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Iridium Communications Inc (NASDAQ:IRDM)
Q3 2020 Earnings Call
Oct 20, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. Welcome to the Iridium Communications Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. I would now like to turn the conference call over to Kenneth Levy, Vice President of Investor Relations. Please go ahead.

Kenneth Levy -- Vice President of Investor Relations

Thanks Kate. Good morning and welcome to our Iridium Q3 2020 earnings call. Joining me on the call this morning are CEO, Matt Desch and our CFO, Tom Fitzpatrick. Today's call will begin with a discussion of our third 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 or expectations change.

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 in the Investor Relation section of our website for further explanation of these non-GAAP financial measures and a reconciliation of the most directly comparable GAAP measures.

With that, let me turn things over to Matt.

Matthew J. Desch -- Chief Executive Officer

Thanks, Ken. Good morning, everyone. As I'm sure you saw in our release this morning, we had a strong third quarter. As many of you know, we started the year on a record-setting pace in January and February and then we were hit abruptly by the global lock down in mid-March and April. With little visibility to understand how the industries we serve would respond, we were comfortable with the steady month-on-month improvement that the second quarter delivered.

Now, with the results of the third quarter in hand, it's clear that we've trended back to the fast pace that kicked off the year. In light of our strong subscriber growth during the past quarter and the momentum we were carrying into the final months of the year, we have greater visibility as to how we'll finish out 2020.

This year, our businesses once again demonstrated its resiliency, perhaps most evident by the surge in net subscriber additions which reached a total, a record 67,000 this quarter, more than doubling growth from the last quarter. With an ongoing thaw in the global business environment, Iridium's financial prospects have continued to improve and we're now on a glide path to end the year with better top and bottom line growth than we expected when we updated guidance on our second quarter call.

Our prospects for free cash flow have also improved to approximately $200 million for the full year as a result of these improved operating results. So what's driving our recovery from the effects of the coronavirus? First, the service we provide is both important and unique and our satellite applications are often essential to the mission critical functions of our customers.

Second, I think our offering, particularly with our new constellation in place is second to none. We do mobile and remote connectivity better than anyone else in the industry. Third, and maybe most importantly, we have a very diverse and effective partner ecosystem covering every important market segment and almost all are telling us they are open for business again and bullish about their futures.

Our more than 450 partners and their businesses are very diverse in terms of geography, industry and application. With the exception of our partners in aviation and to a more limited extent, maritime, both of which may take a few years to fully rebound, the majority of our ecosystem partners are back at work generating new business and activating new customers. We've worked for decades to develop and cultivate our distribution network and I credit this one of a kind, wholesale ecosystem for Iridium's ability to endure economic recessions and keep growing even during a global pandemic.

Now based on our performance, through the first three quarters of the year, we are raising our full year guidance for service revenue growth and operational EBITDA. This move reflects the underlying strength of our business and the greater pace of subscriber additions than we originally expected during our peak summer selling season.

Demand for Iridium services also spurred robust hardware sales in the third quarter and drove engineering revenues. Despite the strong business trends in the third quarter, there are still some parts of our business that have yet to fully recover. I'll speak to broadband and aviation in a minute, but want to start with our voice business. It's been running softer than a year ago even though net subscriber additions have been quite a bit better than we initially expected after the pandemic surfaced.

Consistent summer improvement spurred incremental demand for handsets and that has benefited overall equipment sales. This firming in our legacy voice business is a good indication that this part of our business is returning to its more normal cadence.

In IoT, the consumer bounce back we talked about last quarter has continued and while most of our IoT applications are adding subscribers again in particular, retail demand for consumer personal communication devices really accelerated in the quarter.

Iridium added 61,000 net new subscribers in IoT. This shatters the previous quarterly record set last year by almost 30% or an additional 14,000 net new users. With an increasing number of consumer oriented SKUs and a growing number of partners going after these personal communication services, as well as having the ideal network to support them, this should be an important and growing market for us for a long time to come.

In terms of new products late last month, we launched our latest IoT turnkey end user device called Iridium Edge Pro and it's already generating a lot of interest with current and potential partners. The Edge Pro is a programmable device with built-in sensors for asset tracking and performance monitoring to let the partner reduce their development costs and expedite their time to revenue.

This hardware offering will continue to make Iridium relevant for a growing number of global IoT applications. We'll add the Iridium Edge Solar device to the mix with its launch later this quarter and that will represent another low maintenance turnkey device that will drive incremental IoT partner solutions.

Now, an area we don't have full recovery from yet is maritime. While we added 300 net new broadband customers during the quarter, the pandemic has continued to cause operational and logistical headwinds for the maritime market. We've talked previously about these issues and while we are seeing growth in subscribers each month, global travel restrictions and installation issues are still creating headwinds.

For example, some of our partners centralized installation crews and they have often been unable to travel to meet ships and ports. Those with distributed installation teams are having an easier time of it. So it's going to take longer for this market to fully recover and we believe that installation challenges are likely to persist into 2021.

On a positive note, we continue to see good demand and interest in Iridium Certus. Our partners are excited about selling the product and are very pleased with its performance in the field and ARPUs from our broadband service continue to rise reflecting the propensity for larger data service plans from subscribers.

During the third quarter, we saw a 12% increase in year-over-year broadband revenue and an increase in ARPU. Overall, Iridium Certus remains an important vehicle of our growth and we look forward to seeing it hit its stride in the coming years. I haven't talked much about aviation this year, but you'll probably start to see some press highlighting a few of our equipment suppliers like Collins and SKYTRAC in recent months.

We currently have six partners working on new aviation hardware and these terminals targeting the commercial transport corporate rotorcraft and general aviation markets. This equipment will be available for retrofit as well as new builds and there is a lot of activity taking place today by these partners to develop and certify these terminals for commercial availability in 2021.

Iridium is also very involved in obtaining Safety Certification for Iridium Certus to match the safety services we provide today on legacy aviation terminals. From what we see, the global aviation market, particularly the commercial side may take about two years to three years to fully recover. Given the progress being made, we think our partners will be ready with Iridium Certus aviation products well within that timeframe to take advantage of it.

