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Edited Transcript of IRDM earnings conference call or presentation 25-Feb-20 1:30pm GMT

Q4 2019 Iridium Communications Inc Earnings Call

MCLEAN Mar 4, 2020 (Thomson StreetEvents) -- Edited Transcript of Iridium Communications Inc earnings conference call or presentation Tuesday, February 25, 2020 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kenneth B. Levy

Iridium Communications Inc. - VP of IR

* Matthew Desch;CEO

* Thomas Fitzpatrick;Chief Administrative Officer, CFO

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Conference Call Participants

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* Anthony Francis Klarman

Deutsche Bank AG, Research Division - MD and Global Head of High Yield Research

* Christopher David Quilty

Quilty Analytics, Inc., Research Division - Research Analyst

* Gregory John Burns

Sidoti & Company, LLC - Senior Equity Research Analyst

* Louie DiPalma

William Blair & Company L.L.C., Research Division - Analyst

* Richard Hamilton Prentiss

Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research

* Vahid Khorsand;BWS Financial;Analyst

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Presentation

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Operator [1]

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Good morning. And welcome to the Iridium Communications Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions). Please note, this event is being recorded. I would now like to turn the conference over to your host today, Ken Levy. Please go ahead, sir.

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Kenneth B. Levy, Iridium Communications Inc. - VP of IR [2]

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Thank you, Keith. Good morning. And welcome to Iridium's Fourth Quarter 2019 Earnings Call. Joining me on this morning's call are CEO, Matt Desch; and our CFO, Tom Fitzpatrick. Today's call will begin with a discussion of our fourth quarter results followed by Q&A.

I trust you've had an 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 fact 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 and expectations have changed. During the call, we'll also be referring to certain non-GAAP financial measures, including operational EBITDA and 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 of the most directly comparable GAAP measures. With that, let me turn things over to Matt.

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Matthew Desch;CEO, [3]

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Thanks, Ken. Good morning, everyone. So it was only a bit more than a year ago that we were toasting the 8th and final launch of our Iridium NEXT satellites and celebrating the completion of our new constellation. And of course, that was just the start of a milestone year filled with many accomplishments.

As far as those satellites go, we continue to be very happy with our new network and all its new capabilities. Tom will go into detail on 2019's numbers and our 2020 outlook, but a few trends really stood out to me particularly in context of our recent performance.

Obviously, beating 2019 guidance on operational EBITDA was noteworthy as was achieving another year strong subscriber and service revenue growth.

In 2019, Iridium delivered a 16% increase in net billable subscribers as well as double-digit revenue growth in IoT, government and hosted payload. Not bad for a transition year.

To put this in context, even as we were building our new satellite network over the last 5 years, we grew our operational EBITDA at a 9% CAGR, which is really outstanding for the satellite industry, and we're excited about our opportunities for growth in the future. Perhaps a more meaningful step for our investors was that we generated $168 million in pro forma free cash flow in 2019. This is a dramatic flip from prior years when we were spending significant capital on our network build.

As you know, we believe investors should increasingly be focused on our cash flow going forward. Metrics like free cash flow, cash conversion, cash flow yield and the like, and evaluating us on it. We think we stacked up particularly well on these measures versus other firms in the communications infrastructure space, many of whom enjoy higher valuation multiples than Iridium. These new metrics we're focusing on are important as they should drive real shareholder returns.

After lots of effort and investment, we finally reached what I've been calling financial maturity. What I mean by this is that Iridium has become self-sustaining, especially as we look to the future.

In contrast, throughout Iridium's 30-year history, we've been beholden to the financial markets to supply debt and equity need to build and upgrade our network. At times since I've been here, obtaining needed capital as a very challenging proposition given our level of revenue, the state of the capital markets and the operational risk we faced in launching a new network.

Today, we're in a much different place. In light of our market position, revenue growth and expectations for significant cash generation for years in the future, we now believe that our destiny is in our own hands; particularly so as we've chosen a unique and differentiated path compared to all other satellite players, including existing competitors as well as the new LEO systems being launched today. We have an exciting open lane in front of us for continued growth in areas like specialty broadband services with our new Iridium Certus platform, best-in-class satellite IoT services and consumer-oriented personal communication services. These and the unique new services like Aireon and Satellite Time and Location are all showing great potential.

Our new broadband offering has really thrust Iridium into the mainstream in maritime. 2019 was our first year with this new offering, and I think we did very well. Iridium Certus launched in the first quarter was recently upgraded in speed, making it the fastest L-band service available. It is also more affordable, provides better coverage and has other benefits compared to the incumbent offering. Plus, our partners love selling it. This is why it's both great as a stand-alone service and increasingly being paired with VSAT as a companion product. Today, we have more than 1,200 active subscribers using Iridium Certus and believe that the pace of activations will continue to ramp as new distribution partners and products come online.

With several new terminals scheduled for introduction this year, we have a very competitive offering to grow our footprint. It also helps that we've just been formally authorized for GMDSS service, which will roll out in the coming months. Adding Iridium Certus aviation and U.S. government customers to this mix in the coming years as well as partnerships supporting the new LEO mega constellations, and we think the runway for growth in Iridium Certus broadband is quite exciting. To help you better track this growth, we will begin breaking out service revenues from our broadband services starting in the first quarter.

IoT has become a core market for Iridium with this compounded annual subscriber growth, topping 25% over the last 10 years. IoT posted another great year of growth in 2019 and now generates 27% of our commercial revenue today.

We expect this figure to increase on the continued strong momentum we see moving forward. Our network is perfect for consumer and enterprise-oriented personal communication devices, and that's been driving a lot of our subscriber growth in recent years.

