Feb 27, 2014
Executives
Steve E. Kunszabo - Executive Director of Investor Relations Matthew J.
Desch - Chief Executive Officer and Director Thomas J. Fitzpatrick - Chief Financial Officer, Chief Administrative Officer and Director
Analysts
James D. Breen - William Blair & Company L.L.C., Research Division Andrew DeGasperi - Macquarie Research Chris Quilty - Raymond James & Associates, Inc., Research Division Gregory Burns - Sidoti & Company, LLC James Patrick McIlree - Chardan Capital Markets, LLC, Research Division
Operator
Good day, ladies and gentlemen, and welcome to the Iridium Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded.
I would now like to turn the conference over to Steve Kunszabo. Sir, you may begin.
Steve E. Kunszabo
Good morning, and thanks for joining us. I'd like to welcome you to our Fourth Quarter 2013 Earnings Call.
Joining me on the call this morning are our CEO, Matt Desch; and our CFO, Tom Fitzpatrick. Today's call will begin with a discussion of the 2013 fourth quarter results, followed by Q&A.
I trust you've had an opportunity to review this morning's earnings release, which is available on the Investor Relations section of Iridium's website. Before I turn things over to Matt, I'd like to caution all participants that our call this morning may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are statements that are not historical facts and include statements about our future expectations, plans and prospects. Such forward-looking statements are based upon our current beliefs and expectations and are subject to risks, which could cause actual results to differ from the forward-looking statements.
Such risks are more fully discussed in our filings with the Securities and Exchange Commission. Our remarks today should be considered in light of such risks.
Any forward-looking statements represent our views only as of today. And while we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our expectations or views change.
During the call, we'll also be referring to certain non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles.
Please refer to today's earnings release in the Investor Relations section of our website for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures. With that, let me turn things over to Matt.
Matthew J. Desch
Thanks, Steve. And good morning, everyone.
Thanks for joining us. I'll get started by noting that 2013 was both a rewarding and a challenging year for us.
We achieved our most important strategic objectives in the successful renewal of our agreements with the Department of Defense as well as all the great developments in our Aireon business, while also navigating through a slowdown in the commercial handset market and our maritime business. Our M2M business continued its streak of robust growth, posting 20% subscriber and revenue gains last year.
And while 2013 didn't shape up exactly as I initially thought it would, especially in light of weak equipment sales, we had a revised operational EBITDA target and exceeded our guidance for total service revenue growth. Still, I'm happy to have 2013 in the books and to be off and running in 2014.
Before I jump to where I'll be focusing our efforts this year, I want to share a few thoughts on our financial outlook and the discussions we've been having with our credit facility lenders. First, we published a new package of guidance today that covered both 2014 and our long-range projection to 2018.
I trust this will allow you to take a fresh look at our growth prospects and cash flow profile as we head into the heart of the Iridium NEXT construction and launch period. As you probably know, our investment thesis is rooted in the transformational change to our cash flow profile that is expected to occur in a few years, as our capital cost go way down and our operational EBITDA continues to grow.
In short, we anticipate generating significantly more free cash flow than we do now as these trends play out. I believe the new targets we gave today will help you evaluate our long-term value.
Second, and Tom will touch on both of these items during his remarks, we continue to make headway with our lending group in amending our credit facility. This is perhaps our most significant financial goal this year, and we expect to reach a resolution soon.
Getting this process behind us will give us the needed flexibility to execute our operating plan during the most critical stage of our business model while also providing necessary clarity around our capital structure and funding profile during this important stretch. With that, let me shift to outlining our key initiatives as we embark on 2014 and how that translate to successfully delivering against our long-term plan.
I'd like to begin by emphasizing the importance of our successfully renewed agreements with the Department of Defense. This is a really big deal.
The fixed price 5-year term of this services agreement guarantees Iridium 49% government service revenue growth between 2013 and 2018 with our single biggest customer, which made up 19% of our total revenue in 2013. As you look ahead to 2018, we now have visibility to at least $22 million in incremental high-margin revenue that we won't have in 2014.
This deal was accomplished on favorable terms for both sides, giving an even greater number of government customers access to our network and its full capabilities without concern for price increases based on usage changes or demand growth. And we have visibility on an important chunk of our business for the next 5 years.
We expect the U.S. government's need for commercial satellite services will grow in the future, and we're proud to support their critical missions no matter where they are around the globe.
We benefited from a valuable strategic relationship for many years and look forward to continuing to provide them with global, secured voice and data communications and enhanced services that will become available with Iridium NEXT. For now, we're focused on working with our counterparts in the government to help them find ways to deploy Iridium services far and wide to take advantage of their unprecedented access to our network and services.
To that end, our current network is healthy and performing well, with continued very high availability and robust service quality for our customers. Although we experienced a satellite failure a few weeks ago, our first in about 18 months, the flexibility and resilience of our unique network architecture allow us to remove our remaining spares around and continue operating a healthy constellation without missing a beat.
Our network is still not showing many signs of its age, and we remain confident that it will take us comfortably to the Iridium NEXT era, the start of which will be upon us next year. As for our next generation platform, we've moved into the fabrication and testing phase of our new space vehicles.