As far as the U.S. government goes, we continue to work with them on upgrades to their dedicated Iridium gateway. These engineering upgrades and maintenance services support the government's use of our services and also provide for their ability to utilize Iridium Certus services globally.

On September 15th, the government's EMSS Contract also reached its first of four revenue step-ups. This resets the contract's base rate at $103 million for the next 12 months. Lastly, Aireon continues to develop their business despite the global aviation downturn. They signed another high-profile customer, the Civil Aviation Department of Hong Kong that is the latest ANSP planning to deploy Aireon's space-based ADS-B system.

The region manages more than 400,000 aircraft each year and supports a critical corridor in the South China Sea. Including Hong Kong, Aireon's data services are now being deployed by ANSPs covering 38 countries globally. I am also happy to announce today that the FAA has expanded its relationship with Aireon after the progress of their initial trials in the Miami flight information region.

The FAA signed a significant contract in September to access Aireon's global dataset to support test and integration into their air traffic control automation platforms as well as to support the FAA evaluation of a variety of applications, including airspace safety analysis, accident investigation data analysis, search and rescue and commercial space.

This is an important milestone for Aireon as well as for the FAA and I think signals that their long-standing relationship is progressing to the next level, which will assist in increasing safety and efficiency even further for U.S. passengers and operators. We congratulate the FAA and the Aireon team for getting this done. It's a big deal for the U.S. airspace and U.S.'s leadership in aviation.

Before I pass things over to Tom I'd like to provide an update on our capital investment plans. Since completing Iridium NEXT, we've guided and kept our capital spending to about $35 million per year. Given the strong subscriber growth during this period and the potential we see for growth with our new network's added capabilities, particularly in personal communications and the higher speeds and efficiencies we can create for IoT services, I'd like to step on the gas a bit and invest more right now for the next couple of years.

Our partners are telling us they see opportunities with our system that they'd like to see it developed sooner rather than down the road. Additionally, like many companies, COVID has caused us to rethink the work from home model, which we expect to persist in a hybrid mode even after the pandemic has passed. This presents a timely opportunity for us to consolidate some facilities and save on overhead.

To address these initiatives, Iridium plans to increase capex for the next three years, 2021 through 2023. As such, our capex will rise to about $45 million as we move quickly on product development and a real estate refresh. We expect to be back to a $35 million run rate in 2024. I think this plan is the prudent course to ensure we take full advantage of our competitive position, technical leadership and the opportunities we see today.

To close, let me reiterate that Iridium has remained disciplined this year and continues to execute well. Our focus on mission critical services, global connectivity and reliable communications has allowed us to manage through this challenging year and deliver both subscriber and revenue growth. Our business is performing well and we continue to have strong visibility across our partner channel that underscores our confidence. In addition to top and bottom line growth, the health of our partner network will also help us to improve net leverage and free cash flow this year.

So with that, I'll turn it over to Tom for a more detailed review of our financials. Tom?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Thanks Matt and good morning everyone. I'll get started by summarizing our key financial metrics for the quarter and providing some color on the trends we're seeing in our business lines, which give us confidence in raising our full year guidance. I'll then close with the review of our liquidity position and capital structure.

Iridium generated total revenue of $151.5 million in the third quarter, which was 5% higher than last year's comparable quarter. This increase was primarily attributable to strength in subscriber equipment sales and a contractual step up in hosted payload. Operational EBITDA was $93.4 million, which was up 6% from the prior year's quarter. Our EBITDA margin was 62%. On the commercial side of our business, we reported service revenue of $91.8 million in the third quarter, which was up 2% from a year ago.

This increase primarily reflected growth in hosted payload revenue, which more than offset a decline in revenue in our legacy voice business. During the quarter, voice and data revenue fell 4%. This decrease was predominantly driven by a fall in seasonal activations attributable to the ongoing pandemic that were not as severe as we initially feared back in April.

While billable subscribers were down year-over-year, we actually saw an improvement in net subscriber additions on a sequential quarter basis. These trends continue to be better than our early expectations when the impact of the pandemic was largely unknown. We continue to expect full year voice and data revenues to be down from 2019.

Commercial IoT has largely rebounded from the initial drop caused by the pandemic in March and April. Many markets that had slowed at that time seem to have rebounded and remain [Phonetic] -- and many retail outlets offering consumer oriented IoT that closed temporarily have now reopened.

The notable exceptions are the aviation and oil and gas industries where usage has remained under pressure as the frequency of flight have slowed and demand for oil production has waned. Offsetting these pandemic related declines however has been a resilient retail consumer whose appetite for personal communications devices continues to rise. In the third quarter, commercial IoT revenue was flat to the year-ago period. This is a marked improvement from the 5% decline we reported in the second quarter and another side of the mass appeal of satellite IoT devices in the consumer market.

Summer drove a meaningful increase in activations of personal communications devices. It's clear that even as consumers have sought to socially distance during the pandemic, keeping in communication with others remains a priority. In our commercial broadband segment, we reported revenue of $9.1 million in the third quarter, up 12% from the year ago period. While positive, as previously noted, the pace of broadband growth is slower than we had originally expected and reflects the ongoing disruption that the coronavirus is having on the maritime industry.

As Matt noted, ship accessibility remains a headwind to new installations though Iridium service continues to receive strong reviews from the channel and existing broadband subscribers. During the third quarter, Iridium added a record 64,000 net new commercial subscribers with the bulk of this increase driven by commercial IoT and the unprecedented demand for personal communications devices. Commercial IoT data subscribers now represent 72% of billable commercial subscribers, up from 67% in the year ago period.

Hosting and other data services revenues increased to $14.5 million this quarter, up 21% from the comparable quarter in 2019. The majority of this increase was due to higher data service revenues associated with the step up in Aireon's data service agreement that we noted earlier this year. We continue to forecast normalized revenue from hosted payloads of about $47 million per year.