With expanding offerings from Garmin and quite a few other partners, we still think our brightest days are ahead. We also benefit from being network of choice for industrial IoT solutions where reliability and coverage are critical. You've seen this in the heavy equipment OEM space where we've been adopted by the largest manufacturers over the last few years. Our partner ecosystem remains one of the key reasons for our IoT success. We added over 20 new partners alone in 2019, and I don't see that pace slowing.

With over 450 partners today, we touch a lot of diverse IoT opportunities. However, we're really only scratching the surface. And particularly, we see growth in areas like agriculture, transportation and the emergence of autonomous shipping and unmanned aerial vehicles. As our new Iridium Certus mid-band devices become commercially available later this year, the ability to expand the types of IoT data set, including things like pictures, will only expand our market potential further. At the same time, our strategy is to make it as easy as possible for these industries to utilize Iridium IoT in their applications, and that's become much easier with the launch of Iridium CloudConnect through our relationship with Amazon Web Services. That service went live last month. Another avenue that will facilitate and accelerate our growth is to provide partners with innovative new integrated devices that make it easier and faster for them to get services on our network, which expedites time-to-revenue and improves their margins. We've had good success on that front with the introduction of Iridium Edge in 2017 that integrated our IoT transceiver with an L-band antenna for plug-and-play simplicity to extend existing cellular based applications to satellite. Since its introduction, our partners have purchased over 10,000 of these devices for their customers.

In the next few months, we'll -- we're introducing 2 more products in this category to integrate additional components for ease and speed. The Iridium Edge Solar will integrate solar power to offer a very low-cost and long-lasting tracking device to support asset tracking right out of the box. And the new Iridium Edge Pro device will incorporate a processor in GPS, so that partners have an all-in-one integrated package to develop their applications more easily. We see interest from our partners for these devices and together with Iridium CloudConnect, we believe 2020 will bring new momentum and keep our IoT business on a roll.

Finally, 2019 was a great year for our relationship with the U.S. government, which continues to evolve and grow stronger. The highlight was obviously the new long-term fixed-price contract for our existing narrowband services, but you should also take note of other -- the other 2 long-term government contracts we sign. They contributed to the jump in engineering services we're seeing as we support the government's diverse uses of Iridium for another decade. This new investment on infrastructure and R&D is an indication of the close collaborative relationship we have with the DoD. While the EMSS contract establishes a base for their Iridium services, we anticipate building on this foundation with new incremental pay-for-use services like Iridium Certus broadband. I still think investors may not fully appreciate the range of our business potential with the U.S. government. Beyond the contracts we signed with the DoD in 2019, we have significant opportunities to grow our relationship. This is because Iridium can fill large gap in capabilities and coverage that exist in the government's relationship with other satellite operators.

With 14% compound annual subscriber growth over the last decade and 135,000 active government subscribers today, we continue to view our relationship with the U.S. government as a source of innovation and mutual collaboration for many years to come. Another relationship that is creating significant upside for us is Aireon.

I'm really proud of the progress Aireon made in 2019 as they commercialized their service. The rate of customer additions remain strong, and this is evidenced by our step-up in data revenues, which we announced earlier this year. Over the past 6 months, air traffic controllers around the world have begun managing air traffic using Aireon data, and this is providing real safety and efficiency benefits to airlines and the traveling public. While we have always expected Aireon would become a mainstream service, our optimism about their potential has only strengthened with the success of their commercial introduction. I'm particularly excited that Aireon is now going into initial use by the FAA in their Miami airspace. And Aireon's pipeline for other new customers remains strong.

Aireon expect to generate positive operating cash flow this year and to pay us significant dividends in the years to come. This gives us confidence in our long-term view that Iridium's equity stake in Aireon will be a meaningful source of value creation for our shareholders.

Reflecting on all this, Iridium has created a very powerful business platform built on a new network, delivering unique and differentiated services, generating strong growth. And as a result, it's poised to generate a significant amount of cash in the coming years. I can't help looking back proudly over how far we've come, but I'm really more focused on our tremendous opportunities we see going forward. We are positioned as a long-term leader in L-band satellite mobility services, and our competitive position has actually improved over the last few years, even as the others in this sectors have struggled. I'm excited for 2020 as all the plans we have set into motion for continued growth and innovation with our expanding ecosystem of partners.

For Iridium, the best is yet to come. With that, I'll turn it over to Tom for a review of our financials. Tom?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [4]

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Thanks, Matt. Good morning, everyone. Having just wrapped up another great year for Iridium, I'd like to start with a recap of our 2019 financial results and provide some color on our fourth quarter performance. I'll then walk through the key components supporting our 2020 outlook, discuss the refinancing activities we've executed in recent months and conclude with a review of Iridium's free cash flow and valuation metrics, which we believe are compelling. We made steady progress executing on Iridium's financial transformation in 2019.

As Matt noted, we achieved another year of strong growth in billable subscribers, service revenue and operational EBITDA. Beyond these metrics, Iridium also generated $168 million in pro forma free cash flow, which marked our return to positive free cash flow in 2019 and drove additional balance sheet deleveraging.

In fiscal 2019, total service revenue and operational EBITDA both grew 10%. This strong performance was driven by continued momentum in our commercial business, highlighted by meaningful ramp in hosted payload revenue and IoT.

In the fourth quarter, Iridium reported total revenue of $138.9 million, which was up 5% from last year's comparable period. This growth was attributable to strong trends in commercial voice and commercial IoT and new long-term contracts with the U.S. government, which drove incremental service revenue and engineering and support work this quarter.

Operational EBITDA rose 6% from the prior year's quarter to $80.1 million. The commercial side of our business remains strong and generated revenue of $88.6 million in the fourth quarter. Revenue from commercial voice and data increased 5% and from the prior year period, reflecting demand for Iridium's new broadband offering and increased access in roaming revenue.

