Gogo Inc. - Quarter Report: 2019 March (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One):

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended March 31, 2019

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from                      to                     

Commission File Number: 001-35975

 

 

 

 

Gogo Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		27-1650905
(State or other jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

 

 

111 North Canal St., Suite 1500

Chicago, IL 60606

(Address of principal executive offices)

Telephone Number (312) 517-5000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		☐		Accelerated filer		☒
Non-accelerated filer		☐		Smaller reporting company		☐
				Emerging growth company		☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class		Trading Symbol		Name of Each Exchange on Which Registered
Common stock, par value $0.0001 per share		GOGO		NASDAQ Global Select Market

As of May 6, 2019, 87,797,851 shares of $0.0001 par value common stock were outstanding.

 

 

 

Gogo Inc.

INDEX

 

				Page
Part I.		Financial Information
Item 1.		Financial Statements			2
		Unaudited Condensed Consolidated Balance Sheets			2
		Unaudited Condensed Consolidated Statements of Operations			3
		Unaudited Condensed Consolidated Statements of Comprehensive Loss			4
		Unaudited Condensed Consolidated Statements of Cash Flows			5
		Unaudited Condensed Consolidated Statements of Stockholders’ Equity (Deficit)			6
		Notes to Unaudited Condensed Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			32
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			49
Item 4.		Controls and Procedures			50
Part II.		Other Information
Item 1.		Legal Proceedings			51
Item 1A.		Risk Factors			52
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			52
Item 3.		Defaults Upon Senior Securities			52
Item 4.		Mine Safety Disclosures			52
Item 5.		Other Information			52
Item 6.		Exhibits			52
Signatures					55

 

1

PART I. FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

Gogo Inc. and Subsidiaries

Unaudited Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

 

		March 31,				December 31,
		2019				2018
Assets
Current assets:
Cash and cash equivalents		$	188,690			$	184,155
Short-term investments			—				39,323
Total cash, cash equivalents and short-term investments			188,690				223,478
Accounts receivable, net of allowances of $583 and $500, respectively			123,791				134,308
Inventories			147,354				193,045
Prepaid expenses and other current assets			32,140				34,695
Total current assets			491,975				585,526
Non-current assets:
Property and equipment, net			565,485				511,867
Goodwill and intangible assets, net			82,888				83,491
Operating lease right-of-use assets			70,129				—
Other non-current assets			86,333				84,212
Total non-current assets			804,835				679,570
Total assets		$	1,296,810			$	1,265,096
Liabilities and Stockholders’ deficit
Current liabilities:
Accounts payable		$	27,861			$	23,860
Accrued liabilities			183,067				213,111
Deferred revenue			37,602				38,571
Deferred airborne lease incentives			22,726				24,145
Total current liabilities			271,256				299,687
Non-current liabilities:
Long-term debt			1,030,359				1,024,893
Deferred airborne lease incentives			131,743				129,086
Non-current operating lease liabilities			99,870				—
Other non-current liabilities			47,556				80,191
Total non-current liabilities			1,309,528				1,234,170
Total liabilities			1,580,784				1,533,857
Commitments and contingencies (Note 12)			—				—
Stockholders’ deficit
Common stock, par value $0.0001 per share; 500,000,000 shares authorized at March 31, 2019 and December 31, 2018; 87,878,770 and 87,678,812 shares issued at March 31, 2019 and December 31, 2018, respectively; and 87,797,614 and 87,560,694 shares outstanding at March 31, 2019 and December 31, 2018, respectively			9				9
Additional paid-in-capital			967,727				963,458
Accumulated other comprehensive loss			(3,144	)			(3,554	)
Accumulated deficit			(1,248,566	)			(1,228,674	)
Total stockholders’ deficit			(283,974	)			(268,761	)
Total liabilities and stockholders’ deficit		$	1,296,810			$	1,265,096

See the Notes to Unaudited Condensed Consolidated Financial Statements

 

2

Gogo Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except per share amounts)

 

		For the Three Months Ended March 31,
		2019				2018
Revenue:
Service revenue		$	165,012			$	150,678
Equipment revenue			34,537				81,147
Total revenue			199,549				231,825
Operating expenses:
Cost of service revenue (exclusive of items shown below)			68,121				74,947
Cost of equipment revenue (exclusive of items shown below)			29,731				52,293
Engineering, design and development			24,728				29,777
Sales and marketing			12,318				15,901
General and administrative			22,454				25,159
Depreciation and amortization			30,749				35,919
Total operating expenses			188,101				233,996
Operating income (loss)			11,448				(2,171	)
Other (income) expense:
Interest income			(1,149	)			(1,076	)
Interest expense			32,554				30,554
Other income			(3,365	)			(505	)
Total other expense			28,040				28,973
Loss before income taxes			(16,592	)			(31,144	)
Income tax provision (benefit)			207				(3,725	)
Net loss		$	(16,799	)		$	(27,419	)
Net loss attributable to common stock per share—basic and diluted		$	(0.21	)		$	(0.34	)
Weighted average number of shares—basic and diluted			80,446				79,696

See the Notes to Unaudited Condensed Consolidated Financial Statements

 

3

Gogo Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

 

		For the Three Months Ended March 31,
		2019				2018
Net loss		$	(16,799	)		$	(27,419	)
Currency translation adjustments, net of tax			410				(834	)
Comprehensive loss		$	(16,389	)		$	(28,253	)

See the Notes to Unaudited Condensed Consolidated Financial Statements

 

4

Gogo Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

		For the Three Months
		Ended March 31,
		2019				2018
Operating activities:
Net loss		$	(16,799	)		$	(27,419	)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization			30,749				35,919
Loss on asset disposals, abandonments and write-downs			1,241				1,687
Gain on transition to airline-directed model			—				(19,302	)
Deferred income taxes			44				(3,863	)
Stock-based compensation expense			4,327				4,386
Amortization of deferred financing costs			1,249				1,035
Accretion and amortization of debt discount and premium			4,774				4,539
Changes in operating assets and liabilities:
Accounts receivable			10,635				(14,046	)
Inventories			(1,118	)			(12,304	)
Prepaid expenses and other current assets			3,015				(1,863	)
Contract assets			(6,175	)			2,578
Accounts payable			2,843				11,755
Accrued liabilities			(19,381	)			(7,229	)
Deferred airborne lease incentives			(3,923	)			(1,834	)
Deferred revenue			2,257				5,440
Accrued interest			(19,514	)			(24,955	)
Warranty reserves			(588	)			442
Other non-current assets and liabilities			208				(1,171	)
Net cash used in operating activities			(6,156	)			(46,205	)
Investing activities:
Purchases of property and equipment			(23,154	)			(56,886	)
Acquisition of intangible assets—capitalized software			(4,557	)			(5,772	)
Purchases of short-term investments			—				(39,323	)
Redemptions of short-term investments			39,323				69,482
Other, net			95				—
Net cash provided by (used in) investing activities			11,707				(32,499	)
Financing activities:
Payment of debt issuance costs			(557	)			—
Payments on financing leases			(125	)			(618	)
Stock-based compensation activity			(58	)			(70	)
Net cash used in financing activities			(740	)			(688	)
Effect of exchange rate changes on cash			(276	)			75
Increase (decrease) in cash, cash equivalents and restricted cash			4,535				(79,317	)
Cash, cash equivalents and restricted cash at beginning of period			191,116				203,729
Cash, cash equivalents and restricted cash at end of period		$	195,651			$	124,412
Cash, cash equivalents and restricted cash at end of period		$	195,651			$	124,412
Less: current restricted cash			1,535				738
Less: non-current restricted cash			5,426				6,635
Cash and cash equivalents at end of period		$	188,690			$	117,039
Supplemental Cash Flow Information:
Cash paid for interest		$	46,163			$	49,911
Cash paid for taxes			41				15
Noncash Investing and Financing Activities:
Purchases of property and equipment in current liabilities		$	19,951			$	23,325
Purchases of property and equipment paid by commercial airlines			5,016				2,060

See the Notes to Unaudited Condensed Consolidated Financial Statements

 

5

Gogo Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Stockholders’ Equity (Deficit)

(in thousands, except share data)

 

		For the Three Months Ended March 31, 2019
														Accumulated
										Additional				Other
		Common Stock								Paid-In				Comprehensive				Accumulated
		Shares				Par Value				Capital				Loss				Deficit				Total
Balance at January 1, 2019			87,560,694			$	9			$	963,458			$	(3,554	)		$	(1,228,674	)		$	(268,761	)
Net loss			—				—				—				—				(16,799	)			(16,799	)
Currency translation adjustments, net of tax			—				—				—				410				—				410
Stock-based compensation expense			—				—				4,327				—				—				4,327
Issuance of common stock upon vesting of restricted stock units and restricted stock awards			161,667				—				—				—				—				—
Tax withholding related to vesting of restricted stock units			—				—				(351	)			—				—				(351	)
Issuance of common stock in connection with employee stock purchase plan			75,253				—				293				—				—				293
Impact of the adoption of ASC 842			—				—				—				—				(3,093	)			(3,093	)
Balance at March 31, 2019			87,797,614			$	9			$	967,727			$	(3,144	)		$	(1,248,566	)		$	(283,974	)
		For the Three Months Ended March 31, 2018
														Accumulated
										Additional				Other
		Common Stock								Paid-In				Comprehensive				Accumulated
		Shares				Par Value				Capital				Loss				Deficit				Total
Balance at January 1, 2018			86,843,928			$	9			$	898,729			$	(933	)		$	(1,089,369	)		$	(191,564	)
Net loss			—				—				—				—				(27,419	)			(27,419	)
Currency translation adjustments, net of tax			—				—				—				(834	)			—				(834	)
Stock-based compensation expense			—				—				4,386				—				—				4,386
Issuance of common stock upon vesting of restricted stock units and restricted stock awards			107,335				—				—				—				—				—
Tax withholding related to vesting of restricted stock units			—				—				(526	)			—				—				(526	)
Issuance of common stock in connection with employee stock purchase plan			55,812				—				456				—				—				456
Impact of the adoption of ASC 606			—				—				—				—				24,165				24,165
Balance at March 31, 2018			87,007,075			$	9			$	903,045			$	(1,767	)		$	(1,092,623	)		$	(191,336	)

