Earnings Call Transcript - GOGO Q3 2021

Operator, Operator

Good day, and thank you for joining the Third Quarter 2021 Gogo Incorporated Earnings Conference Call. All participants are currently in listen-only mode. Following the speaker’s presentation, there will be a question-and-answer session. I would now like to pass the conference over to your first speaker today, Vice President of Investor Relations, Will Davis. Thank you. Please proceed.

Will Davis, Vice President of Investor Relations

Thank you, Mika, and good morning, everyone. Welcome to Gogo’s third quarter 2021 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 financial performance of the company. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements on the conference call. These risk factors are described in our earnings press 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 November 4, 2021. 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 third quarter earnings release. This call has been broadcast on the internet and is available on the Investor Relations website at ir.gogoair.com. The earnings press release is also available on the website. After management comments, we’ll host a Q&A session with the financial community only. It is now my great pleasure to turn the call over to Oakleigh.

Oakleigh Thorne, Chairman and CEO

Thanks, everyone, for joining us this morning. A few weeks ago, we held a call to discuss our updated long-term financial targets, so I won't go over those again today. Instead, we'll concentrate on Gogo's third quarter performance and why we believe it shows we are on track to meet our long-term financial objectives. Q3 was a record-setting quarter for us, achieving record total revenue, service revenue, service gross profit, AVANCE shipments, and adjusted EBITDA. We also achieved the notable milestones of having positive net income and earnings per share for the first time. The strong demand for private jet travel certainly aided our performance, but we were also well-prepared to leverage this demand and achieve outstanding growth in both revenue and profits. Our AVANCE platform and 4G network are ideally positioned to meet the demands of our growing customer base and take advantage of the rapid increase in demand for broadband connectivity in business aviation. This vertically integrated and scalable business model is successfully turning that demand into value for our shareholders. I will start with a summary of our Q3 highlights, followed by context on the competitive landscape and Gogo's advantages, and finally, I'll present our updated 2021 financial guidance, reflecting the impact of strong equipment sales and high-margin recurring subscription service revenue associated with those sales. Barry will then delve into our quarterly performance and the latest 2021 guidance before we open the floor to your questions. Let's begin with demand trends for Q3. The business aviation sector is currently booming. We saw an 8% increase in flight counts for Gogo-equipped aircraft from Q2 and a 24% increase from pre-COVID Q3 2019. This increase in flight demand is pushing fleet operators to acquire more aircraft, both in the pre-owned market and through larger orders for new aircraft. This is good for us, as customers are looking for connectivity on these new and used jets. Even more noteworthy is the rising demand for data on these flights; we experienced a 78% increase in megabytes consumed per day on our network and a 44% increase in megabytes consumed per flight compared to pre-COVID Q3 2019. These metrics result from a 33% increase in flight hours per day, a 34% increase in megabytes consumed per hour, and a 17% rise in the number of aircraft flown. This led to record monthly average revenue per user (ARPU) for Gogo. The number of customers upgrading their plans in Q3 was three times the number of those downgrading, a significant improvement from previous years. Additionally, we saw growth in ATG aircraft online, reaching an all-time high of 6,154 aircraft, a 10% increase from Q3 2020. This combination of ARPU and aircraft online growth propelled our total revenue to a record $87.2 million, with service revenue hitting $66.2 million and equipment revenue at $21 million. The continued growth in equipment sales has prompted us to raise our long-term financial targets. Our service revenue is also growing as more units are being installed and activated. It's important to note that once our service is installed, it has a very low churn rate. Since we began tracking churn in 2017, we've averaged a churn rate of just 0.5% monthly, indicating a 17-year equivalent lifespan for our connected aircraft. These factors demonstrate the solidity of the long-term targets we shared recently, highlighting our effective business model. Equipment sales boost our subscriber base, driving recurring high-margin service revenue, which enhances our cash flow. This increased cash flow allows us to invest in improving our network, which attracts new customers, boosts usage, and drives more equipment shipments. We believe this demand will persist. Although Gogo currently connects 85% of broadband-equipped aircraft, about 70% of the market remains unconnected, presenting us with significant opportunities. The average age of aircraft in the business aviation sector is around 20 years, many of which were built before Wi-Fi was an available option. Moreover, when Gogo began operations, in-flight connectivity was largely viewed as a productivity tool, which has changed significantly. Nowadays, broadband is standard on 28 models of business aircraft, with Gogo featured in 27 of them. Passengers now expect internet access for various applications, from business meetings to leisure activities. Our AVANCE platform is also facilitating market penetration, with customers appreciating the interactive video capabilities for conferencing and the small form factor of the L3 model enhancing appeal in lighter jets and turboprop markets where true satellite providers struggle. Given these trends, we anticipate a 50% growth in broadband-connected business aircraft by the end of 2025, enhancing our market potential. We expect to capture a significant share of these aircraft, bolstered by our competitive advantages, including our unique ATG network and the rollout of our 5G network, the versatility of the AVANCE platform, and our robust relationships with customers and distribution partners. Another key factor contributing to our revenue this quarter and our targets for the years ahead is our ability to meet demand. While supply chain challenges have been prevalent in our industry, our longstanding supplier relationships, a unified component strategy for AVANCE, and our solid balance sheet have enabled us to secure all necessary supplies, allowing us to meet our 2021 demands and the anticipated 25% unit growth for 2022, reducing the risks associated with our outlined targets. Most importantly, thanks to the efforts of our sales and production teams, we’ve managed not just to meet demand but also to turn that demand into profitability for our shareholders. In Q3, we achieved positive net income of $19.7 million, translating to $0.16 per share on a fully diluted basis, and recorded adjusted EBITDA of $40.8 million, a 35% year-over-year increase. We anticipate maintaining positive net income as our high-margin service revenue grows while our