Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and applicable notes to our Consolidated Financial Statements and other information included elsewhere in this Report, including risk factors disclosed in Part I, Item IA. Risk Factors. The following information contains forward-looking statements, which are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize, our actual results may differ from those expressed or implied by the forward-looking statements. See “ Forward-Looking Statements ” at the beginning of this Report.
Performance Indicators
Our management reviews and analyzes several key performance indicators in order to manage our business and assess the quality and potential variability of our earnings and cash flows. These key performance indicators include:
• total revenue, which is an indicator of our overall business growth;
• subscriber growth and churn rate, which are both indicators of the satisfaction of our customers;
• average monthly revenue per user, or ARPU, which is an indicator of our pricing and ability to obtain effectively long-term, high-value customers. We calculate ARPU separately for each type of our subscriber-driven revenue, including Duplex, Commercial IoT and SPOT;
• operating income and adjusted EBITDA, both of which are indicators of our financial performance; and
• capital expenditures, which are an indicator of future revenue growth potential and cash requirements.
Comparison of the Results of Operations for the years ended December 31, 2020 and 2019
Our results of operations for the twelve months ended December 31, 2020 were impacted by COVID-19. While we cannot predict the full extent or duration of the future impact of COVID-19, certain trends or uncertainties related to COVID-19 that impact revenue or expense items are discussed below.
Revenue :
Our revenue is categorized as service revenue and equipment revenue. We provide services to customers using technology from our satellite and ground network. Equipment revenue is generated from the sale of devices that work over our network. During the twelve months ended December 31, 2020, total revenue decreased $3.2 million to $128.5 million from $131.7 million in 2019. This variance was due primarily to an out-of-period adjustment, which increased Duplex service revenue by $3.9 million during 2019, related to a change in the calculation of the estimated impact from the initial adoption of ASC 606. See below for a further discussion of the fluctuation in revenue.
The following table sets forth amounts and percentages of our revenue by type of service (dollars in thousands).
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Revenue % of Total
Revenue Revenue % of Total
Revenue
Service Revenue:
Duplex (1)
$ 33,878 27 % $ 39,794 31 %
SPOT 46,417 36 % 50,461 40 %
Commercial IoT 17,174 13 % 16,972 13 %
Engineering and Other 15,722 12 % 2,274 1 %
Total Service Revenue $ 113,191 88 % $ 109,501 85 %
(1) As previously disclosed, we recorded an out-of-period adjustment of $3.9 million during 2019 as a result of a change in the estimated impact of ASC 606. This adjustment, which increased Duplex service revenue, is excluded from Duplex service revenue in the table above. The percentages of total revenue calculations also exclude this adjustment.
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The following table sets forth amounts and percentages of our revenue generated from equipment sales (dollars in thousands).
Year Ended
December 31, 2020 Year Ended
December 31, 2019
Revenue % of Total
Revenue Revenue % of Total
Revenue
Equipment Revenue:
Duplex $ 1,883 1 % $ 1,325 2 %
SPOT 8,176 7 % 7,617 6 %
Commercial IoT 5,140 4 % 9,300 7 %
Other 97 — % 90 — %
Total Equipment Revenue $ 15,296 12 % $ 18,332 15 %
The following table sets forth our average number of subscribers and ARPU by type of revenue.
December 31,
2020 2019
Average number of subscribers for the year ended:
Duplex 50,116 56,856
SPOT 267,816 281,584
Commercial IoT 414,452 399,960
IGO and Other 27,264 27,481
Total 759,648 765,881
ARPU (monthly):
Duplex (1)
$ 56.33 $ 58.33
SPOT 14.44 14.93
Commercial IoT 3.45 3.54
(1) As previously disclosed, we recorded an out-of-period adjustment of $3.9 million during 2019 as a result of a change in the estimated impact of ASC 606. This adjustment, which increased Duplex service revenue, is excluded from Duplex ARPU in the table above. When the out-of-period adjustment is included in the calculation, ARPU for the twelve months ended December 31, 2019 is $64.02.
The numbers reported in the above table are subject to immaterial rounding inherent in calculating averages.
During the twelve months ended December 31, 2020, gross Duplex and SPOT subscriber additions increased 1% and 12%, respectively. The increase in Duplex gross subscriber additions from 2019 to 2020 was driven primarily by activations of Sat-Fi2 ® due to increased demand as we launched an improved version in September 2019; fewer activations from legacy devices partially offset this increase. Also, lower service plan prices continue to drive gross Duplex activations. SPOT gross subscriber activations increased from 2019 to 2020 driven by a higher volume of unit sales, particularly of our SPOT X ® device as well as SPOT Gen4 TM , our refreshed SPOT Satellite GPS Messenger launched in 2020. We are also seeing changes in consumer behavior resulting from COVID-19, driving more customers to purchase our SPOT products for outdoor recreational activities. Because our Commercial IoT subscribers are able to activate and deactivate their units several times during the year, gross Commercial IoT subscriber additions are not considered to be a meaningful metric.
We count "subscribers" based on the number of devices that are subject to agreements that entitle them to use our voice or data communications services rather than the number of persons or entities who own or lease those devices.
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Engineering and other service revenue includes revenue generated primarily from certain governmental and engineering service contracts which are not subscriber driven. Accordingly, we do not present ARPU for engineering and other service revenue in the table above.