See the Notes to Unaudited Condensed Consolidated Financial Statements

 

6

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

 

1.	Basis of Presentation

The Business - Gogo (“we,” “us,” “our”) is the global leader in providing broadband connectivity solutions and wireless in-flight entertainment to the aviation industry. We operate through the following three segments: Commercial Aviation North America, or “CA-NA,” Commercial Aviation Rest of World, or “CA-ROW,” and Business Aviation, or “BA.” Services provided by our CA-NA and CA-ROW businesses include Passenger Connectivity, which allows passengers to connect to the Internet from their personal Wi-Fi-enabled devices; Passenger Entertainment, which offers passengers the opportunity to enjoy a broad selection of in-flight entertainment options on their personal Wi-Fi enabled devices; and Connected Aircraft Services (“CAS”), which offers airlines connectivity for various operations and currently include, among other services, real-time credit card transaction processing, electronic flight bags and real-time weather information. Services are provided by CA-NA on commercial aircraft flying routes that generally begin and end within North America, which for this purpose includes the United States, Canada and Mexico. CA-ROW provides service on commercial aircraft operated by foreign-based commercial airlines and flights outside of North America for North American-based commercial airlines. The routes included in our CA-ROW segment are those that begin and/or end outside of North America (as defined above) on which our international service is provided. BA provides in-flight Internet connectivity and other voice and data communications products and services and sells equipment for in-flight telecommunications to the business aviation market. BA services include Gogo Biz, our in-flight broadband service, Passenger Entertainment, our in-flight entertainment service, and satellite-based voice and data services through our strategic alliances with satellite companies.

Basis of Presentation - The accompanying unaudited condensed consolidated financial statements and notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conformity with Article 10 of Regulation S-X promulgated under the Securities Act of 1933, as amended (the “Securities Act”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements and should be read in conjunction with our annual audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018 as filed with the Securities and Exchange Commission (“SEC”) on February 21, 2019 (the “2018 10-K”). These unaudited condensed consolidated financial statements reflect, in the opinion of management, all material adjustments (which include normal recurring adjustments) necessary to fairly state, in all material respects, our financial position, results of operations and cash flows for the periods presented.

The results of operations and cash flows for the three month period ended March 31, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2019.

We have one class of common stock outstanding as of March 31, 2019 and December 31, 2018.

Reclassifications – To conform with the current year presentation, certain amounts in our unaudited condensed consolidated statements of cash flows for the three month period ended March 31, 2018 have been reclassified. Specifically, contract assets and warranty reserves are presented separately. Contract assets of $2,578 thousand was originally included as $967 thousand within prepaid expenses and $1,611 thousand within other current assets and other non- current assets and liabilities. Warranty reserves of $442 thousand was originally included within accrued liabilities. Additionally, within our unaudited condensed consolidated balance sheets as of December 31, 2018, $652 thousand of the current portion of financing lease liabilities has been combined with accrued liabilities.

Transition of airline models - The accounting treatment for one of our airline agreements transitioned from our turnkey model to our airline-directed model in January 2018 due to specific provisions elected by the airline that resulted in the transfer of control of the previously installed connectivity equipment. Upon transition to the airline-directed model, the net book value of all previously delivered equipment classified within property and equipment was reclassified to cost of equipment revenue. Additionally, the unamortized proceeds previously received for equipment and classified within current and non-current deferred airborne lease incentives were eliminated and included as part of estimated contract value, which was then allocated amongst the various performance obligations under the agreement. The value allocated to previously delivered equipment was immediately recognized as equipment revenue in our unaudited condensed consolidated financial statements; refer to Note 3, “Revenue Recognition,” for additional disclosures relating to the allocation of consideration among identified performance obligations. For amounts recognized in equipment revenue that were in excess of the amounts billed, we recorded current and non-current contract assets included within prepaid expenses and other current assets and other non-current assets, respectively; refer to Note 3, “Revenue Recognition,” for additional details. In connection with the transition of this airline agreement to the airline-directed model, we also established warranty reserves related to

 

7

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

previously sold equipment that are still under a warranty period, which is included within accrued liabilities. See Note 8, “Warranties,” for additional information. This transition from the turnkey model to the airline-directed model occurred on January 4, 2018 and the total financial statement effect on our unaudited condensed consolidated balance sheet and unaudited condensed consolidated statement of operations was as follows (in thousands):

 

		Increase (decrease)
Unaudited condensed consolidated balance sheet
Prepaid expense and other current assets		$	6,603
Property and equipment, net			(32,716	)
Other non-current assets			18,783
Accrued liabilities			2,000
Current deferred airborne lease incentive			(13,592	)
Non-current deferred airborne lease incentive			(17,289	)
Unaudited condensed consolidated statement of operations
Equipment revenue			45,396
Cost of equipment revenue			23,845

As of January 1, 2019, one airline transitioned from the airline-directed model to the turnkey model. As a result of such transition, $46.8 million of Inventory was reclassified to Property and equipment, net as of January 1, 2019. See Note 2, “Summary of Significant Accounting Policies - Inventories,” in our 2018 10-K for information regarding the allocation of airborne equipment between Inventories and Property and equipment, net.

Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates the significant estimates and bases such estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. However, actual results could differ materially from those estimates.

 

2.	Recent Accounting Pronouncements

Accounting standards adopted:

On January 1, 2019, we adopted Accounting Standards Codification Topic 842, Leases (“ASC 842”) using the cumulative effect method. As a result, we recognized the cumulative effect of initially applying ASC 842 as an adjustment to the opening balance of retained earnings as of January 1, 2019. Our historical financial statements have not been restated and continue to be reported under the lease accounting standard in effect for those periods.

We elected the practical expedients regarding use of hindsight to evaluate lease terms as well as maintaining lease classifications established under the prior lease accounting standard. Through this practical expedient, we did not reevaluate contracts to determine if they contained a lease. We did not elect the practical expedients regarding short-term leases or the separation of lease and non-lease components.

Adoption of ASC 842 had a material impact on our consolidated balance sheet through recognition of right-of-use (“ROU”) assets and operating lease liabilities. Adoption did not have a material impact on our consolidated statements of operations or our consolidated statements of cash flows and did not result in the recognition of incremental financing leases, formerly referred to as capital leases.

 

8

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

The discount rate used to calculate the adjustment to the opening balance was our incremental borrowing rate as of the adoption date, January 1, 2019. The cumulative effect of the adoption of ASC 842 to our unaudited condensed consolidated balance sheet as of January 1, 2019 was as follows (in thousands):

 

										Balances
		Balance at								with
		December 31,				Impact of				Adoption of
		2018				ASC 842				ASC 842
Assets
Operating lease right-of-use assets		$	—			$	72,188			$	72,188
Liabilities
Accrued liabilities			212,459				9,019				221,478
Non-current operating lease liabilities			—				102,440				102,440
Other non-current liabilities			80,191				(36,178	)			44,013
Equity
Accumulated deficit			(1,228,674	)			(3,093	)			(1,231,767	)

See Note 11, “Leases,” for additional information.

On January 1, 2019, we adopted ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of tax reform to retained earnings. Adoption of this standard did not have a material impact on our consolidated financial statements.

On January 1, 2019, we adopted ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”), which expands the scope of ASC 718, Compensation – Stock Compensation, to include share-based payment transactions for acquiring goods or services from nonemployees. Adoption of this standard did not have a material impact on our consolidated financial statements.

 

3.	Revenue Recognition

Arrangements with commercial airlines

For CA-NA and CA-ROW, pursuant to contractual agreements with our airline partners, we place our equipment on commercial aircraft operated by the airlines in order to deliver our service to passengers on the aircraft. We currently have two types of commercial airline arrangements: turnkey and airline-directed. Under the airline-directed model, we have transferred control of the equipment to the airline and therefore the airline is our customer in these transactions. Under the turnkey model, we have not transferred control of our equipment to our airline partner and, as a result, the airline passenger is deemed to be our customer. Transactions with our airline partners under the turnkey model are accounted for as an operating lease of space on an aircraft. See Note 11, “Leases,” for additional information on the turnkey model.