Almost all of the subsystems have now been space-qualified. And 2014 will be a year of flight qualification that will ultimately culminate in a full-scale, high rate satellite production ahead of first launch.
And with a detailed review of our schedule underway and although no official changes have been made yet, it now looks like our first launch will probably slip a few months to the second quarter of 2015. Hardware development appears to be right on track, but it's becoming increasingly clear that the software wouldn't have been sufficiently tested in time for a first quarter attempt.
Despite this short initial delay, our plan is still intact to have a system fully deployed by 2017. The recent developments in our Aireon business are also significant.
As many of you know, 3 leading European air traffic control agencies recently became investors in Aireon and have funded the first $50 million of $120 million total commitment. This agreement, along with NAV CANADA's $150 million investment commitment, provides access to the funding needed to develop an operational system, which is a big achievement.
These 3 European ASPs also signed data services agreement to be customers of Aireon as has U.K. NATS, which Aireon actually announced this morning in a separate release.
And of course, NAV CANADA is also a customer. These contracts combined give us confidence that Aireon will become the standard for air traffic control surveillance over the North Atlantic corridor and soon after, the world.
These developments also solidify our view that the FAA, which remains fully engaged in the project, will make a similar data services commitment as early as 2015, thus enabling Aireon to fulfill its full promise along with its financial commitments to Iridium. So let's review Aireon's expected financial contributions to Iridium.
First, there's $200 million in hosting fees. Next, a data services contract we value at $300 million over the life of Iridium NEXT.
And finally, the requirement that Aireon redeem a portion of Iridium's interest for $120 million expected in 2018, which will still leave Iridium with an approximately 25% retained ownership interest. When you add up these figures, it represents more than $600 million in value coming to Aireon -- coming from Aireon to Iridium without even counting the worth of Iridium's retained ownership interests.
That's really an interesting number when you consider Iridium's current equity market capitalization. While Aireon still has work to do, it's encouraging that these leading ANSPs have committed equity capital to the venture, with the obvious assumption on their part being that all of Aireon's financial obligations to Iridium will be satisfied.
As for the outlook in our key business lines, I'd like to start by sharing that we've just returned from our annual partners conference. It was our best and biggest event by many measures, with over 450 attendees representing about 160 of our partners.
One of the highlights of this conference for me was a presentation by our OEM customer, Caterpillar, on the importance of telematics and Iridium's network to their strategic plans. I'll speak more about them in just a second.
We also announced 3 new products, had productive discussions focusing on growth with our partners in 2014. And I came back energized, as I always do, by how valuable Iridium's products and services are to our customers.
In the M2M space, we're building on another year of solid growth in 2013. The competitive dynamics remain strong here, with a large addressable market and low device penetration, keeping it solidly in first place as one of the fastest-growing sectors of the mobile satellite services industry.
Customers tell us there's a great need for telematics and information sharing to support their own business goals, and they choose Iridium because of our truly global network, low latency and our versatile product portfolio. Evidence of our emerging leadership in this market is supported by the fact that, and we can announce this today, Caterpillar just expanded its relationship with us through a significant piece of new business built around our machine-to-machine transceiver.
As many of you recall, we signed our first contract with Cat in mid-2013 and have continued to develop our relationship with them as their primary provider of M2M satellite services. We expect meaningful volumes to begin with Caterpillar later on in 2014.
And with tens of millions of dollars in revenue now committed by them over several years, these agreements will surely lift the financial contribution of our M2M business. And with these Caterpillar deals, we're just scratching the surface in a much broader and target rich OEM landscape.
Caterpillar is a bellwether player as the largest heavy equipment OEM in the world and others in that space are taking notice. We're in various stages of bringing new business on board with brand-name players in the agriculture, construction, energy and mining sectors.
In some cases, we're just beginning to introduce these customers to the value of Iridium and in others, we're conducting field trials and finalizing service agreements. We expect continued momentum here as we move through 2014.
As for the maritime business, we think this will again be a bright spot in our portfolio now that we've worked through our product and operating issues that caused this business to contract last year. We continue to ship new improved Iridium Pilot units that are performing well in strenuous real world environments.
We remain optimistic for a measurable turnaround in 2014 as new customer activation rates remain quite strong and customer churn continues to go down. Finally, we continue to have a leading and defensible position in the handset business.
As we noted last quarter, we're seeing a market-wide pullback in subscriber growth and usage in the land/mobile sector but only a marginal impact from direct competition. And on the most important metrics, subscriber and revenue share, I think we'll see overall stability despite a rough spot for the broader market.
In fact, we added 13,000 net commercial voice customers through the first 3 quarters of 2013, whereas our public competitors added only 7,900 combined on a comparable basis. So we added almost twice as many customers as our 2 closest competitors despite what was a particularly weak summer selling season.
When you consider how much lower their ARPUs are than ours, our net gain and revenue share is even more pronounced. Advancing this leadership position, we're pleased to have announced our Iridium GO!
product at this year's partners conference. And it was a real hit.