In commercial IoT, personal communication devices continue to fuel new subscriber and revenue growth. IoT subs rose 24% from the prior year's quarter, while revenue grew 13%. While these consumer-oriented plans have lower ARPUs, they are particularly attractive in terms of revenue generation relative to network resources used, making them an ideal source of incremental revenue.

For the year, personal communication services and consumer IoT were responsible for over 100,000 new subscribers on our network.

In all, commercial subscribers grew 16% year-over-year and IoT subscribers now represent 69% of billable commercial subs, up from 64% in the year-ago period. Revenue from hosted payload and other data service was $12.1 million in the fourth quarter, down 15% from the year-ago period.

You will recall that in the fourth quarter of 2018, Iridium recognized a $4.5 million catch-up revenue adjustment from Satellite Time and Location services. Government service revenue grew 14% in the fourth quarter to $25 million, reflecting the terms of our new EMSS contract with the U.S. government.

During the same period, government subscribers grew a robust 19%, underscoring the utility of Iridium connectivity for the Department of Defense. Total government subscribers ended the year at a record $135,000.

Revenue from subscriber equipment continued to reflect our outlook for moderation from 2018's record pace. Equipment revenue fell 15% to $17.1 million in the fourth quarter. We believe 2019's equipment revenue is more in line with the long-term trends we've experienced in handset sales.

In 2020, we forecast operational EBITDA in a range of between $355 million and $365 million. Predicated on total service revenue growth between 6% and 8%, over 2019's level of $447.2 million.

The key elements supporting this outlook are as follows: first, we expect service revenue to benefit from continued strength in IoT, growth in hosting revenue, Iridium service broadband activations and the contractual step-up in our government contract.

In IoT, we have good visibility to our partners' business plans and expect the demand for reliable, low-latency personal communication devices to continue, which makes us comfortable forecasting double-digit subscriber growth for IoT for 2020.

We also anticipate approximately $47 million in revenue from hosted payloads in 2020. This increase reflects the full run rate of our data power and hosting contracts with Aireon and L3 Harris, including the $800,000 step-up in monthly data service fees we announced for Aireon earlier this year.

On our new EMSS contract with the U.S. government, this contract started on September 15 at $100 million annual rate and will reach a contractual step up on its anniversary to $103 million. We also expect equipment revenue to increase in 2020 from 2019. This outlook is predicated on expectations for relatively flat handset sales in 2020, but it increased to other products due to technology migration and resulting last-time buys.

Finally, we continue to expect negligible cash taxes in 2020, and consistent with our previous guidance, we currently estimate negligible cash taxes through 2023.

Thereafter, our outlook calls for an estimated cash tax rate at mid- to high single digits until 2028. As you can surmise from our 2020 outlook, Iridium is a completely different company today than we -- when we began Iridium NEXT program 10 years ago. We have a much stronger earnings profitable -- profile, lower capital needs and the ability to generate significant free cash flow at a growth rate that exceeds our growth in EBITDA.

Moving forward, we expect total CapEx to average about $35 million per year. Now focusing on our balance sheet. As of December 31, 2019, Iridium had a cash and cash equivalents balance of $223.6 million. At the end of the first quarter, with the retirement of our high-yield notes, we expect our cash balance to be around $50 million and grow from there.

We closed 2019 with leverage at 4.8x OEBITDA. This was down from 5.2x a year earlier and in line with our forecast, which reflects the impact of refinancing our credit facility with BPIAE in November.

We continue to expect that net leverage will fall in 2020 to approximately 4x OEBITDA as we exit the year. Earlier this month, we retired $360 million of 10.25% high-yield notes using excess cash and the proceeds from a $200 million tack on to our existing term loan facility, which is priced at LIBOR plus 375 basis points. This refinancing, together with the retirement of our BPIAE facility in November materially reduces our annual interest expense moving forward.

In 2019, our pro forma net interest expense was approximately $112 million. Pro forma net interest for 2020 based on our new $1.65 billion term loan is approximately $90 million, a $22 million or 20% reduction. This has a beneficial impact on our pro forma free cash flow. If we use the midpoint of our 2020 EBITDA guidance at $360 million and back off $90 million in net interest pro forma for our new debt structure, $35 million in CapEx and $26 million in working capital, inclusive of the appropriate hosted payload adjustment, we're left with pro forma free cash flow of approximately $208 million, up 20% from 2019.

This is a conversion rate in excess of 55% and suggests that our pro forma free cash flow will grow by more than double the rate of growth of EBITDA in 2020, representing a yield of approximately 5%. I know I shared a lot of numbers here, but we have posted a more detailed description and reconciliation of these cash flow metrics as a supplement on our website.

It's important to note that our $200 million tack-on facility was multiple times oversubscribed and priced at 101. This suggests that LIBOR plus 375 basis points is above market pricing. We can reprice the entire $1.65 billion facility on its 6-month anniversary in May and intend to do so, assuming market conditions hold.

To illustrate, a 50-basis point reduction in our spread would yield $8.25 million in additional annual interest savings or about a 9% reduction. We believe this is an important consideration in evaluating our free cash flow growth prospects particularly given Iridium's deleveraging profile and the ability to reprice our term loan periodically if market conditions allow.

We continue to believe that Iridium's free cash flow statistics compare quite favorably to companies in the communications infrastructure space that trade at much higher multiples than Iridium. For example, certain fiber companies trade in the high teens and certain data center companies enjoy a multiple of 20x, while the tower sector trades around 25x EBITDA. We think this is an important investment consideration in evaluating Iridium.