Service Revenue
Excluding the out-of-period adjustment discussed above, Duplex service revenue decreased 15% in 2020 due primarily to a decline in average subscribers and ARPU of 12% and 3%, respectively. The decrease in average subscribers was driven by normal churn in the subscriber base exceeding gross activations over the last twelve months. The decrease in ARPU was driven primarily by lower priced service plans and promotional pricing in place during 2020, as well as unfavorable exchange rate movements for various currencies.
SPOT service revenue decreased 8% in 2020 due to lower ARPU and average subscribers. The 5% decrease in ARPU was due primarily to lower priced service plans introduced to new subscribers in mid-2019. The 3% decrease in average subscribers (after adjusting for non-revenue-producing subscribers previously in the base) was due to elevated churn experienced during 2020, particularly in the months following the start of the COVID-19 pandemic. Although we had a record number of subscriber activations during 2020, churn more than offset these gross additions.
Commercial IoT service revenue increased 1% in 2020 due to a 3% increase in average subscribers, offset partially by a 2% decrease in ARPU. Average subscribers were higher during 2020 compared to 2019 despite end of period subscribers declining from 421,000 at December 31, 2019 to 408,000 at December 31, 2020 following higher churn from the impact of COVID-19. The decrease in ARPU was due to the impact of unfavorable exchange rate movements, specifically the strengthening of the U.S. dollar relative to the Brazilian real.
Engineering and other service revenue increased $13.4 million in 2020. This increase was driven primarily by a higher volume of engineering services contracts during 2020, including the completion of certain milestones associated with the contract previously discussed, which generated $10.0 million of revenue during 2020. Additionally, in the fourth quarter of 2020, we recognized $2.9 million of revenue associated with a contract that was executed in 2007 for the construction of a gateway in Nigeria, upon its termination due to lack of performance by the partner, and our performance of all obligations in accordance with the terms of the contract. These remaining contract proceeds were previously held in non-current deferred revenue.
Subscriber Equipment Sales
Revenue from Duplex equipment sales increased $0.6 million, or 42%, in 2020. This increase in revenue was driven primarily by sales of our second-generation Duplex devices launched in the second half of 2019; these units are sold at higher prices compared to our first generation devices. Additionally, sales of our GSP-1700 phones also increased year over year. The vast majority of our device sales during the past two years were of our first-generation phones and accessories. We are evaluating the profitability of our second-generation devices relative to our other product and service offerings and the cost to maintain our second-generation ground infrastructure and technology. While we believe that our second-generation products could contribute meaningfully to our future Duplex revenue, our past financial results are an important component of our overall profitability analysis.
Revenue from SPOT equipment sales increased $0.6 million, or 7%, in 2020. This increase in revenue during 2020 was driven by a higher sales volume of SPOT X® and SPOT Gen4 TM , which is our refreshed SPOT Satellite GPS Messenger launched in August 2020. Included in our SPOT Gen4 TM sales were 8,500 units sold to Battlbox, a subscription box service, in December 2020. We expect to see an increase in gross subscriber activations during 2021 following distribution of these boxes to Battlbox subscribers. Offsetting the increase in volume were lower component part sales of $0.8 million. We occasionally sell component parts to our equipment manufacturer to use in final products; these sales fluctuate based on the volume and price of parts that we directly source for the production of our equipment. Compared to 2019, we sold fewer component parts to our equipment manufacturer during 2020.
Revenue from Commercial IoT equipment sales decreased $4.2 million, or 45%, in 2020. This decrease in revenue resulted from a decrease in demand following the start of the COVID-19 pandemic. We have experienced lower demand particularly from our customers operating in the oil and gas industry. Offsetting this decline were sales of our recently-launched ST100, a one-way satellite transmitter IoT board. Numerous resellers are currently conducting trials with this device and we expect additional sales in 2021.
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Operating Expenses :
Total operating expenses decreased 4% to $187.7 million in 2020 from $195.8 million in 2019. Lower cost of services, cost of subscriber equipment sales, and marketing, general and administrative costs primarily contributed to the decrease in total operating expenses. The main drivers of the variance in operating expenses are explained in further detail below.
Cost of Services
Cost of services decreased $2.7 million, or 7%, to $34.8 million in 2020 from $37.5 million in 2019. The decrease in cost of services during 2020 was driven primarily by 1) lower maintenance costs of $1.3 million resulting from revisions to contract terms with certain vendors for gateway and software maintenance and 2) lower research and development costs of $1.1 million driven by the timing of new product development. Other smaller items, such as lower travel costs and costs to support our IGOs also contributed to the remaining variance.
Cost of Subscriber Equipment Sales
Cost of subscriber equipment sales decreased by $2.5 million, or 16%, to $13.3 million in 2020 from $15.8 million in 2019. This decrease is generally consistent with the decline in total revenue from subscriber equipment sales, particularly driven by the decrease in Commercial IoT equipment, as explained above.
Cost of Subscriber Equipment Sales - Reduction in the Value of Inventory
During 2020, we wrote down the carrying value of inventory by $0.7 million following our decision to discontinue production of a second-generation Duplex device, as well as an evaluation of excess or obsolete inventory related to end of life products and technology. During 2019, we wrote down the value of inventory by $0.4 million after adjusting for changes in the net realizable value of gateway spare parts due to excess.
Marketing, General and Administrative
Marketing, general and administrative expenses ("MG&A") decreased $3.5 million, or 8%, to $41.7 million in 2020 from $45.2 million in 2019. MG&A expense was lower in 2020 due in part to the impact of COVID-19, including lower subscriber acquisition costs (such as advertising and trade shows) of $1.8 million and lower travel costs of $1.0 million. Other smaller items, such as personnel costs and credit losses also reduced MGA expense during 2020. Offsetting these decreases were higher professional and legal fees related to strategic opportunities of $2.3 million.