Remaining performance obligations

As of March 31, 2019, the aggregate amount of the transaction price in our contracts allocated to the remaining unsatisfied performance obligations is approximately $831 million, most of which relates to our commercial aviation contracts. Approximately $114 million represents future equipment revenue that is expected to be recognized within the next one to three years. The remaining $717 million primarily represents connectivity and entertainment service revenues which are recognized as services are provided, which is expected to occur through the remaining term of the contract (approximately 5-10 years). We have excluded from this amount: all variable consideration derived from our connectivity or entertainment services that is allocated entirely to our performance of obligations related to such services; consideration from contracts that have an original duration of one year or less; revenue from passenger service on airlines operating under the turnkey model; and revenue from contracts that have been executed but under which have not yet met the accounting definition of a contract since the airline has not yet determined which products in our portfolio it wishes to select, and, as a result we are unable to determine which products and services will be transferred to the customer.

 

9

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

Disaggregation of revenue

The following table presents our revenue disaggregated by category (in thousands):

 

		For the Three Months Ended
		March 31, 2019
		CA-NA				CA-ROW				BA				Total
Service revenue
Connectivity		$	79,818			$	18,854			$	52,685			$	151,357
Entertainment, CAS and other			12,209				918				528				13,655
Total service revenue		$	92,027			$	19,772			$	53,213			$	165,012
Equipment revenue
ATG		$	2,872			$	—			$	11,335			$	14,207
Satellite			630				13,159				5,235				19,024
Other			540				—				766				1,306
Total equipment revenue		$	4,042			$	13,159			$	17,336			$	34,537
Customer type
Airline passenger and aircraft owner/operator		$	54,349			$	5,851			$	53,213			$	113,413
Airline, OEM and aftermarket dealer			30,913				25,491				17,336				73,740
Third party			10,807				1,589				—				12,396
Total revenue		$	96,069			$	32,931			$	70,549			$	199,549
		For the Three Months Ended
		March 31, 2018
		CA-NA				CA-ROW				BA				Total
Service revenue
Connectivity		$	82,040			$	13,649			$	47,392			$	143,081
Entertainment, CAS and other			6,743				596				258				7,597
Total service revenue		$	88,783			$	14,245			$	47,650			$	150,678
Equipment revenue
ATG (1)		$	44,762			$	—			$	15,421			$	60,183
Satellite (1)			10,276				4,924				4,258				19,458
Other			—				—				1,506				1,506
Total equipment revenue		$	55,038			$	4,924			$	21,185			$	81,147
Customer type
Airline passenger and aircraft owner/operator		$	52,924			$	4,729			$	47,650			$	105,303
Airline, OEM and aftermarket dealer (2)			77,426				12,694				21,185				111,305
Third party			13,471				1,746				—				15,217
Total revenue		$	143,821			$	19,169			$	68,835			$	231,825

 

1)

ATG and satellite equipment revenue for the CA-NA segment includes the $45.4 million related to the accounting impact of the transition of one of our airline partners to the airline-directed model. Approximately $43.4 million was included in ATG equipment revenue and approximately $2.0 million was included in satellite equipment revenue.

2)	Airline, OEM and aftermarket dealer revenue includes all equipment revenue for our three segments, including the $45.4 million accounting impact of the transition of one of our airline partners to the airline-directed model.

Contract balances

Our current and non-current deferred revenue balances totaled $62.3 million and $60.1 million as of March 31, 2019 and December 31, 2018, respectively. Deferred revenue includes, among other things, equipment, multi-pack and subscription connectivity products, sponsorship activities and airline-directed connectivity and entertainment.

 

10

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

Our current and non-current contract asset balances totaled $66.4 million and $59.9 million as of March 31, 2019 and December 31, 2018, respectively. Contract assets represent the aggregate amount of revenue recognized in excess of billings for our airline-directed contracts.

Capitalized STC balances for our airline-directed contracts were $16.3 million and $16.5 million as of March 31, 2019 and December 31, 2018, respectively. We recognized $0.3 million and $0.2 million, respectively, of deferred STC costs as part of our engineering, design and development costs in our unaudited condensed consolidated statements of operations during the three month periods ended March 31, 2019 and 2018.

 

4.	Net Loss Per Share

Basic and diluted net loss per share have been calculated using the weighted average number of common shares outstanding for the period.

The shares of common stock effectively repurchased in connection with the Forward Transactions (as defined and described in Note 9, “Long-Term Debt and Other Liabilities”) are considered participating securities requiring the two-class method to calculate basic and diluted earnings per share. Net earnings in future periods will be allocated between common shares and participating securities. In periods of a net loss, the shares associated with the Forward Transactions will not receive an allocation of losses, as the counterparties to the Forward Transactions are not required to fund losses. Accordingly, the calculation of weighted average shares outstanding as of March 31, 2019 and 2018 excludes approximately 7.2 million shares that will be repurchased as a result of the Forward Transactions.

As a result of the net loss for the three month periods ended March 31, 2019 and 2018, all of the outstanding shares of common stock underlying stock options, deferred stock units and restricted stock units were excluded from the computation of diluted shares outstanding because they were anti-dilutive.

The following table sets forth the computation of basic and diluted earnings per share for the three month periods ended March 31, 2019 and 2018; however, because of the undistributed losses, the shares of common stock associated with the Forward Transactions are excluded from the computation of basic earnings per share in 2019 and 2018 as undistributed losses are not allocated to these shares (in thousands, except per share amounts):

 

		For the Three Months
		Ended March 31,
		2019				2018
Net loss		$	(16,799	)		$	(27,419	)
Less: Participation rights of the Forward Transactions			—				—
Undistributed losses		$	(16,799	)		$	(27,419	)
Weighted-average common shares outstanding-basic and diluted			80,446				79,696
Net loss attributable to common stock per share-basic and diluted		$	(0.21	)		$	(0.34	)

 

5.	Inventories

Inventories consist primarily of telecommunications systems and parts and are recorded at the lower of cost (average cost) or market. We evaluate the need for write-downs associated with obsolete, slow-moving and nonsalable inventory by reviewing net realizable inventory values on a periodic basis.

Inventories as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Work-in-process component parts		$	29,043			$	30,340
Finished goods (1)			118,311				162,705
Total inventory		$	147,354			$	193,045

 

(1)	The change between March 31, 2019 and December 31, 2018 primarily relates to the accounting impact of one of our airline partner agreements transitioning to the turnkey model (see Note 1, “Basis of Presentation,” for additional information).

 

11

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

6.	Composition of Certain Balance Sheet Accounts

Prepaid expenses and other current assets as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Contract assets		$	10,852			$	10,423
Prepaid satellite services			7,170				7,755
Restricted cash			1,535				1,535
Other			12,583				14,982
Total prepaid expenses and other current assets		$	32,140			$	34,695

Property and equipment as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Office equipment, furniture, fixtures and other		$	52,637			$	52,320
Leasehold improvements			44,839				44,838
Airborne equipment (1)			715,055				642,151
Network equipment			210,044				205,463
			1,022,575				944,772
Accumulated depreciation			(457,090	)			(432,905	)
Total property and equipment, net		$	565,485			$	511,867

 

(1)	The change between March 31, 2019 and December 31, 2018 primarily relates to the accounting impact of one of our airline partner agreements transitioning to the turnkey model (see Note 1, “Basis of Presentation,” for additional information).

Other non-current assets as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Contract assets		$	55,536			$	49,517
Deferred STC costs			16,289				16,453
Restricted cash			5,426				5,426
Other			9,082				12,816
Total other non-current assets		$	86,333			$	84,212

Accrued liabilities as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Employee compensation and benefits		$	13,437			$	19,463
Airborne equipment and installation costs			17,625				25,119
Airline related accrued liabilities			41,609				45,077
Accrued interest			27,180				46,694
Accrued satellite network costs			14,989				19,557
Warranty reserve			11,750				12,291
Operating leases (1)			11,585				—
Other			44,892				44,910
Total accrued liabilities		$	183,067			$	213,111

 

(1)	The change between March 31, 2019 and December 31, 2018 is due to the adoption of ASC 842. See Note 2, “Recent Accounting Pronouncements,” for additional information.

 

12

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

Other non-current liabilities as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
Deferred revenue		$	24,709			$	21,482
Deferred rent (1)			—				35,897
Asset retirement obligations			9,945				9,696
Deferred tax liabilities			2,206				2,162
Other			10,696				10,954
Total other non-current liabilities		$	47,556			$	80,191

 

(1)	The change between March 31, 2019 and December 31, 2018 is due to the adoption of ASC 842. See Note 2, “Recent Accounting Pronouncements,” for additional information.

 

7.	Intangible Assets

Our intangible assets are comprised of both indefinite-lived and finite-lived intangible assets. Intangible assets with indefinite lives and goodwill are not amortized; rather, they are reviewed for impairment at least annually or whenever events or circumstances indicate the carrying value of the asset may not be recoverable. We perform our annual impairment tests of our indefinite-lived intangible assets and goodwill during the fourth quarter of each fiscal year. We also reevaluate the useful life of indefinite-lived intangible assets each reporting period to determine whether events and circumstances continue to support an indefinite useful life. The results of our annual indefinite-lived intangible assets and goodwill impairment assessments in the fourth quarter of 2018 indicated no impairment.