In closing, 2019 was another strong year for Iridium. I continue to feel very good about the underlying strength of our business. We continue to enjoy strong top-line growth and the deployment of our upgraded satellites unlocks new revenue streams that kick off a new era of growth, characterized by strong free cash flow and declining leverage. Now that we've enhanced our financial structure. I'm very excited about the prospects of unlocking additional value for our shareholders.

With that, I'd like to turn the call over to the operator for the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from Rick Prentiss with Raymond James.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [2]

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Tom, appreciate that color on the guidance. Did have a couple of extra questions there. First, on the hosted payload, the $47 million full run rate. There's also hosted Payload and other. Are you still expecting that other's going to run maybe in that $14 million a year that we saw in 2019 as we go into 2020?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [3]

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No, there's -- that was in '19.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [4]

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Sorry, yes, yes.

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [5]

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Hold on, let me look into that, Rick.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [6]

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Okay. Yes. Because I think total hosted and payload in the quarter was just over $12 million, but now you're up to a better run rate. So yes, if you guys can look at that.

While you're looking at that number, you had also previously thought that the exit of '21 for the new revenue from the broadband service would be $75 million. Is that still the thoughts? And I appreciate you guys are going to start providing actually financial breaking out that in 1Q '20.

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Matthew Desch;CEO, [7]

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Yes. I mean on that one, it's still -- we just provided that really guidance pretty recently at go, and there's nothing really changed much in terms of our optimism about the service, and it's way too early to even think about making that higher or lower. It was fairly back-end loaded anyway. And some -- we're just -- we're now introducing the full speed of 704 kilobits per second this quarter, and GMDSS just got approved, and new terminals are coming online, and our -- I think we're finally have full strength in terms of all the partners like fully selling it. So full speed ahead right now. And I'd say we're still optimistic about those. Those are good numbers, really. But overall, we're still excited about sort of the market position of the service.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [8]

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Okay. And you mentioned the new LEOs. We get a lot of questions from investors about the Billionaire Space Club going on out there with SpaceX, Starlink and Amazon, potentially, and OneWeb and Boeing, lots of questions about the new LEOs.

Can you talk a little bit about how you see those -- they're in your same neighborhood, I think you've used in the past, but not the same source.

What markets do you see these new LEOs attacking and entering? Is it aeronautical, is it maritime, is it consumer broadband? And how does their spectrum or equipment costs kind of compared to what you're trying to deliver?

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Matthew Desch;CEO, [9]

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Those are good questions that whole conferences are right now addressing. I've talked to all those guys here in the last 6, 12 months. And so every one of them is a little bit different. I'd say they're the same neighborhood, but I mean the same neighborhood in space, they're lower at orbit, but they're really completely different business models and frequencies and approaches much more closer to what the existing fixed-satellite services market is offering today versus what any kind of highly mobile personal communication kind of services that we offer today are IoT.

So they're all Ka and Ku-band. I would say that they're mostly focused on what I would call the commodity broadband space, trying to provide services that compete almost more with existing VSAT and fixed-satellite services space. But even going beyond that to someone like Starlink or maybe someday, Amazon Web Services, I would say that they're even going after what I would call the core fixed market, particularly consumer kind of markets that maybe are served by Hughes and ViaSat today and -- or even by fiber and other kinds of solutions. Those are completely different markets than what Iridium is interested in or has been addressing.

We've stayed away from those. Those are extremely competitive markets with very complex distribution issues. Some of them, by the way, are going direct. Some of them are going through existing market channels, it appears. It's quite interesting to watch them all develop, particularly from our historical vantage points of 30 years in satellite and knowing all the challenges they have to go through. I'm rooting them on overall because I think it's interesting and good for the industry. I think there's a lot of challenges ahead in building a lot of those business, as you well know, and everyone is sort of still waiting and watching.

On our front, we see a lot of what they're doing as complementary to what we do. So you've seen, for example, the MOU we put out with OneWeb. We're certainly talking to everybody else because we think our services are complementary to theirs as well and perhaps, at the right time. All of them are very busy just even building their systems. And I think they'll be in that mode for quite a few years to come. So I don't know that if that covered. It's a broad question, an interesting one. I know there's a lot of interest.

But I will say only a final note, I hope they all can achieve the financial maturity I talked about faster than the 30 years it took us. I think many of them probably dream about doing it in 4 or 5, that may be a lot of challenge, and maybe it's a good thing that they have patient equity in terms of billionaires and others who are supporting them because that's what it takes from the satellite industry given the high CapEx and recurring nature of the CapEx requirements to just get to the state that Iridium has gotten to today.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [10]

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Makes sense. Okay. And then one more...

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [11]

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Rick, just coming back to you on your -- and to answer to your question. The other's around 10. It was 10 in '19, and we see it around 10 in 2020.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [12]

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Okay. Great. And then just a bigger picture, obviously, coronavirus is grabbing a lot of attention in the marketplace and the news cycle. How are you feeling about the heavy equipment market, any other global economy items, any early indications that coronavirus is affecting supply or demand?

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Matthew Desch;CEO, [13]

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Yes. I mean obviously, I'm watching it with as much interest as you are. It's capturing everybody, and it's going to clearly have sort of a global economic effect. I've seen like the early projections from like airlines and others about less travel and that sort of thing. So it's certainly of interest and concern to every company.

We're not, I'm sure, totally immune to it, but I can tell you, I haven't really seen a lot of action from any partners. Certainly, our supply chains are in good shape. We don't have a lot of exposure, for example, to China. Our inventories are good. We're not really seeing a big change in any kind of demand today. And I think it's helpful that our business is so diverse in so many businesses and areas, some of which, by the way, are related to emergency and would be on the other side of, say, supporting the coronavirus.