Additionally, during 2019, we wrote off $3.1 million of financing costs associated with our efforts to refinance our debt obligations. This write-off was recorded following our decision to pursue an amendment to our existing First Lien Facility Agreement instead of issuing new first lien debt.
Reduction in the Value of Long-Lived Assets
During 2019, we recorded a reduction in the carrying value of long-lived assets of $1.1 million resulting from the change in classification from held and used to held for sale of our former gateway location in Nicaragua. We reduced the carrying value to the lower of cost or fair value less estimated cost to sell during the fourth quarter of 2019. During the fourth quarter of 2020, we signed a contract for the sale of this property; the final selling price (net of estimated cost to sell) is $0.3 million and, as a result, the Company recorded an additional impairment totaling $0.2 million during 2020. Additionally, during the fourth quarter of 2020, we wrote down $0.2 million related to the ground portion of construction in progress for one of our gateways resulting from an analysis made over these balances.
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Depreciation, Amortization and Accretion
Depreciation, amortization, and accretion expense increased $1.0 million to $96.8 million in 2020 compared to $95.8 million in 2019. This increase was due primarily to placing into service our new billing system implemented in 2020.
Other (Expense) Income:
Interest Income and Expense
Interest income and expense, net, decreased $14.1 million to expense of $48.4 million for 2020 compared to expense of $62.5 million for 2019. This decrease was driven by lower gross interest costs totaling $14.7 million as well as an increase to capitalized interest of $0.8 million (which decreases interest expense). Interest income and expense, net, was also impacted by a decrease in interest income totaling $1.4 million.
Gross interest costs were impacted by lower interest associated with the First Lien Facility Agreement, the Loan Agreement with Thermo, and the June 2019 Subordinated Loan Agreement; these items were offset by higher interest on the Second Lien Facility Agreement that we entered into in November 2019. Lower interest costs for the First Lien Facility Agreement were due to the modification of the First Lien Facility Agreement in November 2019, which reduced the principal balance outstanding and the balance of deferred financing costs (resulting in lower amortization of deferred financing costs), as well as a decrease in the interest rate driven by a reduction in LIBOR. Lower interest costs for the Loan Agreement with Thermo were driven by Thermo's conversion of the entire principal balance outstanding under the Loan Agreement in February 2020. Lower interest costs for the Subordinated Loan Agreement are due to the full repayment of this loan in November 2019.
Interest costs associated with the First Lien Facility Agreement decreased $24.2 million (including $11.7 million of amortization of deferred financing costs), interest costs associated with the Loan Agreement with Thermo decreased $16.6 million (including $3.4 million of accretion of debt discount) and interest costs associated with the Subordinated Loan Agreement decreased $4.5 million (including $0.5 million of amortization of deferred financing costs). These decreases were offset by $30.6 million of interest (including $4.0 million of accretion of debt discount and amortization of deferred financing costs) associated with the Second Lien Facility Agreement.
Derivative Gain
We recorded derivative gains of $2.9 million and $145.1 million in 2020 and 2019, respectively. We recognize gains or losses due to the change in the value of certain embedded features within our debt instruments that require standalone derivative accounting. The gains recorded during 2020 were primarily impacted by fluctuations in the discount yield used in the valuation of the embedded derivative associated with our Second Lien Facility Agreement. The gains recorded during 2019 were impacted primarily by the assumed probability of conversion of the Loan Agreement with Thermo, which occurred in February 2020, and decreased the value of the associated derivative liability. See Note 8: Fair Value Measurements to our Consolidated Financial Statements for further discussion of the computation of the fair value of our derivatives.
Foreign Currency (Loss) Gain
Foreign currency (loss) gain fluctuated by $0.8 million to a loss of $0.7 million in 2020 from a gain of $0.1 million in 2019. Changes in foreign currency gains and losses are driven by the significant financial statement items we have denominated in various currencies. The strengthening of the U.S. dollar relative to the Brazilian real unfavorably impacted our consolidated statement of operations $4.0 million; this unfavorable impact was partially offset by the strengthening of the Canadian dollar and the Euro relative to the U.S. dollar, $1.3 million and $1.7 million, respectively. Other smaller items contributed to the remaining fluctuation. Foreign currency gains and losses are due primarily to the remeasurement of certain balances at the end of each reporting period.
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Other
Other expense increased to $3.6 million in 2020 compared to $2.9 million in 2019. We record the non-operating components of net periodic benefit cost to other expense, including activity related to settlement of our pension liability. In December 2020 and 2019, we settled portions of our pension liability due to certain participants; these settlements resulted in losses of $2.1 million and $0.5 million for each of 2020 and 2019, respectively. Offsetting this increase in expense were lower legal and other adviser costs incurred related to the modification of our First Lien Facility Agreement, which were recorded to non-operating expense under applicable accounting guidance.
Income Tax Expense
Income tax expense increased $0.2 million to $0.7 million in 2020 compared to $0.5 million in 2019. The primary income tax expense is related to deferred state tax liabilities associated with net operating loss limitations.
Comparison of the Results of Operations for the years ended December 31, 2019 and 2018
Discussion of the results of operations for the years ended December 31, 2019 and 2018 can be found in the Globalstar Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on February 28, 2020.
