Edgar Filing: KVH INDUSTRIES INC \DE\

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



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

For the quarterly period ended: June 30, 2017



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

For the transition period from to

Commission File Number 0-28082

KVH Industries, Inc.

(Exact Name of Registrant as Specified in its Charter)



Delaware	05-0420589
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)
50 Enterprise Center, Middletown, RI 02842 (Address of Principal Executive Offices) (Zip Code)
(401) 847-3327 (Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o

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



Large accelerated filer	o	Accelerated filer	ý
Non-accelerated filer	o (Do not check if a smaller reporting company)	Smaller reporting company	o
		Emerging growth company	o

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.



Date	Class	Outstanding shares
August 2, 2017	Common Stock, par value $0.01 per share	17,088,206

KVH INDUSTRIES, INC. AND SUBSIDIARIES

Form 10-Q

INDEX



		Page No.
PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
	Consolidated Balance Sheets as of June 30, 2017 (unaudited) and December 31, 2016	3
	Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016 (unaudited)	4
	Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2017 and 2016 (unaudited)	5
	Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016 (unaudited)	6
	Notes to Consolidated Financial Statements (unaudited)	7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	41
ITEM 4.	CONTROLS AND PROCEDURES	42
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	43
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	60
ITEM 6.	EXHIBITS	61
SIGNATURE		62
EXHIBIT INDEX		63

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

KVH INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share and share amounts)



	June 30, 2017			December 31, 2016
ASSETS	(unaudited)
Current assets:
Cash and cash equivalents	$	30,431		$	26,422
Marketable securities	13,771			25,712
Accounts receivable, net of allowance for doubtful accounts of $2,820 and $3,477 as of June 30, 2017 and December 31, 2016, respectively	27,068			31,152
Inventories	23,412			20,745
Prepaid expenses and other current assets	4,863			4,801
Total current assets	99,545			108,832
Property and equipment, less accumulated depreciation of $48,514 and $45,766 as of June 30, 2017 and December 31, 2016, respectively	41,754			36,586
Intangible assets, less accumulated amortization of $18,514 and $16,344 as of June 30, 2017 and December 31, 2016, respectively	16,657			17,838
Goodwill	32,802			31,343
Other non-current assets	5,751			5,134
Non-current deferred income tax asset	24			24
Total assets	$	196,533		$	199,757
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	11,781		$	8,436
Accrued compensation and employee-related expenses	6,020			4,766
Accrued other	8,094			8,317
Accrued product warranty costs	2,407			2,280
Deferred revenue	9,906			6,661
Current portion of long-term debt	2,477			7,900
Liability for uncertain tax positions	1,356			1,283
Total current liabilities	42,041			39,643
Other long-term liabilities	33			326
Long-term debt, excluding current portion	45,815			50,153
Non-current deferred income tax liability	3,302			3,133
Total liabilities	$	91,191		$	93,255
Commitments and contingencies (Note 12)
Stockholders’ equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares; none issued	—			—
Common stock, $0.01 par value. Authorized 30,000,000 shares; 18,722,987 and 18,420,914 shares issued at June 30, 2017 and December 31, 2016, respectively; and 17,063,996 and 16,761,923 shares outstanding at June 30, 2017 and December 31, 2016, respectively	187			184
Additional paid-in capital	132,325			129,660
(Accumulated deficit) retained earnings	(294		)	6,617
Accumulated other comprehensive loss	(13,726		)	(16,809		)
	118,492			119,652
Less: treasury stock at cost, common stock, 1,658,991 shares as of June 30, 2017 and December 31, 2016	(13,150		)	(13,150		)
Total stockholders’ equity	105,342			106,502
Total liabilities and stockholders’ equity	$	196,533		$	199,757

See accompanying Notes to Unaudited Consolidated Financial Statements.

KVH INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except earnings per share amounts, unaudited)



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2017			2016			2017			2016
Sales:
Product	$	14,323		$	20,062		$	29,186		$	35,444
Service	26,126			25,904			51,474			50,902
Net sales	40,449			45,966			80,660			86,346
Costs and expenses:
Costs of product sales	9,295			12,989			19,834			23,659
Costs of service sales	13,094			13,259			26,362			26,250
Research and development	3,761			4,037			7,708			7,820
Sales, marketing and support	8,124			9,234			16,864			17,892
General and administrative	7,543			7,140			15,730			14,792
Total costs and expenses	41,817			46,659			86,498			90,413
Loss from operations	(1,368		)	(693		)	(5,838		)	(4,067		)
Interest income	159			118			325			223
Interest expense	349			353			702			728
Other (expense) income, net	(112		)	144			(180		)	67
Loss before income tax expense (benefit)	(1,670		)	(784		)	(6,395		)	(4,505		)
Income tax expense (benefit)	356			22			516			(908		)
Net loss	$	(2,026	)	$	(806	)	$	(6,911	)	$	(3,597	)

Net loss per common share
Basic and diluted	$	(0.12	)	$	(0.05	)	$	(0.42	)	$	(0.23	)
Weighted average number of common shares outstanding:
Basic and diluted	16,446			15,825			16,354			15,774

See accompanying Notes to Unaudited Consolidated Financial Statements.

KVH INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands, unaudited)



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2017			2016			2017			2016
Net loss	$	(2,026	)	$	(806	)	$	(6,911	)	$	(3,597	)
Other comprehensive income (loss), net of tax ⁽¹⁾:
Unrealized loss on available-for-sale securities	(3		)	—			(3		)	—
Foreign currency translation adjustment	2,440			(4,472		)	3,041			(5,148		)
Unrealized gain (loss) on derivative instruments, net ⁽²⁾	18			9			45			(11		)
Other comprehensive income (loss), net of tax	2,455			(4,463		)	3,083			(5,159		)
Total comprehensive income (loss)	$	429		$	(5,269	)	$	(3,828	)	$	(8,756	)

(1) Tax impact was nominal for all periods.

(2) Represents the net of the gross unrealized gain (loss) for the period recorded to accumulated other comprehensive loss and the amounts reclassified from accumulated other comprehensive loss to other (expense) income, net in the consolidated statements of operations. See Note 5(d) for further information.

See accompanying Notes to Unaudited Consolidated Financial Statements.

KVH INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)



	Six Months Ended
	June 30,
	2017			2016
Cash flows from operating activities:
Net loss	$	(6,911	)	$	(3,597	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for doubtful accounts	294			434
Depreciation and amortization	5,477			6,255
Deferred income taxes	—			(1,060		)
Loss on sale of fixed assets	3			145
Loss on derivative instruments	—			241
Compensation expense related to stock-based awards and employee stock purchase plan	1,812			1,881
Unrealized currency translation (gain) loss	(119		)	697
Changes in operating assets and liabilities:
Accounts receivable	4,051			10,171
Inventories	(2,661		)	(134		)
Prepaid expenses and other current assets	(49		)	(1,002		)
Other non-current assets	(577		)	(1,575		)
Accounts payable	2,345			603
Deferred revenue	3,004			824
Accrued other	397			(4,957		)
Other long-term liabilities	(294		)	(74		)
Net cash provided by operating activities	$	6,772		$	8,852
Cash flows from investing activities:
Capital expenditures	(6,809		)	(2,528		)
Cash paid for acquisition of intangible asset	(50		)	—
Purchases of marketable securities	(7,348		)	(3,780		)
Maturities and sales of marketable securities	19,286			3,740
Net cash provided by (used in) investing activities	$	5,079		$	(2,568	)
Cash flows from financing activities:
Repayments of long-term debt	(1,561		)	(674		)
Repayments of term note borrowings	(8,200		)	(2,437		)
Payment of employee restricted stock withholdings	(392		)	(313		)
Proceeds from stock options exercised and employee stock purchase plan	1,268			119
Net cash used in financing activities	$	(8,885	)	$	(3,305	)
Effect of exchange rate changes on cash and cash equivalents	1,043			(912		)
Net increase in cash and cash equivalents	4,009			2,067
Cash and cash equivalents at beginning of period	26,422			22,719
Cash and cash equivalents at end of period	$	30,431		$	24,786
Supplemental disclosure of non-cash investing activities:
Changes in accrued liabilities and accounts payable related to fixed asset additions	$	1,452		$	—
Deferred purchase price consideration related to asset acquisition included in accrued expenses	$	50		$	—

See accompanying Notes to Unaudited Consolidated Financial Statements.

KVH INDUSTRIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited, all amounts in thousands except per share amounts)

(1) Description of Business

KVH Industries, Inc. (together with its subsidiaries, the Company or KVH) designs, develops, manufactures and markets mobile connectivity products and services for the marine and land mobile markets, and inertial navigation products for both the commercial and defense markets. In the fourth quarter of 2016, consistent with certain internal organizational changes implemented, the Company changed its reporting structure from two operating segments based on geographies selling navigation, guidance, and stabilization and mobile communication products, to two operating segments based on product lines: mobile connectivity and inertial navigation. The change was driven by several factors including:


•	changes in the Company's overall organizational structure, including the appointment of a Chief Operating Officer and a new Chief Financial Officer;


•	the completion of the Company's planning process for 2017, as a result of which the Company changed how it will measure and assess its financial performance; and


•	the Company's process for measuring incentive compensation for key executives in 2016 and later years.

KVH’s mobile connectivity products enable customers to receive voice and internet services, and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. KVH’s CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. KVH sells and leases its mobile connectivity products through an extensive international network of dealers and distributors. KVH also sells and leases products directly to end users. In the second quarter of 2017, the Company launched a new mini-VSAT Broadband service offering, AgilePlans, which is a monthly subscription model providing global connectivity to commercial maritime customers, including hardware, installation, broadband Internet, VOIP, entertainment and training content and global support for a monthly fee with no minimum commitment. KVH offers AgilePlans customers a variety of airtime data plans with varying data speeds and fixed data usage levels with overage charges per megabyte, which is similar to the plans that the Company offers to its other customers. The Company recognizes the monthly subscription fee as service revenue over the service delivery period. The Company retains ownership of the hardware that it provides to AgilePlans customers, who must return the hardware to KVH if they decide to terminate the service. Because KVH does not sell the hardware under AgilePlans, the Company does not recognize any product revenue when the hardware is deployed to an AgilePlans customer. KVH records the cost of the hardware used by AgilePlans customers as revenue-generating assets and depreciates the cost over an estimated useful life of five years. Since the Company is retaining ownership of the hardware, it does not accrue any warranty costs for AgilePlans hardware; however, any maintenance costs on the hardware is expensed in the period these costs are incurred.