operational costs remain steady, leading to improved operating leverage and strong cash generation. We are proud of what we have accomplished and the momentum we are building, and I commend the Gogo team for rising to the challenge of exceptional demand while gearing up to deploy the world's first 5G ATG network. Our focus on customer needs and continuous improvement is integral to our success. Now, let’s consider the competitive landscape in business aviation. Gogo has created three main competitive advantages over the past 30 years: our proprietary ATG network, our unique AVANCE platform, and our solid relationships with OEMs and dealers. These advantages position us to offer unparalleled value to manufacturers, dealers, owners, and passengers, and we continue investing in fortifying each of them. To begin with our proprietary network, we operate the only air-to-ground network in North America, with exclusive licenses to provide ATG connectivity to aircraft. The advantage of ATG lies in its lower latency compared to geo-satellite competitors, as our antennas are within 200 miles of the aircraft, unlike geo satellites at 22,000 miles. This proximity allows our antennas to be more compact and consume less power, enabling us to fit them on a wider variety of aircraft and attain a larger addressable market. Furthermore, ATG connectivity is considerably less expensive than geo satellite solutions. Building an ATG network is no small feat, requiring significant investment and a commitment to covering operating losses until enough customers are onboarded. We’ve successfully raised over $800 million in equity, supported by positive margins from providing ATG to commercial airline customers. A primary goal of ours is to continually enhance performance to meet our customers’ expectations. We are on track to deploy the world’s first 5G ATG network with nationwide coverage, expected to launch with 150 sites in the second half of 2022. In Q3, we achieved several crucial deployment milestones, advancing from design development to the certification of aircraft hardware and ground stations. We have placed orders for our tower test-bed equipment, and released installation and pricing information to OEMs and dealers. Based on modeling and testing, we expect our Gogo 5G network will deliver around 25 megabits per second on average, with peak speeds reaching 75-80 megabits per second, a substantial jump from the current 2-7 megabits per second provided to our existing customers. As business travelers require reliable video conferencing and leisure travelers seek high-quality streaming, Gogo 5G speeds will be a key differentiator for us. We also announced Jet Edge, the largest operator of super midsize and large cabin private jets, as our launch customer. They have AVANCE L5 installed on most of their managed fleet and plan to upgrade 50 of those aircraft post-launch. The upgrade from AVANCE L5 to Gogo 5G will be straightforward; it involves replacing two current L5 antennas with new 13-inch antennas and completing a software update over the air. Looking ahead, we have a roadmap for future enhancements to our ATG network. Our second main competitive advantage is our AVANCE platform, a software-centric system encompassing hardware built on common components, all operating on a unified system. AVANCE allows us to enhance customer service, add apps over the air for increased revenue and retention, and adopt new network technologies for improved capacity and performance. For instance, our automated ticket creation feature allows the system to monitor itself, creating tickets proactively when issues arise. Our mix app ensures that customers can adjust service levels for different users on the aircraft, optimizing their experience. AVANCE’s flexibility also allows it to integrate with LEO networks being launched in the coming years. Our third competitive advantage is the strong relationships we have built over the years. With a network of 120 dealers worldwide, these mutually beneficial relationships are invaluable. They are invested in Gogo and trust that we will provide quality products and service on time. This trust was demonstrated when Duncan Aviation announced it would modify all its AVANCE L5 installations to include Gogo 5G, covering over 30 aircraft models. Now, onto the competitive landscape. Competitors can be divided into geo-satellite service providers and potential new ATG entrants. Geo-satellite providers boast broader coverage, but since the majority of business aviation flights occur in North America, Gogo remains well-positioned. Our advantages include smaller, lighter antennas that can serve a wider variety of aircraft, lower latency crucial for interactive applications, and more cost-effective offerings in terms of equipment, installation, and service. Potential new ATG entrants face numerous challenges, primarily credibility issues with distribution channels and customers. After repeatedly missing their rollout targets, they have recently set new goals but are struggling to gain trust in the market. Their announced data speeds of 5-8 megabits per second, with peak speeds of 15 megabits, fall short of our expected Gogo 5G speeds. In addition to our distribution and speed advantages, new entrants will also encounter challenges regarding antenna size and will need substantially more capital to achieve operational profitability, making the entry barrier considerable. We also see exciting possibilities to collaborate with new entrants in the LEO satellite service market. Two of the three upcoming LEO providers are pursuing B2B models, and we are in discussions with them to provide a LEO global broadband product for our targeted market. This would enable us to include the 14,000 business aircraft flying internationally in our addressable market and offer integrated AVANCE ATG and LEO products for North American heavy jets. The third LEO provider, Starlink, is pursuing consumer and military markets, which generates substantial revenue compared to the business aviation sector, which is heavily regulated and complex. Given these challenges, we don’t foresee Starlink prioritizing our market. We believe we are in an excellent position to offer a LEO add-on to our AVANCE platform, leveraging our distribution channel relationships and establishing a significant AVANCE install base ready for LEO integration. To briefly cover our updated 2021 financial guidance, we have raised our expectations for adjusted EBITDA and free cash flow, projecting that full-year revenue will come in at the higher end of our previous range. This is the third time we have increased our 2021 guidance, driven by remarkable growth in equipment sales and high-margin recurring subscription service revenues following the activation of our equipment. The margin growth, paired with relatively consistent operating costs, will lead to substantial operating leverage and cash generation following the completion of our 5G network in 2022. Next year, we expect continued revenue growth but want to remind investors that it will require investment as we finalize the 5G network, which will subsequently support growth in our adjusted EBITDA and net income. We look forward to the future and Gogo’s potential to provide for our customers, shareholders, and employees as we implement our strategy for long-term value creation. Now, I'll hand it over to Barry.

