Earnings Call Transcript - GOGO Q2 2023

Operator, Operator

Good morning and thank you for standing by. Welcome to the Second Quarter 2023 Gogo Inc. Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to turn the conference over to your speaker today, Will Davis, Vice President of Investor Relations. Please go ahead.

Will Davis, Vice President of Investor Relations

Thank you, Catherine and good morning everyone. Welcome to Gogo’s second 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 risk factors in our annual report on Form 10-K and 10-Q and other documents that we have filed with the SEC. In addition, please note that the date of this conference call is August 7, 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 second quarter earnings release. This call is being 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 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 Q2 2023 earnings call. Though Gogo executed well in Q2, the results were not up to our own high expectations. On the positive side, we achieved strong new activations. The AVANCE platform now accounts for more than 50% of our install base and we hit some key milestones on our strategic objectives such as our LEO global broadband product, now dubbed Gogo Galileo. On the flip side, we suffered unusually high suspensions, which we will cover in detail in a moment. We faced a further delay in the delivery of our 5G chip, both of which have caused us to lower guidance for the year and in our long-term model. There are a few headwinds, but they do not change our view that Gogo is poised for explosive growth in 2025 and beyond. We serve a highly unpenetrated market, with 78% of the world’s business aircraft flying without a broadband solution today. We see unprecedented demand with a surge of travelers choosing to fly private aviation post-COVID and those travelers demanding connectivity. We have an attractive business model, based on recurring service revenue that drives strong cash flow. We are incorporating new technologies into our platform to deliver orders of magnitude improvements in services to dramatically increase our total addressable market and to enhance our competitive position. We have a strong balance sheet that enables us to make the necessary investments to deliver those new technologies. The price where we have seen that explosive growth and driving substantial returns for shareholders is the two-year investment cycle we are now in. We have built Gogo 5G, developed Gogo Galileo, and executed the FCC rip-and-replace project, all of which I will deep dive into in a few minutes. This morning, I am going to start by getting deep into the data for the quarter to demonstrate that many of the headwinds we faced this year are temporary in nature. I will then update you on our strategic initiatives, and finally, I will spend a moment on the competitive context in which we are executing those initiatives. I will then turn it over to Jessi to dive into the numbers and the rationale behind our guidance update. So, let me start with demand. In the quarter, we saw a little rebound in demand as measured by flight counts. Gogo-equipped aircraft flew 5% fewer flights than in Q2 2022, but the gap to Q2 2022 actually narrowed each month from minus 7% in April to minus 4% in May and minus 3% in June, which frankly could be explained by the number of aircraft currently caught in maintenance traps at dealers, which I will touch on in more detail when I discuss suspensions in a moment. More importantly, we continue to see strong growth from pre-COVID 2019 flight counts, with Q2 up 30% from Q2 2019, indicating that we have reached a new sustainable plateau of flight demand. That thinking is supported by the latest annual survey of private air passengers from Doug Gollan’s Private Jet Card Comparisons, where 92.3% of those who started private travel during COVID said that they plan to continue flying privately in the future. Meanwhile, usage per flight hour surged 20% over Q2 2022 and up 67% from 2019, indicating the demand for Wi-Fi in aircraft continues to grow. Now, I will turn to drivers of our high-margin recurring service revenue, average revenue per aircraft (ARPA) and aircraft online (AOL). Service revenue for the quarter set a record and was up 8% over Q2 2022. But growth slowed from Q1 as suspensions weighed down AOL. ARPA for the quarter was relatively flat as continuing strong plant upgrades were offset by a shift in product mix as more new AVANCE L3s came online than L5s. As for AOL, we are having a record year for activations. But sadly, we are also having a record year for suspensions that we feel are putting temporary downward pressure on AOL. More on that in a moment. On the activation front, driving AVANCE activations is our primary strategic objective, because it enables customers to easily upgrade to new networks and technologies with Gogo as opposed to spending more money and time in the shop installing competitive systems. This should manifest itself in extended customer lifetimes and more high-margin recurring service revenue for Gogo. We had 229 new activations in Q2, our second best quarter ever, up 13% from Q2 2022 and up 10% from Q1 2023. We are projecting a record 950 plus new activations for the year, up more than 15% from 2022 and a 20% jump in AVANCE units online. We are also really pleased that in Q2, for the first time, AVANCE units online exceeded 50% of our total ATG units online, further adding stability to our service revenue portfolio. All that said, we feel that growth in new activations has slowed modestly, as customers wait to see how Gogo 5G and Galileo perform and see what potential competitors may offer in terms of product and customer support. Now for the bad news, growth in suspensions and deactivations, which we believe is a temporary issue. For purposes of clarity in this conversation, I am going to lump transactions that are considered deactivations and reactivations in our customer management system and some that are considered suspensions into one category called 'Suspensions,' because they are all temporary in nature. To be clear, these transactions include maintenance events about 40% of the time, aircraft sold about 30% of the time, and change of management company about 20% of the time. Q2 was our highest suspension quarter ever, up 31% from Q2 2022, driven by a 33% increase in maintenance suspensions and a 41% increase in management changes. Not only are there more aircraft being suspended, but the suspensions are lasting longer, especially maintenance. For example, in January 2022, around 45% of suspensions ended in less than 30 days. In June of this year, that was down to 34%. The primary driver of the volume and duration of suspensions appears to be a logjam for engine maintenance. Many aircraft have been flown hard the last few years and cannot fly passengers again until they get a major seat check, which