KVH’s mobile connectivity service sales represent primarily sales earned from satellite voice and Internet airtime services. KVH provides, for monthly fixed and usage fees, satellite connectivity services, including broadband Internet, data and Voice over Internet Protocol (VoIP) services, to its TracPhone V-series customers. Mobile connectivity service sales also include the distribution of commercially licensed entertainment, including news, sports, music, and movies to commercial and leisure customers in the maritime, hotel, and retail markets through KVH Media Group (acquired as Headland Media Limited), the media and entertainment service company that KVH acquired on May 11, 2013, and the distribution of training films and eLearning computer-based training courses to commercial customers in the maritime market through Super Dragon Limited and Videotel Marine Asia Limited (together referred to as Videotel), a maritime training services company that KVH acquired on July 2, 2014. KVH also earns monthly usage fees from third-party satellite connectivity services, including voice, data and Internet services, provided to its Inmarsat and Iridium customers who choose to activate their subscriptions with KVH. Mobile connectivity service sales also include engineering services provided under development contracts, sales from product repairs, and extended warranty sales.

KVH's inertial navigation products offer precision fiber optic gyro (FOG)-based systems that enable platform and optical stabilization, navigation, pointing and guidance. KVH’s inertial navigation products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. KVH’s inertial navigation products are sold directly to U.S. and foreign governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, KVH's inertial navigation products are used in numerous commercial products, such as navigation and positioning systems for various applications including precision mapping, dynamic surveying, autonomous vehicles, train location control and track geometry measurement systems, industrial robotics and optical stabilization.

KVH’s inertial navigation service sales include product repairs, engineering services provided under development contracts and extended warranty sales.

(2) Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements of KVH Industries, Inc. and its wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company has evaluated all subsequent events through the date of this filing. All significant intercompany accounts and transactions have been eliminated in consolidation.

The consolidated financial statements have not been audited by the Company's independent registered public accounting firm and include all adjustments (consisting of only normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial condition, results of operations, and cash flows for the periods presented. These consolidated financial statements do not include all disclosures associated with annual financial statements and accordingly should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2016 filed on March 9, 2017 with the Securities and Exchange Commission. The results for the three and six months ended June 30, 2017 are not necessarily indicative of operating results for the remainder of the year. The Company’s marine leisure business within the mobile connectivity segment is highly seasonal, and seasonality can also impact the Company’s commercial marine business. Historically, the Company has generated the majority of its marine leisure product revenues during the first and second quarters of each year, and these revenues typically decline in the third and fourth quarters of each year, compared to the first two quarters. Temporary suspensions of the Company’s airtime services typically increase in the third and fourth quarters of each year as boats are placed out of service during the winter months.

Significant Estimates and Assumptions

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of sales and expenses during the reporting periods. As described in the Company’s annual report on Form 10-K, the most significant estimates and assumptions by management affect the Company’s revenue recognition, valuation of accounts receivable, valuation of inventory, valuations and purchase price allocations related to business combinations, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of long-lived assets, including goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, key valuation assumptions for its share-based awards, estimated fulfillment costs for warranty obligations, tax reserves and recoverability of the Company’s net deferred tax assets and related valuation allowance. The Company has reviewed these estimates and determined that these remain the most significant estimates for the six months ended June 30, 2017. There have been no material changes to the significant accounting policies previously disclosed in the Company’s annual report on Form 10-K for the year ended December 31, 2016, except for ASC Update No. 2016-09, Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which the Company adopted as required on January 1, 2017 resulted primarily in a change in the Company’s accounting prospectively for share-based payment forfeitures and accounting for excess tax benefits or deficiencies related to share-based payments as a component of earnings (see Note 5 for further discussion) and ASC Update No. 2015-11, Simplifying the Measurement of Inventory adopted as of January 1, 2017, which simplified the subsequent measurement of inventory by replacing the lower of cost or market test with a lower of cost or net realizable value test (see Note 7 for further discussion).

Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.

(3) Recently Announced Accounting Pronouncements

ASC Updates No. 2014-09, No. 2016-08, No. 2016-10, No. 2016-11, No. 2016-12 and No. 2016-20

In May 2014, the FASB issued ASC Update No. 2014-09, Revenue from Contracts with Customers (Topic 606). Update No. 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies using International Financial Reporting Standards and U.S. GAAP. The core principle requires entities to recognize revenue in a manner that depicts the transfer of goods or services to customers in amounts that reflect the consideration an entity expects to be entitled to in exchange for those goods or services. In July 2015, the FASB voted to

approve a one year deferral, making the standard effective for public entities for annual and interim periods beginning after December 15, 2017.

In March 2016, the FASB issued ASC Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The purpose of Update No. 2016-08 is to clarify the guidance on principal versus agent considerations. It includes indicators that help to determine whether an entity controls the specified good or service before it is transferred to the customer and to assist in determining when the entity satisfied the performance obligation and as such, whether to recognize a gross or a net amount of consideration in their consolidated statement of operations.

In April 2016, the FASB issued ASC Update No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. Update No. 2016-10 clarifies that entities are not required to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract. Update No. 2016-10 also addresses how to determine whether promised goods or services are separately identifiable and permits entities to make a policy election to treat shipping and handling costs as fulfillment activities. In addition, it clarifies key provisions in Topic 606 related to licensing.

In May 2016, the FASB issued ASC Update No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815). Update No. 2016-11 rescinds previous SEC comments that were codified in Topic 605, Topic 932 and Topic 815. Upon adoption of Topic 606, certain SEC comments including guidance on accounting for shipping and handling fees and costs and consideration given by a vendor to a customer should not be relied upon.

In May 2016, the FASB also issued ASC Update No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients. Update No. 2016-12 provides clarity around collectability, presentation of sales taxes, non-cash consideration, contract modifications at transition and completed contracts at transition. Update No. 2016-12 also includes a technical correction within Topic 606 related to required disclosures if the guidance is applied retrospectively upon adoption.

In December 2016, the FASB issued ASC Update No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. Update No. 2016-20 allows entities not to make quantitative disclosures about remaining performance obligations in certain cases and requires entities that use any of the optional exemptions to expand their qualitative disclosures. Update No. 2016-20 also clarifies other areas of the new revenue standard, including disclosure requirements for prior period performance obligations, impairment guidance for contract costs and the interaction of impairment guidance in ASC 340-40 with other guidance elsewhere in the Codification.

The Company will adopt Topic 606 effective January 1, 2018. The Company anticipates that it will adopt Topic 606 under the modified retrospective method and will only apply this method to contracts that are not completed as of the date of adoption. The modified retrospective method will result in a cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings at the date of initial application for any open contracts as of the adoption date. The Company has established an implementation team to assist with its assessment of the impact of the new revenue guidance on our operations, consolidated financial statements and related disclosures. To date, this assessment has included (1) utilizing questionnaires to assist with the identification of revenue streams, (2) performing sample contract analyses for each revenue stream identified, (3) assessing the noted differences in recognition and measurement that may result from adopting this new standard, (4) performing detailed analyses of contracts with larger customers, and (5) developing plans to test transactions for consistency with contract provisions that affect revenue recognition. Based on the preliminary results of the evaluation, which is still in process, the Company currently believes that the most significant potential changes relate to promised services under certain contracts that were previously determined to be separate units of accounting under ASC 605 that will not represent performance obligations under Topic 606 due to the fact that they are not distinct in the context of the contract, which will impact the timing of revenue recognition. The Company also anticipates changes to the consolidated balance sheet related to accounts receivable, contract assets, and contract liabilities.

The Company is in the process of evaluating and designing the necessary changes to its business processes, systems and controls to support recognition and disclosure under the new standard. Further, the Company is continuing to assess what incremental disaggregated revenue disclosures will be required in its consolidated financial statements.

ASC Update No. 2016-01

In January 2016, the FASB issued ASC Update No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. It is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application of certain provisions is permitted. Update No. 2016-01 requires entities to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with changes recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. It also simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. Update No. 2016-01 also requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and liability. The adoption of Update No. 2016-01 is not expected to have a material impact on the Company's financial position or results of operations.

ASC Update No. 2016-02

In February 2016, the FASB issued ASC Update No. 2016-02, Leases (Topic 842). It is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Earlier application is permitted. Update No. 2016-02 creates new accounting and reporting guidelines for leasing arrangements. The new guidance requires organizations that lease assets to recognize assets and liabilities on the balance sheet related to the rights and obligations created by those leases, regardless of whether they are classified as finance or operating leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease primarily will depend on its classification as a finance or operating lease. The guidance also requires new disclosures to help financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. The new standard is to be applied using a modified retrospective approach. The Company is currently evaluating the impact of the new pronouncement on its financial statements. Based on its preliminary assessment, upon adoption the Company expects to recognize significant right-to-use assets and corresponding lease liabilities on its balance sheet related to leased facilities and equipment.

ASC Update No. 2016-13

In June 2016, the FASB issued ASC Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The update is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for fiscal years beginning after December 15, 2018. The purpose of Update No. 2016-13 is to replace the current incurred loss impairment methodology for financial assets measured at amortized cost with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information, including forecasted information, to develop credit loss estimates. The Company is in the process of determining the effect that the adoption will have on its financial position and results of operation.

ASC Update No. 2016-15

In August 2016, the FASB issued ASC Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The purpose of Update No. 2016-15 is to reduce the diversity in practice in presentation and classification of the following items within the statement of cash flows: debt prepayments, settlement of zero coupon debt instruments, contingent consideration payments, insurance proceeds, securitization transactions and distributions from equity method investees. The update also addresses classification of transactions that have characteristics of more than one class of cash flows. The Company is in the process of determining the effect that the adoption will have on its financial position and results of operations.

ASC Update No. 2016-16

In October 2016, the FASB issued ASC Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The update is effective for fiscal years beginning after December 15, 2017, including interim reporting periods within those fiscal years. Early adoption is permitted as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. The purpose of Update No. 2016-16 is to allow an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, as opposed to waiting until the asset is sold to an outside party. The Company is in the process of determining the effect that the adoption will have on its financial position and results of operations.

ASC Update No. 2017-04

ASC Update No. 2017-09

In May 2017, the FASB issued ASC Update No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. The update is effective for annual periods beginning on or after December 15, 2017. Early adoption is permitted. The purpose of Update No. 2017-09 is to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification under Topic 718, Compensation - Stock Compensation. Under this new guidance, modification accounting is only required if the fair value, the vesting conditions, or the equity or liability classification of the award changes as a result of the change in terms or conditions. The Company expects that the adoption of this standard will only affect, on a prospective basis, the manner in which the Company evaluates any changes to the terms or conditions of its share-based payment awards.

There are no other recent accounting pronouncements issued by the FASB that would have a material impact on the Company's financial statements.


(4)	Marketable Securities

Marketable securities as of June 30, 2017 and December 31, 2016 consisted of the following:



June 30, 2017	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Money market mutual funds	$	8,031	$	—	$	—		$	8,031
United States treasuries	4,014		—		(3		)	4,011
Certificates of deposit	1,729		—		—			1,729
Total marketable securities designated as available-for-sale	$	13,774	$	—	$	(3	)	$	13,771



December 31, 2016	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Money market mutual funds	$	21,848	$	—	$	—	$	21,848
Certificates of deposit	3,864		—		—		3,864
Total marketable securities designated as available-for-sale	$	25,712	$	—	$	—	$	25,712

The amortized costs and fair value of marketable securities as of June 30, 2017 and December 31, 2016 are shown below by effective maturity. Effective maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.