So I won't say that I don't think it'll have any impact. Certainly, it must have an impact for every company, at some point, if it gets bad enough, but we're not really seeing any impact or projecting any impact right now and what we're talking about for 2020.

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Richard Hamilton Prentiss, Raymond James & Associates, Inc., Research Division - Head of Telecommunication Services Equity Research [14]

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Great. See you in a couple of weeks in D.C. for the satellite show where those conversations will probably all continue.

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Matthew Desch;CEO, [15]

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Keep your mask on when you come, okay, Rick?

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Operator [16]

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And the next question comes from Greg Burns with Sidoti & Company.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [17]

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I was wondering if maybe you could give us a little bit of an update on the activity around Certus adoption. I know it was -- at the onset, it was maybe a little bit slower than you were expecting. But can you just talk about the pace of activations? Have you seen that pickup? And maybe we can just start there.

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Matthew Desch;CEO, [18]

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Yes, we have -- but it's only been a few months, really, since we even provided that update. So it's really still too early to say it's faster or slower than expectations. I would say, with so many positive things sort of happening around the product, with partners, with new terminals, with GMDSS certification, with a faster speed, which is a firmware upgrade to existing terminals, all those things are coming and sort of affecting it and are coming into the channel and going out there.

So it's going to take, I think a few months before we can start all like looking and saying, I can see that we're on track or ahead of track or behind track. So I'd say we're feeling pretty good about where we are right now, certainly good about the product and the channels and the interest in it and all the things that we've seen so far, but just really too early to kind of call out any changes to 2021 or anything here.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [19]

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Okay. And I guess it was a little -- there's a little bit of uptick in your ARPU, and I know you're going to start breaking it out next quarter with Certus specifically. But could you just help us frame what your typical ARPU was maybe with OpenPort? And what we can expect from a Certus terminal going forward?

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Matthew Desch;CEO, [20]

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Yes. I mean I think you'll end up seeing that sort of with the -- we were up roughly, I don't know, on the order of 10,000 subscribers kind of with our first-generation service. And I've already given you some idea about how far we've done in the last year by adding more than 10% to that number. And I think the ARPUs were in the 200s kind of range with the OpenPort service.

They've gone up 150% to 200%, depending upon -- it's kind of a wide range, but you'll see the average will step up quite a bit with the higher speeds and the higher functionality of the Certus services. So we're seeing both new builds, both on new ships, but also on sort of new installations of stand-alone Certus, but we're also seeing a lot of companion applications. And of course, those ARPUs vary between whether their companion application, a little lower versus a stand-alone application, which can be quite a bit higher. So that all still averages considerably above where we were before and kind of bodes well for the future in terms of how much each of those incremental terminals will add to our bottom line.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [21]

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Okay. And lastly, the equipment cost or the gross margin on the equipment this quarter was a little bit lower than I guess what it's typically been. Is that what we could expect for next year? And then lastly, on the engineering and support revenue, is this a good level to kind of model out or is it -- do you expect it to moderate in 2020?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [22]

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On the engineering and support, I think it's going to be about this level. It was up materially, it's going to be about this level in 2020.

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Matthew Desch;CEO, [23]

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Yes, this feels like sort of the new run rate for a while. We really have stepped up the activity with the -- with our government partner. There's an awful lot of activity around -- almost in some ways we're resource-constrained in terms of being able to handle sort of all the things that we're doing around new activities. So that's -- this is a -- this seems like a good level for us right now. And I know equipment, it's -- was a issue of mix more than anything else. And all depends on exactly what we're selling in a year.

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [24]

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It was light in -- it was light -- the margin was light in the fourth quarter. But on the full year, we're flirting with 40, and that's where we see ourselves in 2020.

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Operator [25]

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And the next question comes from Anthony Klarman with Deutsche Bank.

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Anthony Francis Klarman, Deutsche Bank AG, Research Division - MD and Global Head of High Yield Research [26]

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Earlier in the month, you put out an 8-K that indicated that Aireon had met some milestones in its operating agreement that it has with you that was going to trigger some additional increases in the data billing that you would collect. I'm wondering if the timing of that is that you're recognizing that immediately or if there's some ramp to that that happens throughout 2020? I think you indicated that the annualized impact was about $10 million. I guess I'm just trying to capture if that entire $10 million is baked into the guidance?

And then as an add-on to that, maybe Tom, or Matt, if you could remind us, are there any other important milestones in the agreement you have with Aireon, such that if they continue to scale relatively quickly could accelerate the timing of either cash payments or the buyback that I think is out there at some point in the future?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [27]

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So the -- Aireon's ability to pay off the hosting fee, right, is going to be driven by their contracts that they sign. And we've said that we see that in late 2021 or 2022 depending on their rate of adoptions. So they've been doing very well this year in terms of sign up new customers. So we can expect them to continue to do that. So that's the driver on when we get the hosting payment and then the buyback of the shares comes after that, think 2023.

And yes, Anthony, the step-up is $800 000 a month. So there's your $10 million a year. So it's out of the gate.

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Matthew Desch;CEO, [28]

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And that happened right off the bat, really in the beginning of the year. So you expect that to be that level through the year, and that was all put into our guidance now. So we have good visibility to exactly what Aireon is going to deliver us this year.

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Anthony Francis Klarman, Deutsche Bank AG, Research Division - MD and Global Head of High Yield Research [29]

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Yes, got it. And then maybe, Tom, now that the recapitalization is complete, and you've taken out the high-yield notes and you have an all term loan structure. I guess could you just remind us a little bit about your financial policy? I think you had previously indicated a long-term leverage target of 2.5 to 3.5x over the long term. Your guidance has you, only 0.5 turn above that at 4x net leverage at the end of '20. How do you think about uses of free cash flow here? And do you have any sort of update it to your financial policy about how you prioritize cash here?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [30]

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So no, we still think leverage between 2.5 and 3.5x is right. And we see ourselves, naturally, we -- obviously, we would delever below that in 2021. And so what we would -- we delever into that range in 2021. And so shareholder-friendly actions are on the table, once we get in that range.