typically involves taking the entire engine apart, replacing worn parts, rebuilding it and testing it in a wind tunnel. Last week, we asked one of our largest dealers how soon we could book a seat check; the answer: Q2 2024. Why? Because of high demand, parts shortages, and labor shortages. Another example of this logjam is replacement engines. In normal times, when dealers remove engines to work on them, they often install temporary replacement engines so that the customer can continue flying for the duration of the work. We are hearing many reports that there are literally no replacement engines available, which is leading to many aircraft sitting on tarmacs with no engines. This perfect storm is leaving aircraft stranded on tarmacs across the country. Needless to say, when the aircraft is grounded, the customer usually decides they do not need to pay for internet. The good news is that once they have gone through their maintenance or completed their management change or have a new owner, those aircraft are coming back online. Since January of 2022, 93% of all suspensions returned within 210 days, so the return rate is very good. We further confirmed the suspension trends I just noted by reaching out to 197 tails that were suspended for more than 45 days in Q2. 66% of those tails responded, with 64% of respondents stating that they were still stuck in maintenance, 15% still owed us money, 6% had returned to service, and 8% had been sold. The rest were scrapped or returned to a leasing agent. It is very important to note that none had gone to a competitor. As we analyze this phenomenon, we believe that suspensions were unusually low in ‘21 and ‘22 and are unusually high now, and that when these conditions normalize, we should see a return of roughly 200 aircraft into the active aircraft online pool. Now, let me turn to shipments and field inventory. Inventory in the field actually grew by about 30 units in the quarter to roughly 900. But the good news is that the percentage of field inventory committed to a customer rose from 79% last quarter to 85% this quarter, which creates a nice tailwind for us. Roughly, 130 units in the field are uncommitted. Two-thirds of which are at dealers that regularly hold inventory and sell a lot of systems and where we see low risk. Roughly one-third are of smaller dealers that ordered a system during the COVID supply chain crisis in order to have inventory in case a customer came in wanting an install, and there may be some risk of not having it installed anytime soon. One other note: we include installed, but not yet activated equipment in our inventory count. This generally occurs at the OEMs, where we have standard line fit, and a particular customer does not want ATG connectivity either because they don’t fly in North America or don’t care for connectivity. This installed equipment accounts for about 20% of the inventory count I just mentioned a moment ago. The good news is that if those aircraft are ready for activation by a new owner, or if the current customer decides they want internet for all. So now, let me focus on shipments and equipment revenue. Though behind 2023’s plan, we had a nice pickup in Q2, with 277 units shipped, up 24% from Q1, generating a 20% increase in equipment revenue. We expect to ship over 1,000 units for the year, which will look good on a historical trend line basis, but pales compared to the record 1334 units we shipped last year. Given our slow start in 2023, we are being cautious about Q3 and Q4 projections, though we think we may see some uplift from our recent LX5 announcement. 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 service addressable market by broadening the AVANCE platform product offering and adding networks to meet the needs of each segment of the BA market globally. Second, we want to drive customer loyalty by continually improving our networks and leveraging the AVANCE platform to provide easy upgrade paths as new technologies and networks emerge. And third, we are focused on offering the best product and customer support for 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 replacement program, our 5G network and our GBB LEO offering. I will start with the FCC. 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 3G and 4G networks. Because there were more qualified grants than originally planned, all grants were cut back to 39% of the original reward, which in Gogo’s case is a cutback to $132 million. At this point, we and most other grant recipients are waiting to see if Congress will fully fund the program as part of its reauthorization of SEC auction authority, which is expected to solve. Because the functionality of replacement ground-based equipment will be better than the equipment installed in our 3G and 4G networks 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 the ATG network can manage simultaneously. In the meantime, we started working on the program and received a small reimbursement of federal funds for doing so. On the customer side of this transaction, our goal is to convert all of the 3,400 tails flying with our classic product line to new LAUs with LTE air cards over the next few years. We have been in touch with almost all of those customers and have actually spoken to more than 75% of them. And of those that already have a preference, the overwhelming majority are leaning towards an AVANCE upgrade. Up until now, we created this program as an overlay to our long-term model and excluded it from our financial guidance, except to say that it will be a drain on working capital later this year as we build inventory. Jessi will provide more detail on this program in a few minutes and this quarter we will begin incorporating the costs and reimbursements into our guidance, though we must warn you that the exact timing of reimbursements can be very difficult to predict. Now, let me turn to the most disappointing news of the year: the second delay of our 5G chip. Let me start by describing the issue. Our supplier of 5G airborne and ground station radio technology is Airspan. They, in turn, have a chip supplier GCT, one of a few firms focused on developing 5G chips. They then use Samsung to fabricate those chips. As the chip was being brought up after fabrication by Samsung, three issues were identified in the system block of the chip. A detailed root cause analysis was conducted by GCT and it was ascertained that all three issues were related to the same root cause, a software issue in the peripheral sub-block of the chip, not an issue in the 5G block. GCT is still working on the exact action plan to fix the chip but has made us aware of all the options they are considering, all of which point to a midyear 2024 release of our 5G product, plus or minus a month or two. While this is very disappointing, 5G chips are difficult to design and build because of the dramatic increases in speeds and the increased