Iridium Communications Inc. Q2 FY2024 Earnings Call

Good morning and welcome to the Iridium Second Quarter 2024 Earnings Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity for questions. Please note this event is being recorded. I would now like to turn the conference over to Kenneth B. Levy, Vice President of Investor Relations. Please go ahead.

Thanks, Drew. Good morning and welcome to Iridium's second quarter 2024 earnings call. Joining me on the call this morning are our CEO, Matt Desch; and our CFO, Tom Fitzpatrick. Today's call will begin with a discussion of our second quarter results followed by Q&A. I trust you've had the opportunity to review this morning's earnings release which is available on the Investor Relations section of Iridium's website. Before I turn things over to Matt, I'd like to caution all participants that our call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts and include statements about our future expectations, plans and prospects. Such forward-looking statements are based upon our current beliefs and expectations and are subject to risks which could cause actual results to differ from forward-looking statements. Such risks are more fully discussed in our filings with the Securities and Exchange Commission. Our remarks today should be considered in light of such risks. Any forward-looking statements represent our views only as of today and while we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our views or expectations change. During the call, we'll also be referring to certain non-GAAP financial measures, including operational EBITDA, pro forma free cash flow, free cash flow yield and free cash flow conversion. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles. Please refer to today's earnings release and the Investor Relations website for a further explanation of our non-GAAP financial measures and a reconciliation to the most directly comparable GAAP measures. With that, let me turn things over to Matt.

Thanks, Ken. Good morning, everyone. As you saw in our earnings release this morning, we delivered another strong quarter of revenue and subscriber growth and remain on track for our full year guidance. Our distinctive network and services continue to attract new customers and drive service revenue, enabling us to return capital to our shareholders. We're also investing in our future with research and development and new partnerships to expand our device and service offerings and feel confident in our competitive position in the market going forward. We believe that Iridium's growth and free cash flow generation validate our strategy and make our shares a compelling investment opportunity, particularly at current market valuations. Over time, we expect investors to recognize the durability and strength of our business, especially as service revenue growth accelerates and our progress in the emerging direct-to-device and standard-based internet of things sectors gains attention. Our global presence and specialized safety services will continue to differentiate us and help us meet our long-term guidance through 2030 and beyond. Iridium’s unique service offering is not a commodity, and our performance in the coming years will highlight how we differ from Ka-band companies to which we are often compared. As I mentioned during our April call, we successfully completed our first acquisition of Satelles in the second quarter, and the integration with other parts of our business is going smoothly. This acquisition positions Iridium as the market leader in alternative positioning, navigation, and timing, and we are excited about the business opportunities this new offering creates, particularly given the increasing threats to GPS signals that support critical data and infrastructure worldwide. Since entering the positioning, navigation, and timing market with the Satelles deal, we have already expanded this service to Europe and Asia, enabling our partners to more effectively address opportunities in secure positioning and navigation along with data centers, maritime, in-building wireless, and other market segments. I believe that investors have not yet fully grasped the potential of our satellite-based time and location service, as we face few real competitors in this space and the rising threats to GPS are becoming more prevalent in conflict areas that might seem quite distant to consumers. Our secure time and location service addresses many critical use cases, as it utilizes our powerful paging channel to provide a secure position, navigation, and timing signal that is 1,000 times stronger than GPS. This service is increasingly relevant even beyond conflict zones as jamming and location spoofing become more widespread. Our offering provides redundancy and protection for critical infrastructure and in-building networks. We particularly appreciate that Iridium's service is a wide-area broadcast solution that supports an unlimited number of users while consuming minimal network resources. On the engineering and support side, our work and revenues with the U.S. Space Development Agency continue to grow as our team collaborates with General Dynamics Mission Systems to construct the ground infrastructure for the FDA's new LEO network, which is set to begin launching in earnest later this year through 2025. The scope of our work on this multiyear project has expanded over the past year, and we anticipate it will yield record engineering support revenue in 2024 while simultaneously enhancing the capabilities of our satellite operations team and providing valuable insights into advanced LEO technologies that will inform our future plans. In the second quarter, we also entered into a new contract with the U.S. government to maintain and support the long-standing private network we operate in partnership with them, notably the EMSS program. This new five-year contract strengthens our relationship with the Space Force and is expected to generate more than 50% additional revenue compared to the previous support contract, totaling over $90 million in revenue for Iridium over the duration. Additionally, this contract period coincides with the current EMSS contract as well as a successor contract we are anticipating with the U.S. government. We are beginning to prepare for those initial discussions, expecting a favorable renewal at the close of the current contract term. Regarding our capital market activities, many of you may have noticed that we recently repriced our term loan last month, resulting in approximately $4 million annual savings in interest expenses going forward. This transaction demonstrates the support we have from credit investors and reflects their confidence in our business and future cash flows. We share their optimism and believe our stock is undervalued considering how we expect our business and cash flow to continue to grow. Consequently, we have been more active in our share buyback efforts. In the second quarter, we utilized our revolver to repurchase 3% more of our outstanding shares and intend to continue this activity. Tom will provide more details on this shortly. I also want to highlight that we increased our quarterly dividend to $0.14 per share with our June payment. This increase signifies our confidence in Iridium's capability to generate free cash flow well into the next decade, resulting in a 6% annual increase in our dividend. Overall, our business is performing well, and we are on target with our full-year guidance. The quality, resilience, and reach of Iridium's network remain substantial selling points for partners and customers. We continue to attract new commercial and government partners and provide more services to our global reseller network. In the first half of this year alone, we certified a record 39 new partner devices, matching the full-year total for 2023. This indicates the pace of investment occurring around our network through our partners, which will contribute to our growth. Our partners recognize Iridium's distinctive service and reliability, as well as the performance of our network services. They are enthusiastic about our upcoming IoT technology and how it will broaden their applications. They are particularly eager about the potential for more affordable end-user devices based on 3GPP standard narrowband IoT services that we are developing through our Project Stardust initiative. While 2024 may serve as a transition year for Iridium, I am very optimistic about our strong market position and expanding opportunities, as well as the investments we are currently making. These efforts align with our unique brand position and extend the usefulness of our differentiated services to a wider range of industries and users. With that, I will turn the call over to Tom for a review of our financials. Tom?