June 30, 2017	Amortized Cost		Fair Value
Due in less than one year	$	5,743	$	5,740
December 31, 2016	Amortized Cost		Fair Value
Due in less than one year	$	3,864	$	3,864

Interest income from marketable securities was $30 and $20 during the three months ended June 30, 2017 and 2016, respectively, and $61 and $40 during the six months ended June 30, 2017 and 2016, respectively.

(5) Stockholder's Equity

(a) Stock Equity and Incentive Plan

The Company adopted ASC Update No. 2016-09, Compensation- Stock Compensation (ASC Topic 718): Improvements to Employee Share-Based Payment Accounting on January 1, 2017. Although, this ASC update did not impact the Company’s results of operations, financial position or cash flows for any periods prior to the adoption, the adoption of this ASC update had the following impact on the date of adoption:

•

The adoption of ASC Update No. 2016-09 requires all income tax adjustments to be recorded in the consolidated statements of operations. The cumulative adjustment upon adoption to accumulated earnings was zero since the increase in net deferred tax assets was fully offset by a corresponding increase in the deferred tax asset valuation allowance. The amount of deferred tax assets that had not been previously recognized due to the recognition of excess tax benefits was $1,571.


•	The tax benefit or expense is required to be classified as a cash flow provided by (used in) operating activities. It was previously required to be presented as a cash flow provided by (used in) financing activities in the Consolidated Statements of Cash Flows, with a corresponding adjustment to operating cash flows.


•	In the diluted net earnings per share calculation, when applying the treasury stock method for shares that could be repurchased, the assumed proceeds no longer include the amount of excess tax benefit. This provision, which is only applicable on a prospective basis, did not have an impact on the Company's diluted net earnings per share calculation for the three and six months ended June 30, 2017.

•

The Company has elected to account for forfeitures on share-based payments as these forfeitures occur, which represents a change from the accounting previously required under ASC Topic 718. As a result, future forfeitures could result in a significant reversal of stock-based compensation expense recognized in the period in which such forfeitures occur. During the three and six months ended June 30, 2017, as a result of share-based award forfeitures, the Company recorded a reversal of previously recognized stock-based compensation expense of $52 and $57, respectively. In addition, had the Company continued to account for stock-based compensation expense related to forfeitures of share-based payments based on estimating the number of awards expected to be forfeited and recognizing only stock-based compensation expense on awards expected to vest, the Company would have recognized $778 and $1,705 of stock-based compensation expense, or $71 and $87 less than what was actually recorded, during the three and six months ended June 30, 2017, respectively.

The Company recognizes stock-based compensation in accordance with the provisions of ASC Topic 718, Compensation--Stock Compensation. Stock-based compensation expense, excluding compensation charges related to our employee stock purchase plan, or the ESPP, was $849 and $841 for the three months ended June 30, 2017 and 2016, respectively, and $1,792 and $1,881 for the six months ended June 30, 2017 and 2016, respectively. As of June 30, 2017, there was $1,794 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 3.13 years. As of June 30, 2017, there was $4,913 of total unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted-average period of 2.68 years.

Stock Options

During the three months ended June 30, 2017, no stock options were exercised for common stock. Additionally, during the three months ended June 30, 2017, no stock options were granted and 7 stock options were forfeited.

During the six months ended June 30, 2017, 114 stock options were exercised for common stock, none of which was delivered to the Company as payment for the exercise price or related minimum tax withholding obligations. Additionally, during the six months ended June 30, 2017, 531 stock options were granted with a weighted average grant date fair value of $2.47 per share and 11 stock options were forfeited. The Company has estimated the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions utilized to determine the fair value of options granted during the six months ended June 30, 2017 and 2016 were as follows:




	Six Months Ended June 30,
	2017		2016
Risk-free interest rate	1.96	%	1.43	%
Expected volatility	35.53	%	38.22	%
Expected life (in years)	4.22		4.17
Dividend yield	0	%	0	%

As of June 30, 2017, there were 1,018 options outstanding with a weighted average exercise price of $9.74 per share and 292 options exercisable with a weighted average exercise price of $12.31 per share.

Restricted Stock

During the three months ended June 30, 2017, 14 shares of restricted stock were granted with a weighted average grant date fair value of $9.47 per share and 17 shares of restricted stock were forfeited. Additionally, during the three months ended June 30, 2017, 10 shares of restricted stock vested, of which no shares of common stock were surrendered to the Company as payment by employees in lieu of cash to satisfy minimum tax withholding obligations in connection with the vesting of restricted stock.

During the six months ended June 30, 2017, 223 shares of restricted stock were granted with a weighted average grant date fair value of $8.39 per share and 17 shares of restricted stock were forfeited. Additionally, during the six months ended June 30, 2017, 243 shares of restricted stock vested, of which 43 shares of common stock were surrendered to the Company as payment by employees in lieu of cash to satisfy minimum tax withholding obligations in connection with the vesting of restricted stock and these shares were immediately retired.

As of June 30, 2017, there were 607 shares of restricted stock outstanding still subject to service-based vesting conditions.

As of June 30, 2017, the Company had no shares of restricted stock that were subject to performance-based or market-based vesting conditions.

(b) Employee Stock Purchase Plan

On June 15, 2016, at the Company's 2016 Annual Meeting of Stockholders, the stockholders of the Company approved amendments to the Company's Amended and Restated 1996 Employee Stock Purchase Plan (ESPP) that, among other things, increased the number of shares of common stock reserved for issuance to a total of 1,650. As amended, the ESPP affords eligible employees the right to purchase common stock, via payroll deductions, through various offering periods at a purchase price equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. During the three and six months ended June 30, 2017, 26 shares were issued under the ESPP plan. During the three and six months ended June 30, 2016, 0 and 18 shares were issued under the ESPP plan, respectively. The Company recorded compensation charges related to the ESPP of $3 and $0 for the three months ended June 30, 2017 and 2016, respectively, and $20 and $13 for the six months ended June 30, 2017 and 2016, respectively.

The following table presents stock-based compensation expense, including expense for the ESPP, in the Company's consolidated statements of operations for the six months ended June 30, 2017 and 2016:



	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
Cost of product sales	$	72	$	75	$	154	$	165
Cost of service sales	1		—		1		1
Research and development	170		166		359		352
Sales, marketing and support	221		251		489		524
General and administrative	388		336		809		839
	$	852	$	828	$	1,812	$	1,881

(d) Accumulated Other Comprehensive Loss

Comprehensive income (loss) includes net earnings (loss), unrealized gains and losses from foreign currency translation, unrealized gains and losses from available for sale marketable securities and changes in fair value related to interest rate swap derivative instruments, net of tax attributes, which were not material. The components of the Company’s comprehensive income (loss) and the effect on earnings for the periods presented are detailed in the accompanying consolidated statements of comprehensive income (loss).

The balances for the three months ended June 30, 2017 and 2016 are as follows:



	Foreign Currency Translation			Unrealized Gain (Loss) on Available for Sale Marketable Securities			Interest Rate Swaps			Total Accumulated Other Comprehensive Loss
Balance, March 31, 2017	$	(16,050	)	$	—		$	(131	)	$	(16,181	)
Other comprehensive income (loss) before reclassifications (1)	2,440			(3		)	(1		)	2,436
Amounts reclassified from AOCI to Other income, net (2)	—			—			19			19
Net other comprehensive income (loss), June 30, 2017	2,440			(3		)	18			2,455
Balance, June 30, 2017	$	(13,610	)	$	(3	)	$	(113	)	$	(13,726	)



	Foreign Currency Translation			Unrealized Gain (Loss) on Available for Sale Marketable Securities		Interest Rate Swaps			Total Accumulated Other Comprehensive Loss
Balance, March 31, 2016	$	(8,039	)	$	1	$	(258	)	$	(8,296	)
Other comprehensive loss before reclassifications (1)	(4,472		)	—		(16		)	(4,488		)
Amounts reclassified from AOCI to Other income, net (2)	—			—		25			25
Net other comprehensive (loss) income, June 30, 2016	(4,472		)	—		9			(4,463		)
Balance, June 30, 2016	$	(12,511	)	$	1	$	(249	)	$	(12,759	)

The balances for the six months ended June 30, 2017 and 2016 are as follows:



	Foreign Currency Translation			Unrealized Gain (Loss) on Available for Sale Marketable Securities			Interest Rate Swaps			Total Accumulated Other Comprehensive Loss
Balance, December 31, 2016	$	(16,651	)	$	—		$	(158	)	$	(16,809	)
Other comprehensive income (loss) before reclassifications (1)	3,041			(3		)	4			3,042
Amounts reclassified from AOCI to Other income, net (2)	—			—			41			41
Net other comprehensive income (loss), June 30, 2017	3,041			(3		)	45			3,083
Balance, June 30, 2017	$	(13,610	)	$	(3	)	$	(113	)	$	(13,726	)



	Foreign Currency Translation			Unrealized Gain (Loss) on Available for Sale Marketable Securities		Interest Rate Swaps			Total Accumulated Other Comprehensive Loss
Balance, December 31, 2015	$	(7,363	)	$	1	$	(238	)	$	(7,600	)
Other comprehensive loss before reclassifications (1)	(5,148		)	—		(61		)	(5,209		)
Amounts reclassified from AOCI to Other income, net (2)	—			—		50			50
Net other comprehensive loss, June 30, 2016	(5,148		)	—		(11		)	(5,159		)
Balance, June 30, 2016	$	(12,511	)	$	1	$	(249	)	$	(12,759	)

(1) For additional information, see Note 4, "Marketable Securities."

(2) For additional information, see Note 17, "Derivative Instruments and Hedging Activities."

(6) Net Loss per Common Share

Basic net loss per share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net loss per share incorporates the dilutive effect of common stock equivalent options, warrants and other convertible securities, if any, as determined with the treasury stock accounting method. For the three and six months ended, June 30, 2017 and 2016, since there was a net loss, the Company excluded all outstanding stock options and non-vested restricted shares from its diluted loss per share calculation, as inclusion of these securities would have reduced the net loss per share.