density of transistors on the chip surface to enable those speeds. The benefit to us of this technology is that it will enable us to deliver ATG speeds 5x to 10x faster than our current speeds at around 25 megabits per second mean and 75 megabits to 80 megabits per second peak. Much faster than any potential ATG competitor, but the con is that we have borne some technology risk in doing so. Meanwhile, we are making great progress with OEMs and at dealers in certifying the equipment we can certify today and in selling pre-provisioning kits to customers. On the good news front, we are excited to announce our new LX5 LAU to support 5G last week. Up until now, if a new customer wanted to install our 5G product, they would have to install two line replaceable units or boxes inside the aircraft and add two 15-inch antennas. The LX5 cuts that install down into one LAU plus the antennas. Because the LX5 is the same form factor as our currently popular L5 LAU, this dramatically simplifies upgrades for our 2,300 AVANCE L5 customers. They can swap out their current antennas for MB13 that go into the same location as the old antennas and then pull out the L5 and install the LX5 in the exact same space with the exact same cabling and harness as the old LAU. Finally, because our MB13 can operate on our 4G as well as our 5G network, an AVANCE L5 customer can pre-provision the MB13 antennas today and only have to swap the LX5 box for the L5 box to upgrade when our chip is ready. To encourage pre-provisioning and drive 5G adoption, if a customer installs L5 and MB13 this year, we will ship them an LX5 box to swap for free next year. Because the LX5 is one box and not two, it is considerably cheaper than the previous two-box 5G configuration. This is part of the Gogo Now and Next strategy and a great example of our AVANCE platform enabling easy upgrades to new networks and technologies. We are excited to bring Gogo 5G to market and believe it’s the perfect product for midsized jets down to those completing North American missions that want great speed and better value than competitive satellite products. Now, I will turn to our LEO-based global broadband initiative, which we have now branded Galileo. Galileo adds an electronically steerable antenna to the AVANCE platform and integrates the OneWeb low earth orbit satellite constellation into our network offerings. LEOs are particularly well suited to business aviation because their low altitude allows for an equivalent link budget with less power than GEO satellites, ensuring global coverage with a smaller antenna that can fit on nearly all business aircraft. Last year, we announced our Galileo HDX terminal, a small antenna that fits on almost all business aircraft and targets mid-size and smaller jets that are domiciled outside North America and have no broadband solutions today and those domiciled inside North America who often fly international missions. The exciting news in Q2 was the introduction of the Galileo FDX terminal, a larger antenna that delivers significantly higher bandwidth and targets super mid-size and larger jets that fly global missions. We demonstrated a prototype of FDX at EBACE, the big business aviation show in Geneva, where it delivered a solid 190 to 200 megabits per second link up to the plane and 30 megabits per second on the return. Even more exciting is that those speeds will increase dramatically when OneWeb launches its Gen 2 network in just a few years. Our goals for the Galileo family all drive incremental growth for Gogo. They are to expand our total addressable market to include the 14,000 business aircraft registered outside of North America to add a global satellite offering for the thousands of U.S. super mid-size and heavy jets that already have our ATG products today, and third to drive enhanced stickiness in our core North American medium-size and smaller aircraft segments by offering an easy path to add a LEO product if they require more capacity. A huge advantage is that Galileo is a simple upgrade for any AVANCE-installed aircraft. They only need to add either our HDX or FDX antenna on the fuselage and then run data and power cabling into the aircraft. This is another great example of our AVANCE platform making it easy for customers to upgrade from one AVANCE plan product to another and why expanding AVANCE penetration is a cornerstone of our strategy. Our satellite partner, OneWeb, has completed its 648 satellite Gen 1 constellation and is well on its way to completing its ground network before we launch HDX. We remain on track with Hughes, our antenna partner, to deliver HDX in the second half of 2024 and FDX in the first half of 2025. We received a very enthusiastic response to Galileo from our customers and they have already signed a line-fit agreement with one OEM and have discussions underway with several others. We feel that these strategic enhancements to the AVANCE platform position us very well in our competitive environment. Most of our traditional GEO satellite competitors, who can only serve large jets because of the size of their antennas, have doubled down on GEO connectivity and have no answer to the dramatic performance improvements LEO and 5G technologies will provide to the business aviation market. Our potential LEO satellite competitor seems to be focused mostly on other significantly larger markets that require far less customer support than business aviation. Finally, our potential ATG competitor has been offering demo flights on which their system performs better than our classic ATG offerings, but nowhere close to what Gogo 5G will offer. I would suggest they face a daunting task of financing a business that will take hundreds of millions in capital to have a chance of making a profit in a market where they confront a successful competitor with a superior product and customer service. Though it’s disappointing to lower guidance, I would like to end on a positive note, which is that we have a lot of tailwinds that should drive performance in the future, including great product launches that should drive total addressable market (TAM), extend customer normalized lifetimes and drive high-margin service revenue. We have reduced investments that should drive free cash flow and we should have increased the aircraft online as suspension levels normalize and the 86% of named inventory out in the field gets installed and/or activated. I want to end by thanking the frontline Gogo team for the fantastic work they’ve done delivering great service and support to Gogo customers, innovating, developing, building, and shipping new products, managing our networks and data centers, and working with our customers and distribution partners in the field. I also want to thank all the Gogo team that supports that frontline team and keeps us on the rails in finance, legal, and people experience. With that, I’ll turn it over to Jessi for the numbers.

