Iridium Communications Inc. (IRDM) Earnings Call Transcript & Summary

Good morning or good afternoon to all of you. I'm Mathieu Robilliard from Barclays, and I'm very pleased today to host this fireside chat with Tom Fitzpatrick, CFO of Iridium. Welcome, Tom, and welcome to everyone.

Good morning, Mathieu. How are you?

Good. Thanks.

So that -- maybe we could start the discussion with what's new and what you guys have been working on throughout the year. Obviously, a nice year in terms of rebound of the activity, enabling you to start to push some of your new products. But maybe you could give us a little bit of update in terms of what you've been doing, and what is in the pipeline for the coming quarters, notably, maybe in IRO.

Yes. So yes, we're having -- our year is going very well for us. If you see on our most recent earnings release, we took up our guidance for service revenue, we took up our guidance for EBITDA because the business is performing quite strong at the moment. And so our -- what's driving our revenue growth is our brand-new network. We launched our new network and completed it in 2019, and that brought in -- gave us the ability to bring some new products to market that are given our growth in service revenues and nice shot in the arm. The network that we replaced was in 1990s vintage telecommunications network. Our new network is state of the art. And it's enabled us to go after revenue streams that we couldn't go after with our former network, most notably a product that we call Certus, that is -- it basically leapfrogs the competition on broadband services in the L-band, leapfrogs the competition we have. Our service offering is faster and cheaper than the competition, and we're seeing really nice take-up of that product in the broadband area, speeds of 350 to 700. And we're growing our subscribers like 14%, and our service revenue is around 20% with that broadband offering. So we're seeing nice take up. And we think that continues just only to the fact that we think we have a better mousetrap. We've just launched a new product in the mid-band, so it's 22 to 88 kilobits per second that we think that will have broad application in aviation, in maritime. And so it's -- those additional data speeds in the mid-band, we think, are going to do well for us too, Mathieu.

Great. Maritime is obviously one of the big areas where you've made progress, as you just described. And you're going after growth opportunities but also after some legacy players. And so I guess the question is how is the competitive environment evolving there? I mean, did you still see room to progress with good pricing power?

Yes. Absolutely. So fundamentally, our -- we think our product is superior. And we -- I talked about the numbers that we put out in terms of sub-growth and sub-20% growth in service revenues. And what -- as attractive as that growth is, we're disappointed in it. We thought that we would do better than that. But the fact of the matter is, is during COVID, you just couldn't get on ships. And so we have this brand-new product that we're quite confident in that the channel is quite excited about, but there's just -- there is the practical problem of access to ships, which is abating a bit. We think that the more the operating environment returns to normal safe, the better we do in selling our service product because it's just flat out better.

Maybe it's an unfair question, but could you give us a sense as to how close are you from a normal situation in terms of accessing the boats or maybe versus your expectation? Is it -- I mean are you 50% below at this stage? Or is there a way to quantify that in one way shape or form?

Just -- it feels like it's around 50%. It's definitely not normal, but it's definitely better than it was sort of a year ago.

Great. Obviously, IRO is an area where there is also a big market opportunity, and you're going through some regulatory approvals. Can you give us a little bit of color in terms of the next steps for the main products there?

Yes, we're making progress in the regulatory process. We have been certified for safety services for some time on our existing network and that now the process is to -- for our mid-band offering for that to get approved, and we're in that process currently.

Excellent. If we move to IoT, I mean, this has been a source of growth. Obviously, a bit impacted by COVID, but as you pointed out, your recent numbers show that there's a lot of demand, and it's rebounding very strongly. And I had a question about what are the growth drivers? I mean, you obviously have wholesaler and your product is embedded in lots of applications. And I was trying to understand what was the growth driver here. Was it that the penetration is increasing in the existing verticals where you were present, maybe Garmin that sells more of your product for the same consumers or the same kind of market? Or are you accessing new verticals, and that's also a big source of growth? How should we think about that? And more generally, how should we think about what is your total addressable market? Because IoT is so many things to so many people that sometimes it's hard to kind of figure out, what potential market you're going after?