A reconciliation of the basic and diluted weighted average common shares outstanding is as follows:



	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2017	2016	2017	2016
Weighted average common shares outstanding—basic	16,446	15,825	16,354	15,774
Dilutive common shares issuable in connection with stock plans	—	—	—	—
Weighted average common shares outstanding—diluted	16,446	15,825	16,354	15,774

(7) Inventories

The Company adopted ASC 2015-11, Simplifying the Measurement of Inventory as of January 1, 2017. ASC 2015-11 simplifies the subsequent measurement of inventory by replacing the lower of cost or market test with a lower of cost or net realizable value test. The adoption of this standard did not have a material impact on the Company’s consolidated financial position or results of operations. Inventories are stated at the lower of cost or net realizable value using the first-in first-out costing method. Inventories as of June 30, 2017 and December 31, 2016 include the costs of material, labor, and factory overhead. Components of inventories consist of the following:



	June 30, 2017		December 31, 2016
Raw materials	$	11,946	$	10,606
Work in process	2,623		2,185
Finished goods	8,843		7,954
	$	23,412	$	20,745

(8) Property and Equipment

Property and equipment, net, as of June 30, 2017 and December 31, 2016 consist of the following:



	June 30, 2017			December 31, 2016
Land	$	3,828		$	3,828
Building and improvements	23,848			21,717
Leasehold improvements	354			155
Machinery and equipment	45,359			41,777
Office and computer equipment	16,828			14,824
Motor vehicles	51			51
	90,268			82,352
Less accumulated depreciation	(48,514		)	(45,766		)
	$	41,754		$	36,586

Depreciation expense was $1,614 and $1,815 for the three months ended June 30, 2017 and 2016, respectively, and $3,307 and $3,722 for the six months ended June 30, 2017 and 2016, respectively.

Included within machinery and equipment are certain revenue generating hardware assets that had a net book value of $8,080 and $7,734 as of June 30, 2017 and December 31, 2016, respectively, that are utilized in the delivery of the Company's airtime services, media, and other content.

(9) Product Warranty

The Company’s products carry standard limited warranties that range from one to two years and vary by product. The warranty period begins on the date of retail purchase or lease by the original purchaser. The Company accrues estimated product warranty costs at the time of sale and any additional amounts are recorded when such costs are probable and can be reasonably estimated. Factors that affect the Company’s warranty liability include the number of units sold or leased, historical and anticipated rates of warranty repairs and the cost per repair. Warranty and related costs are reflected within sales, marketing and support in the accompanying consolidated statements of operations. As of June 30, 2017 and December 31, 2016, the Company had accrued product warranty costs of $2,407 and $2,280, respectively.

The following table summarizes product warranty activity during 2017 and 2016:



	Six Months Ended
	June 30,
	2017			2016
Beginning balance	$	2,280		$	1,880
Charges to expense	500			1,044
Costs incurred	(373		)	(697		)
Ending balance	$	2,407		$	2,227

(10) Debt

Long-term debt consisted of the following:



	June 30, 2017		December 31, 2016
Term note	$	45,425	$	53,625
Mortgage loan	2,867		2,951
Equipment loans	—		1,477
Total	48,292		58,053
Less amounts classified as current	2,477		7,900
Long-term debt, excluding current portion	$	45,815	$	50,153

Term Note and Line of Credit

On July 1, 2014, the Company entered into (i) a five-year senior credit facility agreement (the Credit Agreement) with Bank of America, N.A., as Administrative Agent, and the lenders named from time to time as parties thereto (the Lenders), for an aggregate amount of up to $80,000, including a revolving credit facility (the Revolver) of up to $15,000 and a term loan (Term Loan) of $65,000 to be used for general corporate purposes, including both (A) the refinancing of the Company’s $30,000 then-outstanding indebtedness under its previous credit facility and (B) permitted acquisitions, (ii) revolving credit notes (together, the Revolving Credit Note) to evidence the Revolver, (iii) term notes (together, the Term Note, and together with the Revolving Credit Note, the Notes) to evidence the Term Loan, (iv) a Security Agreement (the Security Agreement) required by the Lenders with respect to the grant by the Company of a security interest in substantially all of the assets of the Company in order to secure the obligations of the Company under the Credit Agreement and the Notes, and (v) Pledge Agreements (the Pledge Agreements) required by the Lenders with respect to the grant by the Company of a security interest in 65% of the capital stock of each of KVH Industries A/S and KVH Industries U.K. Limited held by the Company in order to secure the obligations of the Company under the Credit Agreement and the Notes.

The Credit Agreement was amended in March 2017 to modify the Maximum Consolidated Leverage Ratio, the Applicable Rate, the Consolidated Fixed Charge Coverage Ratio and the amortization schedule of the Term Loan, as well as to make certain other changes. The amendment was accounted for as a debt modification as it did not result in a significant modification to the Credit Agreement.

In connection with the March 2017 amendment, the Company made an additional principal repayment of $6,000 on the Term Note and amended the repayment terms. Under the amended terms, the Company must make principal repayments of $575 every three months starting on April 1, 2017 until the Term Note maturity on July 1, 2019. On the maturity date, the entire remaining principal balance of the loan, including any future loans under the Revolver, is due and payable, together with all accrued and unpaid interest, penalties, and any other amounts due and payable under the Credit Agreement. The Credit Agreement contains provisions requiring the mandatory prepayment of amounts outstanding under the Term Loan and the Revolver under specified circumstances, including (i) 100% of the net cash proceeds from certain dispositions to the extent not reinvested in the Company’s business within a stated period, (ii) 50% of the net cash proceeds from stated equity issuances and (iii) 100% of the net cash proceeds from certain receipts of more than $250 outside the ordinary course of business. The prepayments are first applied to the Term Loan, in inverse order of maturity, and then to the Revolver. In the discretion of the Administrative Agent, certain mandatory prepayments made on the Revolver can permanently reduce the amount of credit available under the Revolver.

Loans under the Credit Agreement bear interest at varying rates determined in accordance with the Credit Agreement. Each LIBOR Rate Loan, as defined in the Credit Agreement, bears interest on the outstanding principal amount thereof for each interest period from the applicable borrowing date at a rate per annum equal to the LIBOR Daily Floating Rate or LIBOR Monthly Floating Rate, each as defined in the Credit Agreement, as applicable, plus the Applicable Rate, as defined in the Credit Agreement, and each Base Rate Loan, as defined in the Credit Agreement, bears interest on the outstanding principal amount thereof from the applicable borrowing date at a rate per annum equal to the Base Rate, as defined in the Credit Agreement, plus the Applicable Rate. The Applicable Rate ranges from 1.75% to 2.25%, depending on the Company’s Consolidated Leverage Ratio, as defined in the Credit Agreement. The highest Applicable Rate applies when the Consolidated Leverage Ratio exceeds 1.50:1.00. Upon certain defaults, including failure to make payments when due, interest becomes payable at a higher default rate.

Borrowings under the Revolver are subject to the satisfaction of numerous conditions precedent at the time of each borrowing, including the continued accuracy of the Company’s representations and warranties and the absence of any default under the Credit Agreement. As of June 30, 2017, there were no borrowings outstanding under the Revolver and the full balance of $15,000 was available for borrowing.

The Credit Agreement contains two financial covenants, a Maximum Consolidated Leverage Ratio and a Minimum Consolidated Fixed Charge Coverage Ratio, each as defined in the Credit Agreement. The Maximum Consolidated Leverage Ratio may not be greater than 1.50:1.00. The Minimum Consolidated Fixed Charge Coverage Ratio may not be less than 1.25:1.00. In the March 2017 amendment, the definition of the Consolidated Fixed Charge Coverage Ratio was amended to include only maintenance capital expenditures as defined. The Company was in compliance with these financial ratio debt covenants as of June 30, 2017.

The Credit Agreement imposes certain other affirmative and negative covenants, including without limitation covenants with respect to the payment of taxes and other obligations, compliance with laws, entry into material contracts, creation of liens, incurrence of indebtedness, investments, dispositions, fundamental changes, restricted payments, changes in the nature of the Company’s business, transactions with affiliates, corporate and accounting changes, and sale and leaseback arrangements.

The Company’s obligation to repay loans under the Credit Agreement could be accelerated upon a default or event of default under the terms of the Credit Agreement, including certain failures to pay principal or interest when due, certain breaches of representations and warranties, the failure to comply with the Company’s affirmative and negative covenants under the Credit Agreement, a change of control of the Company, certain defaults in payment relating to other indebtedness, the acceleration of payment of certain other indebtedness, certain events relating to the liquidation, dissolution, bankruptcy, insolvency or receivership of the Company, the entry of certain judgments against the Company, certain events relating to the impairment of collateral or the Lenders' security interest therein, and any other material adverse change with respect to the Company.

Mortgage Loan

The Company has a mortgage loan (as amended, the Mortgage Loan) in the amount of $4,000 related to its headquarters facility in Middletown, Rhode Island. The loan term is ten years, with a principal amortization of 20 years. The interest rate is based on the BBA LIBOR Rate plus 2.00 percentage points. The Mortgage Loan is secured by the underlying property and improvements. The monthly mortgage payment is approximately $14, plus interest, and increases in increments of approximately $1 each year over the life of the mortgage. Due to the difference in the term of the loan and amortization of the principal, a balloon payment of $2,551 is due on April 6, 2019. The loan contains one financial covenant, a Fixed Charge Coverage Ratio, which applies in the event that the Company's consolidated cash, cash equivalents and marketable securities balance falls below $25,000 at any time. As the Company's consolidated cash, cash equivalents, and marketable securities balance was above the minimum threshold throughout the six months ended June 30, 2017, the Fixed Charge Coverage Ratio did not apply.

Under the Mortgage Loan, the Company may prepay its outstanding loan balance subject to certain early termination charges as defined in the Mortgage Loan agreement. If the Company were to default on the Mortgage Loan, the underlying and improvements would be used as collateral. As discussed in Note 17, the Company entered into two interest rate swap agreements that are intended to hedge its mortgage interest obligations by fixing the interest rates specified in the Mortgage Loan to 5.91% for half of the principal amount outstanding and 6.07% for the remaining half of the principal amount outstanding as of April 1, 2010, over the term of the Mortgage Loan.

Equipment Loans

In January 2013, the Company borrowed $4,700 from a bank and pledged as collateral six satellite hubs and related equipment. This equipment loan had a term of five years, and carried a fixed rate of interest of 2.76% per annum. In December 2013, the Company borrowed $1,200 from a bank and pledged as collateral one satellite hub and related equipment. This equipment loan had a term of five years, and carried a fixed rate of interest of 3.08% per annum. In March 2017, the Company repaid in full the remaining outstanding balances of both loans before their 2018 maturity dates.

(11) Segment Reporting

The financial results of each segment are based on revenues from external customers, cost of revenue and operating expenses that are directly attributable to the segment and an allocation of costs from shared functions. These shared functions include, but are not limited to, facilities, human resources, information technology, and engineering. Allocations are made based on management’s judgment of the most relevant factors, such as head count, number of customer sites, or other operational data that contribute to the shared costs. Certain corporate-level costs have not been allocated as they are not directly attributable to either segment. These costs primarily consist of broad corporate functions, including executive, legal, finance, and costs associated with corporate actions. Segment-level asset information has not been provided as such information is not reviewed by the chief operating decision-maker for purposes of assessing segment performance and allocating resources. There are no inter-segment sales or transactions.

The Company's performance is impacted by the levels of activity in the marine and land mobile markets and defense sectors, among others. Performance in any particular period could be impacted by the timing of sales to certain large customers.