Jessi Betjemann, Executive Vice President and CFO

Thanks, Oak, and good morning, everyone. Gogo’s second quarter performance continues to demonstrate strong demand for our services and products and a robust market position. While we delivered solid financial performance in the quarter, especially at the bottom line, even as we undertake significant strategic investments, such as Gogo 5G and Gogo Galileo, it was below our expectations for certain operational metrics on top line performance. In my remarks today, I’ll start by walking through Gogo second 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 I’ll finish up with an update and additional context on our revised 2023 guidance and long-term targets. Total revenue for the second quarter was $103.2 million, up 6% over the prior year and up 5% sequentially. Gogo delivered record service revenue of $79.1 million in the second quarter, an 8% increase year-over-year and a 1% increase sequentially. Our ATG aircraft online reached 7,064 units as of the end of the second quarter, up 6% versus the prior year and up slightly sequentially. AVANCE units online grew to 3,598 and now comprise 51% of our total fleet and generate 52% of our ATG service revenue. Exceeding over 50% is an important milestone in the evolution of the business. We had 229 new activations this quarter, which is a record for second quarter activations. However, this was offset by an increase in temporary suspensions for our AVANCE and classic ATG units due to the maintenance cycle and other dynamics both discussed, which caused incremental units online to be muted in the second quarter. Additional aircraft online is the key driver of service revenue growth and in our view, value creation for the business. We expect the AVANCE aircraft online growth rate to accelerate over the next several quarters due to progress on three factors. First, dealers addressing staffing challenges that are currently contributing to slower installation rates, which will result in more of the equipment shift to be brought online. Second, maintenance events starting to return to normal levels, reducing suspension time. And third, secondhand aircraft inventory getting sold and reactivated. ATG ARPA grew 1% year-over-year to $3,371 and decreased 1% from the prior quarter due to a higher product mix of the AVANCE L3 product. The launch of Gogo 5G and Galileo next year are catalysts to further expand our ARPA growth opportunity over time, partially offset by continued L3 sales into smaller aircraft, which have similarly high service margins but lower ARPA. Moving to equipment, Gogo delivered $24.2 million in equipment revenue in the second quarter, a 2% decrease year-over-year and a 20% increase sequentially due to AVANCE shipments. Gogo AVANCE shipments totaled 277 in the second quarter, down 11% year-over-year and up 24% sequentially, reflecting the changing dynamics of inventory in the channel and dealer demand that Oak discussed. We remain confident that our strong position in a global market that is only 22% penetrated with connectivity coupled with the launch of Gogo 5G and Galileo next year will continue to propel our equipment sales in the future. Overall, we’re expecting our 2023 top line performance to slightly increase in the second half of the year driven by more activations and shipments. Turning to profitability, Gogo delivered service margins of 79% in the second quarter. Service gross profit in the second quarter was up 9% year-over-year and was the main driver for the 7% year-over-year EBITDA growth. We continue to expect long-term service margins in the 75% range and to be the primary lever for free cash flow generation and long-term value creation. Equipment margins in the second quarter increased 18 percentage points sequentially to 27%, in line with our expectations. The increase was driven by higher equipment revenue in the quarter with relatively fixed production costs and the $1.3 million in inventory write-off costs due to the FCC program that we incurred in the first quarter. Equipment costs in the second quarter include costs related to the FCC program, replacing a large number of EVDO air cards and AVANCE-equipped aircraft with dual modem air cards. Equipment gross profit in the second quarter was up to 236% sequentially and was the main driver for the 11% sequential EBITDA growth. Our planned level for equipment margins is in the 25% to 30% range this year. However, this could fluctuate over the next two quarters due to the expected FCC reimbursement accrual, and I will discuss the financial implications of the FCC program in more detail in a little bit. Moving on to operating expenses. Second quarter combined engineering design and development, sales and marketing, and general and administrative expenses of $30 million increased 3% year-over-year and 5% sequentially. This year-over-year increase includes costs for Galileo offset by lower personnel costs tied to a reduction and bonus expense. We continue to expect that 2023 and 2024 will be investment years as we complete our 5G program and ramp spending for Galileo, causing 2024 to be the high point year for these combined investments. Once completed, we expect to see the benefit of these investments through sustained strong top line growth and a ramp in free cash flow in our core operating business. In terms of Gogo 5G, our approximately $7 million of 5G spending in the second quarter was comprised of $1 million in OpEx and $6 million in CapEx. As noted in our press release on July 27, and further described by Oak, due to a design error in a non-5G component at the 5G chip, the commercial launch of 5G is delayed until approximately mid-year 2024. We maintain our estimate of $100 million total cost for our 5G program. But the delay will push approximately $8 million to CapEx and $5 million of OpEx into 2024 and reduce $7 million in planned 5G revenue in 2023. We also expect this delay to dampen revenue, EBITDA and free cash flow in 2024. The impact of the timing shift for 5G on revenue and costs is reflected in our revised 2023 financial guidance. Now on to our Galileo initiative. In the second quarter, Gogo incurred $2.5 million in operating expenses related to Galileo. We expect external development costs for Galileo to be less than $50 million in total. We expect Galileo costs to be $13 million in 2023 and approximately $30 million in 2024. Gogo Galileo will be asset-light with approximately 95% of external development costs and OpEx, and we believe it will deliver an attractive return on investment. The spending profile is reflected in our 2023 adjusted EBITDA and free cash flow guidance. Moving on to our bottom line, Gogo’s second quarter adjusted EBITDA increased 7% year-over-year to $44.1 million as a result of improved service gross profit that I described earlier and lower personnel costs tied to a reduction in bonus expense. Gogo delivered net income of $89.8 million in the second quarter, translating to $0.69 in basic earnings per share and $0.67 in diluted earnings per share of which $0.48 related to an income tax benefit. Our reported net income includes an income tax benefit of $63.8 million in the second quarter, due to the partial release of the valuation allowance on our deferred tax assets related to the Section 163(i) interest limitation carried forward. The remaining valuation allowance of $26 million is still required for deferred income tax assets related to certain state credits, foreign net operating losses, and capital losses. Gogo’s income before taxes increased 15% year-over-year to $26 million in the second quarter. 