Repairing the 2Ku systems affected by deicing fluid seepage will cost Gogo north of $25 million in 2018. That unexpected expense is one of a couple setbacks the company announced in its quarterly earnings call this morning. New CEO Oakleigh Thorne spent much of his prepared remarks explaining to investors how he expects to reshape the company in the coming months, to “improve quality and reduce costs” while breaking down operational silos. As the call closed he acknowledged the challenges but also highlighted the company’s strength in the market:
Yes, we are having our issues right now but I believe the future is bright for this company. Passengers want connectivity and airlines want to provide it. Providing connectivity at 36,000 feet and 600 mph is a really hard thing to do and we’re really good at delivering it. I’d say we’re the best at it.
As long as you believe connectivity is going to grow you’ve gotta believe that Gogo is going to have a positive future.
Supplier Challenges for ATG-NG
One of the biggest questions hanging over the company in the near term is the deployment of the ATG-NG network. The ground systems hardware for that network is manufactured by ZTE, a Chinese company that recently earned itself a US Commerce Department export ban. Gogo’s official position at this time is uncertainty:
We are working hard on assessing the legal, regulatory, supply chain and technology issues presented by this order. At this time we’ve note been able to determine if the order applies to our technology or not, nor the impact on the timing or cost of our Next Gen project.
At the same time, Thorne acknowledges that the delivery delays hits Gogo “mid-stride” in the network build out. Delivery of antennae hardware to Gogo is impacted.
That said, we’ve been working on some sort of Next Gen ATG product since at least 2010 and have considered many other technology paths and vendors. If we need to change direction we can, though obviously that will involve cost and delay.
One potential saving opportunity for the ZTE situation comes in the form of a US trade delegation that visited China this week. While it was not an official appeal opportunity it is widely understood that ZTE has some wiggle room to negotiate. The US delegation did not meet with the senior Chinese officials. That’s not good news for any potential forgiveness.
US delegation not meeting with Wang Qishan or Xi Jinping likely a clear sign of how roughly the meetings went. If I am Huawei or one of its suppliers I am getting even more nervous…
— Bill Bishop (@niubi) May 4, 2018
Gogo’s push into the ATG-NG space comes as SmartSky is also pushing into the high speed ATG connectivity space. Both companies are competing for the significant BizAv market – Thorne believe 70% of the unconnected biz jets flying today are viable potential customers – and also potentially for smaller regional jets in the commercial space. SmartSky provided an update earlier this week claiming, “nearly 60% of the sites needed to provide U.S. coverage in their final stages of deployment.” The initial deployment will not be full coverage and the 60% are not all complete yet, but progress is ongoing. Perhaps more significant is that SmartSky is not using ZTE hardware in its network, removing that wildcard from consideration.
2Ku: Beyond the deicing
The costs of fixing or replacing the antennae affected by the deicing issues is significant, but a non-recurring expense. Replacement hardware, as well as software updates and changes to the manufacturing process are mostly accounted for at this time. Thorne did note that the repair work is not yet fully realized. There are still changes to be made on existing 2Ku aircraft to prevent future issues, “In the second half of this year we’re planning to roll out 2Ku modifications that will keep deicing fluid out of the raceways and that will get us back to our target of 98% system availability.”
With the bulk of the 2Ku deicing reliability issues now resolved Gogo is focused on growing the data consumption (and associated revenue) for the platform. It announced that the first Bombardier CSeries installation occurred at the factory in Mirabel, Canada. That aircraft will eventually be delivered to Delta Air Lines. Both Delta and Air Canada will take the 2Ku kit on their CSeries aircraft. Gogo is also making strong progress in upgrading the modems on its satellite-connected aircraft to the newer Gilat hardware. Some 500 are installed today with another 500 upgrades yet to come.
The company is also taking a more holistic view of systems reliability, with plans to add additional monitoring to the network for a true end-to-end experience metric:
We measured success by network availability, how well the network was reaching the airplane. We failed to measure the user experience once our signal was on board. We’re changing all that and rolling out tools to measure network connection times, portal performance and browsing performance in the cabin.
Gogo faces two headways on the financing front. The company holds significant bond debt at relatively high interest rates. That cash was expected to fully fund the 2Ku rollout when the deal was signed. Thorne indicated in today’s call that is no longer the case, “If we made no changes to the business right now we would need some, but not a lot, of additional capital. The goal of the IBP will be to extract enough cash out of our operation to mitigate that need.” If a new deal comes along – at the right value to the company – Gogo “may seek growth capital to fund the ramp up associated with those opportunities.”
Rightsizing the debt is also critical from a more strategic position. Consolidation is oft discussed around the inflight connectivity market and Thorne is sharing some of those thoughts these days:
We see tremendous change coming to our industry over the next few years, which includes consolidation of existing players, the potential entry of larger, strategic players and large new sources of capital looking to finance consolidation. To ensure that those changes create value for our shareholders we created a Strategy and Corporate Development function as part of our recent reorganization.
Our opportunity is to make sure we understand how that “Game of Thrones” will play out and ensure that we choose a path that will be rewarding to Gogo’s shareholders.
Business aviation remains a bright spot for Gogo. Revenue is up 22% YoY with an 11% increase of ATG aircraft equipped and a 9% increase in average revenue per aircraft. That growth trajectory is expected to continue with the AVANCE system rollout. The L5 kit (for larger biz jets) just hit its 100th install while the L3 (for smaller jets and props) receive STC and PMA certifications from the FAA, allowing installations to commence.