It's the industry's first portable satellite hotspot, allowing people to connect using their smartphones, tablets and other personal devices anywhere in the world. I like to characterize it as a cellphone tower in your pocket for smartphone access, providing connectivity through your trusted devices where no other networks exist.
And in some cases, where other networks do exist but have higher roaming access charges, Iridium GO! is a more cost-effective solution.
It's also going to be the lowest cost device and service offering that we've ever made in this category, and while it will naturally attract a whole new class of consumers, it should also have broad appeal amongst our established base of commercial, industrial and government users. We expect this new product, which should be commercially available in the second quarter, will aid our overall trajectory in 2014.
So in closing, with strong progress on our important strategic objectives and a clear track for our key business lines, we're forecasting a steady climb back up in 2014. As we entered the last year before we begin launching Iridium NEXT, we're also looking ahead to 2018 as we're approaching the period during which our free cash flow profile will change dramatically and create significant long-term value for all of our stakeholders.
I want to thank my colleagues at Iridium and our many partners and customers for their loyalty, dedication and hard work during a busy 2013. I look forward to strong execution and better momentum in 2014.
With that, I'll turn it over to Tom for a more detailed financial review. Tom?
Thomas J. Fitzpatrick
Thanks, Matt. And good morning, everyone.
Before I summarize our key financial metrics and the financial guidance we issued today, I'd like to briefly take you through what has become an increasingly clear picture of Iridium in 2018. Why 2018?
I can think of very few enterprises that are poised to transform their free cash flow profiles in such a meaningful way in what is a relatively short period of time. There's little doubt that we're entering a critical and important part of our history that will define how we create long-term value for our stakeholders.
Let's start with the elements that have the highest degree of certainty. Capital expenditures, which were $404 million in 2013, should fall dramatically and average less than $30 million annually for approximately 10 years beginning in 2018.
This change alone creates a stark transformation in our free cash flow profile even before we layout the excellent prospects for materially increasing our operational EBITDA. First, we have eyes on a $22 million increase in government service revenue when comparing 2018 to 2014, as outlined by our airtime services deal with the Department of Defense.
Given the recent developments in our Aireon business, I also think it's pretty safe to say that this venture is well-capitalized and on track to launch the world's first space-based global aviation monitoring system once Iridium NEXT is completed. When combining the revenue we expect to book from hosting fees and customer data contracts, this business will ramp to $34 million in incremental annual revenue in 2018.
So in executing on these 2 strategic objectives alone, we have solid visibility to recurring service revenue growth of $56 million in 2018, we're about a 19% gain even before we start looking at growth in our commercial markets. Now let's quickly examine the expected contribution from our key commercial business lines.
As Matt described, the M2M market remains a foundation of our success going forward. This business has posted a compound annual service revenue growth rate of 34% since 2008 with strong competitive attributes that supported its expansion for many years to come.
According to Machina Research, who presented at our recent partners conference, global M2M connections are expected to increase sixfold through 2022, a compound annual growth rate of 2%. Equally apparent is the technology advantage Iridium's network enjoys in this sector, which seems to assure our leadership among mobile satellite service players.
Caterpillar's selection of Iridium validates this belief, as does the funnel of other OEM opportunities who share the same view. We're confident that Iridium will be the standard for satellite-based M2M communications.
Turning to the maritime space, where our operational setbacks in 2013 caused this business to contract after several years of double-digit increases. We've addressed the product issue and are eager to put it behind us and are projecting a meaningful recovery from here.
Essential to our turnaround in this market is that the competitive landscape continues to be very attractive. It was evident on our recent partners conference that our customers have been looking for alternatives to our primary competitor given their price increases and distribution changes.
They want us to succeed because we serve an important role in the value segment of this sector. Without us, the incumbent operator would have tremendous pricing power and market share, and our customers will be left with few alternatives.
The demand for our service is clear, and 2014 should see us get back on track. Finally, core telephony, or what we often call our handset business, which represents about half of our service revenue today, is well positioned to stay on top in this space.
We believe that true global coverage and superior products will sustain our leadership position, as will geographic expansion into markets such as Russia. We expect this established revenue base will grow in the low-single digits over the long term.
With that, I'll outline our key financial metrics, then step through our 2014 outlook and long-range guidance and wrap up with a few -- with a review of our capital structure and a progress update on discussions with our credit facility lenders. Iridium reported fourth quarter total revenue of $98.2 million, which was up 6% from last year's comparable period.
Operational EBITDA came in at $49.8 million, a decline of 5% from the prior-year quarter. Our operational EBITDA margin was 51% for the fourth quarter, falling from 57% in the year-ago period, primarily due to lower equipment revenue and reduced sales volumes.
From an operating viewpoint, we reported commercial service revenue of $60.9 million in the fourth quarter, representing 18% growth over last year. We added 9,000 net commercial customers during the quarter, with the entire gain coming from the M2M business compared to 14,000 net subscriber additions in the year-ago quarter.