As of both March 31, 2019 and December 31, 2018, our goodwill balance, all of which related to our BA segment, was $0.6 million.

Our intangible assets, other than goodwill, as of March 31, 2019 and December 31, 2018 were as follows (in thousands, except for weighted average remaining useful life):

 

		Weighted
		Average				As of March 31, 2019												As of December 31, 2018
		Remaining				Gross								Net				Gross								Net
		Useful Life				Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
		(in years)				Amount				Amortization				Amount				Amount				Amortization				Amount
Amortized intangible assets:
Software			2.7			$	169,306			$	(121,933	)		$	47,373			$	164,580			$	(116,873	)		$	47,707
Service customer relationship			1.1				8,081				(7,058	)			1,023				8,081				(6,804	)			1,277
Other intangible assets			7.8				3,000				(1,411	)			1,589				3,000				(1,396	)			1,604
OEM and dealer relationships							6,724				(6,724	)			—				6,724				(6,724	)			—
Total amortized intangible assets							187,111				(137,126	)			49,985				182,385				(131,797	)			50,588
Unamortized intangible assets:
FCC Licenses							32,283				—				32,283				32,283				—				32,283
Total intangible assets						$	219,394			$	(137,126	)		$	82,268			$	214,668			$	(131,797	)		$	82,871

Amortization expense was $5.3 million and $7.6 million, respectively, for the three month periods ended March 31, 2019 and 2018.

 

13

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

Amortization expense for each of the next five years and thereafter is estimated to be as follows (in thousands):

 

		Amortization
Years ending December 31,		Expense
2019 (period from April 1 to December 31)		$	16,775
2020		$	15,915
2021		$	11,061
2022		$	4,230
2023		$	1,090
Thereafter		$	914

Actual future amortization expense could differ from the estimated amount as a result of future investments and other factors.

 

8.	Warranties

We provide warranties on parts and labor related to our products. Our warranty terms range from two to ten years. Warranty reserves are established for costs that are estimated to be incurred after the sale, delivery and installation of the products under warranty. The warranty reserves are determined based on known product failures, historical experience and other available evidence, and are included in accrued liabilities in our unaudited condensed consolidated balance sheets. Our warranty reserve balance was $11.8 million and $12.3 million, respectively, as of March 31, 2019 and December 31, 2018.

 

9.	Long-Term Debt and Other Liabilities

Long-term debt as of March 31, 2019 and December 31, 2018 was as follows (in thousands):

 

		March 31,				December 31,
		2019				2018
2022 Senior Secured Notes		$	701,910			$	702,670
2022 Convertible Notes			193,012				190,083
2020 Convertible Notes			151,800				149,195
Total debt			1,046,722				1,041,948
Less deferred financing costs			(16,363	)			(17,055	)
Total long-term debt		$	1,030,359			$	1,024,893

2022 Senior Secured Notes – On June 14, 2016 (the “Issue Date”), Gogo Intermediate Holdings LLC (“GIH”) (a wholly owned subsidiary of Gogo Inc.) and Gogo Finance Co. Inc. (a wholly owned subsidiary of GIH) (the “Co-Issuer” and, together with GIH, the “Issuers”), issued $525 million aggregate principal amount of 12.500% senior secured notes due 2022 (the “Original 2022 Senior Secured Notes”) under an Indenture, dated as of June 14, 2016 (the “Original Indenture”), among the Issuers, us, as guarantor, certain subsidiaries of GIH, as guarantors (the “Subsidiary Guarantors” and, together with us, the “Guarantors”), and U.S. Bank National Association, as trustee (in such capacity, the “Trustee”) and as collateral agent (in such capacity, the “Collateral Agent”). On January 3, 2017, the Issuers issued $65 million aggregate principal amount of additional 12.500% senior secured notes due 2022 (the “January 2017 Additional Notes”). The January 2017 Additional Notes were issued at a price equal to 108% of their face value resulting in gross proceeds of $70.2 million. On September 20, 2017, the Issuers, the Guarantors and the Trustee entered into the first supplemental indenture (the “Supplemental Indenture” and, together with the Original Indenture, the “Indenture”) to modify certain covenants, as discussed below. On September 25, 2017, the Issuers issued $100 million aggregate principal amount of additional 12.500% senior secured notes due 2022 (the “September 2017 Additional Notes”). The September 2017 Additional Notes were issued at a price equal to 113% of their face value resulting in gross proceeds of $113.0 million. Additionally, we received approximately $2.9 million for interest that accrued from July 1, 2017 through September 24, 2017, which was paid in our January 2018 interest payment. We refer to the Original 2022 Senior Secured Notes, the January 2017 Additional Notes and the September 2017 Additional Notes collectively as the “2022 Senior Secured Notes.”

As noted above, on September 20, 2017, the Issuers, the Guarantors and the Trustee entered into the Supplemental Indenture to (i) increase the amount of additional secured indebtedness under Credit Facilities (as defined in the Indenture) that may be incurred by the Issuer and its Restricted Subsidiaries (as defined in the Indenture) under the Indenture by $100 million (from $75 million to $175 million in aggregate principal amount),

 

14

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

(ii) permit the Issuer and its Restricted Subsidiaries to incur additional secured indebtedness in connection with vendor financing arrangements not to exceed $50 million in aggregate principal amount at any time outstanding and (iii) permit the Issuer and its Restricted Subsidiaries to make additional dividends or distributions to Gogo in an aggregate amount of up to $15 million during any twelve-month period to pay interest on any indebtedness or preferred stock with a maturity later than July 1, 2022. The Supplemental Indenture became effective immediately upon execution, following our receipt of consents from holders of a majority of the outstanding principal amount of the Existing Notes (excluding Existing Notes held by the Issuers or any affiliates of the Issuers) to the Supplemental Indenture and amendments to the collateral agency agreement governing the 2022 Senior Secured Notes (the “Consent Solicitation”). In connection with the Consent Solicitation, GIH paid $1.4 million in fees (“Consent Fees”) to holders of Existing Notes who validly tendered (and did not revoke) their consents prior to the expiration of the Consent Solicitation.

As of March 31, 2019 and December 31, 2018, the outstanding principal amount of the 2022 Senior Secured Notes was $690.0 million and $690.0 million, respectively, the unamortized debt premium and Consent Fees were $11.9 million and $12.7 million, respectively, and the net carrying amount was $701.9 million and $702.7 million, respectively.

Interest on the 2022 Senior Secured Notes accrues at the rate of 12.500% per annum and is payable semi-annually in arrears on January 1 and July 1, interest payments commenced on January 1, 2017 (other than the January 2017 Additional Notes, for which interest payments commenced on July 1, 2017, and the September 2017 Additional Notes, for which interest payments commenced on January 1, 2018). The 2022 Senior Secured Notes mature on July 1, 2022. The January 2017 Additional Notes and September 2017 Additional Notes have the same terms as the Original 2022 Senior Secured Notes, except with respect to the issue date and issue price, and are treated as a single series for all purposes under the Indenture and the security documents that govern the 2022 Senior Secured Notes.

We paid approximately $11.4 million, $2.0 million and $2.5 million, respectively, of aggregate origination fees and financing costs related to the issuance of the Original 2022 Senior Secured Notes, the January 2017 Additional Notes and the September 2017 Additional Notes, which have been accounted for as deferred financing costs. Additionally, as noted above, we paid approximately $1.4 million of Consent Fees, which partially offset the net carrying value of the 2022 Senior Secured Notes. The deferred financing costs on our unaudited condensed consolidated balance sheet are being amortized over the contractual term of the 2022 Senior Secured Notes using the effective interest method. Total amortization expense was $0.8 million and $0.6 million, respectively, for the three month periods ended March 31, 2019 and 2018. As of March 31, 2019 and December 31, 2018, the balance of unamortized deferred financing costs related to the 2022 Senior Secured Notes was $9.3 million and $10.0 million, respectively, and is included as a reduction to long-term debt in our unaudited condensed consolidated balance sheet. See Note 10, “Interest Costs,” for additional information.

The 2022 Senior Secured Notes are the senior secured indebtedness of the Issuers and are:

 

•

effectively senior to all of the Issuers’ existing and future senior unsecured indebtedness and the Issuers’ indebtedness secured on a junior priority basis by the same collateral securing the 2022 Senior Secured Notes, if any, in each case to the extent of the value of the collateral securing the 2022 Senior Secured Notes;

 

•

effectively senior in right of payment to all of the Issuers’ future indebtedness that is subordinated in right of payment to the 2022 Senior Secured Notes;

 

•

effectively equal in right of payment with the Issuers’ existing and future (i) unsecured indebtedness that is not subordinated in right of payment to the 2022 Senior Secured Notes and (ii) indebtedness secured on a junior priority basis by the same collateral securing the 2022 Senior Secured Notes, if any, in each case to the extent of any insufficiency in the collateral securing the 2022 Senior Secured Notes;

 

•

structurally senior to all of our existing and future indebtedness, including our Convertible Notes (as defined below); and

 

•

structurally subordinated to all of the indebtedness and other liabilities of any non-Guarantors (other than the Issuers).