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Liquidity and Capital Resources
Our principal liquidity requirements include paying our debt service obligations and funding our operating costs. Our principal sources of liquidity include cash on hand, cash flows from operations and anticipated proceeds from the exercise of warrants held by our Second Lien Facility Agreement lenders. Our operating cash flows are likely to continue to be negatively impacted by COVID-19, as previously discussed. The uncertainties due to COVID-19 continue to evolve and we are monitoring our financial position as circumstances develop. We expect to use proceeds from the exercise of warrants to meet our obligations to raise no less than $45.0 million of equity prior to March 30, 2021. A portion of these proceeds will be used to pay the next scheduled principal payment due under the First Lien Facility Agreement in June 2021; the remaining proceeds will be used towards the following scheduled payment due in December 2021. A longer-term source of liquidity also includes restricted cash held in our debt service reserve account. Although there are uncertainties related to the future impact from COVID-19, we currently expect that sources of liquidity over the next twelve months will be sufficient for us to cover our obligations. We may also access equity and debt capital markets from time to time, as needed, such as for liquidity, to improve terms of our debt instruments and to lower our principal and interest requirements.
Overview
As of December 31, 2020, we held cash and cash equivalents of $13.3 million and restricted cash of $54.7 million, of which $3.6 million and $51.1 million are recorded as current and non-current restricted cash, respectively, on our consolidated balance sheet required under our First Lien Facility Agreement. The current portion of restricted cash on our consolidated balance sheet will be used towards the next principal payment, which is scheduled for June 2021. The non-current portion of restricted cash on our consolidated balance sheet will generally be used towards the final scheduled payment due upon maturity of the First Lien Facility Agreement in December 2022 (see below for further discussion). As of December 31, 2019, we held cash and cash equivalents of $7.6 million and had $51.5 million in restricted cash.
The carrying amount of our long-term debt outstanding was $385.4 million at December 31, 2020, compared to $464.2 million at December 31, 2019. At December 31, 2020, the current portion of our debt outstanding was $58.8 million and represents the scheduled principal payments under our First Lien Facility Agreement and the PPP Loan due within one year of the balance sheet date. We had no current debt outstanding at December 31, 2019.
The $78.8 million decrease in the carrying amount of our total debt balance was due primarily to the conversion of the Loan Agreement with Thermo in February 2020 into shares of common stock, resulting in a $116.5 million reduction in net debt. Also contributing to the decrease in the carrying amount of our total debt balance were unscheduled mandatory principal payments for the First Lien Facility Agreement totaling $3.4 million during 2020. This decrease was offset by 1) a higher carrying value of the Second Lien Facility Agreement of $32.4 million due to the accrual of PIK interest and the accretion of debt discount, 2) a higher carrying value of the First Lien Facility Agreement of $3.8 million due to amortization of deferred financing costs, and 3) the issuance of the PPP Loan in April 2020 of $4.9 million (net of debt issuance costs).
Cash Flows for the years ended December 31, 2020, 2019 and 2018
The following table shows our cash flows from operating, investing and financing activities (in thousands):
Year Ended December 31,
Statements of Cash Flows 2020 2019 2018
Net cash provided by operating activities $ 22,215 $ 3,048 $ 5,920
Net cash used in investing activities (14,536) (11,491) (17,401)
Net cash provided by (used in) financing activities 1,164 (7,923) (18,196)
Effect of exchange rate changes on cash, cash equivalents and restricted cash 52 4 (112)
Net increase (decrease) in cash, cash equivalents and restricted cash $ 8,895 $ (16,362) $ (29,789)
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Cash Flows Provided by Operating Activities
Net cash provided by operations includes primarily cash receipts from subscribers related to the purchase of equipment and satellite voice and data services as well as cash received from the performance of engineering and other services. We use cash in operating activities primarily for personnel costs, inventory purchases and other general corporate expenditures. Net cash provided by operating activities was $22.2 million during 2020 compared to $3.0 million during 2019. This increase was due primarily to higher net income after adjusting for non-cash items due to lower interest payments and operating expenses. Partially offsetting this variance were working capital changes, which were more unfavorable in 2020 than in 2019. These unfavorable changes were due primarily to an increase in accounts receivable and a decrease in deferred revenue, which were both driven by the timing of services delivered under our subscriber and engineering service contracts relative to the timing of cash receipts. Offsetting these unfavorable items were higher inventory sales as well as fewer inventory purchases and favorable changes in prepaid and other current assets, driven in part by the final installment of $3.7 million received in January 2020 from the 2018 settlement of a business economic loss claim.
Net cash provided by operating activities was $3.0 million during 2019 compared to $5.9 million during 2018. This decrease was due primarily to lower net income after adjusting for non-cash items. Lower net income was driven by: 1) higher interest expense driven by a lower amount of cash interest capitalized during 2019 as well as higher gross interest payments due to the payment of accrued interest on the Subordinated Loan Agreement in November 2019, 2) costs associated with efforts to refinance our debt obligations, including a) the write-off of financing costs for the issuance of new first-lien debt that was ultimately not pursued, as well as third-party costs to support the modification of our First Lien Facility Agreement and b) the write-off of a portion of remaining deferred financing costs resulting from the partial paydown of the First Lien Facility Agreement, and 3) the higher cost of goods sold for tariffs resulting from a recent ruling on the classification of certain of our products. Offsetting the decrease due to lower net income were favorable working capital changes, including primarily the timing of prepaid and other assets as well as other non-current liabilities.