So our IoT business is doing very well as you observed. So we put up a record subscriber net additions in the second quarter and kind of an all-time record. And we think we said at the time, we don't think we're done with putting up records for subscribers. And that is in areas within IoT, like telemetry on heavy equipment, for example, Caterpillar for asset tracking, et cetera. So our business is doing very well there, but the kind of most notable area of growth is in personal communications. You mentioned Garmin. We have something like 0.5 million subscribers in personal communications, and it's led by Garmin, but there are other companies like ZOLEO that are providing similar devices for personal communications. And we think that this is going to be an area of growth as we look out for decades, frankly, Mathieu, because if you just consider there's something like 3.5 billion smartphones in the world. The Garmin device and ZOLEO device attaches to a smartphone and enables connectivity in the 90% of the globe where there is no wireless connectivity. So it turns your smartphone into actually a communications device. It's an accessory to a smartphone. And you talk about addressable market, will just get your mind around 3.5 billion smartphones that globally, that -- so 0.5 million subscribers that we've seen currently is a drop in the bucket, really when you consider the -- that addressable market. So we're quite encouraged and excited about that opportunity, which we think is -- has a very long tail on it. And also, if you consider the, I think it is a testament to the Iridium network that both of these devices that are offered, so arguably ZOLEO competes with Garmin, both of them run on the Iridium network. And it's -- it is -- it just shows the uniqueness of the Iridium network, the fitness for that particular purpose of personal communications for the consumer.

A few years ago, you had signed an agreement with Amazon AWS, which I think, the idea was to embed your product -- your connectivity solutions for some of their clients. Can you give a bit of color in terms of how that has progressed? And what kind of, again, potential market we're talking about?

Right. So that is for IoT solutions. So we have partners that go to market with solutions for vertical markets for connectivity and telemetry, that sort of thing. And the relationship with AWS is to basically provide a platform for the development of offerings on the Iridium network. And so that is what that partnership is. And I think it works very well and that AWS brings some customers to us. And similarly, people like to have a common platform for development. So that relationship is going very well.

And is it possible to contemplate similar deals with companies that are doing the same thing? Because there's obviously quite a number of big players?

Sure. I mean, we are -- we never sort of -- we're open to all kinds of platforms.

Makes sense. You were talking about how you were successful in attaching your product to a personal devices, such smartphones. You have mentioned at your Investor Day that you are also working on an initiative to maybe address what you were describing as lack of coverage from smartphones. Obviously, there are some other companies in the space doing that and thinking about ASC. I know you haven't shared a lot of details into that. So maybe that's still too early to ask. But if you have anything you want to share in terms of how you're progressing with that idea of maybe connecting directly to smartphones, or other types of peripheral applications, that would be very interesting.

Right. I -- so I think what we've said is that we view that as kind of a natural evolution. We've come so far in terms of like sort of our relationship with Garmin and shrinking the electronics and the modem down to a size where Garmin has integrated it into their platform. And so the integration into a smartphone, seems like that would be a natural evolution that, of course, we'd be very interested in that happening.

So it's a work in progress, basically?

I think that's a fair characterization, yes.

Talking a bit about the competitive landscape, but on the broader scale, we're seeing quite a number of things happening. There's a number of players that are launching small IoT dedicated fleets. Now I realize that the scale of those projects is obviously much smaller than yours, but is that something that the margin can represent more competition for you? Is that a source of concern? Or is it really a different verticals?

So we're not concerned about it. I mean, so you don't see Garmin looking at those kind of companies because, our -- like I said, our network has -- is a fitness for that particular purpose. And many of these companies that you're referring to are ideas at this point, right? They're raising capital around an idea. We have been actually running business with over 1 million IoT subscribers currently. And so there's -- I would just -- I would differentiate between ideas for IoT connectivity and actual IoT connectivity, that is industrial strength and used by who's who of players from Caterpillar to Garmin, et cetera, that rely on the quality of the Iridium service.

Got it. Now in terms of actual companies, obviously, one of the big events or announcements this year was the proposed merger between Inmarsat and Viasat, and I won't dwell too much into that because Barclays is involved. But I would like to have your view in terms of -- does that make any difference for you in terms of what these 2 companies together can do to compete in some of the verticals where you are? Because if I remember correctly, Inmarsat has been active also in IoT. Obviously, they are a big player in maritime, where you're growing. And one could think that put together, they would have given sort of capabilities, distribution that could represent a stronger competitor.

Yes. So we don't really compete against Viasat. We compete against Inmarsat. Inmarsat is our competitor. We believe that our network is our source of competitive advantage versus Inmarsat, who we view as our primary competitor in the L-band. Our network, Low-Earth Orbit mesh network, which is one of a kind, we think is, as I said, [indiscernible] in terms of IoT requirements; it fits very nicely in terms of power, in terms of antenna size. It's a superior solution to the Inmarsat solution. So the Viasat acquisition of Inmarsat doesn't change kind of the Inmarsat network, okay? It's a geostationary, they're 50x further from the earth than we are. And so that creates -- just the laws of physics creates difficulties from them in meeting kind of the specs that we can meet in the IoT space. That's why Garmin and ZOLEO are on our network, not on the Inmarsat network. And so an acquisition by Viasat doesn't change the DNA of the network functionality. Similarly, our handheld business are -- Inmarsat has a competing solution. It really has not resonated to any great degree in the marketplace. They didn't really taken a share from us. We feel very good about our prospects there. And we talk about our prospects for Certus. That is largely taking share from Inmarsat. So Inmarsat has a big presence in their fleet broadband product. We want to unseat them on ships and an aircraft because we think our Certus product is better. They're 200 to 400 kilobits per second, we're 350 to 700. Our device is much smaller than theirs, and it's an economical solution. So we're trying to take share from Inmarsat. Like I said, as we just go through our playbook in terms of how we compete against Inmarsat, we don't see the bias that acquisition as being terribly kind of meaningful in terms of the competitive dynamic.