The mobile connectivity segment primarily manufactures and distributes a comprehensive family of mobile satellite antenna products and services that provide access to television, the Internet and voice services while on the move. Product sales within the mobile connectivity segment accounted for 22% and 25% of consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 23% and 26% of consolidated net sales for the six months ended June 30, 2017 and 2016, respectively. Sales of mini-VSAT Broadband airtime service accounted for 41% and 35% of consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 40% and 35% of consolidated net sales for the six months ended June 30, 2017 and 2016, respectively. Sales of content and training services within the mobile connectivity segment accounted for 20% and 19% of consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 20% and 20% of consolidated net sales for the six months ended June 30, 2017 and 2016, respectively.

The inertial navigation segment manufactures and distributes a portfolio of digital compass and fiber optic gyro (FOG)-based systems that address the rigorous requirements of military and commercial customers and provide reliable, easy-to-use and continuously available navigation and pointing data. The principal product categories in this segment include the FOG-based inertial measurement units (IMUs) for precision guidance, FOGs for tactical navigation as well as pointing and stabilization systems, and digital compasses that provide accurate heading information for demanding applications, security, automation and access control equipment and systems. Sales of FOG-based guidance and navigation systems within the inertial navigation segment accounted for 12% and 9% of the consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 11% and 10% of the consolidated net sales for the six months ended June 30, 2017 and 2016, respectively.

No other single product class accounts for 10% or more of consolidated net sales.

The Company operates in a number of major geographic areas across the globe. The Company generates international net sales, based upon customer location, primarily from customers located in Canada, Europe, Africa, Asia/Pacific, the Middle East, and India. International revenues represented 62% and 63% of consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 61% and 63% of consolidated net sales for the six months ended June 30, 2017 and 2016, respectively. Sales to Canada represented 13% of consolidated net sales for the three months ended June 30, 2016. No other individual foreign country represented 10% or more of the Company's consolidated net sales for the three months ended June 30, 2017 and 2016. No individual foreign country represented 10% or more of consolidated net sales for the six months ended June 30, 2017 and 2016.

As of June 30, 2017 and December 31, 2016, the long-lived tangible assets related to the Company’s international subsidiaries were less than 10% of the Company’s long-lived tangible assets and were deemed not material.

Net sales and operating earnings (loss) for the Company's reporting segments and the Company's loss before income tax expense (benefit) for the three and six months ended June 30, 2017 and 2016 were as follows:



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2017			2016			2017			2016
Net sales:
Mobile connectivity	$	34,034		$	36,890		$	68,321		$	72,155
Inertial navigation	6,415			9,076			12,339			14,191
Consolidated net sales	$	40,449		$	45,966		$	80,660		$	86,346

Operating earnings (loss):
Mobile connectivity	$	2,638		$	1,631		$	3,260		$	3,621
Inertial navigation	362			1,596			318			669
Subtotal	3,000			3,227			3,578			4,290
Unallocated, net	(4,368		)	(3,920		)	(9,416		)	(8,357		)
Loss from operations	(1,368		)	(693		)	(5,838		)	(4,067		)
Net interest and other (expense) income	(302		)	(91		)	(557		)	(438		)
Loss before income tax expense (benefit)	$	(1,670	)	$	(784	)	$	(6,395	)	$	(4,505	)

Depreciation expense and amortization expense for the Company's segments are presented in the following table for the periods presented:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2017		2016		2017		2016
Depreciation expense:
Mobile connectivity	$	1,394	$	1,567	$	2,872	$	3,226
Inertial navigation	199		224		395		448
Unallocated	21		24		40		48
Total consolidated depreciation expense	$	1,614	$	1,815	$	3,307	$	3,722

Amortization expense:
Mobile connectivity	$	1,102	$	1,250	$	2,170	$	2,533
Inertial navigation	—		—		—		—
Unallocated	—		—		—		—
Total consolidated amortization expense	$	1,102	$	1,250	$	2,170	$	2,533

(12) Legal Matters

From time to time, the Company is involved in litigation incidental to the conduct of its business. In the ordinary course of business, the Company is a party to inquiries, legal proceedings and claims including, from time to time, disagreements with vendors and customers. The Company is not a party to any lawsuit or proceeding that, in management's opinion, is likely to materially harm the Company's business, results of operations, financial condition, or cash flows.

(13) Share Buyback Program

On November 26, 2008, the Company’s Board of Directors authorized a program to repurchase up to 1,000 shares of the Company’s common stock. As of June 30, 2017, 341 shares of the Company’s common stock remain available for repurchase under the authorized program. The repurchase program is funded using the Company’s existing cash, cash equivalents, marketable securities and future cash flows. Under the repurchase program, the Company, at management’s discretion, may repurchase shares on the open market from time to time, in privately negotiated transactions or block transactions, or through an accelerated repurchase agreement. The timing of such repurchases depends on availability of shares, price, market conditions, alternative uses of capital, and applicable regulatory requirements. The program may be modified, suspended or terminated at any time without prior notice. The repurchase program has no expiration date. There were no other repurchase programs outstanding during the six months ended June 30, 2017 and no repurchase programs expired during the period.

During the six months ended June 30, 2017 and 2016, the Company did not repurchase any shares of its common stock.

(14) Fair Value Measurements

ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820), provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value:


Level 1:	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company’s Level 1 assets are investments in money market mutual funds, U.S. treasury securities, and certificates of deposit.


Level 2:	Quoted prices for similar assets or liabilities in active markets; or observable prices that are based on observable market data, based on directly or indirectly market-corroborated inputs. The Company’s Level 2 liabilities are interest rate swaps.


Level 3:	Unobservable inputs that are supported by little or no market activity, and are developed based on the best information available given the circumstances. The Company has no Level 3 assets.

Assets and liabilities measured at fair value are based on the valuation techniques identified in the table below. The valuation techniques are:


(a)	Market approach—prices and other relevant information generated by market transactions involving identical or comparable assets.

(b)

The valuations of the interest rate swaps intended to mitigate the Company’s interest rate risk are determined with the assistance of a third-party financial institution using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each instrument. This analysis utilizes observable market-based inputs, including interest rate curves and interest rate volatility, and reflects the contractual terms of these instruments, including the period to maturity.

The following tables present financial assets and liabilities at June 30, 2017 and December 31, 2016 for which the Company measures fair value on a recurring basis, by level, within the fair value hierarchy:



June 30, 2017	Total		Level 1		Level 2		Level 3		Valuation Technique
Assets
Money market mutual funds	$	8,031	$	8,031	$	—	$	—	(a)
United States treasuries	4,011		4,011		—		—		(a)
Certificates of deposit	1,729		1,729		—		—		(a)
Liabilities
Interest rate swaps	113		—		113		—		(b)



December 31, 2016	Total		Level 1		Level 2		Level 3		Valuation Technique
Assets
Money market mutual funds	$	21,848	$	21,848	$	—	$	—	(a)
Certificates of deposit	3,864		3,864		—		—		(a)
Liabilities
Interest rate swaps	158		—		158		—		(b)

Certain financial instruments are carried at cost on the consolidated balance sheets, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses. The carrying amount of the Company's debt approximates fair value based on currently

available quoted rates of similarly structured debt.

Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

The Company's non-financial assets, such as goodwill, intangible assets, and other long-lived assets resulting from business combinations, are measured at fair value using income approach valuation methodologies at the date of acquisition and subsequently re-measured if an impairment exists. There were no impairments of the Company’s non-financial assets noted as of June 30, 2017. The Company does not have any liabilities that are recorded at fair value on a non-recurring basis.

(15) Goodwill and Intangible Assets

Goodwill

The following table sets forth the changes in the carrying amount of goodwill for the six months ended June 30, 2017:



	Amounts
Balance at December 31, 2016	$	31,343
Foreign currency translation adjustment	1,459
Balance at June 30, 2017	$	32,802

ASC Topic 350, Intangibles—Goodwill and Other (ASC 350) requires the completion of a goodwill impairment test at least annually. Historically, this goodwill impairment test was comprised of a two-step process. The first step compares the carrying value of the Company’s reporting units to their estimated fair values as of the test date. If fair value is less than carrying value, a second step is performed to quantify the amount of the impairment, if any. As of August 31, 2016 (the Company's annual goodwill impairment test date), the Company performed its annual impairment test for goodwill at the reporting unit level and, after conducting the first step, determined that it was not necessary to conduct the second step as it concluded that the fair value of its reporting units exceeded their carrying value. If different assumptions were used, particularly with respect to estimating future cash flows, weighted average costs of capital, and terminal growth rates, different estimates of fair value may have resulted. However, based on the excess of fair value over carrying value and additional sensitivity analysis considered with respect to the Company’s valuation assumptions, the Company concluded that it was more likely than not that no goodwill impairment exists. As of August 31, 2016, the Company noted that the fair value of all of the Company’s reporting units exceeded their carrying values by more than 10%. The Company notes that its one reporting unit whose fair value exceeded its carrying value by less than 100% had goodwill of approximately $4,401 at June 30, 2017.

In January 2017, the FASB issued ASC Update No. 2017-04, Intangibles--Goodwill and Other (Topic 350): Simplifying the Test of Goodwill Impairment. This ASC simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step of the goodwill impairment test under ASC 350. Under previous guidance, if the fair value of a reporting unit is lower than its carrying amount (Step 1), an entity calculates any impairment charge by comparing the implied fair value of goodwill with its carrying amount (Step 2). The implied fair value of goodwill is calculated by deducting the fair value of all assets and liabilities of the reporting unit from the reporting unit’s fair value as determined in Step 1. To determine the implied fair value of goodwill, entities estimate the fair value of any unrecognized intangible assets (including in-process research and development) and any corporate-level assets or liabilities that were included in the determination of the carrying amount and fair value of the reporting unit in Step 1. Under this new guidance if a reporting unit's carrying value exceeds its fair value, an entity will record an impairment charge based on that difference with such impairment charge limited to the amount of goodwill in the reporting unit. This ASC does not change the guidance on completing Step 1 of the goodwill impairment test. An entity will still be able to perform today’s optional qualitative goodwill impairment assessment before determining whether to proceed to Step 1. This ASC will be applied prospectively and is effective for annual and interim impairment test performed in periods beginning after December 15, 2019 for public business enterprises. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The Company has elected to early adopt this ASC as of January 1, 2017. The adoption of this ASC had no impact on the Company's consolidated statements of operations, financial condition or cash flows. The Company evaluated whether any potential indicators of impairment existed as of June 30, 2017 that would require an interim goodwill impairment test. Although the Company has experienced a decline in sales within its mobile connectivity operating segment, which is the operating segment that contains all of the Company's reporting units with goodwill, the overall period and magnitude of the decline has not been significant and the operating results of its reporting units with goodwill have not differed significantly from the forecasted results utilized in the last annual goodwill impairment test completed as of August 31, 2016. In addition, the operating earnings of the Company's mobile connectivity operating segment increased by 62% for the three months ended June 30, 2017 as compared to the same period of the prior year. As a result, for the two reporting units that had over 100% excess of fair value over carrying value of the reporting unit's respective net assets as of August 31, 2016, given the current and forecasted operating trends, the Company does not believe that there is a significant risk related to a potential goodwill impairment. These two reporting units represent $28,401, or 87%, of the Company's total consolidated goodwill as of June 30, 2017. With respect to the Company other reporting unit with goodwill of $4,401 as of June 30, 2017, the Company does note that a continued further decline sales or operating results could result in a goodwill impairment.