Cash Flows Used in Investing Activities
Net cash used in investing activities was $14.5 million during 2020 compared to $11.5 million during 2019. During both 2020 and 2019, the nature of our capital expenditures was related to the procurement and deployment of new antennas for our gateways. Additionally, in both 2020 and 2019, we incurred costs for other initiatives, including our new billing system, which was placed into service in April 2020, as well as product development, including software and other back-office efforts.
Net cash used in investing activities was $11.5 million during 2019 compared to $17.4 million during 2018. This decrease was due primarily to a reduction in the amount of cash interest capitalized of $2.9 million. As previously disclosed, our construction in progress balance has decreased significantly since 2018, specifically related to our ground network; therefore, the amount of interest eligible to be capitalized is lower. Also contributing to the variance in cash used in investing activities were fewer property and equipment purchases related to our ground network and product development, including software and other back-office efforts.
Cash Flows Provided by (Used in) Financing Activities
Net cash provided by financing activities was $1.2 million in 2020 compared to net cash used in financing activities of $7.9 million in 2019. In April 2020, we received proceeds of $5.0 million from the PPP Loan (discussed below); these proceeds were offset by mandatory prepayments of principal on our First Lien Facility Agreement totaling $3.4 million (discussed below) as well as the timing of payments for debt financing costs from our refinancing in 2019 totaling $1.1 million.
Net cash used in financing activities was $7.9 million in 2019 compared to $18.2 million in 2018. In June 2019, we entered into a $62.0 million Subordinated Loan Agreement, the proceeds from which were used in part to pay principal of $47.4 million towards our First Lien Facility Agreement. In November 2019, we completed a broad refinancing, which included the issuance of a $193.0 million Second Lien Facility Agreement. The proceeds, net of a $6.0 million, or 3% OID, combined with cash on hand and restricted cash were used to prepay a portion of our First Lien Facility Agreement of $151.6 million. Proceeds from the Second Lien Facility Agreement were also used to pay off the entire balance of the Subordinated Loan Agreement of $62.0 million plus accrued interest of $4.0 million. We incurred $6.2 million in debt financing costs associated with the November 2019 refinancing. Additionally, we issued warrants to purchase shares of our common stock to each of the Second Lien Facility Agreement lenders. In December 2019, Thermo exercised 9.5 million warrants resulting in cash proceeds to us of $3.6 million.
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Indebtedness and Available Credit
First Lien Facility Agreement
In 2009, we entered into the First Lien Facility Agreement, which was amended and restated in July 2013, August 2015, June 2017 and November 2019. The First Lien Facility Agreement is scheduled to mature in December 2022. As of December 31, 2020, the principal amount outstanding under the First Lien Facility Agreement was $187.0 million, of which $57.5 million was recorded as current debt based on the contractual terms of the loan.
Our indebtedness under the First Lien Facility Agreement bears interest at a floating rate of LIBOR plus a margin that increases by 0.5% each year thereafter to a maximum rate of LIBOR plus 5.75%. Interest on the First Lien Facility Agreement is payable semi-annually in arrears in June and December of each calendar year. Ninety-five percent of our obligations under the First Lien Facility Agreement are guaranteed by Bpifrance Assurance Export S.A.S. ("BPIFAE"). Our obligations under the First Lien Facility Agreement are guaranteed on a senior secured basis by all of our domestic subsidiaries and are secured by a first priority lien on substantially all of our assets and our domestic subsidiaries (other than their FCC licenses), including patents and trademarks, 100% of the equity of our domestic subsidiaries and 65% of the equity of certain foreign subsidiaries.
The First Lien Facility Agreement contains customary events of default and requires that we satisfy various financial and non-financial covenants. The compliance calculations of the financial covenants of the First Lien Facility Agreement permit us to include certain cash funds we receive from the issuance of our common stock and/or subordinated indebtedness. We refer to these funds as "Equity Cure Contributions". If we violate any covenants and are unable to obtain a sufficient Equity Cure Contribution or obtain a waiver, we would be in default under the First Lien Facility Agreement, and the lenders could accelerate payment of the indebtedness. As of December 31, 2020, we were in compliance with respect to the covenants of the First Lien Facility Agreement.
The First Lien Facility Agreement requires mandatory prepayments of principal with any Excess Cash Flow (as defined and calculated in the First Lien Facility Agreement) on a semi-annual basis. During 2020, we were required to pay $0.3 million and $3.1 million to our first lien lenders resulting from our Excess Cash Flow calculations as of December 31, 2019 and June 30, 2020, respectively. We expect to make another prepayment in 2021 from Excess Cash Flow as of December 31, 2020. These payments reduce future principal payment obligations.
The First Lien Facility Agreement requires that we maintain a debt service reserve account, which is pledged to secure our obligations under the First Lien Facility Agreement. The required balance in the debt service reserve account is fixed and must equal at least $50.9 million. As of December 31, 2020, the balance in the debt service reserve account was approximately $51.1 million and is classified as non-current restricted cash on our consolidated balance sheet as it will be used towards the final scheduled payment due upon maturity of the First Lien Facility Agreement in December 2022.
The amended and restated First Lien Facility Agreement includes a requirement that we raise no less than $45.0 million from the sale of equity prior to March 30, 2021. These proceeds will be applied towards the principal payment due on June 30, 2021 and then, if applicable, to the next scheduled principal payments. We currently expect to fulfill this requirement with proceeds from the exercise of the remaining warrants issued to the Second Lien Facility Agreement lenders in November 2019. We will access equity and debt capital markets, if necessary to fund any remaining requirements not satisfied through warrant proceeds. In December 2019, we received proceeds of $3.6 million from the exercise of a portion of warrants issued to the Second Lien Facility Agreement lenders, which is retained in the equity proceeds account under the First Lien Facility Agreement and is recorded in current restricted cash on our consolidated balance sheet as of December 31, 2020. Since December 31, 2020, certain of the Second Lien Facility Agreement lenders exercised approximately 5.5 million warrants at a price of $0.38 per share, the proceeds of which will be used to fulfill a portion of the $45.0 million requirement discussed above.