Commercial M2M data subscribers now represent 45% of billable commercial subscribers, an increase from 41% during the year-ago period. In addition to the long-term growth fundamentals I just shared, let's pause here to emphasize our new product pipeline.
Matt discussed our Iridium GO! product in nice detail, so I won't cover the same ground, but we've also announced Iridium Burst in early February, and we'll be adding a commercial push-to-talk device to the mix later this year.
Iridium Burst fills a need in M2M space for low latency, one-to-many broadcast communications. Imagine a disaster response agency that needs to simultaneously send an emergency bulletin to its personnel worldwide, or a government agency having to contact embassy personnel across the globe on the heels of a geopolitical crisis.
With Iridium Burst, we can deliver this. Our commercial push-to-talk offering would similarly be targeted at customers in industrial sectors including public safety, utilities, resources and mining, delivering a flexible platform with both traditional voice and push-to-talk capabilities to work teams that operate in remote areas.
And it builds on the investment and success of our Netted Iridium product with the Department of Defense. Most importantly, these products, taken together, strengthen our competitive position in their respective markets and are another source of incremental cash flow as we develop our operational EBITDA profile over the coming years.
Turning now to our government service business, where reviewing this quarter's financials isn't terribly instructive given the successful renewal of our key contracts at the Department of Defense in October. So I'll just briefly underscore that our new agreements with this important customer represent a key leg of our financial profile in the coming years.
Focusing next in equipment line, which produced revenue of $15.9 million, a 28% year-over-year decrease, resulting primarily from lower overall sales volumes. As we look out over the next 12 months, we see equipment sales picking up, primarily due to unit shipments from new products, including Iridium GO!
and Iridium Burst, and L-Band transceiver or LBT devices ramping up as order flow comes in from our Caterpillar contract. All in all, we expect that our equipment revenue in 2014 will be greater than it was in 2013.
Moving now to our financial and operating outlook for 2014, which we issued this morning as part of a broad package that also includes our long-range guidance. We expect operational EBITDA of between $205 million and $215 million for the full year 2014, which compares to $201 million in 2013.
On the same basis, for the full year 2014, we forecast total service revenue growth between 2% and 4%. To provide some additional context to this year's financial targets, it's important to remember that our year-over-year growth won't benefit from the access price increase or change to our prepaid airtime policy that lifted our service revenue by approximately $21 million in 2013.
In addition, non-U.S. military usage declines are behind us as we enter 2014.
If you normalize for the impact of these items, the steady increase in 2014 total service revenue comes from a relatively stable handset business, a turnaround in our maritime market, double-digit gains in the M2M sector and renewed growth from our government customer, much in the same way I described when I began my remarks. Similarly, we expect materially lower warranty expenses in 2014, which will benefit operational EBITDA.
As for our long-range guidance, we issued a new set of metrics today that reflects our projections through 2018. More specifically, we expect a compound annual growth rate for total service revenue of between 8% and 12% between 2014 and 2018.
The fact that our 2014 projections for total service revenue growth of 2% to 4% are below our long-range outlook clearly warrants some clarification. First, the 2% to 4% range is artificially low because we benefited from a change to our prepaid airtime policy in 2013 that won't recur and was worth approximately $6 million.
When adjusting for this onetime item, our total service revenue growth for 2014 comes in at 4% to 6%, still below our long-range forecast but less so. Then as we bridge from a pro forma rate of 4% to 6% in 2014 to a CAGR of 8% to 12% between 2014 and 2018, there are a number of factors at play.
First, our government service revenue will be higher than the 2014 growth rate due to the new airtime services agreement. For example, 2014 government service revenue will be 12% higher than 2013, and 2015 will be up 15% from there.
Our commercial service revenue will be higher than the 2014 growth rate due to a series of elements including: an increasing rate of growth in M2M as Caterpillar's contribution continues to ramp and is augmented by other OEM business; an increasing rate of growth in maritime as Iridium OpenPort continues to regain its footing; the benefit from new products including Iridium GO!, Iridium Burst and commercial push-to-talk gaining momentum through the period; and the financial contributions from Aireon I described just a few minutes ago. We also expect an operational EBITDA margin of approximately 60% in 2018, which continues to represent the trajectory of solid operating leverage in our business.
And we continue to expect manageable cash taxes from 2014 to approximately 2020. And finally, a review of our capital structure and liquidity position.
As of the end of the fourth quarter, we had drawn $1 billion from the Coface facility relating to payments we've made to Thales for their successful completion of contractual milestones for Iridium NEXT. We've now invested over $1.3 billion in the last 3 years toward this approximately $3 billion project.
We had a cash and marketable securities balance of approximately $263 million. Turning to the ongoing negotiation with our credit facility lenders.
We continue to have productive discussions geared towards amending our credit agreement and modifying certain financial covenants. I expect that we'll have a complete resolution sometime in the next few months.
As Matt noted, we're determined to get this wrapped up soon as it gives us the needed flexibility to execute our operating plan during the heart of the Iridium NEXT construction launch period while also fortifying our capital structure and funding profile. In wrapping up my thoughts, I'm confident that we have a clear path to create long-term value for our stakeholders.