Okay. Makes sense. Now again, talking about competition. I mean, obviously, when we talk with investors, there's this general concern or certainly question marks about all the new constellations that are being announced, and it seems there's a new one every quarter, LEO constellation, I should make clear, with big funders or big companies behind it. And so I think it's always helpful to hear your take on that as to why you think that these projects may not necessarily represent a competitive threat to you, because the reality is that they're going to be very big. They're investing a lot of money. So they'll probably be looking for lots of different revenue sources and why not some of your current markets?

So these proposed LEO constellations are all -- every one of them is in the K-band, Ka, Ku, none of them are in the L-band. And so that is a key differentiator between our offering and those proposed offerings. So when the L-band, it's for about mobile communications. It's about safety services, et cetera. K-band is very good for streaming video, but has the same issue that many of the existing companies have, which is it's susceptible to rain fade. So -- and when you talk about things like safety services, that's not possible in the K-band. And so we think that those proposed constellations, they're going after a different space. They want to do kind of residential broadband in remote areas. That's not our space. We're about mobile communications, small antennas, highly mobile. And so we think we're prosecuting different opportunities.

Great. Moving to kind of some financial considerations, obviously, your constellation is quite new. But at some point, you will have to renew it. That's the law of satellites. And last time, you kind of spent $3 billion for the construction and the launch of this constellation. When you start to think about the next constellation, obviously, we've had continued fall in launch costs. We've had improvements on the manufacturing side and probably also lower costs, more for the same. So I don't know how much you can delve into that. But when you think about the renewal and the potential bill for that renewal, are you thinking I can actually get the much better constellation in 5 or 10 years' time for $3 billion? Or actually, I can get a better but at a much cheaper price or -- I mean, whatever combination you guys think it's possible. But if you could -- yes, give a little bit of sense of how you're thinking about this topic?

Right. So the first way we think about it is we think it's a long way off, right? We think we're in the early stages of what we think is about a 10-year CapEx holiday. And so that's the first point. We completed the new network in 2019, and feel like we have a nice long runway of CapEx holiday. But just history as any guide, the original constellation built by Motorola, I think, costs well over $5 billion. And so the new one costs $3 billion, and it's sort of just laws of electronics, Moore's Law says that things get cheaper, you get more functionality for less money kind of over time. So how that exactly shakes out and what our next-generation constellation looks like, there's a lot of cards to be played before we kind of settle on what the right path there is. The headline I would leave you with is it's a long way off.

Got it. Moving to other aspects of your financials, you have a very high gross margin in the service business. By the way, you also have a good margin on equipment, which is great. Are they -- and have you seen -- or can you -- or are you thinking about different types of revenue mix that could lead to a change in the gross margin up or down? Or you think it is something that should remain pretty stable?

Right. So there's tremendous operating leverage in this business, right? So an incremental minute of use on our network, it's really hard to find the variable costs, but very low variable costs. So incremental service revenue yields disproportionately higher EBITDA. And just the story I leave you with is when we launched our construction campaign in 2010, we were -- our EBITDA margins, I think we're in the high 40% area, Mathieu, and we put out a guide so that investors could kind of get their minds around what does this investment look like? And we said, look, we're -- our EBITDA margins are high 40s. By our estimation, we think we're more like 60% EBITDA margins when we finish this constellation. And you see where we are today. We're right around 60%. That was a 10-year kind of a guide that we delivered on. And so if you look at more mature satellite companies that have larger businesses than us, there's 70%, 80% EBITDA margins. So there's really no reason that we couldn't get to that level. And it's -- the driver is just purely operating leverage.

Makes sense. Cash returns to shareholders, so obviously, you've implemented a share buyback. And I was wondering if you ever considered a dividend policy, because for some investors, that kind of income is attractive? Or you think share buyback is really the best way to return excess cash?