See Note 6: Long-Term Debt and Other Financing Arrangements to our Consolidated Financial Statements for further discussion of the First Lien Facility Agreement.
Subordinated Loan Agreement
On July 2, 2019, we entered into a Subordinated Loan Agreement (the “Subordinated Loan Agreement”), effective as of June 28, 2019, with Thermo Funding Company LLC (an affiliated entity to Thermo, as previously defined in this filing), and certain other unaffiliated parties (together with Thermo, the “Lenders”). Under the Subordinated Loan Agreement, we borrowed $62.0 million from the Lenders on June 28, 2019 for the primary purpose of funding the June 30, 2019 scheduled payment of
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interest and principal under our First Lien Facility Agreement and maintaining compliance with the financial covenants thereunder. The Subordinated Loan Agreement accrued interest at 15% per annum, which was capitalized and added to the outstanding principal in lieu of cash payments. Prior to repayment, the Subordinated Loan Agreement had accrued a total of $4.0 million. In November 2019, the Subordinated Loan Agreement was paid in full from a portion of the proceeds from the Second Lien Facility Agreement (see further discussion below).
Second Lien Facility Agreement
In November 2019, we entered into a $199.0 million Second Lien Facility Agreement with Thermo, EchoStar Corporation and certain other unaffiliated lenders. The Second Lien Facility Agreement is scheduled to mature in November 2025. The loans under the Second Lien Facility Agreement bear interest at a blended rate of 13.5% per annum to be paid-in-kind (or in cash at our option, subject to restrictions in the First Lien Facility Agreement). The cash proceeds from this loan were net of a 3% original issue discount. As of December 31, 2020, the principal amount outstanding under the Second Lien Facility Agreement was $230.6 million.
As additional consideration for the loan, we issued the lenders warrants to purchase 124.5 million shares of common stock an exercise price of $0.38 per share. These warrants expire on March 31, 2021. As of December 31, 2020, approximately 115.0 million warrants remain outstanding. Subsequent to December 31, 2020, an additional 5.5 million warrants were exercised at price of $0.38 per share.
The Second Lien Facility Agreement contains customary events of default and requires us to satisfy various financial and non-financial covenants. As of December 31, 2020, we were in compliance with all the covenants of the Second Lien Facility Agreement.
See Note 6: Long-Term Debt and Other Financing Arrangements in our Consolidated Financial Statements for further discussion of the Second Lien Facility Agreement.
Thermo Loan Agreement
We had an amended and restated loan agreement with Thermo (the “Loan Agreement”). Our obligations to Thermo under the Loan Agreement were subordinated to all of our obligations under the First Lien Facility Agreement and the Second Lien Facility Agreement. The Loan Agreement was convertible into shares of common stock at a conversion price of $0.69 (as adjusted) per share of common stock and accrued interest at 12% per annum, which we capitalized and added to the outstanding principal in lieu of cash payments.
On February 19, 2020, Thermo converted the entire principal balance outstanding under the Loan Agreement, which totaled $137.4 million and included accrued interest since inception of $93.9 million. This conversion resulted in the issuance of 200.1 million shares of common stock.
See Note 6: Long-Term Debt and Other Financing Arrangements in our Consolidated Financial Statements for further discussion of the Thermo Loan Agreement.
8.00% Convertible Senior Notes Issued in 2013
Our 2013 8.00% Notes are convertible into shares of our common stock at a conversion price of $0.69 (as adjusted) per share of common stock. As of December 31, 2020, the principal amount outstanding of the 2013 8.00% Notes was $1.4 million. The 2013 8.00% Notes will mature on April 1, 2028, subject to various call and put features. Interest on the 2013 8.00% Notes is payable semi-annually in arrears on April 1 and October 1 of each year. We pay interest in cash at a rate of 5.75% per annum and by issuing additional 2013 8.00% Notes at a rate of 2.25% per annum.
A holder of 2013 8.00% Notes has the right to require us to purchase some or all of the 2013 8.00% Notes on April 1, 2023 at a price equal to the principal amount of the 2013 8.00% Notes to be purchased plus accrued and unpaid interest.
The indenture governing the 2013 8.00% Notes provides for customary events of default. As of December 31, 2020, we were in compliance with the terms of the 2013 8.00% Notes and the Indenture.
See Note 6: Long-Term Debt and Other Financing Arrangements in our Consolidated Financial Statements for further discussion of the 2013 8.00% Notes.
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Payroll Protection Program Loan
As previously discussed, we sought relief under the CARES Act, including receiving a PPP Loan of $5.0 million loan under the payroll protection program (the "PPP") in April 2020. As of December 31, 2020, the principal amount outstanding under the PPP Loan was $5.0 million, of which $1.4 million is classified as current based on the contractual terms of the loan (as modified). The Company applied for loan forgiveness in December 2020, in accordance with the terms of the CARES Act, based on payroll and other allowable costs incurred since the date of the loan. Any amount not forgiven by the Small Business Administration (the "SBA") is subject to an interest rate of 1.00% per annum commencing on the date of the loan with principal and interest payments beginning after the SBA has concluded on forgiveness, subject to the PPP rules. Our first and second lien lenders will require us to accelerate the repayment of any portion of the loan amount that is not forgiven.