I'm proud that we've achieved our most strategic -- our most important strategic objectives and navigated the tough challenges that 2013 had in store for us. As our operational EBITDA goes up through 2018 and our capital costs go way down to maintenance levels averaging less than $30 million per year, we expect to benefit from a dramatic change to our free cash flow profile, a truly unique and transformational story, with the best still ahead of us.
With that, I'll turn things back to the operator for the Q&A portion of this morning's call.
Operator
[Operator Instructions] Our first question is from James Breen of William Blair.
James D. Breen - William Blair & Company L.L.C., Research Division
Just a couple of questions. One, Matt, wondering if you can talk about the Caterpillar contract extension there, in terms of how it's different from the existing agreement you have, maybe potentially some of the services they're offering?
And then secondly, you talked about the voice market in general being weak. You guys are gaining share.
Why do you think you're gaining outside share there despite the weak market?
Matthew J. Desch
And that second question you said was about handsets? Is that what's your -- okay, yes, so the first question about Caterpillar: Yes, we did announce that last year.
In fact, it was on a call like this. And it was really more what I would call the high-end part of their business, using higher-speed circuit-switch data to a higher -- for devices that they need to monitor a lot of different information from.
We've been working on extending that and just finally completed the contract -- and for what I would call more the wire variety of lower-end tracking kind of applications, sometimes called slap-and-track, in some of these areas. And this really rounds out sort of a little lower ARPU but still much higher volume kind of business.
So combined between the 2, we really see ourselves on pretty much everything that comes out of Caterpillar over time. So we're kind of -- we're quite excited about that.
But even more excited of the fact that so as Cat goes, so do many others in the heavy equipment OEM space, and really a lot of the other players are also interested in many of the same sort of objectives that Caterpillar has in terms of expanding their telematics, helping their clients and their customers and their dealers, manage their equipment and inventories, service vehicles with their customers. And so we think that, that's going to be great for the future.
The second question about handsets, and sort of the fact we've done very well in that segment. Yes, last year was sort of, as we look at everyone else in the industry, it wasn't only we that had sort of weaker results, it looked like the others did as well.
But we did, as I said, almost twice better than they did, really, even during that slowdown period. Which I think relates to the quality, really, of our products.
I mean, more than anything else, the uncompromising nature of our coverage, the fact that people don't have to wonder if it works, in Oceanic or in Polar or in some country where there isn't coverage. The toughness of them, the fact that our partners really make money when they sell them, is valuable.
As you know, we don't talk as much about this, but our partners appreciate that we open up the interfaces to our devices so that they can build applications around them, which ends up meaning that they're selling them as part of an overall solution sometime, as opposed to just putting them out one at a time trying to make a sale to someone. And that's been extended now to this Iridium GO!
product. Again, it's not just about price.
I've always believed that while satellite phones will not go away, they'll be a stable and steady part for emergency responders around the world. What all of us really want to use is the phone we already have in our pocket, the smartphone.
It's where we have our contacts, it's where we have the applications, we want e-mail, et cetera. And if we can make it really, really easy for people to use that, then more people are going to use the satellite connection to their device.
And that's what Iridium GO! represents.
It will be lower cost. I think it's going to expand the market a bit.
But again, we did just what we did with our core base business, we opened up the interfaces to it, which I think is very powerful, so that lots of other app developers and applications will be selling Iridium GO! almost as part of what people really want to do, which is that weather app or that pilot app or that whatever it might be that people are really using for.
So I think that's why we maintain a solid share in, certainly, the higher end of that business, the higher-margin, higher ARPU business.
Operator
Our next question comes from Andrew DeGasperi of Macquarie Capital.
Andrew DeGasperi - Macquarie Research
I just had a follow-up on the handset market. I just wanted to know like going forward -- I know it was weak last year, but is it improving in general?
And also on Aireon, have you had any talks with any of the Pacific air-traffic control entities or in Asia or in Africa, which obviously, lack coverage?
Matthew J. Desch
So first question on handsets and is it improving this year. Look, we're not -- I wouldn't say that we're projecting sort of necessarily any kind of particular improvement.
I think our basis, as I think I said in the comments, was more on stability in this segment, that we think that we'll start to see -- we should see the same sort of performance overall in the big scheme of things as we go forward and then add to that with new segments, like Iridium GO!, and try to expand the market share by finding other applications. So that's not really where we perceive our long-term high-growth areas to be.
That's more in data, in broadband, in machine-to-machine and in Aireon and other applications, but it's still a solid, important part of our business that we think, things like Iridium GO!. And later this year, I didn't talk a lot about it, maybe one of the most exciting things at our conference to our partners was commercial push-to-talk, which we'll formally announce later this year.
But that will be an expansion, really, going forward and a new application segment that's using our handsets in enterprises. So that's handsets.
On Aireon, yes, Aireon has had many discussions around the world with international players going beyond the North Atlantic and the FAA. A lot of interest in this in the Pacific.
There's a lot of interest in this in Africa, particularly Africa has very -- almost no radar coverage, really, across the region. You almost have to look at Africa as, they once told me, as Oceanic territory in some ways.