The 2022 Senior Secured Notes are guaranteed, on a senior secured basis, by us and all of GIH’s existing and

 

15

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

future domestic restricted subsidiaries (other than the Co-Issuer), subject to certain exceptions. The Issuers’ obligations under the 2022 Senior Secured Notes are not guaranteed by Gogo International Holdings LLC, a subsidiary of ours that holds no material assets other than equity interests in our foreign subsidiaries. Each guarantee is a senior secured obligation of such Guarantor and is:

 

•

effectively senior to all of such Guarantor’s existing and future senior unsecured indebtedness and such Guarantor’s indebtedness secured on a junior priority basis by the same collateral, if any, securing the guarantee of such Guarantor, in each case to the extent of the value of the collateral securing such guarantee;

 

•

effectively senior in right of payment to all of such Guarantor’s future indebtedness that is subordinated in right of payment to such Guarantor’s guarantee;

 

•

effectively equal in right of payment with all of such Guarantor’s existing and future (i) unsecured indebtedness that is not subordinated in right of payment to such Guarantor’s guarantee, and (ii) indebtedness secured on a junior priority basis by the same collateral, if any, securing the guarantee of such Guarantor, in each case to the extent of any insufficiency in the collateral securing such guarantee; and

 

•

structurally subordinated to all indebtedness and other liabilities of any non-Guarantor subsidiary of such Guarantor (excluding, in the case of our guarantee, the Issuers).

The 2022 Senior Secured Notes and the related guarantees are secured by first-priority liens, subject to permitted liens, on substantially all of the Issuers’ and the Guarantors’ assets, except for certain excluded assets, including pledged equity interests of the Issuers and all of our existing and future domestic restricted subsidiaries guaranteeing the 2022 Senior Secured Notes.

The security interests in certain collateral may be released without the consent of holders of the 2022 Senior Secured Notes, if such collateral is disposed of in a transaction that complies with the Indenture and related security agreements. In addition, under certain circumstances, we and the Guarantors have the right to transfer certain intellectual property assets that on the Issue Date constitute collateral securing the 2022 Senior Secured Notes or the guarantees to a restricted subsidiary organized under the laws of Switzerland, resulting in the release of such collateral without consent of the holders of the 2022 Senior Secured Notes.

On or after July 1, 2019, the Issuers may, at their option, at any time or from time to time, redeem any of the 2022 Senior Secured Notes in whole or in part. The 2022 Senior Secured Notes will be redeemable at the following redemption prices (expressed in percentages of principal amount), plus accrued and unpaid interest, if any, to (but not including) the redemption date (subject to the right of holders of record on the relevant regular record date on or prior to the redemption date to receive interest due on an interest payment date), if redeemed during the twelve-month period commencing on July 1 of the following years:

 

		Redemption
Year		Price
2019			106.250	%
2020			103.125	%
2021 and thereafter			100.000	%

In addition, at any time prior to July 1, 2019, the Issuers may redeem up to 35% of the aggregate principal amount of the 2022 Senior Secured Notes with the proceeds of certain equity offerings at a redemption price of 112.500% of the principal amount redeemed, plus accrued and unpaid interest, if any, to (but not including) the date of redemption; provided, however, that 2022 Senior Secured Notes representing at least 65% of the principal amount of the 2022 Senior Secured Notes remain outstanding immediately after each such redemption.

The Issuers may redeem the 2022 Senior Secured Notes, in whole or in part, at any time prior to July 1, 2019, at a redemption price equal to 100% of the principal amount of the 2022 Senior Secured Notes redeemed plus the make-whole premium set forth in the Indenture as of, and accrued and unpaid interest, if any, to (but not including) the applicable redemption date.

The Indenture contains covenants that, among other things, limit the ability of the Issuers and the Subsidiary Guarantors and, in certain circumstances, our ability, to: incur additional indebtedness; pay dividends, redeem stock

 

16

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

or make other distributions; make investments; create restrictions on the ability of our restricted subsidiaries to pay dividends to the Issuers or make other intercompany transfers; create liens; transfer or sell assets; merge or consolidate; and enter into certain transactions with the Issuers’ affiliates, including us. Most of these covenants will cease to apply if, and for as long as, the 2022 Senior Secured Notes have investment grade ratings from both Moody’s Investment Services, Inc. and Standard & Poor’s.

If we or the Issuers undergo specific types of change of control prior to July 1, 2022, GIH is required to make an offer to repurchase for cash all of the 2022 Senior Secured Notes at a repurchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to (but not including) the payment date.

The Indenture provides for events of default, which, if any of them occur, would permit or require the principal, premium, if any, and interest on all of the then outstanding 2022 Senior Secured Notes issued under the Indenture to be due and payable immediately. As of March 31, 2019, no event of default had occurred.

On April 15, 2019, the Issuers elected to call for redemption in full all $690.0 million aggregate principal amount outstanding of the 2022 Senior Secured Notes in accordance with the terms of the Indenture (the “Redemption”). The Redemption was conditioned, among other things, upon the incurrence of indebtedness in connection with the offering of the 2024 Senior Secured Notes (as defined below) or from one or more other sources, in an amount satisfactory to the Issuers. On April 25, 2019, the Issuers irrevocably deposited or caused to be irrevocably deposited with the Trustee, solely for the benefit of the holders of the 2022 Senior Secured Notes, cash in an amount sufficient to pay principal, premium and accrued interest on the 2022 Senior Secured Notes to, but not including, the date of redemption and all other sums payable under the Indenture. The Trustee executed and delivered, among other documents, an acknowledgement of satisfaction, discharge and release, dated as of April 25, 2019, with respect to the satisfaction and discharge of the 2022 Senior Secured Notes. The 2022 Senior Secured Notes will be redeemed on May 15, 2019 at a redemption price equal to 100% of the principal amount of the 2022 Senior Secured Notes to be redeemed plus a make-whole premium and accrued and unpaid interest to, but not including, the redemption date.

2024 Senior Secured Notes - On April 25, 2019, the Issuers issued $905 million aggregate principal amount of 9.875% senior secured notes due 2024 (the “Initial Notes”) under an indenture, dated as of April 25, 2019, among the Issuers, us, as guarantor, certain subsidiaries of GIH, as guarantors (the “2024 Subsidiary Guarantors” and, together with us, the “2024 Guarantors”), and U.S. Bank National Association, as trustee (the “Trustee”) and collateral agent (the “Base Indenture”). On May 3, 2019, the Issuers, the 2024 Guarantors and the Trustee entered into the first supplemental indenture (the “First Supplemental Indenture” and together with the Base Indenture, the “2024 Indenture”) to increase the amount of indebtedness under Credit Facilities (as defined in the 2024 Indenture) that may be incurred by GIH or its subsidiaries acting as 2024 Guarantors by $20 million in aggregate principal amount. On May 7, 2019, the Issuers issued an additional $20 million aggregate principal amount of their 9.875% senior secured notes due 2024 (the “Additional Notes”). We refer to the Initial Notes and the Additional Notes collectively as the “2024 Senior Secured Notes”. The 2024 Senior Secured Notes are guaranteed on a senior secured basis by Gogo Inc. and all of GIH’s existing and future restricted subsidiaries (other than the Co-Issuer), subject to certain exceptions. The 2024 Senior Secured Notes and the related guarantees are secured by first-priority liens (subject to certain exceptions) on substantially all of the Issuers’ and the 2024 Guarantors’ assets, including pledged equity interests of the Issuers and all of GIH’s existing and future restricted subsidiaries guaranteeing the 2024 Senior Secured Notes, except for certain excluded assets and subject to permitted liens.

The 2024 Senior Secured Notes will mature on May 1, 2024. The 2024 Senior Secured Notes bear interest at a rate of 9.875% per year, payable semiannually in arrears on May 1 and November 1 of each year, beginning on November 1, 2019.

The Issuers used a portion of the net proceeds from the issuance of the Initial Notes to fund the redemption of all of the outstanding 2022 Senior Secured Notes. The Issuers intend to use the remaining net proceeds from the issuance of the Initial Notes for general corporate purposes, including the repurchase, retirement or repayment of the 2020 Convertible Notes (as defined below). The Issuers intend to use the net proceeds from the issuance of the Additional Notes for general corporate purposes.

 

17

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

Convertible Notes

2022 Convertible Notes

On November 21, 2018, we issued $215.0 million aggregate principal amount of 6.00% Convertible Senior Notes due 2022 (the “2022 Convertible Notes”) in private offerings to qualified institutional buyers, including pursuant to Rule 144A under the Securities Act, and in concurrent private placements. We granted an option to the initial purchasers to purchase up to an additional $32.3 million aggregate principal amount of 2022 Convertible Notes to cover over-allotments, of which $22.8 million was subsequently exercised during December 2018, resulting in a total issuance of $237.8 million aggregate principal amount of 2022 Convertible Notes. The 2022 Convertible Notes mature on May 15, 2022, unless earlier repurchased or converted into shares of our common stock under certain circumstances described below. Upon maturity, we have the option to settle our obligation through cash, shares of common stock, or a combination of cash and shares of common stock. We pay interest on the 2022 Convertible Notes semi-annually in arrears on May 15 and November 15 of each year. Interest payments begin on May 15, 2019.