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 forward. As a reminder, our financial statements reflect non-cash income tax expense as you 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 5-year planning horizon. In addition, our shareholders' rights plan that is designed to preserve NOLs is set to expire in September, and our Board of Directors has voted not to renew the plan. As changes in the shareholder base over a 3-year period will lapse. This will not affect our current NOL status. In the second quarter, we generated $13.3 million in free cash flow, down $2.2 million compared to Q2 2022, due to an increase in interest costs from higher interest rates and switching at our election to a 1-month SOFR resulting in 5 months of interest paid, partially offset by the interest cap benefit. Free cash flow was down $6.7 million sequentially due to the increase in interest costs and higher CapEx, partially offset by lower net working capital. Now I turn to a discussion of our balance sheet. We ended the quarter with $610.5 million in outstanding principal on our term loan and $97.2 million in cash and short-term investments, with our $100 million revolver remaining undrawn. Gogo’s net leverage was lowered slightly to 3.2x in line with our target range of 2.5x to 3.5x. As announced on May 1, Gogo made a strategic decision to pay down an aggregate principal amount of $100 million on our outstanding term loan debt facility. As previously mentioned, we have a hedge agreement in place and the first step down to $525 million occurred in July. Now approximately 86% of our loan is hedged until July 2024, when the next step down to $350 million occurs with an increase in strike rate from 0.75% to 1.25%. Gross leverage at the end of the first quarter was 4.2x and it was reduced to 3.5x at the end of the second quarter after the $100 million pay down. 2023 interest costs will be reduced by approximately $4.5 million based on the July forward SOFR curve, and $3 million net of foregone interest income. As a result of executing a more conservative financial policy with a lower leverage target and paydown of debt, Moody’s upgraded our credit rating to B1 with a stable outlook in May and S&P improved its credit outlook in June from B+ stable to B+ positive outlook. Another notable item in the second quarter was that we generated positive shareholder equity for the first time in the company’s history of $9.2 million, primarily due to the release of the valuation allowance. Our capital allocation priorities have not changed and are aligned with our strategic goals. As a reminder, Gogo’s capital allocation priorities are the following: First, maintaining adequate liquidity. Second, investing in strategic opportunities to drive competitive positioning and financial value including 5G and Galileo. Third, maintaining an appropriate level of leverage for the economic environment with a target net leverage ratio of 2.5x to 3.5x. And fourth, returning capital to shareholders as appropriate in the future. For the $100 million paid on a debt in May, we are focused on building our surplus cash position over the next few quarters as we continue to generate positive free cash flow. However, we don’t anticipate any major capital allocation decisions until 2024. I would now like to provide a summary of the expected financial impacts of the partially funded FCC secure and trusted communications network reimbursement program from which Gogo expects to receive $132 million. We are waiting to see if Congress will approve full funding, which would significantly increase our total reimbursement value, as we were granted up to $334 million. The company has recently retained external advisors to assist us in the reimbursement process. We submitted and received our first reimbursement claim in July, which triggered the start of the 1-year clock to complete the program by July 21, 2024. In our application, we stated that we would need multiple extensions to complete the program and are waiting to see if the FCC will grant a blanket extension or if 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 and related costs to enable existing customer aircraft to communicate with the new network, including swaps of L3 air cards to replace EVDO air cards, and third operating expenses. We expect spending to be partially offset by the FCC reimbursement. In the second quarter, we recorded a $0.9 million receivable from the FCC, which is included in prepaid expenses and other current assets on our balance sheet, primarily for the reimbursement of network equipment purchases and a corresponding reduction to property and equipment. Since the program is currently partially funded, we have some optionality on what we request reimbursement for that could impact our grant money received which will be recorded between the income statement and balance sheet. In addition, the overall process is complex, with specific documentation requirements that may change our assumptions on reimbursement accruals in our forecasts. At a high level, we expect 2023 and 2024 free cash flow to be negatively impacted by the FCC program and a benefit in 2025 due to the timing of reimbursement proceeds. However, this timing is a bit unpredictable as we’re still early in the process. Now, I’ll turn to our financial outlook. Gogo is updating our fiscal 2023 financial guidance and long-term targets to reflect the market dynamics that Oak described, the impact of Gogo’s participation in the FTC program and the 5G delay. Gogo now expects 2023 total revenue to be in the range of $410 million to $420 million. This decrease is driven by expected reductions to both the equipment and service revenue. On the equipment side, the drivers are twofold: First, we have seen excess inventory in the channel as we adjust from long COVID lead times to our usual very short lead time. Second, we anticipated shipping a large backlog of 5G orders in Q4. That is now delayed, pushing $7 million of 5G equipment revenue into 2024. On the service revenue side, the decrease is driven by the account suspension and activation issues we discussed in-depth earlier, reducing our expectations for aircraft online for the year. We continue to expect 2023 adjusted EBITDA to be in the range of $150 million to $160 million. We are able to maintain adjusted EBITDA guidance despite lower revenue as we prudently manage costs down as well as push out 5G spending due to the delay. This guidance now includes operating expenses of approximately $20 million, compared to $30 million previously for strategic and operational initiatives, including $4 million for the expected 5G delay, which reflects the shift of $5 million from 2023 to 2024 related to the chip delay, approximately $30 million of Galileo development spend, and approximately $3 million in additional operational initiatives focused on penetrating the 78% of the global business aviation employee connectivity market that remains untapped and maintaining our long-term competitiveness. Our adjusted EBITDA guidance also includes approximately $10 million of costs related to the FCC program offset by $100 million of accruals for the expected FCC reimbursement. We expect our 2023 CapEx to be at the low end of our previously announced range of $30 million to $40 million, including $12 million for the Gogo 5G program, which reflects the shift of $8 million to 2024. As a result of the 5G delay, and approximately $3 million related to the FCC program. We are revising our 2023 free cash flow guidance to a range of $60 million to $70 million driven by the additional FCC-related spend, including increased inventory purchases and the expected lag of FCC reimbursements. Before I review the revised long-term targets issued this morning, I’d like to provide some color on the expected financial trajectory for 2024. As we previously stated, 2024 will continue to be an investment year with an increase in Gogo Galileo expenses as anticipated, but now further burdened due to the push out of 5G spending. These investments coupled with lower shipments and lower aircraft online this year, and delay in 5G launch will negatively impact our financials, causing 2024 to be a tough free cash flow year. Given the near-term headwinds Oak and I discussed, we have updated our long-term targets as follows: We are revising our revenue growth at a compound annual growth rate to a range of approximately 15% to 17% from 2022 through 2027, with global broadband expected to materially contribute to revenue in 2025. We continue to expect annual adjusted EBITDA margin to be in the mid-40% range by 2027. We are revising our 2025 free cash flow target, excluding the impact of the FCC, to be in the range of $150 million to $200 million. With solid growth in 2026 and beyond, we expect the FCC program to negatively impact 2024 and to positively impact free cash flow in 2025. However, the timing of reimbursements is unpredictable. While it was disappointing to lower targets, I would like to remind you of the evolution of our business since we set the $200 million 2025 free cash flow target in September 2021. At that time, our target included delivery assumptions but did not include investing in Gogo Galileo. Since then, we have been able to absorb the Galileo investment, the first delay of the 5G launch and invest in operational initiatives with the lower aircraft online this year, and now the second 5G launch delay. We feel it’s prudent to provide an expected range for our free cash flow target. As we make progress and continue to assess the potential impacts to our long-term plan, we believe our value proposition is underpinned by this future strong growth and free cash flow as near-term headwinds reverse. We complete our Gogo 5G and Galileo investments and benefit from the revenue growth our new products and services will generate in the expected under-penetrated global market. Gogo is confident in our current strategy and market position, and we are determined to support long-term success and deliver value for our shareholders and customers as we continue to grow our business. Before we open the call up to questions, I want to thank the entire Gogo team for their continued commitment and for providing unparalleled service to our customers.