Turning to our government service business, we reported revenue of $25.1 million in the third quarter including the impact of the contractual step up in the EMSS Contract on September 15th. Year-over-year revenue was down fractionally reflecting the 2019 benefit of increasing rates on monthly contract extensions prior to the finalization of the seven-year contract under which we are operating today.

In the third quarter government subscribers grew 8% year-over-year to 142,000 users. Equipment sales continued to trend better than our April forecast aided by a rebound in store openings and strengthening partner business trends. We also have enjoyed the benefit of currency tailwinds where weakness in the U.S. dollar results in lower equipment pricing for foreign purchasers.

Through the first nine months of the year, equipment sales are up 2% compared to last year. This is a noteworthy turn from last quarter when first half revenue was trailing the prior-year period by 5%. In light of recent trends, we now anticipate full year equipment sales will be equal to or greater than 2019 levels. Engineering and support revenue was $9.4 million in the third quarter compared to $7.6 million in the prior year's quarter, the change reflects increased work on commercial and government contracts, both of which are episodic.

All told, Iridium's revenue has remained resilient this year especially in the face of the global pandemic. This is not to say that we have been immune to the effects of COVID-19 however, improvement in our commercial business and equipment sales through the third quarter heightens our confidence in revenue growth and operational EBITDA for the full year.

Accordingly, we are raising our full year guidance for 2020 to reflect the health of our business partners and the momentum that we continue to see in subscriber additions. We now expect full-year EBITDA of approximately $355 million in 2020 based upon total service revenue growth of approximately 3%.

This full year outlook reflects a stabilization in our voice business and renewed momentum in IoT following the initial shock of the coronavirus pandemic on channel partners. We continue to expect capital expenditures of approximately $35 million this year. As Matt described, couple of initiatives will cause our capital expenditures to run a bit higher in the next couple of years, but we expect them to return back to around $35 million in 2024 and stay at that level for several years.

If you consider the 10-year capex holiday period we have previously described, the increase during the next few years would take our average capex up closer to $40 million from the $35 million we had previously guided to. We view this is a modest increase that will not change our stated goals of deleveraging and returning capital to shareholders. Moreover, the increases are warranted as they will yield expense efficiencies from the consolidation of facilities and increased revenues from the delivery of additional functionality to our already popular lineup of devices as evidenced by our record-setting gain in subscribers this quarter.

Specifically on facilities, we anticipate consolidating our real estate footprint in Arizona, which will save us about $1 million a year in overhead starting in 2022. We'll need to refurbish the remaining facilities and expect to spend about $6 million on this over the next two years. Moving to our capital position, Iridium had a cash and cash equivalents balance of $182.7 million as of September 30th, 2020. This is up $63.6 million from June 30th. We believe that free cash flow provides a useful benchmark for the health and earnings power of our Company, particularly in the current climate.

Based on the quarterly results we announced today and our updated outlook for EBITDA in 2020, we believe Iridium will generate pro forma free cash flow of approximately $200 million for the full year 2020 compared to pro forma free cash flow of $168 million in 2019. For illustrative purposes consider the following. If we start with EBITDA of $355 million and subtract $90 million in pro forma net interest to reflect our new debt structure, $35 million for capex and $30 million in working capital, inclusive of the appropriate hosted payload adjustment, 2020's pro forma free cash flow supports a conversion rate in excess of 55% and a cash flow yield of approximately 6%.

This is indicative of the underlying strength of our core business and compares well to companies in the communications infrastructure space which enjoy higher trading multiples than Iridium. As in the past, we have provided supplemental information on the Investor Relations section of our website laying out these pro forma free cash flow calculations. Iridium closed the third quarter with leverage at 4.2 times EBITDA and based upon guidance revisions expects to exit 2020 with net leverage of approximately four times EBITDA.

As we've discussed previously, our goal is to reduce net leverage to a range between 2.5 times and 3.5 times EBITDA to provide ample flexibility to support shareholder friendly activities. The business in '20 -- business environment in 2020 has been unique. Even as the pandemic has continued to create uncertainty in certain sectors, Iridium's business has shown great resilience. We see meaningful business opportunities for Iridium moving forward and have confidence that we can capitalize on these to grow our earnings and bolster our free cash flow.

With that, I'll turn things back to the operator for the Q&A.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions]. Our first question is from Ric Prentiss from Raymond James. Go ahead.

Ric Prentiss -- Raymond James -- Analyst

Thanks, good morning.

Matthew J. Desch -- Chief Executive Officer

Hey Ric.

Ric Prentiss -- Raymond James -- Analyst

Hey. Obviously good to see the beaten rates on the axles in the guidance. Question on COVID-19 and the visibility. You mentioned obviously you're seeing some nice signs out there. Any concerns on second wave or lock downs that we're seeing in Europe and some signs in the U.S. of what that might mean to the business?

Matthew J. Desch -- Chief Executive Officer

Probably not for 2020. I mean -- because we're pretty well on a path, I think for this year. I mean, I'm concerned that it will kind of continue well into next year, and so areas like aviation and maritime will still sort of stay at the same levels. I don't think there is a lot -- I don't know about you -- what you think, but I don't think there's a lot of tolerance for sort of completely locking down businesses anymore. It seems like we've -- you know, the global environments kind of learned to live in sort of a new normal right now and the economy is as it is. But, you know, means we're all not going to go to restaurants and have much fun at sporting event for a lot longer somehow.

But I don't really think, I think we're kind of in the environment we're going to be in for a while here. And I'm sort of expecting that's going to last well into next 2021.

Ric Prentiss -- Raymond James -- Analyst

Sure. Okay. And then, obviously, some nice improvement also on margins. Tom, as you think about the business and growing the revenues and kind of the cost basis of the business, where could aspirationally margins go over time when you look at your competitive universe out there?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

So -- Hi, Ric. So, we've said for a long time that there is inherent operating leverage in this -- in this model, it's a network [Indecipherable] so the variable costs to produce -- to produce the incremental minute [Phonetic] of use is very small. And so, when we started our capital cycle, we had margins in the high 40s and had said that when we exited, we saw 60%. And so we're now there. So there is really nothing stopping us. If you look at mature satellite companies that have been around longer than us, their kind of model is the same, they enjoy the operating leverage and they have EBITDA margins in the 80s.