The $237.8 million of proceeds received from the issuance of the 2022 Convertible Notes was initially allocated between long-term debt (the liability component) at $188.7 million and additional paid-in capital (the equity component) at $49.1 million, within the consolidated balance sheet. The fair value of the liability component was measured using rates determined for similar debt instruments without a conversion feature. The carrying amount of the equity component, representing the conversion option, was determined by deducting the fair value of the liability component from the aggregate face value of the 2022 Convertible Notes. If we or the note holders elect not to settle the debt through conversion, we must settle the 2022 Convertible Notes at face value. Therefore, the liability component will be accreted up to the face value of the 2022 Convertible Notes, which will result in additional non-cash interest expense being recognized in the unaudited condensed consolidated statements of operations through the 2022 Convertible Notes maturity date (see Note 10, “Interest Costs,” for additional information). The effective interest rate on the 2022 Convertible Notes, including accretion of the notes to par and debt issuance cost amortization, was approximately 13.6%. The equity component will not be remeasured as long as it continues to meet the conditions for equity classification.

As of March 31, 2019 and December 31, 2018, the outstanding principal on the 2022 Convertible Notes was $237.8 million and $237.8 million, respectively, the unamortized debt discount was $44.7 million and $47.7 million, respectively, and the net carrying amount of the liability component was $193.0 million and $190.1 million, respectively.

We incurred approximately $8.1 million of issuance costs related to the issuance of the 2022 Convertible Notes, of which $6.4 million and $1.7 million were recorded to deferred financing costs and additional paid-in capital, respectively, in proportion to the allocation of the proceeds of the 2022 Convertible Notes. The $6.4 million recorded as deferred financing costs on our consolidated balance sheet is being amortized over the term of the 2022 Convertible Notes using the effective interest method. Total amortization expense of the deferred financing costs was $0.4 million for the three month period ended March 31, 2019. Amortization expense is included in interest expense in the unaudited condensed consolidated statements of operations. As of March 31, 2019 and December 31, 2018, the balance of unamortized deferred financing costs related to the 2022 Convertible Notes was $5.8 million and $6.2 million, respectively, and is included as a reduction to long-term debt in our consolidated balance sheets. See Note 10, “Interest Costs,” for additional information.

The 2022 Convertible Notes had an initial conversion rate of 166.6667 common shares per $1,000 principal amount of 2022 Convertible Notes, which is equivalent to an initial conversion price of approximately $6.00 per share of our common stock. Upon conversion, we currently expect to deliver cash up to the principal amount of the 2022 Convertible Notes then outstanding. With respect to any conversion value in excess of the principal amount, we currently expect to deliver shares of our common stock. We may elect to deliver cash in lieu of all or a portion of such shares. The shares of common stock subject to conversion are excluded from diluted earnings per share calculations under the if-converted method as their impact is anti-dilutive.

Holders may convert the 2022 Convertible Notes, at their option, in multiples of $1,000 principal amount at any time prior to January 15, 2022, but only in the following circumstances:

 

•

during any fiscal quarter beginning after the fiscal quarter ended December 31, 2018, if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during the last 30 consecutive trading days of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price of the 2022 Convertible Notes on each applicable trading day;

 

18

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

•

during the five business day period following any five consecutive trading day period in which the trading price for the 2022 Convertible Notes is less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the 2022 Convertible Notes on each such trading day; or

 

•

upon the occurrence of specified corporate events.

None of the above events allowing for conversion prior to January 15, 2022 occurred during the three month period ended March 31, 2019 or the year ended December 31, 2018. Regardless of whether any of the foregoing circumstances occurs, a holder may convert its 2022 Convertible Notes, in multiples of $1,000 principal amount, at any time on or after January 15, 2022 until the second scheduled trading day immediately preceding May 15, 2022.

In addition, if we undergo a fundamental change (as defined in the indenture governing the 2022 Convertible Notes), holders may, subject to certain conditions, require us to repurchase their 2022 Convertible Notes for cash at a price equal to 100% of the principal amount of the 2022 Convertible Notes to be purchased, plus any accrued and unpaid interest. In addition, following a make-whole fundamental change, we will increase the conversion rate in certain circumstances for a holder who elects to convert its notes in connection with such make-whole fundamental change.

2020 Convertible Notes

On March 3, 2015, we issued $340.0 million aggregate principal amount of 3.75% Convertible Senior Notes due 2020 (the “2020 Convertible Notes”) in a private offering to qualified institutional buyers, pursuant to Rule 144A under the Securities Act. We granted an option to the initial purchasers to purchase up to an additional $60.0 million aggregate principal amount of 2020 Convertible Notes to cover over-allotments, of which $21.9 million was subsequently exercised during March 2015, resulting in a total issuance of $361.9 million aggregate principal amount of 2020 Convertible Notes. The 2020 Convertible Notes mature on March 1, 2020, unless earlier repurchased or converted into shares of our common stock under certain circumstances described below. Upon maturity, we have the option to settle our obligation through cash, shares of common stock, or a combination of cash and shares of common stock. We pay interest on the 2020 Convertible Notes semi-annually in arrears on March 1 and September 1 of each year. Interest payments began on September 1, 2015. During November 2018, we repurchased $199.9 million of outstanding principal amount of the 2020 Convertible Notes. As a result of the repurchase, the carrying value of the 2020 Convertible Notes was accreted up $17.9 million to face value.

The $361.9 million of proceeds received from the issuance of the 2020 Convertible Notes was initially allocated between long-term debt (the liability component) at $261.9 million and additional paid-in capital (the equity component) at $100.0 million, within the consolidated balance sheet. The fair value of the liability component was measured using rates determined for similar debt instruments without a conversion feature. The carrying amount of the equity component, representing the conversion option, was determined by deducting the fair value of the liability component from the aggregate face value of the 2020 Convertible Notes. If we or the note holders elect not to settle the debt through conversion, we must settle the 2020 Convertible Notes at face value. Therefore, the liability component will be accreted up to the face value of the 2020 Convertible Notes, which will result in additional non-cash interest expense being recognized in the unaudited condensed consolidated statements of operations through the 2020 Convertible Notes maturity date (see Note 10, “Interest Costs,” for additional information). The effective interest rate on the 2020 Convertible Notes, including accretion of the notes to par and debt issuance cost amortization, was approximately 11.5%. The equity component will not be remeasured as long as it continues to meet the conditions for equity classification.

As of March 31, 2019 and December 31, 2018, the outstanding principal on the 2020 Convertible Notes was $162.0 million and $162.0 million, respectively, the unamortized debt discount was $10.2 million and $12.8 million, respectively, and the net carrying amount of the liability component was $151.8 million and $149.2 million, respectively.

We incurred approximately $10.4 million of issuance costs related to the issuance of the 2020 Convertible Notes, of which $7.5 million and $2.9 million were recorded to deferred financing costs and additional paid-in capital, respectively, in proportion to the allocation of the proceeds of the 2020 Convertible Notes. The $7.5 million recorded as deferred financing costs on our consolidated balance sheet is being amortized over the term of the 2020 Convertible Notes using the effective interest method. Total amortization expense of the deferred financing costs was $0.2 million and $0.4 million, respectively, for the three month periods ended March 31, 2019 and 2018. Amortization expense is included in interest expense in the unaudited condensed consolidated statements of operations. As of March 31, 2019 and December 31, 2018, the balance of unamortized deferred financing costs related to the 2020 Convertible Notes was $0.7 million and $0.9 million, respectively, and is included as a reduction to long-term debt in our consolidated balance sheets. See Note 10, “Interest Costs,” for additional information.

 

19

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

The 2020 Convertible Notes had an initial conversion rate of 41.9274 common shares per $1,000 principal amount of 2020 Convertible Notes, which is equivalent to an initial conversion price of approximately $23.85 per share of our common stock. Upon conversion, we currently expect to deliver cash up to the principal amount of the 2020 Convertible Notes then outstanding. With respect to any conversion value in excess of the principal amount, we currently expect to deliver shares of our common stock. We may elect to deliver cash in lieu of all or a portion of such shares. The shares of common stock subject to conversion are excluded from diluted earnings per share calculations under the if-converted method as their impact is anti-dilutive.

Holders may convert the 2020 Convertible Notes, at their option, in multiples of $1,000 principal amount at any time prior to December 1, 2019, but only in the following circumstances:

 

•

during any fiscal quarter beginning after the fiscal quarter ended June 30, 2015, if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during the last 30 consecutive trading days of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price of the 2020 Convertible Notes on each applicable trading day;

 

•

during the five business day period following any five consecutive trading day period in which the trading price for the 2020 Convertible Notes is less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the 2020 Convertible Notes on each such trading day; or

 

•

upon the occurrence of specified corporate events.

None of the above events allowing for conversion prior to December 1, 2019 occurred during the three month period ended March 31, 2019 or the year ended December 31, 2018. Regardless of whether any of the foregoing circumstances occurs, a holder may convert its 2020 Convertible Notes, in multiples of $1,000 principal amount, at any time on or after December 1, 2019 until maturity.

In addition, if we undergo a fundamental change (as defined in the indenture governing the 2020 Convertible Notes), holders may, subject to certain conditions, require us to repurchase their 2020 Convertible Notes for cash at a price equal to 100% of the principal amount of the 2020 Convertible Notes to be purchased, plus any accrued and unpaid interest. In addition, if specific corporate events occur prior to the maturity date, we will increase the conversion rate for a holder who elects to convert its 2020 Convertible Notes in connection with such a corporate event in certain circumstances.