Operator, Operator

This concludes our prepared remarks. We are now ready for our first question.

Richard Prentiss, Analyst

Hey, good morning, everybody.

Jessi Betjemann, Executive Vice President and CFO

Good morning.

Oakleigh Thorne, Chairman and CEO

Good morning, Ric.

Richard Prentiss, Analyst

Yes. Obviously, some disappointment on the 5G chip delay we laid out pretty well, the Airspan to GCT to Samsung to sub-design shop. How comfortable are you that they have got the issue identified? And what specific steps are they taking to get you comfortable that the release date is mid-’24 now?

Oakleigh Thorne, Chairman and CEO

Yes, I think we’re very comfortable. They’ve identified the root cause. As I said in my comments, they’re still developing the exact plan for remediation. We actually expect that next week. We’re very confident that they’re going to deliver. I mean, they were a very significant design house in the 4G world and did a great job there. They are one of the few players that are competent enough to play in the 5G world. Right now, there’s really two chip companies that are producing 5G chips, Qualcomm and MediaTek. We were too small for them. There are two others coming along behind them. GCT is one of those two, and we think they’re a front-runner there. So we’re confident in them. They’ve also made some changes in their lineup in terms of the sub-design house that Samsung designated before now. They’re pulling in a sub-design house that GCT is more familiar with and has worked with a lot in the past. That gives us confidence. Both Airspan and GCT have really opened up to a combined working team with Gogo’s project management team to really manage this in a more transparent manner for us, so that we can keep a very steady eye on how things are going. So, we’re confident. There’s always risk in these kinds of projects, and if we will know more in a week or two, we’ll keep people updated as things develop.

Richard Prentiss, Analyst

Great, thanks for that. Also, in your prepared remarks, you talked about that there were some customers that were looking at wanting to understand competitive offers that might come into the marketplace. Can you elaborate a little further on that? Is that the GEOs, is that the LEOs, is that air to ground? Kind of where are people saying? Well, let me take a look at what the competitors might be offering?

Oakleigh Thorne, Chairman and CEO

I think everybody is kind of curious about what Starlink will do in this vertical. I don’t want to speak for Starlink; but I think they seem more focused, frankly, on other verticals right now that are easier to serve, which have less customer service demand, and frankly, there is a lot more of a revenue opportunity for them. People are not terribly curious about GEOs at this point. Due to some of the bad luck that ViaSat had, the GEO presence in the market is, I think, more at risk than it has been in a while. We are quite convinced that LEOs are going to replace GEOs over time in this vertical. The last one would be SmartSky, who is still around and has been making a lot more noise recently in terms of their publicity. I think they have a hard path in front of them, just because their product is probably about half the speed of our 5G product, and their customer service is really not there. This is a market where I think an established player that’s profitable, has great customer service, and has a reputation for delivering and a better product will probably win. So, that’s how we view the competitive environment.

Richard Prentiss, Analyst

Okay. And then finally, for me on the suspensions, obviously, somewhat off guard. What’s the best way that you all have found to kind of get a handle on the suspensions? And how should we, from the external side, think about monitoring suspensions and trends?

Oakleigh Thorne, Chairman and CEO

We track every deactivation and suspension by cause. I shared some of that data on the call. So, on top of tracking it all, we reached out to 197 accounts that had been suspended for more than 45 days in Q2. We just basically corroborated our own data. Most of the ones that were suspended were actually still in maintenance. I think it’s hard from outside to really track it, Ric. I mean, there is not published data in terms of how many aircraft are in the shop, or on the tarmac, or anything like that. I mean you can track it probably best just anecdotally. So, we had one anomaly in the quarter that drove things a little bit, which is one small fractional fleet went bankrupt, and that resulted in 15 deactivations. In those cases, those aircraft will end up somewhere else and owned by somewhere else, and they are already installed, so most people will turn those aircraft back on. Sometimes watching what’s happening in some of the fleets can give you indicators of potential impact on us.

Richard Prentiss, Analyst

Great. Well, I appreciate it. Stay well. Thank you.

Oakleigh Thorne, Chairman and CEO

Thanks a lot.