Barry Rowan, Executive Vice President and CFO

Thanks, Oak and good morning, everyone. As Oak mentioned, the tailwinds driving the business aviation market are strong, and by all indications are sustaining and picking up momentum. This coupled with Gogo’s business execution creates a strong foundation for continued profitable growth. As we have demonstrated, our financial model is a virtuous circle. Strong equipment shipments drive high margin recurring service revenue, leading to strong cash flow that we can invest in enhancing our network, which in turn attracts new customers, generates more usage and drives more equipment shipments. Our record third quarter results demonstrate that our model is firing on all cylinders, as we reached an exciting inflection point for the company, which was Gogo generated positive net income and EPS for the first time, as Oak mentioned. Strong equipment shipments are de-risking our long-term targets, and we continue to strengthen our balance sheet to enhance our foundation for innovation, investment in future success and eventually capital returns. I will walk through the key results of the quarter starting with the top line, which are a reflection of the accelerating strength of the business aviation market and Gogo’s unique ability to capitalize on that growing demand. Total revenue for the third quarter was a record $87.2 million, increasing 31% year-over-year and 6% sequentially, fueled by strong growth in both service and equipment revenue, as demand continues to exceed our expectations. Our record service revenue of $66.2 million in the third quarter represents an increase of 24% year-over-year and was driven mainly by more AVANCE units coming online. On a sequential basis, our third quarter service revenue grew 5%, excluding the one-time benefit of $1.8 million in our second quarter from recognizing deferred revenue from a specific customer contract. Growth of our recurring subscription-based service revenue is a key long-term value driver of our business. ATG aircraft online reached 6,154, up 10% compared to the third quarter of last year, and 2% compared to the second quarter of this year. New customer activations remain strong, representing over 60% of total activations during the quarter, which is in line with the last several quarters. As we said over the past year, penetration of the AVANCE platform into both our installed base and with new customers is a centerpiece of our long-term strategy. AVANCE provides unparalleled extensibility as our technology evolves, laying the foundation for even stickier, enduring relationships with our customers. In the third quarter, total AVANCE units online grew to 2,237, an increase of 46% compared to Q3 2020. This is comparable to AVANCE growth for the last five quarters, which ranged from 42% to 51%. AVANCE units comprise 36% of total AOL, as of September 30, 2021, a meaningful increase from the 27% a year ago. As we grew our AOL, ARPU also grew to $3,264 representing an increase of 9% year-over-year, excluding the one-time benefit from last quarter’s deferred revenue, ARPU increased 2% sequentially. Looking ahead, we expect our 2021 revenue to be at the high end of the guidance range we announced last quarter, reflecting our expectations that service revenue for the full year 2021 will grow at least 20% over the full year 2020. Turning out to equipment revenue, Gogo delivered very strong equipment revenue of $21 million, a dramatic 59% increase year-over-year, and a 19% increase sequentially due to strong demand for AVANCE L3 and L5 products. We had a record 264 AVANCE product shipments in the third quarter, which represents 58% growth from Q3 2020 and 33% growth sequentially. It’s worth noting that our expectations for 2021 AVANCE shipments are now more than 30% ahead of our original 2021 internal budget. Our 2021 revenue guidance reflects equivalent revenue for the full year 2021 at 30% above 2020 levels. The strong performance is based on the underlying strength of the market, as well as the seasonal dynamics in our business. We generally see equipment sales back-loaded to the second half of the year and we expect that same seasonality to occur this year. As we shared at the end of September when we updated our long-term financial targets, we expect continuing strength in AVANCE shipments with growth of 20% to 25% next year and this is on top of this year’s strong performance. Let me add one final point regarding equipment shipments and that is to underscore the important results achieved by our production operations team in the face of the global supply chain crisis. As Oak described, our efforts to efficiently manage our supply chain benefited from our AVANCE platform hardware strategy, which is focused on standardizing common component tree across our L3 and L5 products to manage our costs and drive quality. Gogo is also committing $10 million in cash for additional inventory purchases during 2022 to ensure we meet demand and to reduce our supply chain challenges. The outstanding results achieved by our supply chain team certainly de-risked our long-term guidance by ensuring that we can deliver on equipment orders that already stretch well into 2022. Now I’ll turn to a discussion of our profitability for the quarter. Our stronger than expected performance in the third quarter reflected the power of our business model, which flows from our recurring high margin service revenue. Gogo delivered service margins of 80% in the third quarter, an increase of 300 basis points sequentially. This increase was mainly driven by a one-time $2 million catch-up credit for federal Universal Service Fund regulatory surcharges from which we have recently become exempt. Telecommunications companies must pay a percentage of their interstate and user revenues to the fund and due to changes in our operating structure in 2020, prior to the sale of the CA division, Gogo is now exempt from these surcharges and this credit was for the seven months from January through July of this year. Beginning in August 2021 and going forward, we will have $3 million in annual savings as a result of the exemption and this impact was factored into the long-term targets we announced in late September. Excluding this credit, service margin would have been in line with expectations and approximately even with