On April 18, 2019, we commenced a cash tender offer (the “Tender Offer”) to purchase any and all of the outstanding 2020 Convertible Notes for an amount equal to $1,000 per $1,000 principal amount of 2020 Convertible Notes purchased, plus accrued and unpaid interest from the last interest payment date on the 2020 Convertible Notes to, but not including, the date of payment for the 2020 Convertible Notes accepted in the Tender Offer. The Tender Offer will expire at 11:59 p.m., Eastern time, on May 15, 2019, or any other date and time to which we extend such Tender Offer, unless earlier terminated. We expect to finance the payment of the purchase price for any 2020 Convertible Notes validly tendered in the Tender Offer and accepted for purchase by us with the proceeds we received from the issuance of the 2024 Senior Secured Notes and cash on hand. The Tender Offer is not conditioned upon a minimum amount of 2020 Convertible Notes being tendered and we cannot assure that the Tender Offer will be subscribed for in any amount.

Forward Transactions

In connection with the issuance of the 2020 Convertible Notes, we paid approximately $140 million to enter into prepaid forward stock repurchase transactions (the “Forward Transactions”) with certain financial institutions (the “Forward Counterparties”), pursuant to which we purchased approximately 7.2 million shares of common stock for settlement on or around the March 1, 2020 maturity date for the 2020 Convertible Notes, subject to the ability of each Forward Counterparty to elect to settle all or a portion of its Forward Transactions early. In the future, we may request that any Forward Counterparty modify the settlement terms of its Forward Transaction to provide that, in lieu of the delivery of the applicable number of shares of our common stock to us to settle a portion of its Forward Transaction in accordance with its terms, such Forward Counterparty would pay to us the net proceeds from the sale by such Forward Counterparty (or its affiliate) of a corresponding number of shares of our common stock in a registered offering (which may include block sales, sales on the NASDAQ Global Select Market, sales in the over-the-counter

 

20

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

market, sales pursuant to negotiated transactions or otherwise, at market prices prevailing at the time of sale or at negotiated prices). Any such sales could potentially decrease (or reduce the size of any increase in) the market price of our common stock. The Forward Counterparties are not required to effect any such settlement in cash in lieu of delivery of shares of our common stock and, if we request for any Forward Counterparty to effect any such settlement, it will be entered into in the discretion of the applicable Forward Counterparty on such terms as we may agree with such Forward Counterparty at the time. As a result of the Forward Transactions, total shareholders’ equity within our consolidated balance sheet was reduced by approximately $140 million. Approximately 7.2 million shares of common stock that will be effectively repurchased through the Forward Transactions are treated as retired shares for basic and diluted EPS purposes although they remain legally outstanding.

Restricted Cash - Our restricted cash balances were $7.0 million and $7.0 million, respectively, as of March 31, 2019 and December 31, 2018 and primarily consist of letters of credit. Certain of the letters of credit require us to maintain restricted cash accounts in a similar amount, and are issued for the benefit of the landlords at our current office locations in Chicago, IL, Bensenville, IL and Broomfield, CO.

 

10.	Interest Costs

We capitalize a portion of our interest on funds borrowed during the active construction period of major capital projects. Capitalized interest is added to the cost of the underlying assets and amortized over the useful lives of the assets.

The following is a summary of our interest costs for the three month periods ended March 31, 2019 and 2018 (in thousands):

 

		For the Three Months
		Ended March 31,
		2019				2018
Interest costs charged to expense		$	26,531			$	24,980
Amortization of deferred financing costs			1,249				1,035
Accretion of debt discount on Convertible Notes			5,534				5,224
Amortization of debt premium on Senior Secured Notes			(760	)			(685	)
Interest expense			32,554				30,554
Interest costs capitalized to property and equipment			4				12
Interest costs capitalized to software			125				32
Total interest costs		$	32,683			$	30,598

 

11.

Leases

Operating and Financing Leases — We identify whether a contract contains a lease at contract inception. For leases subsequent to adoption of ASC 842, lease liabilities are calculated using a discount rate based on our incremental borrowing rate at lease commencement. We have operating lease agreements for certain facilities and equipment as well as tower space and base stations. Certain tower space leases have renewal option terms that have been deemed to be reasonably certain to be exercised. These renewal options extend a lease up to 20 years. We recognize operating lease expense on a straight-line basis over the lease term. As of March 31, 2019, there are no significant leases which have not commenced.

 

21

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

The following is a summary of our lease expense included in the unaudited condensed consolidated statements of operations (in thousands):

 

		For the Three
		Months Ended
		March 31, 2019
Operating lease cost		$	4,918
Financing lease cost
Amortization of leased assets			205
Interest on lease liabilities			11
Total lease cost		$	5,134

Other information regarding our leases is as follows (in thousands, except lease terms and discount rates):

 

		For the Three
		Months Ended
		March 31, 2019
Supplemental cash flow information
Cash paid for amounts included in measurement of lease liabilities:
Operating cash flows used in operating leases		$	6,117
Operating cash flows used in financing leases			11
Financing cash flows used in financing leases			125
Right-of-use assets obtained in exchange for lease obligations:
Operating leases			279
Weighted average remaining lease term
Operating leases			9 years
Financing leases			1 year
Weighted average discount rate
Operating leases			10.3	%
Financing leases			8.7	%

Annual future minimum lease payments as of March 31, 2019 (in thousands):

 

		Operating				Financing
		Leases				Leases
Years ending December 31,
2019 (period from April 1 to December 31)		$	16,966			$	550
2020			21,192				206
2021			20,870				—
2022			19,441				—
2023			15,606				—
Thereafter			76,900				—
Total future minimum lease payments			170,975				756
Less: Amount representing interest			(59,520	)			(28	)
Present value of net minimum lease payments		$	111,455			$	728
Reported as of March 31, 2019
Accrued liabilities		$	11,585			$	584
Non-current operating lease liabilities			99,870				—
Other non-current liabilities			—				144
Total lease liabilities		$	111,455			$	728

As of December 31, 2018, annual future minimum obligations for operating leases for each of the next five years and thereafter, were as follows (in thousands):

 

		Operating Leases
Years ending December 31,
2019		$	21,902
2020		$	19,867
2021		$	19,742
2022		$	18,420
2023		$	14,826
Thereafter		$	78,100

Arrangements with Commercial Airlines — Pursuant to contractual agreements with our airline partners, we place our equipment on commercial aircraft operated by the airlines for the purpose of delivering our service to passengers on the aircraft. There are currently two types of commercial airline arrangements: turnkey and airline-directed.

 

22

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

Under the turnkey model, we account for equipment transactions as operating leases of space for our equipment on the aircraft. We may be responsible for the costs of installing and/or deinstalling the equipment. Under the turnkey model, the equipment transactions involve the transfer of legal title but do not meet sales recognition for accounting purposes because the risks and rewards of ownership are not fully transferred due to our continuing involvement with the equipment, the length of the term of our agreements with the airlines, and restrictions in the agreements regarding the airlines’ use of the equipment. Under the turnkey model, we refer to the airline as a “partner.”

Under the turnkey model, the assets are recorded as airborne equipment on our unaudited condensed consolidated balance sheets, as noted in Note 6, “Composition of Certain Balance Sheet Accounts.” Any upfront equipment payments are accounted for as lease incentives and recorded as deferred airborne lease incentives on our unaudited condensed consolidated balance sheets and are recognized as a reduction of the cost of service revenue on a straight-line basis over the term of the agreement with the airline. We recognized $9.0 million and $7.6 million, respectively, for the three month periods ended March 31, 2019 and 2018 as a reduction to our cost of service revenue in our unaudited condensed consolidated statements of operations. As of March 31, 2019, deferred airborne lease incentives of $22.7 million and $131.7 million, respectively, are included in current and non-current liabilities in our unaudited condensed consolidated balance sheet. As of December 31, 2018, deferred airborne lease incentives of $24.1 million and $129.1 million, respectively, are included in current and non-current liabilities in our unaudited condensed consolidated balance sheet. The decrease in our deferred airborne lease incentives and the amortization of the deferred airborne lease incentives relate to the accounting impact of the transition of one of our airline agreements to the airline-directed model. See Note 1, “Basis of Presentation,” for additional information.

Under the turnkey model, the revenue share paid to our airline partners represents operating lease payments. They are deemed to be contingent rental payments, as the payments due to each airline are based on a percentage of our CA-NA and CA-ROW service revenue generated from that airline’s passengers, which is unknown until realized. Therefore, we cannot estimate the lease payments due to an airline at the commencement of our contract with such airline. This rental expense is included in cost of service revenue and is partially offset by the amortization of the deferred airborne lease incentives discussed above. Such rental expenses totaled a net charge of $3.7 million and $6.4 million, respectively, for the three month periods ended March 31, 2019 and 2018. The decrease in rental expense was due to the transition of one of our airline agreements to the airline-directed model. See Note 1, “Basis of Presentation,” for additional information.