Intangible Assets

The changes in the carrying amount of intangible assets during the six months ended June 30, 2017 are as follows:



	Amounts
Balance at December 31, 2016	$	17,838
Amortization expense	(2,170		)
Intangible assets acquired in asset acquisition	100
Foreign currency translation adjustment	889
Balance at June 30, 2017	$	16,657

Intangible assets arose from an acquisition made prior to 2013, the acquisition of KVH Media Group (acquired as Headland Media Limited) in May 2013 and the acquisition of Videotel in July 2014. Intangibles arising from the acquisition made prior to 2013 are being amortized on a straight-line basis over an estimated useful life of 7 years. Intangibles arising from the acquisition of KVH Media Group are being amortized on a straight-line basis over the estimated useful life of: (i) 10 years for acquired subscriber relationships, (ii) 15 years for distribution rights, (iii) 3 years for internally developed software and (iv) 2 years for proprietary content. Intangibles arising from the acquisition of Videotel are being amortized on a straight-line basis over the estimated useful life of: (i) 8 years for acquired subscriber relationships, (ii) 5 years for favorable leases, (iii) 4 years for internally developed software and (iv) 5 years for proprietary content. The intangibles arising from the KVH Media Group and Videotel acquisitions were recorded in pounds sterling and fluctuations in exchange rates could cause these amounts to increase or decrease from time to time.

In January 2017, the Company completed the acquisition of certain subscriber relationships from a third party. This acquisition did not meet the definition of a business under ASC 2017-01, Business Combinations (Topic 805)-Clarifying the Definition of a Business, which the Company adopted on October 1, 2016. The Company ascribed $100 of the initial purchase price to the acquired subscriber relationships definite-lived intangible assets with an initial estimated useful life of 10 years. Under the asset purchase agreement, the purchase price includes a component of contingent consideration under which the Company is required to pay a percentage of recurring revenues received from the acquired subscriber relationships through 2026 up to a maximum annual payment of $114. As the acquisition did not represent a business combination, the contingent consideration arrangement is

recognized only when the contingency is resolved and the consideration is paid or becomes payable. The amounts payable under the contingent consideration arrangement, if any, will be included in the measurement of the cost of the acquired subscriber relationships. During the six months ended June 30, 2017, no additional consideration was earned under the contingent consideration arrangement.

Acquired intangible assets are subject to amortization. The following table summarizes acquired intangible assets at June 30, 2017 and December 31, 2016, respectively:



	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value
June 30, 2017
Subscriber relationships	$	17,523	$	7,366	$	10,157
Distribution rights	4,277		1,312		2,965
Internally developed software	2,318		2,064		254
Proprietary content	8,128		5,152		2,976
Intellectual property	2,284		2,219		65
Favorable lease	641		401		240
	$	35,171	$	18,514	$	16,657
December 31, 2016
Subscriber relationships	$	16,888	$	6,431	$	10,457
Distribution rights	4,122		1,180		2,942
Internally developed software	2,301		1,904		397
Proprietary content	7,960		4,431		3,529
Intellectual property	2,284		2,056		228
Favorable lease	627		342		285
	$	34,182	$	16,344	$	17,838

Amortization expense related to intangible assets for the three and six months ended June 30, 2017 and 2016 was as follows:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
Expense Category	2017		2016		2017		2016
Cost of service sales	$	367	$	417	$	722	$	869
General administrative expense	735		833		1,448		1,664
Total amortization expense	$	1,102	$	1,250	$	2,170	$	2,533

As of June 30, 2017, the total weighted average remaining useful lives of the definite-lived intangible assets was 4.7 years and the weighted average remaining useful lives by the definite-lived intangible asset category are as follows:



Intangible Asset	Weighted Average Remaining Useful Life in Years
Subscriber relationships	5.3
Distribution rights	10.8
Internally developed software	0.9
Proprietary content	2.0
Intellectual property	0.3
Favorable lease	2.0

Estimated future amortization expense remaining at June 30, 2017 for intangible assets acquired is as follows:



Remainder of 2017	$	2,113
2018	3,931
2019	3,007
2020	2,206
2021	2,206
Thereafter	3,194
Total future amortization expense	$	16,657

For intangible assets, the Company assesses the carrying value of these assets whenever events or circumstances indicate that the carrying value may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset, or asset group, to the future undiscounted cash flows expected to be generated by the asset, or asset group. There were no events or changes in circumstances during the second quarter of 2017 which indicated that an assessment of the impairment of goodwill and intangible assets was required.

(16) Business and Credit Concentrations

Concentrations of risk with respect to trade accounts receivable are generally limited due to the large number of customers and their dispersion across several geographic areas. Although the Company does not foresee that credit risk associated with these receivables will deviate from historical experience, repayment is dependent upon the financial stability of those individual customers. The Company establishes allowances for potential bad debts and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and its expectations for future collectability concerns. The Company performs ongoing credit evaluations of the financial condition of its customers and generally does not require collateral.

No single customer accounted for 10% or more of consolidated net sales for three and six months ended June 30, 2017 or 2016 or accounts receivable at June 30, 2017 or December 31, 2016.

Certain components from third parties used in the Company’s products are procured from single sources of supply. The failure of a supplier, including a subcontractor, to deliver on schedule could delay or interrupt the Company’s delivery of products and thereby materially adversely affect the Company’s revenues and operating results.

(17) Derivative Instruments and Hedging Activities

Effective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, the Company entered into two interest rate swap agreements. These interest rate swap agreements are intended to hedge the Company’s mortgage loan related to its headquarters facility in Middletown, Rhode Island by fixing the interest rates specified in the mortgage loan to 5.9% for half of the principal amount outstanding and 6.1% for the remaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019. The Company does not use derivatives for speculative purposes. For a derivative that is designated as a cash flow hedge, changes in the fair value of the derivative are recognized in accumulated other comprehensive (loss) income (AOCI) to the extent the derivative is effective at offsetting the changes in the cash flows being hedged until the hedged item affects earnings. As the Company makes the required principal and interest payments under the mortgage loan and the related interest rate swaps are settled, the Company reclassifies the amounts recorded in AOCI related to the changes in the fair value of the settled interest rate swaps to earnings. To the extent there is any hedge ineffectiveness, changes in fair value relating to the ineffective portion are immediately recognized in earnings in other income (expense) in the consolidated statements of income. The interest rate swap is recorded within accrued other liabilities on the balance sheet. The critical terms of the interest rate swaps were designed to mirror the terms of the Company’s mortgage loans. The Company designated these derivatives as cash flow hedges of the variability of the LIBOR-based interest payments on principal over a nine-year period, which ends on April 1, 2019. As of June 30, 2017, the Company determined that the existence of hedge ineffectiveness, if any, was immaterial and all changes in the fair value of the interest rate caps were recorded in the consolidated statements of comprehensive (loss) income as a component of AOCI.

As of June 30, 2017, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:



Interest Rate Derivatives	Notional (in thousands)		Asset (Liability)			Effective Date	Maturity Date	Index	Strike Rate
Interest rate swap	$	1,433	$	(54	)	April 1, 2010	April 1, 2019	1-month LIBOR	5.91	%
Interest rate swap	$	1,433	$	(59	)	April 1, 2010	April 1, 2019	1-month LIBOR	6.07	%

As of December 31, 2016, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:



Interest Rate Derivatives	Notional (in thousands)		Asset (Liability)			Effective Date	Maturity Date	Index	Strike Rate
Interest rate swap	$	1,476	$	(76	)	April 1, 2010	April 1, 2019	1-month LIBOR	5.91	%
Interest rate swap	$	1,476	$	(82	)	April 1, 2010	April 1, 2019	1-month LIBOR	6.07	%

(18) Income Taxes

The Company’s effective tax rate for the three and six months ended June 30, 2017 was (21.3)% and (8.1)%, respectively, compared with (2.8)% and (20.2)% for the corresponding periods in the prior year, respectively. The effective income tax rates are based on estimated income for the year, the estimated composition of the income in different jurisdictions and discrete adjustments, if any, in the applicable periods, including retroactive changes in tax legislation, settlements of tax audits or assessments, the resolution or identification of tax position uncertainties and acquisitions of other companies.

For both the three and six months ended June 30, 2017, the effective tax rates were lower than the statutory tax rate primarily due to the Company maintaining a valuation allowance reserve on its US deferred tax assets and the composition of income from foreign jurisdictions that were taxed at lower rates compared to the statutory tax rates in the U.S. For the three and six months ended June 30, 2016, the effective tax rates were lower than the statutory tax rate primarily due to the composition of income from foreign jurisdictions taxed at lower rates.

As of January 1, 2017 the Company adopted ASC 2016-09, Improvements to Employee Share-Based Payment Accounting (ASC 2016-09). In accordance with ASC 2016-09, previously unrecognized excess tax benefits are recognized on a modified retrospective basis. On January 1, 2017, the Company recorded a $1,117 deferred tax asset related to unrecognized excess tax benefits with an offsetting adjustment to retained earnings. As the Company had previously recorded a full valuation allowance on its U.S. deferred tax assets, a corresponding increase to the valuation allowance was recorded with an offsetting adjustment to retained earnings. During the three and six months ended June 30, 2017, exercises of non-qualified stock options and releases of restricted stock awards resulted in shortfalls and related tax expense of $50 and $392, respectively. The Company also recorded offsetting tax benefits of $50 and $392 resulting from corresponding decreases to the valuation allowance for the three and six months ended June 30, 2017, respectively.

As of June 30, 2017 and December 31, 2016, the Company had reserves for uncertain tax positions of $1,356 and $1,283, respectively. The Company incurred $11 and $22 in interest and penalties for the three and six months ended June 30, 2017, respectively, which were recorded as a component of income tax expense. There were no material changes during the six months ended June 30, 2017 to the Company’s reserve for uncertain tax positions. The Company does not expect that its unrecognized tax benefits will materially change within the next twelve months.

The Company is subject to taxation in the U.S. and various state and foreign jurisdictions. The Company's tax years from 2013 through 2016 are subject to examination by these various tax authorities. With few exceptions, the Company is no longer subject to U.S. federal, state, local and foreign examinations by tax authorities for years before 2013.


ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The statements included in this quarterly report on Form 10-Q, other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include statements regarding our future financial results, operating results, business strategies, projected costs, products and services, competitive positions and plans, customer preferences, consumer trends, anticipated product development, and objectives of management for future operations. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,” or the negative of these terms or other comparable terminology. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in the section entitled “Risk Factors” in Item 1A of Part I of our annual report on Form 10-K for the year ended December 31, 2016. These and many other factors could affect our future financial and operating results, and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by us or on our behalf. For example, our expectations regarding certain items as a percentage of sales assume that we will achieve our anticipated sales goals. The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report.