Thanks, Matt, good morning, everyone. I'd like to start my remarks by summarizing our key financial metrics for the second quarter and providing some color on the trends we're seeing across the business. Then I'll recap the 2024 guidance which we affirmed this morning and close with a review of our liquidity position and capital structure. Iridium continued to execute on its annual plan, delivering 5% service revenue growth in the second quarter and generating strong subscriber growth with net additions of 80,000. Operational EBITDA was $114 million in the second quarter, with growth from commercial service revenue and engineering and support, largely compensating for equipment sales returning to more normalized levels. In our commercial business, service revenue was up 6% this quarter to $126 million, with the increase reflecting continued strength in IoT. Voice and data revenue rose 3% from last year's comparable quarter to $56.5 million. The increase was driven by subscriber growth as demand for Iridium's push-to-talk services remained healthy. Commercial IoT continued to benefit from demand for personal satellite communications as well as traditional industrial services. Revenue rose 20% from the prior year quarter to $41.6 million, in part reflecting the new 2-year contract we signed earlier this year with a large, fast-growing partner. As I discussed during our April call, this new contract has the effect of materially increasing revenue from this customer in 2024 compared to 2023 which served as a tailwind to IoT ARPU for the quarter and the first half of the year. Revenue in commercial broadband fell 4% from the year-ago period to $13.5 million, even as we grew subscribers by 4% from the year-ago period. As we have previously noted, we're forecasting a reduction in broadband ARPU this year related to vessels where Iridium was being used as the primary communications device. During the quarter, we added 83,000 net new commercial subscribers. Commercial IoT data subscribers now represent 81% of billable commercial subscribers, up from 79% in the year-ago period. Hosting and other data service revenue was $14.4 million this quarter, down 4% from last year's comparable quarter. As we've discussed previously, the decline from the year-ago quarter reflects lower revenue recognition from extending the useful life of our satellites. The extension of the useful life has no bearing on cash flow and only impacts the time over which we recognize revenues from the associated fixed-price hosting contracts. As Matt noted, in the second quarter, we also started to recognize retail revenue from Iridium STL, the time and location business we acquired in the Satelles transaction that closed on April 1st. We see a tremendous revenue opportunity in broadening the availability of Iridium's alternative position, navigation and timing service and believe it will generate over $100 million in annual service revenue by 2030. Government Service revenue was stable during the quarter at $26.5 million, reflecting the terms of our EMSS contract with the U.S. government. Subscriber equipment was $22.8 million in the second quarter and continues to return to more normalized levels following 2 years of heightened demand owed to supply chain constraints and customer inventory buildup. Engineering and support revenue was $25.8 million in the second quarter as compared to $20.6 million in the prior year period. The rise reflects growing activity with the U.S. government and the increasing scope of work with the space development agency. As Matt noted, Iridium was also awarded an upsized contract with the government earlier this year to support maintenance and engineering work when our EMSS contract through 2029. In light of our second quarter results, we are affirming our full year guidance on service revenue and EBITDA. To aid with your financial models as we look to the second half of 2024, I would like to highlight some trends that provide context and support our outlook. We continue to expect service revenue growth of between 4% and 6%, primarily driven by momentum in commercial IoT. 2024 IoT revenue growth in the mid-teens represents an increase in the growth rate compared to both 2022 and 2023. The Satelles acquisition which we completed in April, will be additive to the service revenue growth but the impact is expected to be limited this year at less than 100 basis points to our full year forecast. Revenue from our EMSS contract with the U.S. government will rise in the second half of the year with a contractual step-up in mid-September. Full year revenue in our government business will be $106.3 million in 2024. As we previously discussed, equipment sales will moderate this year. We saw this moderation begin in the second half of 2023 which will make year-over-year comparisons easier as we move to the second half of 2024. On the expense side of the ledger, our R&D will remain higher this year, up about $5 million as we make progress on our standards-based initiatives to support narrowband IoT and directed device. We had initially expected that SG&A would be in line with 2023 for the full year 2024. We now expect SG&A will be up about 15% in 2024 over last year. This change gives