 

12.	Commitments and Contingencies

Contractual Commitments - We have agreements with vendors to provide us with transponder and teleport satellite services. These agreements vary in length and amount and as of March 31, 2019 commit us to purchase transponder and teleport satellite services totaling approximately $77.3 million in 2019 (April 1 through December 31), $95.2 million in 2020, $81.3 million in 2021, $67.6 million in 2022, $58.8 million in 2023 and $159.0 million thereafter.

We have agreements with various vendors under which we have remaining commitments to purchase satellite-based systems, certifications and development services. Such commitments will become payable as we receive the equipment or certifications, or as development services are provided.

A contract with one of our airline customers required us to provide the airline customer with a cash rebate of $1.8 million in June 2018, which has not yet been paid.

Damages and Penalties - We have entered into a number of agreements with our airline partners that require us to provide a credit or pay penalties or liquidated damages to our airline partners if we are delayed in delivering our equipment, unable to install our equipment on aircraft by specified timelines or fail to comply with service level commitments. The maximum amount of future credits or payments we could be required to make under these agreements is uncertain because the amount of future credits or payments is based on certain variable inputs.

Indemnifications and Guarantees - In accordance with Delaware law, we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The maximum potential amount of future payments we could be required to make under this indemnification is uncertain and may be unlimited, depending upon circumstances. However, our Directors’ and Officers’ insurance does provide coverage for certain of these losses.

 

23

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

In the ordinary course of business we may occasionally enter into agreements pursuant to which we may be obligated to pay for the failure of the performance of others, such as the use of corporate credit cards issued to employees. Based on historical experience, we believe that the risk of sustaining any material loss related to such guarantees is remote.

We have entered into a number of agreements, including our agreements with commercial airlines, pursuant to which we indemnify the other party for losses and expenses suffered or incurred in connection with any patent, copyright, or trademark infringement or misappropriation claim asserted by a third party with respect to our equipment or services. The maximum potential amount of future payments we could be required to make under these indemnification agreements is uncertain and is typically not limited by the terms of the agreements.

Linksmart Litigation - On April 20, 2018, Linksmart Wireless Technology, LLC filed suit against us and eight of our airline partners in the U.S. District Court for the Central District of California alleging that our redirection server and login portal infringe a patent owned by the plaintiff. We are required under our contracts with these airlines to indemnify them for defense costs and any liabilities resulting from the suit. The Court has stayed the suits against our airline customers pending resolution of the suit against Gogo. Linksmart has also filed suit against other defendants asserting the same patent. One of these defendants has filed an inter parties review against the asserted patent and must meet a certain threshold to continue. Linksmart sought to stay the suit against Gogo until the earlier of (i) a decision by the U.S. Patent and Trade Office that the threshold for review has not been met and that the review may not continue or (ii) if the review continues, its resolution. We agreed and the court has granted our request to stay our case until the first to occur of such events. Cases against the other defendants have also been stayed pending the inter parties review. The outcome of the inter parties review and this matter overall is inherently uncertain. No amounts have been accrued for any potential losses under this matter, as we cannot reasonably predict the outcome of the litigation or any potential losses.

Securities Litigation - On June 27, 2018, a purported stockholder of the Company filed a putative class action lawsuit in the United States District Court for the Northern District of Illinois, Eastern Division styled Pierrelouis v. Gogo Inc., naming the Company, its former Chief Executive Officer and Chief Financial Officer and its current Chief Financial Officer and President, Commercial Aviation as defendants purportedly on behalf of all purchasers of our securities from February 27, 2017 through May 4, 2018. The complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, alleging misrepresentations or omissions by us purporting to relate to our 2Ku antenna’s reliability and installation and remediation costs. The plaintiffs seek to recover from us and the individual defendants an unspecified amount of damages. In December 2018 the plaintiffs filed an amended complaint and in February 2019, we filed a motion to dismiss such amended complaint. In April 2019 the plaintiffs filed a response to our motion. We intend to file a reply in May 2019 at which time the motion will be submitted to the Court for a ruling. We believe that the claims are without merit and intend to defend them vigorously. In accordance with Delaware law, we will indemnify the individual named defendants for their defense costs and any damages they incur in connection with the suit. We have filed a claim with the issuer of our Directors’ and Officers’ insurance policy with respect to this suit. No amounts have been accrued for any potential losses under this matter, as we cannot reasonably predict the outcome of the litigation or any potential losses.

Derivative Litigation - On September 25, 2018 and September 26, 2018, two purported stockholders of the Company filed substantively identical derivative lawsuits in the United States District Court for the Northern District of Illinois, Eastern Division, styled Nanduri v. Gogo Inc. and Hutsenpiller v. Gogo Inc., respectively. Both lawsuits were purportedly brought derivatively on behalf of us and name us as a nominal defendant and name as defendants each member of the Company’s Board of Directors, its former Chief Executive Officer and Chief Financial Officer and its current Chief Executive Officer, Chief Financial Officer and President, Commercial Aviation. The complaints assert claims under Section 14(a) of the Securities Exchange Act of 1934, breach of fiduciary duty, unjust enrichment, and waste of corporate assets, and allege misrepresentations or omissions by us purporting to relate to our 2Ku antenna’s reliability and installation and remediation costs, as well as allegedly excessive bonuses, stock options, and other compensation paid to current Officers and Directors and excessive severance paid to former Officers. The two lawsuits were consolidated and are stayed pending the Court’s ruling on the motion to dismiss in the class action suit. We believe that the claims are without merit and intend to defend them vigorously. The plaintiffs seek to recover, on our behalf, an unspecified amount of damages from the individual defendants. We have filed a claim with the issuer of our Directors’ and Officers’ insurance policy with respect to these suits. No amounts have been accrued for any potential costs under this matter, as we cannot reasonably predict the outcome of the litigation or any potential costs.

 

24

Gogo Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements – (Continued)

 

13.	Fair Value of Financial Assets and Liabilities

A three-tier fair value hierarchy has been established which prioritizes the inputs used in measuring fair value. These tiers include:

 

•

Level 1 - defined as observable inputs such as quoted prices in active markets;

 

•

Level 2 - defined as observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

 

•

Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

Long-Term Debt:

Our financial assets and liabilities that are disclosed but not measured at fair value include the 2022 Senior Secured Notes, the 2022 Convertible Notes and the 2020 Convertible Notes, which are reflected on the unaudited condensed consolidated balance sheet at cost. The fair value measurements are classified as Level 2 within the fair value hierarchy since they are based on quoted market prices of our instruments in markets that are not active. We estimated the fair value of the 2022 Senior Secured Notes, 2022 Convertible Notes and 2020 Convertible Notes by calculating the upfront cash payment a market participant would require to assume these obligations. The upfront cash payment used in the calculations of fair value on our March 31, 2019 unaudited condensed consolidated balance sheet, excluding any issuance costs, is the amount that a market participant would be willing to lend at March 31, 2019 to an entity with a credit rating similar to ours and achieve sufficient cash inflows to cover the scheduled cash outflows under the 2022 Senior Secured Notes, the 2022 Convertible Notes and the 2020 Convertible Notes. The calculated fair value of our 2022 Convertible Notes and 2020 Convertible Notes is correlated to our stock price and as a result, significant changes to our stock price could have a significant impact on their calculated fair values.

The fair value and carrying value of long-term debt as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

 

		March 31, 2019								December 31, 2018
		Fair Value (1)				Carrying Value				Fair Value (1)				Carrying Value
2022 Senior Secured Notes		$	745,000			$	701,910	(2)		$	737,000			$	702,670	(2)
2022 Convertible Notes			236,000				193,012	(3)			216,000				190,083	(3)
2020 Convertible Notes			157,000				151,800	(4)			150,000				149,195	(4)

 

(1)	Fair value amounts are rounded to the nearest million.

(2)	Carrying value of the 2022 Senior Secured Notes includes unamortized debt premium and Consent Fees of $11.9 million and $12.7 million, respectively, as of March 31, 2019 and December 31, 2018. See Note 9, “Long-Term Debt and Other Liabilities,” for further information.

(3)	Carrying value of the 2022 Convertible Notes excludes unamortized debt discount of $44.7 million and $47.7 million, respectively, as of March 31, 2019 and December 31, 2018. See Note 9, “Long-Term Debt and Other Liabilities,” for further information.

(4)	Carrying value of the 2020 Convertible Notes excludes unamortized debt discount of $10.2 million and $12.8 million, respectively, as of March 31, 2019 and December 31, 2018. See Note 9, “Long-Term Debt and Other Liabilities,” for further information.

We have held-to-maturity financial instruments where carrying value approximates fair value. There were no fair value adjustments to these financial instruments during the three month periods ended March 31, 2019 and 2018.

 

14.	Income Tax

The effective income tax rates for the three month periods ended March 31, 2019 and 2018 were (1.2%) and 12.0%, respectively. For the three month period ended March 31, 2019, our income tax expense was not significant primarily due to the recording of a valuation allowance against our net deferred tax assets. An income tax benefit was recorded for the three month period ended March 31, 2018 resulting from a reduction in our valuation allowance of approximately $4.0 million due to the application of provisions of H.R. 1, commonly known as the Tax Cuts and Jobs Act (“U.S. Tax Reform”), to our evaluation of our deferred tax assets.

 

25