See Note 6: Long-Term Debt and Other Financing Arrangements to our Consolidated Financial Statements for further discussion of the PPP Loan.
Contractual Obligations and Commitments
Contractual obligations at December 31, 2020 are as follows (in thousands):
Contractual Obligations: 2021 2022 2023 2024 2025 Thereafter Total
Debt obligations (1) $ 57,468 $ 129,520 $ 1,455 $ — $ — $ 446,782 $ 635,225
Interest on long-term debt (2) 8,996 7,030 41 — — — 16,067
Purchase obligations (3) 1,585 4,220 2,280 — — — 8,085
Inventory purchase obligations (4) 6,430 — — — — — 6,430
Operating lease obligations (5) 2,597 2,479 2,510 2,383 2,405 8,802 21,176
Pension obligations 502 505 497 510 526 2,604 5,144
Total $ 77,578 $ 143,754 $ 6,783 $ 2,893 $ 2,931 $ 458,188 $ 692,127
(1) These amounts include principal and payment in kind interest payments. Interest on the Second Lien Facility Agreement accrues interest at a blended rate of 13.5% per annum and is capitalized and added to the total outstanding principal in lieu of cash payments. Principal and interest under the Second Lien Facility Agreement become due and payable in November 2025.
We have $5.0 million outstanding under the PPP Loan. We applied for loan forgiveness, including both principal and interest, in accordance with the terms of the CARES Act. Any amounts not forgiven are subject to an interest rate of 1.00% per annum. As we expect the entire $5.0 million to be forgiven, this amount is excluded from the table above.
See Note 6: Long-Term Debt and Other Financing Arrangements in our Consolidated Financial Statements for further discussion of these debt arrangements.
(2) Amounts include projected interest payments to be made in cash. Debt outstanding under our First Lien Facility Agreement bears interest at a floating rate and, accordingly, we estimated our interest costs in future periods.
(3) We have purchase commitments with certain vendors related to the procurement, deployment and maintenance of our network. In prior disclosures, our contractual obligations table included a contract that we previously had with MIL-SAT LLC for the procurement and production of new antennas for our gateways. While there are no remaining purchase commitments under this contract, we expect to purchase additional antennas for certain gateways in the future directly from the manufacturer.
See Note 9: Commitments and Contingencies in our Consolidated Financial Statements for discussion on our contractual commitments.
(4) Amounts include obligations for non-cancelable purchase orders for inventory as of December 31, 2020. We expect to fulfill these purchase orders during 2021 based on current forecasted equipment sales.
(5) As of December 31, 2020, we executed additional operating leases, primarily for new gateway locations, that are expected to commence during 2021. Accordingly, these leases are not included on the balance sheet as of December 31, 2020 or in the table above. We are in the process of evaluating these lease obligations.
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Recently Issued Accounting Pronouncements
For a discussion of recent accounting guidance and the expected impact that the guidance could have on our Consolidated Financial Statements, see Note 1: Summary of Significant Accounting Policies in our Consolidated Financial Statements.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. Note 1: Summary of Significant Accounting Policies in our Consolidated Financial Statements contains a description of the accounting policies used in the preparation of our financial statements as well as the consideration of recently issued accounting standards and the estimated impact these standards will have on our financial statements. We evaluate our estimates on an ongoing basis, including those related to revenue recognition; property and equipment; income taxes; and derivative instruments. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual amounts could differ significantly from these estimates under different assumptions and conditions.
We define a critical accounting policy or estimate as one that is both important to our financial condition and results of operations and requires us to make difficult, subjective or complex judgments or estimates about matters that are uncertain. We believe that the following are the critical accounting policies and estimates used in the preparation of our Consolidated Financial Statements. In addition, there are other items within our Consolidated Financial Statements that require estimates but are not deemed critical as defined in this paragraph.
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Revenue Recognition
Our primary types of revenue include (i) service revenue from two-way voice communication, and one-way and two-way data transmissions between a mobile or fixed device, (ii) subscriber equipment revenue from the sale of fixed and mobile devices as well as other products and accessories, and (iii) service revenue from providing engineering and support services to certain customers. The complexities or judgements involved in revenue recognition is discussed in detail below by type of revenue.
Unless otherwise disclosed, service revenue is recognized over a period of time (consistent with the customer's receipt and consumption of the benefits of our performance) and revenue from the sale of subscriber equipment is recognized at a point in time (consistent with the transfer of risks and rewards of ownership of the hardware). We record customer payments received in advance of the corresponding service period as deferred revenue. We provide Duplex, SPOT and Commercial IoT services directly to customers and indirectly through resellers and IGOs. Credits granted to customers are expensed or charged against revenue or accounts receivable over the remaining term of the customer contract. Subscriber acquisition costs primarily include dealer and internal sales commissions and certain other costs, including but not limited to, promotional costs, cooperative marketing credits and shipping and fulfillment costs. We capitalize incremental costs to obtain a contract to the extent we expect to recover them; these costs include internal and external initial activation commissions. All other subscriber acquisitions costs are expensed at the time of the related sale.