effect to the Satelles acquisition which was not contemplated in our original guide and to a reclassification of certain expenses from cost of service as originally modeled to SG&A. This reclassification does not change our EBITDA outlook as the increased SG&A is offset by lower cost of services than was originally modeled. Depreciation and amortization will be significantly lower than a year ago as a result of the change in our satellite useful life. We would advise modeling 2024 DNA close to $200 million. Iridium still expects cash taxes of less than $10 million through 2026. Lastly, on interest expense, I would highlight that we increased outstanding debt under the term loan which we use for the Satelles acquisition and drew on our revolving facility in the second quarter. Iridium also repriced its term loan in the second quarter which reduced the spread paid on the credit facility by 25 basis points to SOFR plus 225. The repricing transaction will save $4 million in annual interest expense. However, for 2024, the additional interest on the new borrowings will outpace the lower facility rate. Based upon the current outstanding term loan and prevailing interest rate, we expect interest expense to total about $86 million in 2024. Taken together, this outlook allows us to reiterate our forecast for service revenue growth between 4% and 6% and operational EBITDA between $460 million and $470 million this year. Moving to our capital position. As of June 30, Iridium had a cash and cash equivalents balance of $63.5 million. During the second quarter, we utilized cash from an upsized term loan to complete the acquisition of Satelles which closed on April 1st. As of June 30th, Iridium's term loan balance was $1.62 billion. We ended the quarter with net leverage of approximately 3.5 times EBITDA. With our earnings update today, I would note that we have updated our interim guidance for net leverage to provide additional capacity for share repurchases in light of recent trading levels. We believe that Iridium stock is undervalued today and represents a compelling value at current levels. In fact, during the second quarter, we drew $50 million on our revolver to facilitate additional open market purchases. While we had guided to net leverage of below 2.5 times EBITDA as a 2026 exit rate, we are increasing net leverage guidance to below 4 times EBITDA through 2026. This update reflects our plans to raise additional debt to facilitate increased share repurchases in the near term. We continue to forecast Iridium's net leverage will fall below 2 times EBITDA by the end of 2030. The rate at which we expect Iridium to naturally delever makes us very comfortable with this long-term guide, notwithstanding the projected uptake in leverage in the near term. In the second quarter of 2024, Iridium retired approximately 3.3 million shares of common stock at an average price of $29.25. This activity leaves Iridium with an outstanding balance of $180.8 million under our Board-approved authorization through December 31, 2025. As I've noted, we believe that Iridium's equity offers a compelling investment opportunity at current levels. We will continue to execute on our buyback program, balancing the desire to maximize return on investment with our long-term objective for deleveraging. During the second quarter, we made a quarterly dividend payment of $0.14 per share paid on June 28th. This was up from $0.13 in the first quarter and will result in a full year increase of approximately 6% to Iridium's annual dividend from 2023. Between our dividend program which started in 2023 and the commencement of our share repurchases, Iridium has already returned more than $900 million to shareholders. Capital expenditures in the second quarter were $12.4 million. We expect capital expenditures to reach close to $70 million in 2024 as we invest in new product development initiatives like Project Stardust. Thereafter, it will trend below $60 million in the latter part of the decade to average $60 million annually during the period from 2023 through 2030. Turning to our pro forma free cash flow. If we use the midpoint of our 2024 EBITDA guidance and back out $86 million in net interest pro forma for our current debt structure, approximately $69 million in CapEx for this year, $5 million in cash taxes and $6 million in working capital, inclusive of the appropriate hosted payload adjustment, we're projecting pro forma free cash flow of approximately $299 million for 2024. These metrics would represent a conversion rate of EBITDA to free cash flow of 64% in 2024 and a yield of close to 10%. A more detailed description of these cash flow metrics, along with the reconciliation to GAAP measures, is available in a supplemental presentation under Events on our Investor Relations website. Iridium continues to execute well on this year's plan and we see meaningful growth ahead to support free cash flow generation and service revenue expansion. We remain comfortable with our long-term guidance for $1 billion in service revenue by 2030 and our capacity to return $3 billion to shareholders from 2023 through the end of the decade. With that, I'll turn things back to the operator and look forward to your questions.