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Anthony Francis Klarman, Deutsche Bank AG, Research Division - MD and Global Head of High Yield Research [31]

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But we should assume that for 2020, you're sort of sticking to the core of kind of the operating business. And that as we think about other uses for the free cash flow, I guess your expectation is that cash would just sort of build to the balance sheet as you get towards that leverage target?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [32]

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Yes. As we see the world today, yes, that's our expectation.

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Operator [33]

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And the next question comes from Hamed Khorsand with BWS Financial.

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Vahid Khorsand;BWS Financial;Analyst, [34]

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This is for Vahid for Hamed. Just a few questions. Have you been able to address your manufacturing needs for Certus equipment? And do you need more partners or just the ability to make more equipment?

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Matthew Desch;CEO, [35]

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Yes. So we have -- yes, so just to understand how our Certus product works. We build the core transceiver module, which kind of is at least for most terminals, though we will even license that technology, if desire to some, to make it themselves. We've made those, shipped many of them more out than are terminals in the market. Those then get turned into terminals by our terminal dams, which we've announced a number and have some more potentially coming. They then create the terminals, people like Cobham and Thales, in particular, are the primary ones in the maritime market today. And we've given some guidance in the past about sort of the additional terminals that they have made than even have been activated. So the channel seems to have a good supply of terminals right now to support the growth in 2020. They'll be augmented by, I think, we've discussed and Intellian is coming on board, a really strong Asian manufacturer. They should be delivering their product in the first half of this year. And I'm sure they'll also address, particularly, they have a fan base kind of cored in Asia, but really all over the world as well and that will add product as well.

In addition, we see some other even lower-cost terminals coming on the market in 2020 that provide different levels of service. We also see aviation terminals, which are under test right now that will hit more later in the year.

And there's some other sort of visibility to other things that are coming in the market as we license additional people to make terminals. So supply of terminals is good. The kind of the diversity of applications that they can support is growing and competitive nature seems healthy in terms of sort of the kinds and price points of the terminals that are out there. So we feel good about the supply of Certus terminals for the market.

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Vahid Khorsand;BWS Financial;Analyst, [36]

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And then 1 more question. With regards to IoT, is Garmin still your main source of subscriber growth? Or are you seeing any new customer trends develop?

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Matthew Desch;CEO, [37]

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Well, Garmin certainly is putting some big numbers up because being a consumer player and having such a broad -- first of all, global scope in terms of who they support, but also a growing product -- number of products that they're delivering to the market and expanding sort of the base of the applications that they're supporting. That's certainly, I think, going to continue to be a driver of just raw subscriber numbers out in the future. It's kind of hard to expect others will match them, though we are having discussions with others who certainly have the potential long term, of being able to add good numbers, too, that are also in sort of a broader segments.

We are seeing some new consumer products coming online. Really pleased to see sort of others entering the market as well. There's really a -- more than a handful right now of really nice-looking products in different market segments, going from consumer to enterprise to government and others that are also addressing this personal communication space. Plus, we're seeing this mid- band technology that we're deploying this year. We're in trials with a number of -- beta trials, really with a number of our partners on new applications using higher-speed services, and we see that entering into the consumer and enterprise space, especially into 2021 and '22. And I think those will also add some interesting numbers as well. But yes, definitely, Garmin is definitely the winner in terms of subscriber growth, short-to-medium term.

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Operator [38]

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And the next question comes from Louie DiPalma with William Blair.

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Louie DiPalma, William Blair & Company L.L.C., Research Division - Analyst [39]

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Matt, Iridium shares are near their all-time high, and it seems as though you have a lot of new products in the pipeline, particularly in IoT. Meanwhile, your closest IoT competitor, ORBCOMM has seen its shares near their all-time low. At a high level, can you discuss the competitive dynamics in the IoT market from the various sources of competition, whether it's ORBCOMM, Cellular and even future LEO IoT services? And the differences in system architecture that has thus far allowed your team to prevail?

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Matthew Desch;CEO, [40]

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Yes. So we have -- our competitive position in the IoT space has only sort of improved as we develop more unique devices, made it easier to get into service, provided more competitive pricing plans and brought on more partners who put us into more applications and all that has been sort of an engine of growth, as I said, that has delivered consistently high-performing subscriber growth. And it all is due to the unique nature of our global, first of all, there is no -- no one has to have reservations about where the coverage is on any device, the latency is consistent everywhere in the world. It's just a very high performing, reliable application. So partners, I think, have been drawn to really our service versus others, over time. And really, in some ways, I think anybody new who really wants to go into market around sort of the applications we support are really being drawn to us. I've said in the past, I still agree, we've never lost a partner to any other satellite player. Once they come to us, they stay.

We have taken a lot of share from others who are in the market earlier. You mentioned 1, but there have been others as well, and we seem to be migrating their applications over to our network as well, especially with the new Iridium NEXT network that we built. Everyone sees the long-term future and potential of the -- for the capabilities we can provide versus anybody else. So when it comes to what I call 1:1 premium satellite IoT, I don't think we have a lot of competition compared to the past.