For Duplex service revenue, we recognize revenue for monthly access fees in the period services are rendered. Access fees represent the minimum monthly charge for each line of service based on its associated rate plan. We also recognize revenue for airtime minutes and data in excess of the monthly access fees in the period such minutes or data are used. Under certain annual plans whereby a customer prepays for a predetermined amount of minutes and data, revenue is recognized consistent with the customer's expected pattern of usage, based on historical experience because we believe that this method most accurately depicts the satisfaction of our obligation to the customer. The estimated timing of revenue recognition for these usage-based customers is driven by historical customer usage patterns. For annual plans where the customer is charged an annual fee to access our system, we recognize revenue on a straight-line basis over the term of the plan.
We provide certain engineering services to assist customers in developing new applications to operate on our network. We generally recognize the revenues associated with these services when the performance obligations are performed, the timing of which may involve complex judgements by management.
At times, we sell subscriber equipment through multiple-element arrangement contracts with services. When we sell subscriber equipment and services in bundled arrangements and determine that we have separate performance obligations, we allocate the bundled contract price among the various performance obligations based on relative stand-alone selling prices at contract inception of the distinct goods or services underlying each performance obligation and recognizes them when, or as, each performance obligation is satisfied. Determination of the relative stand-alone selling prices is complex and involves judgement, as prices may vary based on many factors, such as promotions, customer, volume and/or type of equipment sold.
Property and Equipment
The vast majority of our property and equipment is costs incurred related to the construction of our second-generation constellation and ground station upgrades. Accounting for these assets requires us to make complex judgments and estimates. We capitalize costs associated with the design, manufacture, test and launch of our low earth orbit satellites. For assets that are sold or retired, including satellites that are de-orbited and no longer providing services, we remove the estimated cost and accumulated depreciation. We recognize a loss from an in-orbit failure of a satellite equal to its net book value, if any, in the period it is determined that the satellite is not recoverable.
Estimating the useful life of our assets is complex and involves judgement; to the extent the useful life of our significant assets changes, this could impact our operating results. The estimated useful lives of our assets is based on many factors, including estimated design life, information from our engineering department and our overall strategy for the use of the assets. A one year reduction in the estimated useful life of our second-generation satellites and ground network would result in an annual increase to depreciation expense of $5.2 million and $1.1 million, respectively. We capitalize costs associated with the design, manufacture and test of our ground stations and other capital assets. We track capitalized costs associated with our ground stations and other capital assets by fixed asset category and allocate them to each asset as it comes into service.
We evaluate the appropriateness of estimated depreciable lives assigned to our property and equipment and revise such lives to the extent warranted by changing facts and circumstances.
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We review the carrying value of our assets for impairment whenever events or changes in circumstances indicate that the recorded value may not be recoverable. If indicators of impairment exist, we compare future undiscounted cash flows to the carrying value of the asset group. If an asset is not recoverable, its carrying value would be adjusted down to fair value and an impairment loss would be recorded. Key assumptions in our impairment tests include projected future cash flows, the timing of network upgrades and current discount rates. Additionally, from time to time, we perform profitability analyses to determine if investments in certain products and/or services remain viable. In the event we determine to no longer support a product or service, or that an asset is not expected to generate future benefit, the asset may be abandoned and an impairment loss may be recorded.
Income Taxes
We use the asset and liability method of accounting for income taxes. This method takes into account the differences between financial statement treatment and tax treatment of certain transactions. We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Our deferred tax calculation requires us to make certain estimates about our future operations. Changes in state, federal and foreign tax laws, as well as changes in our financial condition or the carrying value of existing assets and liabilities, could affect these estimates. We recognize the effect of a change in tax rates as income or expense in the period that the rate is enacted; however, as we have a full valuation allowance on our deferred tax assets, there is no impact to the consolidated statements of operations and balance sheets.
GAAP requires us to assess whether it is more likely than not that we will be able to realize some or all of our deferred tax assets. If we cannot determine that deferred tax assets are more likely than not to be recoverable, GAAP requires us to provide a valuation allowance against those assets. This assessment takes into account factors including: (a) the nature, frequency, and severity of current and cumulative financial reporting losses; (b) sources of estimated future taxable income; and (c) tax planning strategies. We must weigh heavily a pattern of recent financial reporting losses as a source of negative evidence when determining our ability to realize deferred tax assets. Projections of estimated future taxable income exclusive of reversing temporary differences are a source of positive evidence only when the projections are combined with a history of recent profitable operations and can be reasonably estimated. Otherwise, GAAP requires that we consider projections inherently subjective and generally insufficient to overcome negative evidence that includes cumulative losses in recent years. If necessary and available, we would implement tax planning strategies to accelerate taxable amounts to utilize expiring carryforwards. These strategies would be a source of additional positive evidence supporting the realization of deferred tax assets.
Derivative Instruments
We recognize all derivative instruments as either assets or liabilities on the balance sheet at their respective fair values. We record recognized gains or losses on derivative instruments in the consolidated statements of operations.
We estimate the fair values of our derivative financial instruments using various techniques that are considered to be consistent with the objective of measuring fair values. In selecting the appropriate technique, we consider, among other factors, the nature of the instrument, the market risks that embody it and the expected means of settlement. There are various features embedded in our debt instruments that require bifurcation from the debt host. For the conversion options and the contingent put features in the Loan Agreement with Thermo and the 2013 8.00% Notes, we use a Monte Carlo simulation model to determine fair value. For the mandatory prepayments in the Second Lien Facility Agreement, we use a probability weighted discounted cash flow model to determine fair value. The timing and amount of these cash flows involve significant judgement. Valuations derived from these models are subject to ongoing internal and external verification and review. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Our financial position and results of operations may vary materially from quarter-to-quarter based on changes to the inputs and assumptions used in the derivative valuation models changes in these estimates.
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