last quarter 77%. As we’ve said previously, we anticipate service margins to come down to the mid-70s in the fourth quarter of this year, and for 2022 and then to increase over the longer term as we benefit from increased operating leverage. On the equipment side, margins increased to 41% in the third quarter, an increase of 320 basis points sequentially driven by strong equipment sales and mix skewing more significantly toward AVANCE products in line with our strategy. This profitable customer acquisition is a significant differentiator of the unit economics of our business, particularly relative to traditional telecom and other digital infrastructure businesses. We continue to expect equivalent margins for the full year 2021 to be above the 2020 levels, even as margins in the second half are expected to be lower than in the first half of the year, largely due to mix between L3 and L5 equipment shipments. It’s important to note that while equipment margins are lower on the less expensive L3 product, service margins are quite similar across the two product offerings, which of course is most important for our overall business model. Our L3 product is delivering on its strategic objective of penetrating the market for smaller airframes, as demonstrated by our continued momentum in personal jets, including our previously announced agreement with Cirrus as well as the HondaJet announcement Oak referenced on this call. Moving to operating expenses, Gogo’s third quarter combined engineering design and development, sales and marketing and G&A expenses of $26.7 million increased 16% year-over-year. This was primarily due to a one-time catch-up in non-cash stock-based compensation expense related to vesting that occurs on employee retirements and primarily impacted G&A. Q3 OpEx spending did benefit from a reduction of $3 million relative to our previous expectations, half of which are permanent savings and half being deferred to future periods. We continue to expect G&A to decrease in 2021 relative to 2020. We also remain on track to deliver our targeted $10 million reduction in G&A, excluding non-cash stock-based compensation from the 2020 level by the end of 2022. Now I’ll provide some additional details on our Gogo 5G program and spending profile. As I’ve mentioned, we are on track to deploy our 5G ATG network in the second half of 2022. In the third quarter, we spent a total of $1.8 million in external Gogo 5G development and deployment costs, split evenly between CapEx and OpEx. Two factors contributed to the level and timing of Gogo 5G-related spending. First, we reached the accounting requirements to capitalize Gogo 5G spend earlier than originally budgeted. We demonstrated technical feasibility in early 2020 and achieved R&D completion milestones for Gogo 5G in July of this year. As a result, we expect to capitalize $3 million of Gogo 5G costs in 2021 that were initially anticipated to be treated as OpEx. Secondly, we are expecting that some OpEx and CapEx spend projected previously in Q4 2021 will shift to the first quarter of 2022. I want to be clear that these shifts in our expense schedule do not change our expectations on the timing of network deployment. As we look ahead, our Gogo 5G spend is expected to ramp significantly in the fourth quarter, and to peak in the first quarter of 2022 in anticipation of our launch in the second half of next year. We expect that over 90% of our total Gogo 5G investment of approximately $100 million will be completed by the end of 2022. It’s significant that we are able to fund the entire remaining amount of Gogo 5G deployment costs from internally generated cash flow. To reiterate our long-term expectations, after Gogo 5G is launched, we expect ongoing capital expenditures in the $15 million to $20 million range annually, supporting an even stronger adjusted EBIT to free cash flow conversion rate in 2023 and beyond. Now, on to our bottom line. Our adjusted EBITDA of $40.8 million was a new record and represents a 35% increase year-over-year and an 11% increase sequentially. This record certainly reflects the strength of our business model and the underlying trends driving our business. As I mentioned a few minutes ago, our third-quarter adjusted EBITDA does include some benefits that we don’t expect to recur, namely the $2 million credit for Federal Universal Service Fund surcharges. Our full year 2021 guidance for adjusted EBITDA, which we increased to a range of $140 million to $145 million from our previous guidance of more than $130 million reflects somewhat lower adjusted EBITDA in the fourth quarter compared to this quarter. This is due to the one-time surcharge credit in Q3, and lower equipment margins and higher operating expenses related to 5G deployment expected in the upcoming quarter. As we mentioned earlier in the call, Gogo achieved a tremendous milestone in our third quarter. We achieved positive net income for the first time. During this quarter, we achieved $19.7 million in net income from continuing operations, which translated into $0.18 in basic earnings per share and $0.16 diluted earnings per share from continuing operations. Free cash flow for the quarter was $24.6 million. This reflects our strong top line growth and healthy 47% adjusted EBITDA margins, as well as the impact of the comprehensive refinancing we completed in April, which materially reduced our annual interest expense and enhances our strategic and financial flexibility. While there will certainly be variation from quarter to quarter, particularly due to the timing of our Gogo 5G investment, our expectation is to deliver positive annual free cash flow going forward. Based on this performance, we have increased our free cash flow guidance for 2021 and as you know, we substantially increased expectations for free cash flow in 2023 and 2025, several weeks ago. Now let’s turn to a discussion about the balance sheet. Gogo is in a very strong liquidity position with $133.2 million in cash on hand as of September 30, and our $100 million revolver remains undrawn. As at the end of the third quarter, we had approximately $826.2 million in outstanding debt, including the $723 million Term Loan B we recently put in place and approximately $103 million in outstanding convertible notes. Our strong financial performance has reduced our net