In the way that it's -- that the airlines really cross big regions without being in direct sight, if you will, of the controller. So it's a -- viewed as procedural airspace, where they have to keep airplanes far apart and inefficiently -- inefficient kind of routes.
So yes, I really do believe, Aireon believes, and I have been told by the investors in Aireon who have aspirations not just in the regions, as you know, that they are in. In fact, the U.K.
NATS announcement this morning that Aireon made, I thought, was interesting. As you notice, they really have aspirations to go beyond U.K.'
s aerospace and provide air traffic control services elsewhere in the world, in Asia, Middle East, other places. And I think you're going to see that to be a trend really for Aireon.
Operator
Our next question is from Chris Quilty of Raymond James.
Chris Quilty - Raymond James & Associates, Inc., Research Division
I had a follow-up question on the Iridium GO! and the distribution strategy with that product.
It appears to me that it might have some more consumer-like potential. And given the fact you're going through your distribution partners, are you leaving money on the table or do you have some way through your partners to reach, call it, the REI, Cabela's type of channel where consumers can be aware of it?
Matthew J. Desch
Yes. Well, remember, leaving money on the table in terms of volume, you're also -- it's very expensive to create direct consumer channels for any company.
And to do that, and to maintain -- to expand your brand and to put them not just in North America but around the world is an expensive proposition, which is why we haven't aggressively move towards consumer. Not that there aren't consumer applications, but really, our distribution channels can take us into those markets much more efficiently than we can.
So I do think -- you noticed that we have a number of partners sign up to adopt the applications. One of them, for example, was DeLorme.
And I think I could see DeLorme taking this product to their channels. They're in a lot of those places, and I think they'll be able to put it in front of consumers much more effectively than Iridium could.
As could others that you don't see as much but show up in -- on websites and in other places that consumers happen to frequent where, increasingly, we're moving online as opposed to sort of the real world -- I mean, the bricks-and-mortar kind of world. But I think you'll see Iridium GO!
in many of those online kind of outfits pushed by our distribution channel to those places. You just won't see us as direct in those places, selling direct.
One, it screws up the channel. It makes us compete with our channel, and we're loath to do that, because it really ends up working against you.
And secondly, it's very expensive to constantly have to advertise yourself and put all the expense into going to those channels directly. But I do think Iridium GO!
will be much more broadly distributed than maybe particular handsets are today.
Chris Quilty - Raymond James & Associates, Inc., Research Division
Okay. And on the Iridium OpenPort or Pilot, can you give us a little more color on what you're seeing there in the market, both in terms of customer acceptance of new hardware and performance of the new hardware, and sort of opportunity set as you go into 2014?
I think for last year, you indicated that your -- at least your gross adds were up over the prior year, you were just churning a lot off.
Matthew J. Desch
Yes, that's correct. And in fact, despite having a lot of problems in the field with those older OpenPort units, we actually had, I think, almost record activations, record gross activations in 2013.
The problem was we had a lot of deactivations. So the net activations were lower than expected, and that caused, with some falling ARPUs as we lost some higher-ARPU customers to lower-ARPU customers, it caused an overall contraction there, which I think is going to get fixed going forward.
I think if we can keep the activation rates up, and right now the dynamics in the market are very similar to what they were last year, with competitors raising prices on all their lower-end customers who have to find other solutions, these customers called ENE customers, which are kind of being moved off of their area and they have to select something else, they have maybe enough [ph] choices now in terms of quality products, and Iridium Pilot will be part of that. And we're seeing positivity from our partner base and others.
I mean, it still has to play out in the marketplace and everything and fleets have to move over. But if we can lower the deactivation rate, which has already gone down, we are seeing less churn already, that will really help in terms of making this a positive adder in the future.
Chris Quilty - Raymond James & Associates, Inc., Research Division
Okay. And can you give as an update on the likely deployment for the Netted Iridium or DTCS with the military, which I think is sort of the gating factor for rolling the commercial side of that?
Matthew J. Desch
Yes, so that was actually what I was talking about a year ago, was that we were using sort of the enhancements that we're making to the Netted capability of the military, what they call global services or Phase 3 or whatever you want to do. And that we were -- the commercial products were being built on top of that.
When we realized last year that we couldn't count on when the government R&D would flow -- it's flowing again, and that's going to get completed. We decoupled those 2 developments and have been really working now in the last year on the commercial push-to-talk product on its own R&D streams.
So it's not, in any way, gated. And in fact, it's in initial demonstrations right now.
The operational systems is really what has to be updated more than anything else, and I think they're going to be outstanding. Some of the ways that you can configure these -- configure our product for our customers and for them to have dealers be able to manage their talk groups and their nets globally, et cetera, that's all getting finalized right now.
But we're going to have wide-scale demonstrations this summer, with the product going general availability in the second half of this year. I would say sometime in the third, fourth quarter it's going to be able to be deployed commercially and widely.
So it's more of a 2015 event in terms of our bottom line. But again, it sort of supports our long-term thesis why we feel there'll be stability or growth in this sort of core underlying personal communications space, I think is the best way to really call it, as opposed to handsets.