And you're right, it is more about doing nothing would be a competitor or Cellular being good enough in the 10% of the world it works. But we're making it easier and easier for Cellular IoT customers to move over into satellite as well with things like Iridium CloudConnect and new devices that really are attractive to those who built their networks on Cellular. So it really feels like we have a strong engine of growth going well into the future. We continue to bring in new products, new devices, new partners. I don't really see anybody challenging us in the traditional MSS space in the way we have maybe 10, 15 years ago. And these new mega constellations, these new LEO bands, all are focused on a completely different segment of IoT. It's sort of a niche segment called Broadband IoT, where they deliver sort of a broadband node to a regional area and then distribute the signal to make it cost-effective to lots of devices in a very limited area. And that's an area that is a smaller part, I think, of the market. We serve it with Certus more than anything else. But really for the most part, I don't really see that as an area of -- that's just an area that's complementary to what we really provide as our core IoT space. So very different IoT. I've talked to all, by the way, the mega constellations. And I say when you say IoT, do you mean what I mean? And they all agree that what we're talking about is very, very different and complementary.

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Louie DiPalma, William Blair & Company L.L.C., Research Division - Analyst [41]

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Got you. And Tom, I think you provided an unofficial pro forma free cash flow guidance of $208 million. And that amount of free cash flow generation is fairly unique in this industry. I was also wondering, related to that, can you provide a little color in terms of the difference between that pro forma $208 million number and the change in net debt that's implied by your deleveraging forecast?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [42]

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Well, so the pro forma for 2020 is pro forma for our new capital structure, which was implemented in February of this year. So we think that the kind of what's important here is, what's the run rate of cash flow, right? And so that's why we provide that pro forma statistic because we think that the growth rate which is more than double the rate of growth in EBITDA is unique. And that's why we highlight it.

And so, we have a detailed calculation, Louie, for you to kind of have that. It's on our web page. And we've footnoted every calculation there. And so rather than take the time here, I would just direct you to the website, and then we can have a follow-up as appropriate.

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Louie DiPalma, William Blair & Company L.L.C., Research Division - Analyst [43]

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Okay. And do you expect -- I know you said you expect to average $35 million for CapEx per year, I think for roughly the next 10 years. Do you expect to already hit that mark for 2020?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [44]

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Yes. So $35 million is our guide for 2020. And as you'll see in the website, that's evident on the exhibit we posted to our website, there's a $35 million deduct in arriving at the $208 million.

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Operator [45]

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(Operator Instructions) And the next question comes from Chris Quilty with Quilty Analytics.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [46]

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Congratulations on finally, finally, getting that GMDSS certification. Can you answer 2 questions? Number one, do you have any other terminal manufacturers besides Lars Thrane at this point? And I guess how large would all the Certus providers eventually be certified for GMDSS? And then second of all, maybe this is more qualitative. Can you give us a sense of how you think that's going to impact the market and competition going forward now that you finally have that in pocket?

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Matthew Desch;CEO, [47]

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Yes. So there, Lars Thrane, that terminal, which is a great terminal, by the way, is the first terminal, but there are others that have been -- that are under development, and we'd expect to see those coming later in the year or into '21. I'll let them announce them when they're available, but there will be multiple choices. And the Certus suppliers are also going to be certifying their terminals for GMDSS as well. Again, just to -- you're right, it was a long process to get there. Given full authorization is a big deal because we kind of broke a monopoly of 30-plus years. It's a -- I would say, too, I should tell you, our GMDSS service is truly going to be the best in just about every front coverage to start with, but really the fact that, that Lars Thrane terminal can do all services, including voice and data as well as all the information services, and it's a really attractive package, I think we're going to get equally great new terminals when they're available going forward.

The most important aspect about it isn't the revenues necessarily that'll generate. Technically, GMDSS services are free, certainly in the early term. Though those terminals can generate revenue revenue-generating services, that Lars Thrane service can be used for ship more data and that sort of thing, which will generate revenues on top of it. But I think it's the most important thing is that the distribution chain not only has an alternative to offer, but they do not have to offer a mixed solution. They can offer a completely noncompetitive solution to what they offer. And they've obviously been looking for an Iridium solution to be able to offer their customers so that they don't have to mix it with their primary competitor on the VSAT market onto a new ship or a new service. So our goal isn't to replace all the existing GMDSS terminals out there, will probably be a lot more new devices going forward. Because I don't know there's a business case for necessarily changing out the GMDSS terminal. But certainly, if you're going to put a new system on a ship, I think we're going to be an extremely attractive offering, not just because it's lower cost and provides more services and works in places the other solution doesn't, but because it's really much more friendly from a competitive perspective.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [48]

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Got you. And on Aireon, obviously, you -- or Aireon tripped the recognition due to their rollout of that service with the FAA. But what is the next step and expected timing of the next step for Aireon in terms of brokering a broader, more global agreement with the FAA?

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Matthew Desch;CEO, [49]

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Yes. So they're starting now with the -- what I would call a small straightforward step to be able to serve the surveillance needs in the Caribbean, where they -- it's a fairly straightforward step for them to implement Aireon. And I think it will be a great confidence booster as they get comfortable. It's easy to integrate into their existing sort of back-office software systems that they use to control traffic. So it was the obvious first step. I mean the big growth is in the oceanic space, where the airlines really want them to deploy it, where there's a lot of value to be added. The software systems that they have that will ingest that data are being updated now. And I think that, that -- they'll be available to use later in the year in 2021. I think there's an awful lot of discussions right now at the FAA about their phase plan and exactly how fast do they go, and I think we'll believe that to Aireon and FAA to work that out. But I'm encouraged that I think that they see the benefits of space-based ADS-B.

I think they're seeing the value of the efficiency, but also the safety improvements it's had. There's been some really high profile, by the way, saves that have been underway in the last few months as the FAA and others have called Aireon to find out where downed aircraft are. I think you're going to see more stories about that. That's certainly just the visibility to a lot of areas that they've never had visibility to is really attractive to controllers, to pilots, to airlines, to everybody who is involved in the aviation system.