So as we grow our service revenues, we think it's accretive to the margins over time.

Ric Prentiss -- Raymond James -- Analyst

Makes sense. And I'd like to focus on free cash flow, we really like looking at that as well. One of the items that you kind of called out the EBITDA, good to see margin improvement continue there. Interest expense, how are you thinking about the debt markets right now? Is there the ability, are they open? What kind of rates are you seeing? Is it something you could actually improve free cash flow as you -- as you look at the interest expense?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Yes. I mean our Term Loan B is trading very well. I mean, as you know we can reprice the Term Loan B if the market is there and we're keeping a close eye on that. A 50 basis point reduction in the margin is $8 million to us. So that's directly benefits -- would benefit the free cash flow.

Ric Prentiss -- Raymond James -- Analyst

And the market is stabilizing now as far as the debt market maybe being up and what would cause the trigger to enter the market then?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

The appetite. Just that, that it would -- it would be a market clearing transaction for us to reprice. And we and our bankers are keeping a close tab on that.

Ric Prentiss -- Raymond James -- Analyst

Okay. And last one from me. I appreciate the questions. You called out aviation a couple of times. I know that's obviously going to take couple of years to recover. Walk us through or remind us again on what that effect is on the ARPU side, on the IoT that we mostly see it right?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

[Speech Overlap]. So yeah, we've said it's the usage on commercial airliners for safety services, Ric. And we said there's best about $1.5 [Phonetic] million a quarter headwind from our prior run rate just because of planes aren't flying, so it's not -- we're not seeing the usage.

Ric Prentiss -- Raymond James -- Analyst

Right. And when we do see usage come up, that would be [Phonetic] something would come back, but that's what we have to -- as Matt pointed out going to watch where aviation and maritime come back.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Yeah, that's right.

Matthew J. Desch -- Chief Executive Officer

Yeah, both come back and plus we'll start -- we'd also see potentially new installations for a more higher speed terminals, which potentially also could drive additional ARPU on aircraft as they take advantage of the higher speeds and more functionality, as those products become ready in the next year or two.

Ric Prentiss -- Raymond James -- Analyst

Yeah. That's what you were talking earlier about the system hardware and also getting into the safety side.

Matthew J. Desch -- Chief Executive Officer

Right. And we're a big player in aviation today. And you know, obviously, we're on a lot of long-haul commercial aircraft right now, and those are the ones most affected right now because nobody wants to really fly a long, long distance. Domestic is coming back a little faster -- and but, I think over the next two years or three years we'll see a recovery, our existing systems will then go back to normal or growth and we'll possibly see new additional installations then at that time too of the higher speeds stuff.

Ric Prentiss -- Raymond James -- Analyst

There not so much the in-flight connectivity as more of the cockpit and the safety and other broadband services. You're not going into the in-flight connectivity business, per se.

Matthew J. Desch -- Chief Executive Officer

No. That's right. We're really focused on the cockpit communication, safety services and that's where we've been, that's where our sweet spot is and where we don't see as much competition really either because we have a truly global product versus anyone else.

Ric Prentiss -- Raymond James -- Analyst

Makes sense. Glad to see the results guys. Glad to hear you're doing well. Will talk to you later.

Matthew J. Desch -- Chief Executive Officer

Thanks Ric.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Thanks Ric.

Operator

Our next question is from George [Phonetic] Burns from Sidoti & Company. Go ahead.

Gregory Burns -- Sidoti & Company, LLC -- Analyst

Good morning. Yeah. The update on the FAA with Aireon, does that in any way change the calculus of the raising capital paying the remaining hosting fees that they owe you? Can you just maybe just update us on the status there in terms of their financing? Thanks.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

So, we view the -- Hi, Greg. We view the developments with the FAA as constructive to Aireon's financing obviously, but the slowdown in air traffic that's resulted from COVID is going to delay their ability to pay us the lump sum hosting fee and the buyback of the share.

So we don't think that that happens before the end of 2022 when we're going to see how fast traffic comes back. As you understand, we view those payments as highly likely and the developments with the FAA only bolster that opinion of ours. But that as you know has no effect on what is -- what is our -- our revenue, annual revenue that is $39 million from them per year, between hosting and data. They're going to pay -- they're going to pay us that cash pay based on their updated financing outlook. So kind of the downside cases that there will still be a delay in the lump size payments of the hosting and the share buyback, probably beyond the end of 2022.

But as I say, let me reiterate, we are highly confident that we will receive those payments eventually.

Gregory Burns -- Sidoti & Company, LLC -- Analyst

Great, thanks. And then in terms of the U.S. government consuming like Certus broadband services on top of their EMSS Contract, do you have any visibility on when maybe they might start to do that or when there might be -- maybe some upside to the contractual numbers you're seeing quarterly?

Matthew J. Desch -- Chief Executive Officer

Well, they're already starting to use some sort of not using our commercial gateway, so they've already especially our threshold sort of services and they are planning to, we are expecting to see more in 2021. So we are seeing growth in terms of the potential kind of backlog and opportunities are increasing. Again we'll primarily come through the commercial gateway though we'll describe them as government revenues.

And then as the -- as their gateway gets completed sometime either later next year or early in 2022, then I think that will also spur incremental additional growth beyond that out into -- out and beyond that. But there is already usage already today and we're seeing, we're seeing progress and I think it's going to be part of our Certus broadband revenues going forward.

Gregory Burns -- Sidoti & Company, LLC -- Analyst

Okay. So that will be reported as Certus and not as separate from the government line item that you --

Matthew J. Desch -- Chief Executive Officer

Yeah, that's right. We're going to -- we're putting all that in our broadband revenues. Government or commercial... [Speech Overlap]

Gregory Burns -- Sidoti & Company, LLC -- Analyst

Okay, and the...[Speech Overlap].

