’t materialized, leaving those units sitting. The remaining are from a few dealers that typically sell a lot of inventory. We believe this is returning to normal, which should assist with orders. However, a challenge next year will be that dealers want to avoid accumulating excessive L5 inventory after the launch of LX5, so while they will fulfill current orders, I do not expect them to stock up significantly.