Operator
[Operator Instructions] Our next question is from Greg Burns of Sidoti & Company.
Gregory Burns - Sidoti & Company, LLC
On a previous call, you'd mentioned that the uptake in Russia is a little bit slower than you were originally projecting. Can you just give us an update on that market and maybe some other international markets that might be of interest to you in terms of expansion?
Matthew J. Desch
Yes, so I think we are really more describing that we had a plan that was based upon being licensed in Russia at a specific time, and it took a little longer to get really licensed. We are licensed now.
We've been in market now for over a year, and it really still is turning out to -- it is right now, I think, what I'd call our highest growth market of any specific sort of country or region of any of ours in the market now because of that. So it's contributing more than the average, certainly, across the bases.
And we have a lot of enthusiasm for that market. We've been adding resources, we're adding partners.
We're going to start seeing, say, products like OpenPort or Pilot start to penetrate that market, which is great. And we'll see interesting things like GO!
and other things, where that's more of a nascent market for many things. So Russia is still very positive.
As far as others, we quietly open up other markets. There are countries in which we hadn't been licensed before where we become licensed, and we haven't made a really big deal out of it.
The really bigger markets in terms of, I think, untapped growth are more China and India. They are taking longer, really, to find the right business model to get into there.
India really requires gateways and other things, and the payback on that is still questionable, at least in terms of our partners and us. But I think long term, we'll see those markets open up.
China continues to expand in terms of business with a number of different partners but not as fast as I think it could be growing in the future. But those are always still the bigger markets.
Gregory Burns - Sidoti & Company, LLC
And given your long-range guidance, it doesn't appear that funding of NEXT or -- is at risk here. So I just wanted to gauge your -- get a sense of whether you feel additional capital will be needed, and that in relation to the discussions that you're having with your lenders, do you feel in a stronger position with those negotiations?
Thomas J. Fitzpatrick
I would characterize our negotiations with the -- with our lenders as very productive, and we've made a lot of progress with them. And we'll announce the terms of our amendment once it's finalized.
We are in the -- making great progress toward that end currently.
Operator
Our next question is from Jim McIlree of Chardan Capital.
James Patrick McIlree - Chardan Capital Markets, LLC, Research Division
The equipment margins have declined sharply in the last couple of quarters, is that the warranty expense issue? And do we see the equipment -- do you see the equipment margins improving in 2014?
Thomas J. Fitzpatrick
So the equipment margins will improve due to 2 things, the -- we expect materially lower warranty expenses in 2014, and we also took a inventory op to lessen its charge $1.5 million in fourth quarter '13. So we don't expect those kind of unusual events to occur.
As we think about just sort of regular equipment margins without those type of items, we see equipment margins declining usually just principally due to mix. So we get -- the growth areas in equipment is machine-to-machine.
We talked about Caterpillar and others in that growth rate. We get lower margin on our SBD devices than we do handset.
And so this is going to be mix that will cause margins to compress a bit over time.
James Patrick McIlree - Chardan Capital Markets, LLC, Research Division
Okay. So is the first half of 2013 more of a new normal for equipment margins?
Thomas J. Fitzpatrick
I think we had a warranty charge in the first half of '13, so you have to pro forma for that.
James Patrick McIlree - Chardan Capital Markets, LLC, Research Division
Okay, great. And then I'm just trying to puzzle through the operating expenses.
It sounds as if with the new initiatives that you're undertaking, that you're going to see an increase in SG&A. Kind of -- that you'll see an increase in SG&A.
I'm trying to understand how that might -- what that level or what that rate of growth is in SG&A and for everything that you have going on?
Thomas J. Fitzpatrick
Well, the new initiatives -- maybe give me a little bit more color on what initiative you're tracking to an increase in SG&A.
James Patrick McIlree - Chardan Capital Markets, LLC, Research Division
Well, for instance, you're bringing out these new products, GO!, Burst, you're trying to bring out the Netted Iridium for the commercial markets. I'm assuming that there's some sort of extra cost associated with the government contract as well.
Matthew J. Desch
No, there really isn't on any of those things. I mean, our overall, say, headcount and investment, if you will, and the resources we have to do this as well as generally really R&D, have been pretty consistent.
We have happened to have a lot of products coming out this year. But that just happens to be based on the fact that a lot of these things, we have been working on over the last 18 to 24 months, and are coming to fruition at the same time.
But they're really on the basis of more or less the same organization. We're not adding a lot of expense this year or anything.
There may be some movements, for example, in bonus levels and things like that kind of year-over-year that make it look like SG&A is increasing, but it's really because they were overly depressed the previous year with lower, say, management bonuses and that sort of thing. And so I think that's more of just a -- is that correct, Tom?
Thomas J. Fitzpatrick
Yes. I mean, this business is about operating leverage.
The incremental service revenue does not come with incremental SG&A or other infrastructure costs. So we've guided that we see 2018 EBITDA margins at 60%, and we're out there with that.