Okay, great. And then lastly the 300 net activations on the broadband side, is that kind of the pace that you're still expecting for the foreseeable future? Thanks.

Matthew J. Desch -- Chief Executive Officer

Well, I'd like it to go up from there. Interesting, I had a meeting last week with one of our larger service partners there, and I was asking them what kind of level of business did they see out there, and they said that they were particularly in VSAT installations, which is sort of a proxy to me of our L-band installations that often go with them and whatnot.

They said they were roughly about 70% of where they normally would have thought that they would have been and I asked them, how much of that was a slowdown due to some of those issues I just described and how much of that was sort of due to the overall economy and that sort of thing and they said they had record backlog. So it was almost all due to installation and they have -- they have a global installation team so they weren't really limited by some of the problems that I told you about.

So I think it's mostly these challenges that sort of COVID creates in terms of getting installers on ships and that sort of thing. I think as that starts recovering here and I don't know that that will happen in the fourth quarter or first quarter even in next year, but I believe they're getting better and better at figuring out ways of getting terminals on to ship and then I think we'll see the numbers grow, just it's hard to forecast at this point how fast that they will.

Gregory Burns -- Sidoti & Company, LLC -- Analyst

Okay, thank you.

Matthew J. Desch -- Chief Executive Officer

Thanks. Take care.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Thanks Greg.

Operator

Our next -- excuse me, our next question is from Louie DiPalma from William Blair. Go ahead.

Louie DiPalma -- William Blair -- Analyst

Matt, Tom and Ken, good morning.

Matthew J. Desch -- Chief Executive Officer

Good morning.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Hello, Louie.

Louie DiPalma -- William Blair -- Analyst

Congrats to you, Don Thoma and the Aireon, Iridium teams on the FAA contract announcement.

Matthew J. Desch -- Chief Executive Officer

It's been a long time coming, I think for Don, I'm happy for him and happy for the FAA.

Louie DiPalma -- William Blair -- Analyst

And on that note, can you provide a high level more details in terms of what that expanded relationship entails for like the debate of ADS-B versus ADS-C and how the FAA may be viewing those two technologies, long term? I know that you also provide ADS-C, but can you just at a high level discuss that debate and what it might mean with the FAA?

Matthew J. Desch -- Chief Executive Officer

Yeah, well, that debate ADS-C is the traditional every 15 minutes sending a position report through a satellite connection like our safety service terminals that are on long-haul airplanes. That has been sort of, that is the baseline, and that is what's been done for a number of years. ADS-B is the sending not through a satellite network, but through a stand-alone transponder from every airplane a position reported twice a second. And that being picked up in the past by ground transmitters, but now by Aireon's space-based ADS-B. ADS-B is ubiquitous and it provides position information, but it is actually complementary to ADS-C which is more of a communication technology and goes along with a number of other things that you can send through the satellite network.

So we've always felt as has Aireon that the two technologies were complementary and would grow together. You're right, there was a debate with one other company that thought ADS-B or that ADS-C was the way that you should go and that you should only install satellite systems onto airplanes, etc.

So I think that debate is over. I think it's been over for a year. I think the view of not just the FAA, but of all the ANSPs around the world is that they're complementary and both will be utilized for both surveillance and communication and together -- and taken together, they will provide higher safety, more efficiency, more accuracy, better travel times, fuel savings and the like.

So, I hope that answers your question.

Louie DiPalma -- William Blair -- Analyst

Yes. That was great. And in terms of the expanded relationship. Is the expanding relationship more of like an IT systems relationship in order for the FAA to like enhance its systems in order to be like integrated risk with Aireon or is it something different from that?

Matthew J. Desch -- Chief Executive Officer

So, look it's a -- it's the use of Aireon's dataset in many more ways and had previously been quite limited. They have expanded the use of the data to use in a number of applications. It's hard for me to go much beyond that. I'd really rather frankly that the FAA and Aireon told you more about that, we're just pleased to report that there has been a step-up. It's certainly not the complete potential of that relationship and where it ultimately can go in terms of size and revenue and that sort of thing for Aireon and the scope of use of the data yet with the FAA, but it's significantly greater than it had been before and felt it was worth kind of calling out because we've had this discussion for years about when and if the FAA would get more involved with Aireon and take advantage of it and I think it's important to sort of say, we see that happening now.

Louie DiPalma -- William Blair -- Analyst

Yeah, definitely. You guys have been talking about the -- this FAA catalysts for at least eight years. So it's definitely great to see. One last question, in terms of the increase in broadband ARPU, are you seeing a lot of your OpenPort subscribers upgrading to Certus or are more of the Certus or more of the broadband activations completely new subscribers?

Matthew J. Desch -- Chief Executive Officer

There is both going on. I will say based upon our expectations several years ago, OpenPort has actually, I think been holding up better if you will, less, less replacements, than I think we were expecting or you could say potentially feared because if it's just sort of a one-for-one, we aren't really gaining market share. I'd say that, I think it probably goes along with the fact that it's difficult to get these new broadband terminals on to ship, it also means it's harder to get older technology off the ships as well.

So while the transition is not been happening, OpenPort sales -- OpenPort customers, subscribers have been not declining that fast. And so, I would say it's -- I don't know, two-thirds probably new sales and one-third, maybe something like that, replacements, it's hard, that's a really rough number and not really relevant.

Maybe more sometimes 50-50, it's hard to tell exactly what that is. But those are new sales they're at higher ARPUs of course because of the higher speeds and higher usage. And that's why that the mix is still heavily oriented toward OpenPort terminal still in our broadband revenues. So the ARPUs are going up, but that I expect would continue as the mix favors more and more higher speed Certus terminals.

Louie DiPalma -- William Blair -- Analyst

Thanks, Matt.