The first question comes from Ric Prentiss with Raymond James.

A couple of questions. First, on the service revenue guidance, maintaining at 4% to 6% year-over-year increase, I think last quarter, though, you thought you might be heading to the higher end of the service revenue guidance. Any update from what you were thinking last quarter to what you're thinking this quarter as far as in that range?

No, not really, Ric. What I would say is that Satelles was not included in our original guidance. Even though we made the acquisition, it added some positive impact to that original guidance. However, we estimated it at less than 100 basis points. So, we're in a similar situation as we were last quarter. I want to emphasize that we are very comfortable reiterating the original guidance of 4% to 6% and, more importantly, reinforcing the $1 billion service revenue goal for 2030.

Okay. And obviously, taking the leverage up to see opportunity in your stock price. Is there something that goes on when leverage is above 3.5% but less than 4% kind of on what happens with the debt or prepayments or cash sweeps that was written through the 10-Q a little bit there.

Not between 3.5 and 4, when you get over 4, there are certain things happened there. And when you get over 4, they're manageable. We just like keeping it inside of 4 times. And that provides a lot of capacity for additional share repurchases.

Okay. And last one for me is on the IoT, you did have that ARPU increase. You called it out a little bit in your prepared remarks. Talk to us a little bit about that competitive positioning of those IoT devices versus what's going on with direct-to-device of other operators out there and should that ARPU trend upward and net adds? Just trying to think the competitive dynamics on that particular line item.