leverage ratio to 4.7 times, based on our year-to-date annualized results as of September 2021. This is a dramatic improvement over where we were a year ago just before the CA divestiture. Based on annualizing the three quarters of adjusted EBITDA from continuing operations for the first three quarters of 2020, our net leverage ratio for continuing operations was 10.1 times as of September 30 a year ago, more than double our current leverage ratio. I’m also pleased to highlight one of the provisions we’re able to negotiate as a part of our most recent financing, which was that our interest rate would decline as our leverage declines. During the third quarter our lower leverage ratio enabled us to achieve the maximum 50 basis point reduction in the interest rate on our Term Loan B, as provided by our contract. Our interest rate will be reduced to LIBOR plus 3.25% with a 75 basis point LIBOR floor and a revolver commitment fee will be reduced by 25 basis points. These reduced rates will take effect in November and in aggregate will result in approximately $3.8 million in annual savings. Assuming we settle conversions at $103 million in convertible notes maturing in May of 2022 in stock, as currently planned, we expect our net leverage ratio to be below four times by the end of 2022. With this final step in our comprehensive refinancing plan, our annual interest expense will have been reduced from $111 million before we were able refinancing to approximately $30 million annually, after the equalization of the remaining convertible notes and reflecting the reduced interest rates due to our lower leverage ratio, as I mentioned a moment ago. Our strong balance sheet and financial performance afforded Gogo unprecedented levels of strategic and financial flexibility. On previous calls, we indicated that we would pursue a balanced capital allocation strategy focused on four primary areas in the following order of priority. First is enhancing our network through the deployment of Gogo 5G. Second, is reducing overall leverage to an appropriate operating level. Third is strategically investing in our business in ways to capitalize on market opportunities or further strengthen our competitive position, such as the global broadband opportunity. And fourthly, over the longer term, considering returning capital to shareholders as appropriate. We have made considerable progress on the first two of these with Gogo 5G on track and on budget, and the natural deleveraging that has occurred on an accelerated basis with a stronger than expected operating performance. We are now in a position to more actively consider the latter two priorities. Over the coming quarters, we will continue to assess value-creating investment opportunities, like the LEO-based global broadband opportunity. We will then be in a position to begin considering the potential timing of returning capital to shareholders in the context of a targeted capital structure. With that, I’ll provide some additional color on our updated financial guidance. As we announced in our press release this morning, we expect our full year revenue to come in at the high end of the $325 million to $335 million range we had previously communicated. We also raised our 2021 adjusted EBITDA guidance to a range of $140 million to $145 million, versus at least $130 million, as we previously expected. This guidance excludes approximately $2 million of separation migration costs related to the sale of the CA division. In terms of free cash flow, we now anticipate generating at least $40 million in free cash flow for the 2021 fiscal year, compared to the $25 million to $30 million to which we had previously guided. And finally, given the Gogo 5G spend dynamics I spoke to earlier, we now anticipate 2021 capital expenditures at the low end of our $20 million to $25 million range. While we plan to provide full year 2022 guidance on our next earnings call, as we normally do, we thought it would be helpful to offer some high-level perspective, as we finish out 2021 and look forward to 2022. We continue to expect significant top line growth. However, we want to be clear that we don’t expect our bottom line to continue to grow at the pace we are delivering in 2021. For one, we will not have the approximately $4 million one-time benefit as we did in 2020 with a deferred revenue recognition and USF surcharge credit. We expect service and equipment margins to contract somewhat next year and we will be significantly ramping investments to deploy our Gogo 5G network. In addition, Gogo will be returning to more normalized post-COVID spending on sales and marketing, particularly as we continue to commercialize Gogo 5G. And we anticipate that meeting the significant growth in advanced unit shipments expected in 2022 will require some investments in working capital. Over the longer term, we continue to drive toward the long-term financial targets for revenue growth, adjusted EBITDA margin and free cash flow we announced in late September, which remain unchanged. As a reminder, the long-term financial targets are as follows: Revenue growth at a compounded annual growth rate of approximately 15% from 2020 to 2025, annual adjusted EBITDA margin reaching 45% in 2025, adjusted EBITDA margin may decline modestly from the higher than expected level achieved this year, due to the investments we described for next year for example, but our target of 45% in 2025 remains unchanged. Free cash flow at approximately $125 million in 2023 following the deployment of the Gogo 5G network in 2022, and approximately $200 million in 2025. In conclusion, our business is really hitting its stride, leveraging our unique competitive advantages to capitalize on the positive trends driving growth in the attractive underpenetrated BA market. Our equipment shipments and supply chain strength continue to de-risk our long-term financial projections as more aircraft come online and feed the virtuous circle that creates value for our customers, shareholders, and employees. Before we turn the call over for your questions, I’d like to thank the Gogo team for the outstanding performance we delivered this quarter. Again, our continuing progress, including reaching the exciting milestone of achieving positive net income, is a testament to the hard work of our talented team, so thank you.