Matthew J. Desch -- Chief Executive Officer

Thanks Louie, take care.

Operator

Our next question is from Anthony Klarman from Deutsche Bank. Go ahead.

Anthony Klarman -- Deutsche Bank -- Analyst

Hi, thanks. Two questions. First on the capex revision, or the modest increase in capex, I certainly think it makes sense in the context of the $200 million run rate free cash flow you are producing. I guess maybe Tom, what should we think about in terms of returns or payback on that incremental capex spend? How do you -- how should we think about it in terms of sort of future margin improvement or other kinds of benefits that you will see from that incremental $30 million investment?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Well, I mean if you just, I mean just for example, if you look at -- look at how we're growing personal communications, adding functionality to that can -- could -- really accelerate that rate of growth. And so the returns could be really very attractive, we think there's the shot that the growth could get there.

Anthony Klarman -- Deutsche Bank -- Analyst

Got it. Thank you. And then, all right, go ahead, Matt, sorry.

Matthew J. Desch -- Chief Executive Officer

Well, that's -- I think Tom covered it pretty well. I mean, we have a long road map of things that our partners would like to see us do to fully exploit our network with a number of different transceivers and new products and incremental things and we could continue to spend the same level and deliver those things over extended period of time, but what we're kind of doing is accelerating those earlier than they would otherwise be developed if we maintained at $35 million run rate.

So it's generating revenues earlier for us in some ways, which obviously have a positive overall rate of return.

Anthony Klarman -- Deutsche Bank -- Analyst

Yeah. And maybe you just answered my follow-up, but I'll ask it in case there's any additional clarifying details. Is it -- is it that you know that the capex will be sort of $45 million for, call it three years, but then maybe rather than the subsequent years being $35 million, maybe they are sort of $30 million to $32 million? Are you literally just pulling future capex forward that would have been in that $35 million run rate, and then also pulling forward the incremental revenue recognition or operational expense benefits?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

No -- so we've said Anthony that the $45 million -- it's going to go to $45 million -- based on projects that we see, it's going to bump to $45 million for three years and we think it settles back down to $35 million. So the 10-year average, if you will, which we had thought about as $35 million is going to be $40 million-ish and the only proviso there is what we don't include is any launch of our ground spares, because we've not made a decision to do that, we don't know whether we're going to do that. So, that wouldn't be in that, but it feels to us like we got three $45 million, and then the balance of $35 million to average $40 million for the capex holiday period which we had previously thought was a $35 million average, think of it as a bump.

Anthony Klarman -- Deutsche Bank -- Analyst

Okay, understood.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

And then the takeaway here is, look, we just put up record subscribers, right. We think we've got to play to this trend, most notably this personal communications trend. Investors should consider what could be the penetration of Iridium into consider the number of smartphones in the world and this personal communication is turning out to be an accessory to a smartphone and so additional functionality playing into that market, we think is, could be very meaningful returns.

Anthony Klarman -- Deutsche Bank -- Analyst

Yeah. Thank you. And maybe a question on guidance. If I look at the $355 million, you're actually back to the original low end of guidance that you provided in February, obviously pre-COVID, which is pretty exceptional, I think when you think about what the impact is to the business and the leverage guidance is now back to the original leverage target of four times, but the service revenue guidance is still only about half of what the original guidance was.

I was hoping you could maybe give us some additional color on the other benefits that you've seen, maybe come back a little faster, clearly some of it is expense reductions, which you've talked about before, but could you maybe talk about what some of the other catalysts were there, kind of getting you back to the original low end of the guidance range, despite all the impacts the business has seen?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

So it's expense reductions, it's travel, it's sadly incentives are down right, because we're not quite where we needed to be and we're a pay for performance kind of a Company, so that's less. So we're getting natural expense reductions from the slightly lower level of EBITDA production and that's what resulted in us getting to the very low end of our -- of our previous range.

Anthony Klarman -- Deutsche Bank -- Analyst

And would you think Tom on those comments that if -- if the world starts to normalize, maybe we'll use the timeframe Matt talked about in his comments of maybe it's not '21, but maybe it's '22 when we're a bit more normalized. Do some of those expenses have to creep back into the business such that you're sort of more in a normalized state at some point in the future and we shouldn't necessarily just run rate exit levels of operational expense here?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Yeah, you shouldn't run rate exit levels because for one, incentives will come back. So, we'll pay it a 100% if we -- for a level of performance in '21. So you're going to see a year-over-year expense increase added to that. As to SG&A kind of, it's a new world, let's see what travel winds up being. Are we going to travel the same way we used to, and so we'll have to establish what the new run rate is in post-COVID, how do we all work, what do we -- how do we travel. It feels like it ought to be down from what it was pre-COVID, but probably up from where we see -- where we see 2020. We'll just have to figure that out.

Anthony Klarman -- Deutsche Bank -- Analyst

All right, thank you guys very much.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Thanks Anthony.

Operator

Our next question is from Hamed Khorsand from BWS Financial. Go ahead.

Hamed Khorsand -- BWS Financial -- Analyst

Hi, good morning. So on the last call you mentioned you were running promos. Did that generate the return you were looking for or was that just harmful to gross margins this quarter?

Matthew J. Desch -- Chief Executive Officer

Well, we're always running promotions. You can see we had really strong subscriber growth. I don't think it was related really to specific promotions. I would say it was positive and that it continues to help encourage our positive activations and performance ongoing.

But yeah, I'd say it was -- it was definitely still continues to be positive.

Hamed Khorsand -- BWS Financial -- Analyst

And then on the retail side, do you think the growth that you saw this quarter as far as demand, do you think that that was a pull-in from the holiday season, or do you think it's going to be resilient again for the holiday shopping season?

Matthew J. Desch -- Chief Executive Officer

Oh, I mean -- you know, what I can tell, I don't think anything is a pull-in. I mean I think people you might have seen we announced a week or two ago just a study we had done where we had looked at the state parks, we looked at like the ten top state parks in the U.S. and sort of looked at the usage of our network, you know, it was up something like 26% or something over last year. I think people are using these personal communication devices as they increasingly get off the grid during social distancing.