Well, in terms of competitive aspects, I mean, one of the reasons it's trending upwards is that we're introducing new devices into the market that offer higher speeds, more capabilities, the ability to send consumer devices, pictures and voice snippets and things like that. And we think that that will help in terms of driving some ARPU in those kind of products. But in addition, I mean, we really have a strong competitive advantage over everyone in IoT because we're a global service, day one. I mean the other activities people have are either typically non-real-time or they are regional. We're expecting, for example, we don't really compete with cellular IoT. We supplement it. We support it but it only covers the low teens part of the world. And even with supplemental coverage from space coming, that only adds a couple of points to sort of the IoT footprint. So we're expecting still to have an important kind of global role for that. And then you add on top of that, that we've been in service for many, many years in IoT and have hundreds of partners and potentially thousands of solutions out there today that are deeply embedded in all kinds of industries and expanding into more industries. So we're real comfortable with our position in IoT. In fact, it's even a particular strength right now in our results and what we're looking at going forward.

As far as getting into the D2D yourself, still a couple of years to get kind of designed through the standards body, 3GPP, how should we think about kind of the cost and then the revenue curve of that effort?

I believe that our efforts will continue to drive and support our growth as we expand our use cases and reduce our product costs. We plan to significantly decrease our prices even before we establish any standards, which will seamlessly transition into standard environments. This will enable previously sold terrestrial devices to connect to our network, creating new revenue streams for us. The Stardust project is progressing well; we have chosen numerous partners and have made substantial development strides. We've already showcased demonstrations of narrowband IoT using our unique waveform and have integrated effectively with chip vendors and similar stakeholders. We're making excellent progress with Stardust, although it may take a couple of years for it to contribute significantly. However, we do not expect any setbacks in the meantime, and I believe it will enhance our growth.

The next question comes from Simon Flannery with Morgan Stanley.

If I could just come back to the leverage point. It's a pretty significant increase from the 2.5 to the 4. And I understand that your stock is attractive. One, is there anything else going into this? I think you confirmed the CapEx guidance but any other changes? Or is this all essentially keeping leverage higher to return more capital to shareholders? And just, what was the decision to go to up 1.5x rather than, say, keep it in that 3, 3.5 or whatever? How did you balance that and come up with this ratio?

Good morning, Simon. The additional leverage is solely aimed at repurchasing more shares. Our strategy involves evaluating our competitive position and our commitment to achieving $1 billion in service revenue. We believe that our stock is undervalued, and we can increase the leverage up to just under 4 times. There are no impacts on the credit facility; it only means a slight increase in interest.

And you won't go over 4x, I think you mentioned?

We plan to maintain a leverage ratio of under 4x, which will provide considerable capacity for share repurchases. It's difficult to envision our EBITDA being less than $500 million in 2026. At a leverage ratio of 1.5 turns, this allows for approximately $750 million for share repurchases, which is quite meaningful given our $3 billion market capitalization. We believe this strategy is appropriate based on current trading levels.

Great. And then on commercial broadband, I think you had sort of talked about this as going as expected, given some of the primary to complementary. Can you just help us what inning are we in on this? ARPU is down to 269. Are we near the bottom of this sort of rate of percentage decline? Or is there a couple more quarters before we can sort of say we're seeing some sort of easing of that pressure?

Which support do you want to use? I think we're in the latter part of the game here, maybe the third or fourth quarter. It definitely feels like we're mostly through a lot of that. We're getting to the point where the predominant use these days is us as a companion service, and the development is progressing very well and is on track for adding GMDSS to our broadband service. This means that one terminal can handle all the safety and companion aspects, which we believe is a standout product. Therefore, I think we're very well positioned to continue our broadband business.

And where should that ARPU settle out in the kind of mid-200s or...

I think that's fair.

Yes, I think that's about right.

Yes. And then just one last one. You talked about the $90 million in incremental revenue over the next 5 years from the U.S. government. How does that flow through the next several years?

It's in engineering and support, Simon.