Operator, Operator

Your first question comes from Phil Cusick from J.P. Morgan. You may now ask your question.

Unidentified Participant, Analyst

Good morning, everyone. I'm asking on behalf of Phil about your 2022 goal for the 5G launch. What were the factors influencing that, and how is the supply chain functioning for it? Additionally, can you confirm if you're seeing revenues from the Intelsat agreement, and will that increase as airlines resume operations and flight counts rise? Thank you.

Oakleigh Thorne, Chairman and CEO

Thanks. I’ll address the first part and let Barry handle the Intelsat aspect. We are very confident in delivering in the second half of 2022 and do not anticipate any issues with the timeline. We previously faced a 5G chip problem, which has now been resolved, and everything is on track. Although there was a six-month delay with that chip, we successfully managed the project to remain on schedule. Regarding the supply chain, we are in excellent shape; we have secured all necessary supplies and parts to fulfill our commitments for this year, as well as for the first and second quarters of next year. For the third and fourth quarters next year, we have also secured all parts needed to achieve our current projections of 25% unit growth. We are currently entering demand into our systems for growth greater than 25%, anticipating a potential surge in orders like we experienced this year. We remain cautious but confident in handling any increased demand in the third and fourth quarters. We are already placing orders 18 months in advance to ensure supply, which means we are actively ordering for 2023. Overall, we feel positive about our performance in this area. Concerning 5G, most of the supply pertains to the network and the equipment needed to operate it, and that is arriving on schedule. The airborne equipment is undergoing certification, but we do not foresee any supply chain issues since we are working with three reliable vendors on this project, and everything is running smoothly. It’s worth noting that this project utilizes a lot of the same components as our AVANCE L5 and L3 products, ensuring consistency in the supply chain. Overall, we feel confident.

Barry Rowan, Executive Vice President and CFO

And on your second question regarding the Intelsat revenue, yes, that is on track. As a reminder, we have a 10-year contract with them and the amount of the minimums grow over time to total $177 million over that 10-year period. We are on track for that and there is a step up in that rev share amount as the 5G deployment takes place.

Unidentified Participant, Analyst

Great. Thank you, guys. Congrats on the quarter.

Oakleigh Thorne, Chairman and CEO

Thanks a lot.

Operator, Operator

Your next question comes from the line of Scott Searle from Roth Capital. Your line is now open.

Scott Searle, Analyst

Hey, good morning. Nice quarter. Thanks for the color, as always, and thanks for taking my questions. Just a real quick clarification, looking to ‘22, talking about 20% plus unit growth, it sounds like you’ve got the supply chain well in order. I’m wondering what you have in terms of visibility to order coverage at this point in time and kind of how that breaks down when you think about the attach rate on new aircraft coming off versus retrofits. And I had a couple follow ups.

Oakleigh Thorne, Chairman and CEO

Yeah, I’ll take the beginning of that. And right now about 6% of our units are committing to our aftermarket, about 40% line-fit and that’s been kind of a skew we’ve seen develop here as I think we get more penetration in older aircraft in the market. So that is a trend we would anticipate to continue. Barry, do you want to talk about the order flow?

Barry Rowan, Executive Vice President and CFO

Yeah, in terms of the orders, Scott, we have a strong backlog, actually the highest we’ve had in our company’s history and the lead times are a bit longer than where they had been. They’d normally run from the time that somebody starts the shipment, one to two months. Those are stretching out closer to six months now as the demand has so significantly outstripped our previous expectations. So we’re now taking orders to be delivered in the May timeframe. But with supply chain work, we’re continuing to work that down and expect to be able to return to those shorter lead times over time, but it’s really based on the booming demand for the equipment that we’ve seen.

Scott Searle, Analyst

Great, thanks very helpful. And lastly, if I could, looking at the equipment gross margins are very high at 40% but then you start to talk about how AVANCE is growing both for the L3 and the L5, and then the low churn rates, which translates to basically aircraft, 18 years in the field. And what you can do with the AVANCE in terms of the easy upgrade to 5G, so basically, you’re securing that customer. So I’m wondering how you’re thinking about being more aggressive on the AVANCE front because that really locks in your customer effectively for the next 10 to 15 plus years. If you accelerate that, do you get more aggressive on the gross margin or if you don’t have to, at this point in time, simply because of the supply-demand balance within the industry? And also, as part of that, I’m kind of wondering what you think the overall installation capacity from an industry standpoint is in 2022? Thanks.

Oakleigh Thorne, Chairman and CEO

I’ll start with that. Driving AVANCE penetration is a key part of our strategy. Currently, we don’t need to push for more orders due to some supply chain constraints. We have managed to achieve 25% growth compared to this year, and we are working to ensure we can meet demand if it exceeds that. In our guidance, we noted lower equipment margins for the next couple of years, partly to accommodate incentives we may offer to encourage upgrades from classic to AVANCE products. Additionally, the AVANCE’s multiple bearer capabilities allow us to easily add a global broadband LEO product, giving us a competitive edge against potential satellite rivals. Encouraging shifts to AVANCE is crucial; it is growing at 46% this year. We hope by the end of next year, it will represent about 50% of our install base, and we will continue to promote this growth.