Overview

We design, develop, manufacture and market mobile connectivity products and services for the marine and land mobile markets, and navigation, guidance and stabilization products for both the defense and commercial markets. We operate in two operating segments based on product lines: mobile connectivity and inertial navigation.

Mobile Connectivity Segment

Our mobile connectivity segment offers satellite communications products and services. Our mobile connectivity products enable customers to receive voice and Internet services and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. Our CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. We sell and lease our mobile connectivity products through an extensive international network of dealers and distributors. We also sell and lease products directly to end users. In the second quarter of 2017, we launched a new mini-VSAT Broadband service offering, AgilePlans, which is a monthly subscription model providing global connectivity to commercial maritime customers, including hardware, installation, broadband Internet, VOIP, entertainment and training content and global support for a monthly fee with no minimum commitment. We offer AgilePlans customers a variety of airtime data plans with varying data speeds and fixed data usage levels with overage charges per megabyte, which is similar to the plans that we offer to our other customers. We will recognize the monthly subscription fee as service revenue over the service delivery period. We retain ownership of the hardware that we provide to AgilePlans customers, who must return the hardware to us when they terminate our service. Because we do not sell the hardware under AgilePlans, we do not recognize any product revenue when hardware is deployed to an AgilePlans customer. To the extent that customers select the AgilePlans model, we expect product revenue to decline commensurately. We record the cost of the hardware used by AgilePlans customers as revenue-generating assets and depreciate the cost over an estimated useful life of five years. To the extent that AgilePlans are successful, our capital expenditures and related depreciation expense could increase significantly. Further, without upfront capital costs and longer-term contractual commitments from customers, we may experience increased rates of terminations, as well as increased costs of recovering hardware, write-offs of equipment damaged in shipment or deemed unrecoverable, and higher bad debt expense. Since we are retaining ownership of the hardware, we will not accrue any warranty costs for AgilePlans hardware; however, any maintenance costs on the hardware will be expensed in the period these costs are incurred rather than charged against our warranty reserve, which may lead to increased period-to-period variability in costs of service sales and gross profit.

Our mobile connectivity service sales include sales of satellite voice and Internet airtime services, engineering services provided under development contracts, sales from product repairs, and extended warranty sales. Our mobile connectivity service sales also include our distribution of entertainment, including news, sports, music, and movies, to commercial and leisure customers in the maritime, hotel, and retail markets through KVH Media Group, as well as the distribution of training films and eLearning computer-based training courses to commercial customers in the maritime market through our Videotel business. We typically recognize revenue from media content sales ratably over the period of the service contract. We provide, for monthly fixed and usage fees, satellite connectivity services for broadband Internet, data and Voice over Internet Protocol (VoIP) service to our TracPhone V-series customers. We also earn monthly usage fees for third-party satellite connectivity for voice, data and Internet services to our Inmarsat and Iridium customers who choose to activate their subscriptions with us. Our service sales have grown as a percentage of total revenue from 56% and 59% of our net sales for the three and six months ended June 30, 2016, respectively, to 65% and 64% for the three and six months ended June 30, 2017, respectively. The majority of KVH Media Group's and Videotel’s services are invoiced in pounds sterling, which increases our exposure to fluctuations in exchange rates.

Our leisure marine business within the mobile connectivity segment is highly seasonal, and seasonality can also impact our commercial marine business. Historically, we have generated the majority of our leisure marine product revenues during the first and second quarters of each year, and these revenues typically decline in the third and fourth quarters of each year, compared to the first two quarters. Temporary suspensions of our airtime services typically increase in the third and fourth quarters of each year as boats are placed out of service during the winter months.

Inertial Navigation Segment

Our inertial navigation segment offers precision fiber optic gyro (FOG)-based systems that enable platform and optical stabilization, navigation, pointing, and guidance. Our inertial navigation products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in a variety of military vehicles, including tactical trucks and light armored vehicles. Our inertial navigation products are sold directly to U.S. and foreign governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, our inertial navigation products are used in numerous commercial products, such as navigation and positioning systems for various applications including precision mapping, dynamic surveying, autonomous vehicles, train location control and track geometry measurement systems, industrial robotics and optical stabilization.

We generate sales primarily from the sale of our mobile connectivity systems and services and our inertial navigation products and services. The following table provides, for the periods indicated, our sales by segment:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2017		2016		2017		2016
	(in thousands)				(in thousands)
Mobile connectivity	$	34,034	$	36,890	$	68,321	$	72,155
Inertial navigation	6,415		9,076		12,339		14,191
Net sales	$	40,449	$	45,966	$	80,660	$	86,346

Product sales within the mobile connectivity segment accounted for 22% and 25% of our consolidated net sales for the three months ended June 30, 2017 and 2016, respectively and 23% and 26% of our consolidated net sales for the six months ended June 30, 2017 and 2016, respectively. Sales of mini-VSAT Broadband airtime service accounted for 41% and 35% of our consolidated net sales for the three months ended June 30, 2017 and 2016, respectively and 40% and 35% of our consolidated net sales for the six months ended June 30, 2017 and 2016, respectively. Sales of content and training service sales within the mobile connectivity segment accounted for 20% and 19% of our consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 20% and 20% of our consolidated net sales for the six months ended June 30, 2017 and 2016, respectively.

Within our inertial navigation segment, net sales of FOG-based guidance and navigation systems accounted for 12% and 9% of our consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 11% and 10% of our consolidated net sales for the six months ended June 30, 2017 and 2016, respectively.

No other single product class accounts for 10% or more of our consolidated net sales for the three months ended June 30, 2017 and 2016 and six months ended June 30, 2017 and 2016, respectively. No individual customer accounted for 10% or more of our consolidated net sales for the three months ended June 30, 2017 and 2016 or the six months ended June 30, 2017 and 2016, respectively.

We operate in a number of major geographic areas across the globe. We generate our international net sales, based upon customer location, primarily from customers located in Canada, Europe, Africa, Asia/Pacific, the Middle East, and India. Our international net sales totaled 62% and 63% of our consolidated net sales for the three months ended June 30, 2017 and 2016, respectively, and 61% and 63% of our consolidated net sales for the six months ended June 30, 2017 and 2016, respectively. Sales to Canada represented 13% of our consolidated net sales for the three months ended June 30, 2016. No other individual foreign country represented 10% or more of our consolidated net sales for the three months ended June 30, 2017 and 2016. No individual foreign country represented 10% or more of our consolidated net sales for the six months ended June 30, 2017 and 2016.

In addition to our internally funded research and development efforts, we also conduct research and development activities that are funded by our customers. These activities relate primarily to engineering studies, surveys, prototype development, program management, and standard product customization. In accordance with accounting principles generally accepted in the United States of America, we account for customer-funded research as service revenue, and we account for the associated research and development costs as costs of service and product sales. As a result, customer-funded research and development are not included in the research and development expense that we present in our statement of operations. The following table presents our total

annual research and development effort, representing the sum of research costs of service and product sales and the operating expense of research and development as described in our statement of operations. Our management believes this information is useful because it provides a better understanding of our total expenditures on research and development activities.



	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
	(in thousands)				(in thousands)
Research and development expense presented on the statement of operations	$	3,761	$	4,037	$	7,708	$	7,820
Costs of customer-funded research and development included in costs of service sales	530		123		1,039		270
Total consolidated statements of operations expenditures on research and development activities	$	4,291	$	4,160	$	8,747	$	8,090

Critical Accounting Policies and Significant Estimates

The discussion and analysis of our financial condition and results of operations are based upon 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 judgments that affect the reported amounts of assets and liabilities, sales and expenses, and related disclosure at the date of our financial statements. Our significant accounting policies are summarized in Note 1 to the consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2016.

As described in our annual report on Form 10-K for the year ended December 31, 2016, our most critical accounting policies and estimates upon which our consolidated financial statements were prepared were those relating to revenue recognition, valuation of accounts receivable, valuation of inventory, valuations and purchase price allocations related to business combinations, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of long-lived assets, including goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, key valuation assumptions for its share-based awards, estimated fulfillment costs for warranty obligations, tax reserves and recoverability of the our net deferred tax assets and related valuation allowance. We have reviewed our policies and estimates and determined that these remain our most critical accounting policies and estimates for the six months ended June 30, 2017.

Readers should refer to our annual report on Form 10-K for the year ended December 31, 2016 under “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Critical Accounting Policies and Significant Estimates” for descriptions of these policies and estimates, as well as the notes to the consolidated financial statements included elsewhere within this report.

Results of Operations

The following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2017		2016		2017		2016
Sales:
Product	35.4	%	43.6	%	36.2	%	41.0	%
Service	64.6		56.4		63.8		59.0
Net sales	100.0		100.0		100.0		100.0
Cost and expenses:
Costs of product sales	23.0		28.3		24.6		27.4
Costs of service sales	32.4		28.8		32.7		30.4
Research and development	9.3		8.8		9.6		9.1
Sales, marketing and support	20.1		20.1		20.8		20.7
General and administrative	18.6		15.5		19.5		17.1
Total costs and expenses	103.4		101.5		107.2		104.7
Loss from operations	(3.4	)	(1.5	)	(7.2	)	(4.7	)
Interest income	0.4		0.3		0.4		0.3
Interest expense	0.8		0.8		0.9		0.8
Other (expense) income, net	(0.3	)	0.3		(0.2	)	0.1
Loss before income tax expense (benefit)	(4.1	)	(1.7	)	(7.9	)	(5.1	)
Income tax expense (benefit)	0.9		—		0.7		(1.1	)
Net loss	(5.0	)%	(1.7	)%	(8.6	)%	(4.0	)%

Three months ended June 30, 2017 and 2016

Net Sales

As discussed further under the heading "Segment Discussion" below, product sales decreased $5.8 million, or 29%, to $14.3 million for the three months ended June 30, 2017 from $20.1 million for the three months ended June 30, 2016, primarily due to a decrease in mobile connectivity product sales of $2.8 million and a decrease in inertial navigation product sales of $3.0 million. Service sales for the three months ended June 30, 2017 increased $0.3 million, or 1%, to $26.2 million from $25.9 million for the three months ended June 30, 2016, due to an increase in inertial navigation service sales of $0.3 million.

Costs of Sales

Costs of sales consists of costs of product sales and costs of service sales. Costs of sales decreased by $3.9 million, or 15%, in the three months ended June 30, 2017 to $22.4 million from $26.3 million in the three months ended June 30, 2016. The decrease in costs of sales was driven by a $3.7 million decrease in costs of product sales and a $0.2 million decrease in costs of service sales. As a percentage of net sales, costs of sales was 55% for the three months ended June 30, 2017 and 57% for the three months ended June 30, 2016.