Yes, it's pretty flat. The previous contract, as we said, was lower than that and it was pretty flat each year. This one obviously stepped it up roughly 50% or so. So that will just be an increase over the next 5 years to that.

And when is the first quarter you get to step up?

I believe we will see some impact this year and then a more significant effect next year, though it won't be substantial. Overall, it is a positive trend among several positive developments.

The next question comes from Walter Piecyk with LightShed.

This is Joe on for Walt. You mentioned the Maritime sector in relation to the area that is affecting broadband. Are there any other sectors that might be at risk? Could you provide some insight into what is happening in those other sectors within the broadband market?

The three main areas we focus on are land/mobile, aviation, and government. Government is still in its early stages, and we're currently engaged in their emergency management model. We're positioned well there. Land/mobile has been a smaller segment for us, primarily focused on trains and remote assets, and while it hasn't been significantly affected, it remains a niche business for us. Aviation is a crucial area as it involves safety systems in aircraft, and that work is nearing completion. We are beginning to deploy broadband terminals in helicopters, corporate jets, and commercial airliners, and we expect this to grow in the coming years as we achieve final safety certifications. This gives us a unique advantage since few can provide this kind of service, unlike lower-cost Ka/Ku-band services. Overall, the only significant impact we’ve observed so far has been in the Maritime sector.

Okay. And then on SG&A, I know there was some reclass and there's some step-up for Satelles and then Tom mentioned that the guide year-over-year should be plus 15%. So that implies, I guess, that SG&A will be a little lower in Q3 than it was in Q2 and in Q4. So is there some one-timer that's in that $47 million that was in Q2?

In the second quarter, there was the reclass that made the second quarter number higher. So a lot of the year-to-date reclass occurred in the second quarter. And you're right to observe that SG&A will move down sequentially in the third and the fourth from where you see it in the second. And you modeled it 165 to 170, that ought to be good.

Okay. And then what specifically was reclassed out of SG&A?

Certain costs related to our SDA contract were more appropriately classified as SG&A rather than cost of service, so we made that reclassification. As I mentioned, there is no impact on EBITDA since it is simply a reallocation.

Okay. And then last one on CapEx. It's been kind of, I guess, light in the first half. Is that expected to ramp each quarter into the end of the year to get to like this $70 million-ish guidance?

Yes, that's our expectation.

The next question comes from Hamed Khorsand with BWS.

So first off, on the IoT front, excuse me if you already answered this, but what caused the increase in ARPU and IoT on that side? Was it driven by consumer or industrial segments?

Consumer and it's on the back of the new contract that we referred to with a large fast-growing customer.

Got it. And then is that just going to be a one-time benefit, though?

The contract is 2 years.

Front load increasing like a one-time benefit and then just tapers off?

The key trend in IoT, when viewed over several years, shows that personal communications is expanding at a quicker rate than industrial in terms of subscribers. Consequently, there will naturally be a shift in the average revenue per user for personal communications, which is around $4, compared to the overall average revenue per user of about $7. This has been the consistent pattern for years and is expected to persist as personal communications continue to grow rapidly.

Okay. And then my last question is, is your partner the same partner that we're talking about, are they promoting their product more that includes you? Or are they doing anything to increase the units sold?

Yes. I mean, they're heavily promoting their products. Obviously, that's the whole point to this and why the revenue has gone up is that they've been very successful and are introducing new products to the market with new capabilities, et cetera and we're working together to make that a success for them and for ourselves.

The next question comes from Chris Quilty from Quilty Space.

Tom, just quickly, are we safe modeling sort of high 30s margins for equipment? And then what's sort of the range there for full year?

I think that's about right, yes.

Okay. Second question, Tom, did I hear you mention you have partners on the Stardust program? I hadn't heard you specifically mentioned that previously.

When it comes to supply and building new equipment to support the standard in the gateway, I wouldn’t necessarily call them partners. We see them as collaborators in some respects. As we work to integrate this capability into our network, we aren’t doing it alone. There’s new hardware needed for the ground infrastructure, along with software programming and satellites. That's what I was referring to. We haven’t yet announced the partnerships you might be inquiring about, but we are in discussions with many companies and are receiving a lot of encouragement and support. As we progress further, we’ll be able to share more details about these collaborations.