And so if you just draw a line from where -- from our last 12 months to that, then it should be pretty clear.
Matthew J. Desch
I mean, and the government contract doesn't require more resources or expense to service it. I mean, we may add one person, really, because there's a number of new business development opportunities with them right now, and we want to go after those and exploit the contract.
But that's really on the margins in terms of expense.
Operator
Our next question is a follow-up from Chris Quilty of Raymond James.
Chris Quilty - Raymond James & Associates, Inc., Research Division
A clarification on the government. The contract itself is just the service portion, so any of the equipment that's generated from deploying new devices or services, you're still going to see that flow through your general equipment line, correct?
Matthew J. Desch
That's correct. That's correct.
Thomas J. Fitzpatrick
That is -- Chris, and when we cite the $22 million increase between '14 and '18, that is exclusive of new services.
Matthew J. Desch
New equipment.
Thomas J. Fitzpatrick
Exclusive of equipment, but it's also exclusive of new services, new service offering. So that's a minimum number.
Chris Quilty - Raymond James & Associates, Inc., Research Division
So if you're launching the military version of the Netted Iridium, presumably they're going to be buying lots of devices to deploy that service?
Matthew J. Desch
Well, yes. I mean, in fact, one of the bigger areas of interest right now is in the machine-to-machine area right now.
Given that there's no incremental cost to, say, add tracking devices, say, to -- you could track every dismounted soldier if you wanted to. And if you do that, you could be adding tens of thousands of tracking devices at no additional costs that's already in the service revenues, but it is additional hardware each time we ship one of those units.
So there's a number of areas to do that in. And there are additional services that as we move into broadband, as we move into NEXT services, I think there's going to be a lot of interest in buying additional things from them too, which were not...
Chris Quilty - Raymond James & Associates, Inc., Research Division
Was the Burst service included as part of the overall agreement?
Matthew J. Desch
That was. That is part of the DoD contract, and they are taking advantage of that, but not on equipment.
So for example, in terms of equipment for Burst, so Burst requires you create a device that looks a lot like a machine-to-machine device to embed in something. That isn't in the contract nor -- another one is waveform, the air interface of the system is not included in the contract.
So as that gets embedded into tactical radios, for example, of others, there would be additional charges to utilize that and take advantage of that.
Chris Quilty - Raymond James & Associates, Inc., Research Division
Got you. And I guess, both for Burst as well as the Netted Iridium business, when you launch on the commercial side, are we looking at, like, 1 discrete piece of hardware or do you have partners that you expect there'll be multiple devices coming to market?
And is all of this based upon a single board or a single design that you've already developed and proven?
Matthew J. Desch
That is going to come to market in a couple of different ways. I think the primary one will be through a mobile device like -- well, really a variant, if you will, of our Extreme handset, that's sort of that's dual-mode that's able to deploy both voice service in the way it does today, with tracking and emergency functions, as well as have a personality that will turn it into a push-to-talk device as part of an unlimited number of users and a talk group that are global.
So that will be 1 way and that will be developed our way, but another way will be through partnerships with threshold suppliers who embed, really, our services into their terrestrial services and use links, if you will, to tie the 2 together and deploy our products using, say, our 9523 transceiver card and build it into other devices that they already have for police and fire and first responders and government workers, and other people or enterprise workers who have push-to-talk requirements. So it will come to market in a couple of ways.
Chris Quilty - Raymond James & Associates, Inc., Research Division
And in terms of pricing plans, both for Burst -- and I don't think you probably discussed on the Iridium GO!, are you using sort of a traditional handset pricing model or something that's designed to be more consumer-friendly?
Matthew J. Desch
A little more consumer-friendly. What we're going to do is we're really going to encourage data usage.
We really think this makes it simple for someone to use e-mail, for text messaging, for transferring photos. And our pricing will reflect that to encourage people to do a lot of that.
So I think it will, for a bundle, together, more value, if you will, when people use it so that they really are encouraged to take their smartphone out of their pocket and use it. We haven't talked specifically about that, we'll announce it formally when the product is available in the second quarter.
We've been talking a bit about that to our partners, so they're aware of it and are excited about it, but we haven't really publicly announced that. Iridium Burst, you mentioned, is a completely different pricing mechanism, which is really what's exciting about Iridium Burst.
It's not just that it can reach unlimited number of devices inside buildings to provide a kind of a broadcast capability of messaging or data, but the fact that we can kind of price that, if you will, on -- we will broadcast your data for a fixed fee and you can put as many devices as you want to. So really, in applications where people consider using many, many devices, in fact unlimited number of devices, really, their costs don't go up.
In fact, their costs go way, way down on a per device basis; can be infinitely low if you put it in enough devices. So I think that's one of the unique aspects about Burst that I think will be attractive in the future, as the applications come on board to use it.
Operator
I would now like to turn the conference back over to Matt Desch for closing remarks.
Matthew J. Desch
Well, great. Another year under our belts.
We're at the start of 2014. We look forward to seeing you all on our First Quarter Results Call in a couple of months and talking to you further after this call.
Thanks for joining us today.
Operator
Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.