So our hope is it moves faster. Obviously, the faster they move, the better it is for Aireon, the better it is for us as traveling public.

I think there's a lot of good reasons for that. Obviously, financially, Aireon -- not just the FAA, but they have a pretty long pipeline. And I think you're going to see a lot of new customers come onboard in 2020 and 2021 as they adopt it beyond the existing 35 countries or so that have adopted it initially. And I think that's going to continue to drive revenues. It will allow them to refinance their debt. That will allow them to pay their hosting and dividends and all kinds of the other financial benefits that happen out, as Tom said, when they happen in the next few years.

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [50]

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I mean it's really just -- the model is just add customers, of which the FAA is a big one. And the more they add, then the sequencing is hosting first, then buyback of our -- certain of our interest for $120 million, then dividends, and we've laid that out in our Investor Day, and that's how we saw it this time last year. It's how we continue to see it. They just continue to prosecute and add new customers.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [51]

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Well, and maybe let me ask this in a more direct way. Are there -- the issues that are throttling a final agreement, are they technical in nature or is it budget related? They haven't yet been allocated the money they need to sign a broader agreement.

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Matthew Desch;CEO, [52]

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I don't think I can characterize as one thing. I mean it's -- obviously, the other countries and people have moved along faster than the U.S. has in terms of deploying space-based ADS-B. I'm just happy they're moving forward right now and starting to see some progress.

For a long time there, they had been acting as if maybe it wasn't even part of the solution or something that they may only consider for long into the future. Now they seem to have -- be moving on a phased introduction plan that sort of is going to move forward. I think you know agencies with the size and scope and the traffic that they have to support, have to move at certain rates for lots of different reasons. And I'm sure that Aireon and they will move through that. I just like the momentum I'm seeing right now.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [53]

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Understand. Shifting gears with Certus and your government customer. Are you engaged currently in negotiations to provide that service? And any sort of update on timing of when there might be a contract in place?

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Matthew Desch;CEO, [54]

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Yes. So actually, we have contracted already to COMSAT with a take-or-pay contract that -- and they are the primary supplier of L-band services to the U.S. government. And so they have already kind of committed to a revenue stream for us from the U.S. government.

In addition, the U.S. government has already committed and is spending money and working through the process of implementing the Certus equipment at the government gateway.

So they have already -- spending money and working on implementing a secure Iridium Certus capability. That's moving along well, and it takes longer than I always think it will, but it should be available, I think probably out in 2021.

And in the meantime, they have procured services via the commercial gateway. So particularly on the land-based side, already have a number of terminals activated and are liking what they're seeing from the service and are having discussions around a number of areas from Aviation, Maritime, Inland to deploy it. So don't think you're going to see a direct contract per se from us, it will be more through their procurement through COMSAT. So the channel is all set up, the revenues will flow. They'll just accelerate more when they have a secure capability is implemented fully at the -- at their gateway and can deploy it more rapidly.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [55]

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So Tom, where would COMSAT -- I mean to the degree they were successful with the government, where would those revenues flow? Would they still come through your government reported line? Or would that show up as commercial?

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [56]

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No, we see -- we -- and there's not much of them now, but we see that being reported in our Broadband segment that we -- when we introduced that broadband target, we had -- if you remember the slide, there's a slice for government on that slide. So we see that as part of our broadband target. So it would not be on the government line. That's the government line. We see that as the contract with DISA.

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Matthew Desch;CEO, [57]

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Yes. We primarily, the narrowband existing fixed price services, and then we'll move sort of a government line into the Broadband section for the broadband area.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [58]

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Okay. And final question. Commercial IoT net adds were sort of -- were flat, year-over-year, 35,000. I would have expected that might have been up, given you've got more products and Garmin's been at this longer. Was there anything about the fourth quarter that you saw as onetime in nature, either that benefited last year or might have created a headwind for you this year on the commercial side?

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Matthew Desch;CEO, [59]

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No, there was no headwinds. There's some puts and takes. I remember there was a cleanup from one partner from some kind of nonproductive customers. And they weren't -- they didn't have much ARPU associated with them, and there were -- I don't remember how many there were, but it was a significant kind of number that was sort of unexpected. That happens occasionally, some people seem to do that. And yet, we don't really know when it's going to happen. So it depends on what quarter it hits. I wouldn't read anything into the nature of it being flat. That was sort of -- it had been running ahead for quite a while from expectations. And then I think there was a bit of cleanup in the fourth quarter from some people. But really, the ARPU stayed strong, the momentum stayed strong. Nothing really happened around any business changes or anything. I don't think it had anything to do with economics or anything else right now. I don't see any issues with our IoT.

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Thomas Fitzpatrick;Chief Administrative Officer, CFO, [60]

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No. As we said in our prepared remarks, we have visibility into the personal communication partners and feel real good about our prospects in 2020. So we don't -- we're not fussed about the fourth quarter net adds, Chris.

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Christopher David Quilty, Quilty Analytics, Inc., Research Division - Research Analyst [61]

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Perfect. Congrats and good luck on 2020.

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Operator [62]

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And this concludes the question-and-answer session. I would now like to turn the conference back over to management for any closing comments.

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Matthew Desch;CEO, [63]

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Well, obviously, this was a good year. We're off and running. We're going to see you very soon in the first quarter, but there's also a number of conferences I think we'll probably see some of you at here. The big satellite show is in a couple of weeks here in Washington, and I know some of you will be here then. There'll be a lot to talk about, I think in 2020. We look forward to seeing all of you each quarter going forward.

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Operator [64]

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