I was looking at your DoD subscriptions, and they seem to be fluctuating. Considering the current developments in drone warfare and the sensor networks around Ukraine that detect drone signals, it appears that there should be significant market activity for your secure communication devices with the government. However, I haven't seen much movement. The p-LEO contract doesn't seem to be the right avenue for that. Could you provide an update on both the p-LEO and what you are observing in the market?

Our subscriber count is quite dynamic and fluctuates frequently. We are currently in a transition period regarding government subscribers, involving both clean-ups and new additions. However, we believe the trends moving forward will be very positive. There are several new contracts and opportunities we are pursuing with the government that should lead to a significant increase in subscribers over the next few years. Since it's a fixed-price contract, we aren't overly concerned with daily subscriber numbers; instead, our focus is on ensuring we are involved in key activities where we provide essential technology and services, which we anticipate will lead to long-term growth. Maintaining a strong relationship with the government is crucial, and while the immediate subscriber count might not reflect this, we expect it to turn positive in the coming years.

And do you still feel that the strategy of selling Certus as separate from the EMSS contract? Does that still look like a solid plan?

Yes, I think so. I mean, I think we're continuing to see niches of things that we can do well that others can't, and it's a bit of a niche service. I think we're going to see it finally been installed at the government gateway soon which will help continue to see sort of us as a contingency backup sort of service for other technologies too. So I think we're still well positioned with that technology on the broadband side and then really well positioned in sort of the mid-band and what I call narrowband side of the Certus technology as well in applications.

Final question. Don't ask why I was looking at a pre-pandemic Inmarsat annual report and they were sizing, I think the aviation safety market that you and I share. And I think like $250 million and growing to $1 billion whenever, right? I think your business there is still probably around $30 million, I think, Tom? And what do you think is the outlook for that market? Obviously, you need to get your certification in place. But is it really about getting equipment deliveries? Is it aircraft deliveries? Is it the OEM activity of getting all the STCs for aircraft? And how is that activity being managed?

I can't comment directly on the market forecast you mentioned. However, I view things differently. We see aviation as a growth opportunity for us, especially given our strong positioning and the approval of new products by our partners with the FAA, as well as the relevant safety certifications. We also recognize that we can tap into segments of the market that other competitors cannot address from GEO, particularly rotorcraft, where our antennas have a distinct advantage due to their smaller size, making them suitable for various aircraft. We're particularly enthusiastic about the drone sector, which has yet to see significant development, but there is considerable activity aimed at integrating drones into the National Airspace System. We believe we have one of the few technologies capable of facilitating this and are well-positioned at the forefront of beyond visual line of sight operations. We anticipate that in the coming years, this will serve as a substantial growth driver. While I can't provide specific figures, I believe it will be considerably larger than our current position, and I see it as a key contributor as we look towards 2030.

Do the incremental contributor next year?

Yes, I think so. Yes, absolutely.

The next question comes from Mathieu Robilliard with Barclays.

My first question was about the trajectory of the gross margin on service revenues. Over the past years and quarters, we've seen the margin go down a bit. I understand that part of that is explained by the fact that some of the government services come with lower margin but I was wondering if there was anything else impacting the trajectory of the gross margin on the service revenues beyond the mix in revenues?

Good morning, Mathieu. The decrease in our overall gross margin or EBITDA margin is solely due to engineering and support. The FDA contract is significant but comes with lower margins, which is contributing to the decline in EBITDA margin. However, the service revenue margin remains strong, and we will continue to show operating leverage consistently. I hope that clarifies things.

That's very clear. I have a second question regarding your legacy satellite form business. I was hoping to gain more insight into the types of customers you have and how they are using the service. This is important because I'm curious if it might be affected by all the D2D initiatives. I understand that for some customers, connecting through a commercial network enabled by satellite on their iPhone isn’t functioning as they desire. If possible, could you provide an overview of the different customer segments and identify where you see potential risks from D2D and where there might not be any? That would be very helpful.