Barry Rowan, Executive Vice President and CFO

Scott, regarding your question about the margins, service margin is the primary contributor to our overall economics and makes up about 90% of the gross margin dollars. This is the key factor influencing Gogo's value creation. For the equipment margins, they were strong this quarter, but we anticipate a decline as we launch Gogo 5G. We find it worthwhile to invest in the transition to 5G and to increase AVANCE penetration for various reasons we've discussed. As we introduce more AVANCE products, it enhances customer retention and ensures they can operate as we've mentioned. Even though we expect some compression in the equipment gross margin percentages over the next couple of years, it remains beneficial for our overall business model.

Oakleigh Thorne, Chairman and CEO

Thanks. Yeah, then in terms of the MRO capacity, I think there’s plenty of MRO capacity to go up to now to install, I don’t think that’s really an issue. Now, the thing is that you have to be a compelling product for the MROs to sell something that they make money on and that makes our customers happy. And, right now, we’re really in the catbird seat on that and the distributors are very happy with their relationships with Gogo. So that’s the way to keep another sort of weapon in driving that penetration. And right now, we don’t really see that as a limiting factor.

Scott Searle, Analyst

Great. Thanks, guys. Nice quarter.

Barry Rowan, Executive Vice President and CFO

Thanks, Scott.

Oakleigh Thorne, Chairman and CEO

Thanks, guys.

Operator, Operator

Your next question comes from the line of Ric Prentiss from Raymond James, your line is now open.

Unidentified Participant, Analyst

Hey, guys, this is Brent on for Ric. Good morning. ED&D came in a little bit lower than you expected this quarter. Were there any deferred costs within that category or one-timers? And how should we think about that trending going forward?

Barry Rowan, Executive Vice President and CFO

Yes, it did come in a little bit lower, there were a couple of reasons, some of which we pointed out. One was that we were able to capitalize more of the cost than we had previously anticipated because of having crossed the technical feasibility proof and milestones for the Gogo 5G products and that certainly helped. There was a couple million dollars that will be deferred, some of which will be deferred into next year. So we do expect ED&D spending to ramp in the next quarter as we continue to invest in the Gogo 5G product.

Unidentified Participant, Analyst

Got it. Thanks. And then my other question is, you guys have talked about some of these new markets that could provide upside to your expectations, general aviation and international and connectivity to the cockpit? Just could you provide an update on where you’re most encouraged and which of these markets you think could provide the most upside to your long-term expectations?

Oakleigh Thorne, Chairman and CEO

Yeah, I’ll take that. I think the one that would have the most upside would be the global broadband initiative. However, that’s still in the business case stage and we have not formed any formal relationships with external parties or gotten Board approval to move ahead with that. That’s something we’ll talk about in more detail when we get there. Where we’re having the most success right now, of course, is moving down market, and by that I mean into smaller aircraft that’s both general aviation aircraft like the Cirrus Vision Jet and small business aircraft like the HondaJet STC; STC we announced a couple of weeks ago. So, right now we’re having good success. We are in an area where it’s hard for our competitors to compete, and that is aircraft that require small form factors like our AVANCE L5 and we’re going to keep driving and we keep looking at other ways we can modify our products to further drive penetration there. The two big things so far have been the small form factor L3 and then the lowering of the flight floor or altitude floor for getting connectivity to 3,000 feet, because smaller planes tend to fly shorter routes and not get over 10,000 feet very often. So there are other things we can do that we’re working on to further drive that. So those would be the two big ones. By far the biggest, that would drive probably wouldn’t start driving revenue until the second half of the decade, but we think it would accelerate growth dramatically for the second half of the decade.

Unidentified Participant, Analyst

Great, thanks.

Operator, Operator

Your next question comes from the line of Louie DiPalma from William Blair. Your line is now open.

Louie DiPalma, Analyst

Both, Barry and Oak, good morning.

Oakleigh Thorne, Chairman and CEO

Hi, Louie. Good morning. Good morning, Louie. How are you doing?

Louie DiPalma, Analyst

Great. Have you been able to test the bonding of your licensed four megahertz of 850 megahertz band spectrum with the unlicensed 60 megahertz of Wi-Fi spectrum and have the results been positive? Does the bonding work?

Oakleigh Thorne, Chairman and CEO

Yes, it’s actually aggregation and not bonding; there’s an engineering difference between the two. Currently, we have our first end-to-end aircraft setup that includes tower equipment and data center, and we’re testing that right now, Louie, so more updates will come in the next call.

Louie DiPalma, Analyst

Great. And Oak, you also mentioned how the existing AVANCE system will easily support future LEO broadband antennas and systems. Will AVANCE also support the new Iridium Certus L-band service? And are you still working on developing your own Iridium Certus antennas?

Oakleigh Thorne, Chairman and CEO

It could support Certus or any other with a new antenna similar to the LEO. Installing LEO was necessary to get an antenna. We’re not a Certus dealer, so we continue to sell many Iridium products and have plans for what I would describe as narrowband that we’re not quite ready to discuss yet. However, that would not provide much bandwidth for us like LEO would, so we’re not concentrating on that.

Louie DiPalma, Analyst

Right. And one final one financially for Barry. Even with this quarter’s upside, do you still project that your 2022 revenue growth will be at the upper end of your 10% to 15% long-term guidance growth range?

Barry Rowan, Executive Vice President and CFO

Well, we actually going to increase the expectations for service revenue growth, saying that we expect it to be 15% each year compounding from ‘22 forward, so, yes, we do expect it to be up at that 50% range for next year.

Louie DiPalma, Analyst

Awesome. Thanks, guys.