Operator, Operator

Thank you. Our next question comes from Lance Vitanza with TD Cowen. Your line is open.

Lance Vitanza, Analyst

Thanks. Thanks guys for taking the questions. First on the 5G delay, obviously disappointing for Gogo and its investors, but what are you hearing from your customers, I guess our aircraft owners and/or dealers? Are they complaining? Are they frustrated? I know in the last question, you talked about some of the competitive questions, but is your sense that there are questions around competition intensifying in the wake of the 5G delay or are people kind of taking it in stride? I’m just trying to get a sense of the impact on pent-up demand for the competitive products here.

Oakleigh Thorne, Chairman and CEO

No, I don’t think it’s changing the competitive dynamic any. People are actually pretty excited about having the LX5 finally announced in public. The delivery date on that coincides with the launch of 5G. Most of our big customers, dealers, and OEMs were aware that LX5 was coming along under NDA, and they really love that product. I mean it’s much easier to install than the former configuration which required an L5 box and an X3 box. People are really happy about that. We are continuing to take orders. There are people that are changing orders from X3 and L5 to LX5 already. While people are a bit disappointed, I think there are some dealers out there who are relieved because they were kind of behind on their STCs. This gives them a chance to catch up and a couple of them had that relief as well. We don’t see a big impact. Of course, the impact to us is revenue loss and the unit count in the meantime.

Lance Vitanza, Analyst

Sure, of course. So, on the suspension side, you commented that when planes are grounded, they don’t want to pay for Internet. But I just want to probe that a little bit more because part of our investment thesis, at least, has been that the cost of Internet was a pretty small fraction of the total cost of aircraft ownership, kind of whether you are flying it or not. Perhaps that’s no longer the case. Can you discuss that concept and maybe remind us if you are paying Gogo, let’s say, $3,000 to $4,000 a month for Internet, how much are you paying to hangar the aircraft and the other kinds of ancillary expenses that are needed to maintain that plane?

Oakleigh Thorne, Chairman and CEO

Well, you are paying a lot more, that’s for sure. I can’t give you an exact breakdown of what you pay to hangar the aircraft. Most of these aircraft that are stuck without engines are sitting out on the tarmac. I doubt they are getting charged that much by the dealer when they are just sitting out there; they probably have some fee. But I am not aware of exactly what it is. The dealer is going to make most of their money taking the engines off, repairing them, putting them back on. They probably make some money leasing engines for temporary use, which are hard to find right now. Flight departments are trying to make the owners happy. If an owner is going to ask, “Well, I am sitting here for six months not able to use my plane, why shouldn’t we be able to reduce the expense in operating it?” The pilot or the director of the flight department is going to want to be able to say, “Yes, we shut down the Internet, we are not doing this, we are not paying for that.” So, you are actually saving money while we are sitting here. We have always offered suspensions for maintenance. It’s one of the things customers like about us. So, it’s very common for those who are gone for maintenance for a long period to suspend. If you go back to COVID, we had a huge number of suspensions; I think 20% of our customer base suspended service. It’s not very unusual in times when people are suspended for maintenance to turn off the Internet.

Lance Vitanza, Analyst

In any case, we certainly want the logjam removed, and is your sense the industry is responding to the problem? Are we seeing more capacity coming online or do you think we're going to have to sort of suffer through this period of excess demand for engines and parts?

Oakleigh Thorne, Chairman and CEO

I think the engine OEMs are cranking up, their production is as fast as they can. That’s where the parts shortages are really impacting supply. They’ve been hit with an increase in orders at the business aircraft OEMs, which is driving demand for engines and unusually high activity in maintenance events where people are wanting to lease additional engines at the same time. We’d expect that they will be working through those issues and that their supply will increase. It’s hard for us to predict the pace of that though, so we are not going to put a quarter on it when it’s going to all turn around. I imagine it will take a couple of quarters.

Lance Vitanza, Analyst

Sure. And then maybe just one quick one for Jessi. You mentioned this on the call that EBITDA. It sounds like you have benefited. EBITDA on the quarter sounds like you benefited from some non-recurring, and perhaps non-cash items in the quarter. Could you just go over those again quickly for me? Thanks.

Jessi Betjemann, Executive Vice President and CFO

Not the EBITDA; it was net income. Our net income benefited from a tax benefit because we had a reversal of our valuation allowance. On the EBITDA side, there was a reduction in personnel expenses due to lower bonus expense. So, that’s not going to be necessarily recurring. But that was a benefit in the quarter for the EBITDA.

Lance Vitanza, Analyst

Great. Thanks so much.

Jessi Betjemann, Executive Vice President and CFO

Thanks, Lance.

Operator, Operator

Thank you. We will have a question from Phil Cusick from JPMorgan. Your line is open.

Phil Cusick, Analyst

Hi, guys. Thank you. So, you have addressed this somewhat already, but I wonder if you could just explain to me, number one, where we are in the inventory issues? You talked about inventory drawdown last quarter. And number two, why do these maintenance issues hit now? You have had a deceleration for a couple of quarters in terms of ATG net adds, but this is pretty stark. I don’t understand why it’s happening right now. And how we should think about Q2 on that path? Thank you. I heard Jessi; I heard you talking about better in the second half. But the trend does not look great for Q3.