So I think -- I think it was the strong summer usage of those devices as people got out and they couldn't travel to exotic locations, they were certainly at least getting off grid. And it's also representing the fact that there is just more and more devices out there, both the existing partners like Garmin have more and more devices that are satellite connected and we see a number of new partners that are showing some success, and particularly, there's one called ZOLEO, but there is a number of others as well that are offering consumer devices that people are finding attractive, that they want to stay connected while they're away from cellphone coverage, which is still spotty in many places and still only covers less than 15% of the planet. So I believe that was a complete summer activity and it doesn't really forecast anything as to what will happen for our Christmas season, or any other kind of period.

Hamed Khorsand -- BWS Financial -- Analyst

Okay. And the last thing on the equipment revenue, can you help us to decipher how much of that bump in equipment was related to the retail versus Certus equipment of new installs?

Matthew J. Desch -- Chief Executive Officer

Well, I mean equipment is broad based. I'd say, you know, especially as it relates to margins and that sort of thing, handsets is obviously a -- is a high margin area for us. And the fact that we saw sort of a recovery based upon previous expectations of what handset sales would be, because you know, our voice business strengthened during the summer, it was a better summer season than I think we were worried about back in the second quarter when everything locked down. So we saw more handsets, IoT continues to be very strong across the board in terms of sending modems out, since setting the devices out that go into all kinds of IoT devices. I don't think a lot of it is related to the broadband, because I don't think that --

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

[Speech Overlap]. Because our vendors sell the service equipment.

Matthew J. Desch -- Chief Executive Officer

That is really -- we just sell our radio and it doesn't add tons of margin when we sell the radio to our value-added manufacturers and then they turn that into terminals and sell those to the fleets and ship owners and that sort of thing.

Hamed Khorsand -- BWS Financial -- Analyst

Great. All right, thank you.

Matthew J. Desch -- Chief Executive Officer

Thanks, Hamed.

Operator

[Operator Instructions]. Our next question is from Mathieu Robilliard from Barclays. Go ahead.

Mathieu Robilliard -- Barclays -- Analyst

Hey, good morning and thank you for taking the questions. I had a follow-up question on the equipment side. So obviously you had -- you pointed to very strong IoT devices during the quarter, and now [Phonetic] in terms of the contribution to equipment and I was wondering if all of that is already reflected in IoT subscribers that are activated, generating service revenue and that creates a tailwind for good growth in IoT into Q4. So that was the first question really.

Matthew J. Desch -- Chief Executive Officer

Yeah. So I mean, equipment sales are more of a harbinger of the future as opposed to current, because it takes anywhere from three months to 12 months for equipment to kind of get into service. So I think when -- I think it's fair to say when you see equipment firming up and improving, it's really a sign that our partners are bullish about the future and have orders that they need to fulfill in future quarters as opposed to current quarters. The equipment that was used in the third quarter was equipment sold several quarters ago probably in most -- in most cases for IoT.

Mathieu Robilliard -- Barclays -- Analyst

Thanks, great. And then I had a question on your Certus product on aviation and maybe I didn't get everything you said in your prepared remarks. But, in terms of the Certus product, when can we expect it to be ready to be marketed in aviation?

Matthew J. Desch -- Chief Executive Officer

Yeah, it's taken longer than I had hoped due to a variety of factors, I'm sure as it relates to the licensed terminal manufacturers, whose license as I said there has been six who are working on terminals, we started to see as you could see in the last couple of months some of them are starting to announce successful demonstrations and trials of their technology. I mentioned two who've been pretty public in this last quarter, Collins and SKYTRAC. But there is four others that are also at various stages and starting to see some progress as we're seeing them come into the lab to test their designs with our systems. And so, we're starting to get visibility that some of them are telling us that they believe that they'll be ready and certified, at least one or two in 2021 and that's encouraging, and there could be more.

But I think that they will be coming online in 2021 and 2022 for the most part, which as I said, I guess, while it's taken longer to see the aviation side of the business, which we think we have a lot of advantages for given our global network and the smaller size of our antennas and the fit for the cockpit use etc, in corporate and general aviation and rotorcraft and other market segments, frankly the aviation downturn kind of gave our partners a little bit more time to get their products ready. And I think as we start to see those markets recover they'll all be ready with very competitive and exciting new products to offer that space.

Mathieu Robilliard -- Barclays -- Analyst

Thanks. That's very clear and congratulations for the great quarter.

Matthew J. Desch -- Chief Executive Officer

Thanks, Mathieu.

Operator

Our next question is from Chris Quilty from Quilty Analytics. Go ahead.

Chris Quilty -- Quilty Analytics -- Analyst

Hi guys. Follow-up question on the increased capex, which by the way, I mean nobody is happy when you spend more money, but I think it's a good decision in the context to get those products to market. And the question I had for you was first of all, Tom, can you break that down into how much is going to facility consolidation versus new products? And the second part is, on the new products as you just mentioned recently you've typically been moving toward a strategy of building modules that you then feed to your VAMs. Are you allocating any of this development for actual finished product or is it a continuation of that previous strategy?

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

So I'll take the first part, Chris. The facilities is about three a year in '21 and '22.

Matthew J. Desch -- Chief Executive Officer

So that covers that quickly. As far as the second question, it's broad based, in fact you could say why are we doing this now in the third quarter, part of this, because we are budgeting right now for 2021 and we have so many things that our technology team wants to develop and for which our product management and partner management team has been requesting and it covers a wide range. Some of it has to do with even satellite developments and strong network efficiencies that would get a lot of performance, capacity, efficiency out of our network and some and -- a big part of it still goes toward accelerating this road map of devices that are the foundation for more and more applications in all the different market segments that we are. And I will say we have some ideas for some additional finished products as well that may or may not be in that category as well.