Right. So we had been outside of our leverage guidance. So we've said that we see our leverage kind of between 2.5 to 3.5x OEBITDA as kind of our target. And notwithstanding the fact that we were above that early in 2010, we -- the Board authorized a $300 million share buyback because we were going to be opportunistic. And if you just look at the 52-week trading of the stock, it's -- it goes from $30 to $55, right? And so you can create a lot of value when -- if you're able to buy when there's a correction in the market that has nothing to do with our business. And that's what we've done. We bought, I think, $125 million worth of our shares back because we thought it was a handsome return to what we think the kind of intrinsic value. So in the near term, we're about share buybacks for that reason that we think that we were able to buy kind of on dips and provide a handsome return to our shareholders. But dividends are not out of the question. We're studying that. When we get into our target leverage range, dividends or something that we give consideration to as another potential way to provide returns to our shareholders. I mean if you just look at the levered free cash flow that this company is throwing off currently, and we think that continues to grow, there's a large pot of capital available to reward our shareholders.

Thank you. And in terms of other uses of cash, I mean, I can't recall you saying that you're out there looking at big acquisitions, but probably more on a tactical basis or a special basis. I mean, are you looking at some small businesses that could complement either on the distribution, or I don't know, on the satellite capacity? Is that something that is part of your occupation, or really that's very marginal for you?

So in terms of distribution, what we've said is we are not going to vertically integrate. We're not going to buy up the channel. The channel, we think, likes the fact that we're independent, and we're not going to compete against them. And so we're -- I would characterize this as unlikely to acquire distribution. We will make investments, as we have done in the past, like we made an investment in Aireon and in Satelles, both of which run in our network, and we think are very interesting businesses in and of themselves. And so those were investments that made sense to us, highly strategic, and we think we'll be very, very profitable. We made an investment in a company called DDK that does precision GPS or agriculture applications. And those are the type of things that we're looking at. I think we've said we are not spectrum rich. And so ways to improve our and increase our spectrum position, we take a good long look at that should opportunities present themselves.

Excellent. If I circle back to some of the revenue opportunity, something we didn't discuss was the government side. So obviously, the U.S. government has been a very important client, an anchor client for some of your traditional voice or messaging services. With Certus, you're also now entering into probably a new type of service. But more generally, I mean, the government, as I understand it, once diversified solution, they need redundancy, certainly for the military, that's quite key. L-band has some quite unique attributes as you put it out. It is very robust and reliable. Some other players in L-band, and there's not a lot, have big contracts with the U.S. government. And I don't know if this is an expanding pie or if it's a pie where you can grow your market share, because it seems like it could be quite an interesting opportunity for you guys.

Right. So the government is our oldest and largest customer. We do things for them that no one else can do. And again, it all traces back to our network, the Low-Earth Orbit mesh network. The fact that our calls away, our calls are routed, the traffic is handed off in space between satellites. And the government has their own gateway in Hawaii where they terminate their traffic. So that solution for them, which is highly secure. The call originates and it never touches the ground again until it comes to their proprietary gateway is almost tailor-made to their needs. So notwithstanding a desire for diversity, the fact of the matter is, is that attribute of our service is unique, and the U.S. DoD is highly desirous of that. And so we think they just signed up a 7-year contract with us. It was sole source because of the unique requirements. And so we think the U.S. DoD is going to be a customer of ours for a very long time. You mentioned Certus. We think Certus is an opportunity within the DoD. That is outside of our 7-year contract that they would pay for those services, but we think that we're going to do well there as well. So like I said, the DoD, we think, is a customer for a very long time. And it's a win-win relationship. Their contract is kind of an all you can eat. They can put as many IoT devices on for the fixed base, many handsets. And so as I said, we think it's a win-win, and it's a very long-term partnership in our view.

And besides the U.S. government, have you been working with other governments or militaries in the rest of the world?

Yes, routinely. So the only difference is other governments, they -- all of their traffic goes through our regular network. So our gateway in Tempe, Arizona. That's where that traffic is routed through. What's unique about the DoD is, their traffic is routed to their own proprietary gateway. But we do -- we routinely through our partners serve the needs of military from other countries.

And is that a market that is growing overall? I mean, because the U.S. has dominated this market. I think maybe 5 or 10 years ago, 90% or 80% of demand for commercial capacity coming from public entities government with the U.S.? Are you seeing other countries adopt this kind of communication solutions more aggressively?

Yes. So like -- the U.K. MoD was a big customer of ours. And kind of those volumes wax and wane with the state of -- is there piece? Or is there -- are there areas where of conflict. And so -- but satellite kit is part of the communications solution for other military organizations besides the U.S.

Great. Well, Tom, I think we reached the end of the hour, and everybody has lots of meetings to follow. So thank you so much for joining. Thank you all for attending the call and have a fruitful day.

Thanks, Mathieu. All the best to you.

Thanks.