Currently, D2D is mainly being discussed in connection with Starlink and possibly a few other services in the future. At the moment, it is proposed to utilize terrestrial spectrum, which the FCC has referred to as supplemental communication from space. This setup acts as a coverage enhancer in select markets where spectrum can be used across borders, but it is limited to just a few countries right now. Assuming the regulatory and technical challenges are addressed, I believe these issues will be resolved gradually. While D2D may enhance cell phone performance in a few markets, it does not provide a global service, which has always been our focus. Our primary strength is in IoT, as our services are reliable worldwide. Many industries and applications have integrated our capabilities precisely due to this reliability, and that’s not what D2D currently offers. While there may be improved services on specific phones in certain markets, that's not the reason users purchase our satellite phones. Customers typically buy our devices for scenarios like being a first responder in situations like hurricanes or for travel to regions where D2D isn’t offered yet. Our services are effective across various locations, including Africa and Europe, where D2D won't be available in the near future. We believe that D2D is more of a marginal concern, and we have factored this into our forecasts and expectations through 2030. We recognize some people may not fully understand this yet, but over time it will become clear that we can coexist and our growth can align with these developments. Additionally, we will be able to engage in that market as a global solution, leveraging our global L-band allocations to provide reliable services. I hope this clarifies things.

Got it. It does. And then I'll try a last one. With regards to your new leverage target for year-end 2026 and that was discussed already in previous questions. I was wondering if the decision to move from 2.5 to 4 was maybe also linked to the fact that you had been looking at some deals potentially. And in the end, you're deciding not to go for these and that's why you have this new flexibility?

No, that's not at all. We're taking the leverage guide up exclusively to repurchase shares given their current trading levels.

No. No, I mean I'm always looking at things and that's a separate aspect and if something can pay for itself, we'll be interested in looking at that independently and there may be opportunities for that sort of thing in the future. But the focus on this was strictly shareholder-friendly activities.

Right. The only connection between doing deals and the leverage occurred when we acquired Satelles. We received inquiries about whether we would reduce share repurchases due to the funding for Satelles, and we confirmed that we would not, as we believe in increasing leverage given the current stock price. This decision aligns with our previous statements. We think the shares are at a favorable level and it’s necessary to increase leverage a bit.

The next question comes from Bryce Sandberg with William Blair.

Matt, Tom and Ken. I just want to ask about the Soraya outage this quarter, if you saw any positive impact from that outage and if you're able to quantify that impact at all?

There has been a positive impact in the sense that Asia Pacific customers are looking for alternate solutions. Soraya is really not going to be assuming that they have a successful launch and all that sort of thing are going to be kind of out of the market for two years here. And I think the reliability of GEO solutions has been put to test here between themselves and Inmarsat's outages in Asia as well. So we are getting a lot of positive reception. It takes time for that to kind of develop or seeing certainly, particularly around the handset but in some cases, IoT customers in that region are looking for different solutions. So it's certainly been supportive. Will it move the needle substantially? We'll see. We certainly hope so but it's a little too early to call that yet.

And our final question is a follow-up from Chris Quilty from Quilty Space.

Anything to update on Aireon and if not okay?

During a Board meeting a month ago, I recall hearing Don discuss a lot of optimism regarding the computer and CDS business, particularly in data services. They are developing several new products and expanding their team due to the opportunities arising from their customers renewing contracts. We've been collaborating with them on system engineering for a potential global VHF service to complement ADS-B. This is something they are considering long-term; however, decisions have not been made yet, and developing such a service will take time. We would like to be involved, possibly with our next constellation. Overall, the sentiment is very positive at the moment. It's encouraging that they have successfully refinanced their financing, which alleviates some restrictions. Things are looking quite favorable over there right now.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Well, thanks for joining us. We'll see you again in August and talk to you, I'm sure, individually. Thanks for your time.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.