But that's not really our strategic focus. For the most part, what we're really trying to do is, continue to deliver more and more products, because that is our growth model. We put more modules and devices and capabilities in the hands of more and more partners and more and more market segments and that drives -- that drives growth. And as the market recovers in 2021 and '22, we want to be there with the best portfolio and the broadest portfolio covering all those additional market segments.

So like I said, I just looked at, I looked at next year and thought, I have about -- I have at least $45 million actually more than $45 million worth of demand for what we could be delivering right now. And while we could have probably slowed things down and done $35 million, it just seems to make sense at this time to really step on the gas a bit.

Chris Quilty -- Quilty Analytics -- Analyst

I understand. And specific question, you mentioned that the U.S. government is buying Certus services off the commercial gateway. Are they using commercial off the shelf devices?

Matthew J. Desch -- Chief Executive Officer

Yes, yes. At this time their revenues are using either Thales or Cobham, Certus terminals and primarily I think we've even talked about some applications that use Thales mission linked terminals in the terrestrial environment. But there is some -- there is some sales in the maritime environment as well. That will continue to expand into 2021 and then we're starting to see a lot of interest in what we'd call Ffx or the new Iridium 9770 modem, there's a number of different applications that they like, the portability -- and not just them, but other, many other applications on both the commercial and international side as well that will take advantage of that -- that new modem and ideas of other devices as well.

Chris Quilty -- Quilty Analytics -- Analyst

Okay. And is there an effort or a possibility of securing government funding for government specific product development?

Matthew J. Desch -- Chief Executive Officer

Yes. And I mean, we've been very good at doing that over the years. That goes into our engineering revenues, you saw this was obviously a good quarter in terms of sort of fulfilling contracts. Our number of contracts we have doing special development, whether it's developing things like the distributed tech communication system or new IoT applications or other specialized devices and modems that just, I think is expanding in some ways.

I mean, it's not obviously, the area of revenue, that's the most strategic orientation for us, but it's all good, all good margin revenue, because it develops more capabilities as many times it can be used in commercial applications as well. But yes, that continues.

Chris Quilty -- Quilty Analytics -- Analyst

Got you. One question on maritime, what's the status of GMDSS?

Matthew J. Desch -- Chief Executive Officer

Very, very soon. It is in -- actually the beta trials are now completed, we're in sort of a final cleanup mode of the final, final barriers because that thing has to -- that service has to be absolutely bulletproof. And I believe it will be commercial literally within weeks at this point. And we're excited to see that date. It's a very comprehensive and end-to-end service products with lots of connections. We're completing all those connections with all the different safety service organizations around the world for navigational information and meteorological information and testing all those links and finalizing the absolute final bugs being cleaned up in the terminals and end-to-end systems. But it's very robust at this point and literally is within a few weeks of going commercial.

Chris Quilty -- Quilty Analytics -- Analyst

And you do expect to have some of your other partner products certified because I think right now you just got one stand-alone terminal with [Indecipherable]

Matthew J. Desch -- Chief Executive Officer

Yeah, that is going to be the primary vehicle for definitely the next few quarters. We're starting to work on the process of getting Certus terminals, a Certus service completed and certified that will still be a lot of effort, but there is activity around that front as well. And that will be the primary next phase. We won't see any other stand-alone terminals installed. It will be Certus based terminals after this.

Chris Quilty -- Quilty Analytics -- Analyst

Okay. And final question back to Aireon. What's the next step with the FAA? Like what would be the next announcement or the next milestone that the guys at Aireon will be targeting?

Matthew J. Desch -- Chief Executive Officer

You know, I think this is a major step. I mean, obviously the use of the data for broader, I mean it's still continued additional applications they could use in terms of the data in oceanic regions and for domestic regions, and there's lots of other still applications that they can work with on Aireon. And I think that will be a focus for 2021 for the two of them to continue working on it. They're still in, I would say the development stage, they're doing a lot of development of the automation systems and that sort of thing and integrating them. So it will be really the usage of that to control traffic which is still to come yet.

Chris Quilty -- Quilty Analytics -- Analyst

Okay. And is there still an expectation that at some point, perhaps in 2021, that there's just a fixed -- long-term fixed price contract that the FAA signs?

Matthew J. Desch -- Chief Executive Officer

Yeah, I think that's a fair assumption, again I mean, our focus is I've been trying to actually defocus a little bit away from this. I mean, this is great news for Aireon and continues to be, but it really doesn't make that much difference in terms of our business. We're not waiting for anything like that in terms of our expectations of timing for getting hosting fees or dividends. I don't think it will really affect that timeline. I think what Tom described in terms of our timeline is what we're going to see no matter what other announcements you see between Aireon and FAA.

So it's probably not as important to focus on that anymore from an Iridium perspective. And I think the focus should be on really what Aireon and the FAA announced in the future going forward.

Chris Quilty -- Quilty Analytics -- Analyst

Great. Thank you very much and great quarter guys.

Matthew J. Desch -- Chief Executive Officer

Yeah, thanks. Appreciate it.

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Thank you Chris.

Operator

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

Matthew J. Desch -- Chief Executive Officer

Well, thanks, everybody for joining us. It was a good quarter. And I think we now have visibility to the rest of the year. And we look forward to seeing you as we maybe sometime I guess in February for as we talk about the full-year and talk about 2021 at that time. So thanks all for joining us. Take care.

Operator

[Operator Closing Remarks].

Duration: 66 minutes

Call participants:

Kenneth Levy -- Vice President of Investor Relations

Matthew J. Desch -- Chief Executive Officer

Thomas J. Fitzpatrick -- Chief Financial Officer and Chief Administrative Officer

Ric Prentiss -- Raymond James -- Analyst

Gregory Burns -- Sidoti & Company, LLC -- Analyst

Louie DiPalma -- William Blair -- Analyst

Anthony Klarman -- Deutsche Bank -- Analyst

Hamed Khorsand -- BWS Financial -- Analyst

Mathieu Robilliard -- Barclays -- Analyst

Chris Quilty -- Quilty Analytics -- Analyst

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