Oakleigh Thorne, Chairman and CEO

Yes. I think now because of what happens in charter and fractional markets, the demand has been so huge over the last couple of years, and they didn’t have enough jets to meet that demand. They are now taking deliveries at a more rapid pace from the OEMs, and that’s helping relieve that demand. A number of ways you can maintain an aircraft. One is that you can take it in for more frequent short inspections and maintenance events. That reduces the amount of time required for large C check maintenance events. When you’ve got a lot of demand, and you can take that jet out of the sky for those short intervals, it’s a real revenue hit. So, charter operators and fractionals would say, ‘Okay, well, that’s optional; we don’t really need to maintain it that way.’ What has delayed has put more pressure on these big maintenance events this year. We’ve seen that climb steadily. Yes, it started climbing in Q1. We didn’t understand the full extent of that, and frankly, we should have. But it did really accelerate this quarter. When we go talk to people, the numbers are different but there’s nothing different in terms of they’re going to competitors, or they’re shutting off because they don’t want the Internet. So, that's the real cause of why it’s going up now. I can’t predict exactly where that’s going to go in Q3 and Q4. But we started calling around some dealers last week, saying, 'Hey, when can I get in to get a C check if I wanted to?' The first answer we got was Q2 2024. A couple of other dealers were more in the fourth quarter this year, so there is demand and people are booked.

Phil Cusick, Analyst

Thank you.

Operator, Operator

Thank you. Our next question will come from Simon Flannery with Morgan Stanley. Your line is open.

Simon Flannery, Analyst

Thank you very much. Good morning. I wanted to come back to the new product developments. Can you help us with the timing of getting real revenues out of the 5G product and out of the Galileo product? Will that really start from early Q3? Are we actually going to see aircraft flying and start to ramp fairly steadily from there, or is this sort of going to be a couple of quarters to really embed this, get it working properly? And then it’s really more of a 2025 before we see any material revenues from that? Any color around that would be great.

Oakleigh Thorne, Chairman and CEO

I mean I think we often get a boost in equipment revenue when we first launch, if there’s a backlog of orders, so you could see that in Q3, Q4 next year. Service revenue, of course, will be a bit slower to ramp up as those get installed, and will be more evident in ‘25.

Simon Flannery, Analyst

When do you think you will actually have these services installed on the aircraft and actually start generating revenues? Is that a Q3 event for both of them?

Oakleigh Thorne, Chairman and CEO

Well, on the 5G part, we said mid-year we would launch, plus or minus one or two months depending on the exact remediation plan that GCT implements. There are four options right now, but they all would have us launching mid-year, plus or minus one month or two on either side, depending on which option they end up with. We will know that about in a week. You could see shipments in Q3, or if there’s a delay over that possibly Q4 for 5G when we first start to ship. The service revenue would ramp up as those are installed in ‘25. It’s kind of the same on the HDX terminal with Galileo; that won’t be until ‘25, of course.

Simon Flannery, Analyst

Thank you. And then on the Galileo, you gave some speed estimates on the performance there. How does performance stack up against Starlink for the OneWeb product?

Oakleigh Thorne, Chairman and CEO

Yes, I think it will be comparable. The new announcement was around our FDX antenna, which is a larger ESA than the previous announcement. The performance I shared of 190 to 200 megabits per second was an FDX performance, and that’s designed for the heavier aircraft. Starlink is still smaller than our antenna. In terms of performance, we think it’s comparable. JSX, for example, is doing 100 to 150 megabits per second. Everybody is very happy about that. We think 190 to 200 megabits per second is great speed and will be viewed as comparable. When Gen 2, OneWeb comes out, which will have satellite links, we even see that speed doubling or tripling, even. But that will obviously be a few years out, and it will be great.

Simon Flannery, Analyst

Great. Thank you.

Operator, Operator

Thank you. And our next question comes from Louie DiPalma with William Blair. Your line is open.

Louie DiPalma, Analyst

Oakleigh, Jessi and Will, good morning.

Oakleigh Thorne, Chairman and CEO

Hey Louie.

Jessi Betjemann, Executive Vice President and CFO

Good morning.

Louie DiPalma, Analyst

Oakleigh, is there any change to the planned commercial launch timing for Galileo? And is there significant chip risk for the Galileo product?

Oakleigh Thorne, Chairman and CEO

No, there is no chip risk for the Galileo product. All of that is working already, which is why we were able to demo it. We actually pulled the delivery of the smaller Galileo antenna, the HDX, in two months, but we did that a quarter or so ago. So, nothing new in this quarter.

Louie DiPalma, Analyst

Okay. So, it is still on track for the second half of ‘24 and further...?

Oakleigh Thorne, Chairman and CEO

Yes, exactly. Second half ‘24 for the smaller one and first half of ‘25 for the larger one.

Louie DiPalma, Analyst

Sounds good. And the engine logjam issue is well documented in the engine MRO industry for business aviation. However, are there any signs that a significant portion of the deactivations is related to customers leaving for competitors, or are you able to pinpoint it to the engine logjam issue?

Oakleigh Thorne, Chairman and CEO

I think we are able to pinpoint it. We actually reached out to 197 customers in Q2 who had been suspended for more than 45 days, 66% of those responded and not one was going to a competitor.

Louie DiPalma, Analyst

Sounds good. And for the FCC reimbursement plan, the strategy is to upgrade the Gogo classic customers to AVANCE. Has there been any pushback from some of your strategic customers, or do you have visibility that you are going to be able to upgrade essentially all of your strategic customers with this plan?

Oakleigh Thorne, Chairman and CEO

Yes. They are all strongly leaning to upgrades. They need to do it anyhow. A number of them have been putting off upgrade programs and are still flying the classic product and their customers don’t like it anymore. So, we are making good progress there, Louie.

Louie DiPalma, Analyst

Sounds good. That’s it for me. Thanks. Thanks everyone.

Oakleigh Thorne, Chairman and CEO

Alright. Thank you.

Will Davis, Vice President of Investor Relations

Thanks Louie.

Operator, Operator

I am showing no other questions in the queue. I would like to turn the call back to Will Davis for closing remarks.

Will Davis, Vice President of Investor Relations

Thank you, Catherine. This concludes our second quarter earnings conference call. You may disconnect.