Oakleigh Thorne, Chairman and CEO

Thank you.

Operator, Operator

Your next question comes from the line of Jonnathan Navarrete from Cowen. Your line is now open.

Jonnathan Navarrete, Analyst

Hey, good morning. This is Jonnathan in for Lance. Congrats on the quarter. My first question is, what are the trends that the company is seeing in terms of unit expansion and pricing into the fourth quarter? And perhaps any viewpoint on how the beginning of 2022 will look in terms of expansion and pricing?

Oakleigh Thorne, Chairman and CEO

Barry, you want to take it?

Barry Rowan, Executive Vice President and CFO

Are you talking, Jonnathan, about basically what we see happening in the ARPU over time? That’s your question in the fourth quarter going forward?

Jonnathan Navarrete, Analyst

Right, like, what are the trends that you’re seeing right now, and maybe what we can expect in ‘22, the beginning of it, at least?

Barry Rowan, Executive Vice President and CFO

Our ARPU has increased over the past few years, primarily due to the high demand for more bandwidth that has led people to upgrade their plans. We anticipate this trend will continue. In the long term, there are two factors pushing ARPU upward and one factor pulling it down, though the latter is justifiable. The first upward factor is the ongoing shift towards higher value, higher megabyte plans, particularly with the introduction of the full streaming plan. We expect this trend to persist as consumers desire more megabytes. The second factor contributing to growth is Gogo 5G; we are confident that we can charge more for it due to the enhanced performance. Conversely, the downward pressure comes from our entry into the light jet turboprop market. These aircraft typically operate shorter routes, resulting in a lower average revenue per user. However, it’s important to note that in-flight revenue remains comparable to other markets, making it a valuable business. Overall, while this will impact ARPU, we foresee a continued increase in ARPU as we move forward.

Jonnathan Navarrete, Analyst

Understood. Thank you. Very helpful. And just two more on my end, how many L5s were installed during the quarter, and the last one is in terms of the 15% revenue CAGR from 2020 through ‘25, what percent of the market share does that imply? Thank you.

Barry Rowan, Executive Vice President and CFO

Yeah. Oak, do you want to take the second part of that question and I we see unit volume market share growing over time and I can comment that.

Oakleigh Thorne, Chairman and CEO

Yeah, I will take that one. We’ll pick up the data point on installs. We don’t really look at market share as an internal measure, to be honest it’s more something that investors are concerned with. We focus on unit growth and growth in the number of service plans we have and pricing of those service plans. So there is a lot of room in this market, if there are other entrants. 70% roughly of the market is unpenetrated today, and frankly, we project, we’ve shared our projections through the end of 2025 and at the end of 2025, assuming success of a potential APG entrant and assuming that our geo competitors succeed on their plans and continue their current growth trajectories, the 50% of the market is still unpenetrated in 2025. So there’s enough whitespace for everybody and as for market shares, it’s not something we focus on as much as unit growth and our own growth.

Barry Rowan, Executive Vice President and CFO

And then to answer your question, Jonnathan, about the shipments, that were 139 shipped in last quarter.

Oakleigh Thorne, Chairman and CEO

That’s shipments, I think he was asking about installs. Total there, yeah, 244 AVANCE platforms shipped. You gave a five number. I don’t have the install number handy but it would be simply the growth in units online for L5.

Barry Rowan, Executive Vice President and CFO

Yeah, 107 units online growth for L5.

Jonnathan Navarrete, Analyst

Thank you.

Operator, Operator

Your next question comes from the line of Chris Sakai from Singular Research. Your line is now open.

Chris Sakai, Analyst

Hi, good morning. I have a question about your marketing spend. You recently mentioned that you plan to increase it moving forward, and I wanted to know if you have any metrics regarding your spending on new customers and how that will change in the near term.

Barry Rowan, Executive Vice President and CFO

Your marketing spend was artificially low during COVID for obvious reasons where it didn’t make sense to do marketing during that period of time, really. So, marketing spend is coming back up. We see it remaining relatively constant as a percentage of revenue going forward, but it will grow as the overall top line grows. As we look to 2022, as I mentioned, we expect the marketing spend to grow during that year as we, one, normalize it back to those levels, but secondarily, as we invest in marketing and promoting the exciting Gogo 5G product.

Chris Sakai, Analyst

Okay, great. And then for when would you expect L3 sales to really pick up and maybe become higher than L5 sales?

Barry Rowan, Executive Vice President and CFO

We don’t necessarily see it getting higher than L5 but they certainly have picked up and when you look at the relative percentages of L3 versus L5, if you go back a couple of years ago, it was about half the number of L3 versus L5, and now it’s over 80%. So, we see that ratio continuing to grow but we also expect L5s to be very strong going forward and particularly because you have the upgrade capability directly from L5 to go 5G for example. Oak, did you want to add something there?

Oakleigh Thorne, Chairman and CEO

Yeah, we do see L3 sales to be projected they will narrow with L5 sales over the four-year plan; they don’t quite reach that level though, the L5 level.

Chris Sakai, Analyst

Okay, great. Thanks.

Operator, Operator

There are no further questions at this time. I’ll turn it over back to William Davis.

Will Davis, Vice President of Investor Relations

Thank you, Mika and thank you everyone for joining our third quarter conference call. This call is now concluded and you may disconnect.

Operator, Operator

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