Our costs of product sales consist primarily of materials, manufacturing overhead, and direct labor used to produce our products. For the three months ended June 30, 2017, costs of product sales decreased by $3.7 million, or 28%, to $9.3 million from $13.0 million in the three months ended June 30, 2016. As a percentage of product sales, costs of product sales were 65% and 65% for the three months ended June 30, 2017 and 2016, respectively. Mobile connectivity costs of product sales decreased by $2.6 million, or 29%, and mobile connectivity costs of product sales as a percentage of mobile connectivity product sales were 71% and 76% for the three months ended June 30, 2017 and 2016, respectively. The decrease was principally driven by product mix. Inertial navigation costs of product sales decreased by $1.1 million, or 27%, primarily due to a $0.8 million decrease in our TACNAV costs of product sales, offset by a $0.4 million increase in our FOG costs of product sales. As a percentage of inertial navigation product sales, cost of inertial navigation product sales were 55% and 49% for the three months ended June 30, 2017 and 2016, respectively.

Our costs of service sales consist primarily of satellite service capacity, depreciation, service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, Inmarsat service costs, product installation costs, engineering and related direct costs associated with customer-funded research and development, media materials and distribution costs, and service repair materials. For the three months ended June 30, 2017, costs of service sales decreased by $0.2 million, or 2%, to $13.1 million from $13.3 million for the three months ended June 30, 2016. As a percentage of service sales, costs of service sales were 50% and 51% for the three months ended June 30, 2017 and 2016, respectively. Mobile connectivity costs of service sales decreased by $0.6 million, or 5%, primarily due to a $0.9 million decrease in content and learning costs of service sales, partially offset by a $0.5 million increase in airtime costs of service sales. As a percentage of mobile connectivity service sales, cost of mobile connectivity service sales were 50% and 52% for the three months ended June 30, 2017 and 2016, respectively. Inertial navigation costs of service sales increased by $0.4 million, or 332%, due to an increase in contract engineering service revenues. As a percentage of inertial navigation service sales, costs of inertial navigation service sales were 55% and 19% for the three months ended June 30, 2017 and 2016, respectively, due to the mix of services delivered.

We expect the cost of sales in our mobile connectivity segment to decrease in the short term in correlation with our expected growth in AgilePlans sales where product hardware costs related to our owned hardware that is utilized to provide service will be depreciated over the useful life of the revenue-generating asset. We expect the cost of sales in our inertial navigation segment to increase along with expected growth in overall inertial navigation sales. We expect that the mobile connectivity costs of service sales as percentage of mobile connectivity sales will decrease slightly as we are seeking to implement additional airtime cost-saving initiatives.

Operating Expenses

Research and development expense consists of direct labor, materials, external consultants, and related overhead costs that support our internally funded product development and product sustaining engineering activities. Research and development expense for the three months ended June 30, 2017 decreased by $0.2 million, or 5% to $3.8 million from $4.0 million for the three months ended June 30, 2016. The primary reasons for the decrease in research and development expense was a $0.4 million decrease in unfunded engineering expenses, partially offset by a $0.2 million increase in salaries and employee benefits. As a percentage of net sales, research and development expense for the three months ended June 30, 2017 and 2016 was 9% and 9%, respectively.

We expect that research and development expense will grow year-over-year as we continue to invest in developing new technologies and applications for our products.

Sales, marketing, and support expense consists primarily of salaries and related expenses for sales and marketing personnel, commissions for both in-house and third-party representatives, costs related to the co-development of certain content, other sales and marketing support costs such as advertising, literature and promotional materials, product service personnel and support costs, warranty-related costs and bad debt expense. Sales, marketing and support expense also includes the operating expenses of our sales office subsidiaries in Denmark, Singapore, Brazil, and Japan. Sales, marketing and support expense for the three months ended June 30, 2017 decreased by $1.0 million, or 11% to $8.2 million from $9.2 million for the three months ended June 30, 2016. The primary reasons for the decrease in sales, marketing, and support expense were a $0.7 million decrease in external commissions driven by lower hardware sales, a $0.3 million decrease in warranty expense, a $0.2 million decrease in computer hardware and software maintenance expense, and a $0.1 million decrease in bad debt expense, partially offset by a $0.3 million increase in salaries and employee benefits. As a percentage of net sales, sales, marketing and support expense was 20% and 20% for the three months ended June 30, 2017 and 2016, respectively.

We expect that our sales, marketing, and support expense will increase year-over-year primarily driven by increased personnel, marketing and technology investments to support product sales and launches.

General and administrative expense consists of costs attributable to management, finance and accounting, information technology, human resources, certain outside professional services, and other administrative costs. General and administrative expense for the three months ended June 30, 2017 increased by $0.4 million, or 6%, to $7.5 million from $7.1 million for the three months ended June 30, 2016. The increase in general and administrative expense primarily resulted from an increase in salaries and associated compensation due to an increase in headcount. As a percentage of net sales, general and administrative expense for the three months ended June 30, 2017 was 19% as compared to 16% for the three months ended June 30, 2016.

We expect general and administrative expenses to increase year-over-year in 2017, primarily driven by increased personnel costs.

Interest and Other Expense, Net

Interest income represents interest earned on our cash and cash equivalents, as well as from investments. Interest income increased slightly to $0.1 million for the three months ended June 30, 2017 from $0.1 million for the three months ended June 30, 2016. Interest expense remained flat at $0.3 million for the three months ended June 30, 2017 and 2016. Other expense, net decreased to $0.1 million from other income, net of $0.1 million for the three months ended June 30, 2017 and 2016 primarily due to a decrease in foreign exchange losses from our UK operations.

Income Tax Expense (Benefit)

Income tax expense for the three months ended June 30, 2017 was $0.3 million due to taxes related to income earned in foreign jurisdictions and no associated income tax benefit related to the loss incurred in the U.S. due to a full valuation allowance on our U.S. deferred tax assets. Income tax benefit of $0.0 million for the three months ended June 30, 2016 was based on the estimated effective tax rate for fiscal 2016 and the related composition of the pre-tax loss for the period.

Segment Discussion - Three months ended June 30, 2017 and 2016

Our net sales by segment for the three months ended June 30, 2017 and 2016 were as follows:



					Change
	For the three months ended June 30,				2017 vs. 2016
	2017		2016		$			%
	(dollars in thousands)
Mobile connectivity sales:
Product	$	8,875	$	11,649	$	(2,774	)	(24	)%
Service	25,159		25,241		(82		)	—	%
Net sales	$	34,034	$	36,890	$	(2,856	)	(8	)%

Inertial navigation sales:
Product	$	5,448	$	8,413	$	(2,965	)	(35	)%
Service	967		663		304			46	%
Net sales	$	6,415	$	9,076	$	(2,661	)	(29	)%

Operating earnings (loss) by segment for the three months ended June 30, 2017 and 2016 were as follows:



							Change
	For the three months ended June 30,						2017 vs. 2016
	2017			2016			$			%
	(dollars in thousands)
Mobile connectivity	$	2,638		$	1,631		$	1,007		62	%
Inertial navigation	362			1,596			(1,234		)	(77	)%
	$	3,000		$	3,227		$	(227	)	(7	)%
Unallocated	(4,368		)	(3,920		)	(448		)	(11	)%
Loss from operations	$	(1,368	)	$	(693	)	$	(675	)	(97	)%

Mobile Connectivity Segment

Net sales in the mobile connectivity segment decreased $2.8 million, or 8%, for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016. Mobile connectivity product sales decreased by $2.8 million, or 24%, to $8.9 million for the three months ended June 30, 2017 from $11.7 million for the three months ended June 30, 2016. The decrease was primarily due to a $2.8 million, or 26%, decrease in marine product sales. The decrease was partly due to the receipt of a particularly large order in 2016, as well as the impact of the new AgilePlans subscription service. Inclement weather in the 2017 second quarter, particularly in the US East Coast region, also impacted our marine business as boat owners delayed the seasonal retrofitting of their vessels.

Overall mobile connectivity service sales remained flat at $25.2 million for the three months ended June 30, 2017 and 2016, but the components of those service sales changed. Mini-VSAT service sales increased $1.0 million due to an increase in the number of installed mini-VSAT units and service offerings. Offsetting this increase were a $0.8 million decrease in our content and training service revenue, which resulted primarily from exchange rate weakness arising from content and training service sales recorded in pounds sterling, and a $0.1 million decrease in Inmarsat service sales due to a decrease in Inmarsat airtime customers.

We expect that our mini-VSAT service sales will grow moderately year-over-year, primarily through the continued expansion of our mini-VSAT Broadband customer base, and due to a new product offering, our subscription service model "Agile Plans", which allows customers the option to receive mini-VSAT Broadband airtime and hardware for a single monthly charge. We expect mini-VSAT product sales to decline to the extent that customers select the new subscription service model as an alternative to purchasing mini-VSAT hardware.

Operating earnings for the mobile connectivity segment increased $1.0 million or 62%, for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016. This increase resulted primarily from a $0.8 million decrease in external commissions, a $0.3 million decrease in warranty expense, and the increase in mini-VSAT Airtime sales, partially offset by an increase in salaries and benefits.

We anticipate that we will improve our service margins to the extent that customers adopt our mini-VSAT Broadband rate plans that provide customers with faster speeds with data caps. Additionally, we intend to seek to improve margins by lowering costs through increased network volume and lower-cost network capacity.

Inertial Navigation Segment

Net sales in the inertial navigation segment decreased $2.7 million, or 29%, for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016. Inertial navigation product sales decreased $3.0 million, or 35%, to $5.4 million for the three months ended June 30, 2017 from $8.4 million for the three months ended June 30, 2016. Specifically, TACNAV sales decreased $3.5 million, due to a large order which occurred in the second quarter of 2016. This decrease was partially offset by a $0.5 million increase in FOG product sales.

Inertial navigation service sales increased $0.3 million or 46%, to $1.0 million for the three months ended June 30, 2017 from $0.7 million for the three months ended June 30, 2016. The primary reason for the increase was a $0.4 million increase in contracted engineering services due to a new project which began in January 2017, which is anticipated to run through the third quarter of 2017. This increase was partially offset by a $0.1 million decrease in inertial navigation repair revenue.

We expect that TACNAV product sales will continue to see growth in 2017 compared with 2016; however, it is challenging to forecast the specific timing that orders will be received and delivered to the customer. Our current forecast is based on our expectation that these sales will be received in the second half of 2017, and we anticipate that product sales on a quarter-to-quarter basis may be very uneven. Additionally, we expect to see modest growth in our FOG product sales in 2017 as these products are incorporated into additional commercial applications and programs. We also expect to see modest growth in contracted engineering service sales year-over-year.

Our operating earnings for the inertial navigation segment decreased $1.2 million, or 77%, for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016. This decrease is primarily due to a decrease in product sales, partially offset by a $0.4 million decrease in unfunded engineering costs.

We expect our overall inertial navigation operating earnings, before consideration of corporate allocations, to decline in 2017 primarily from higher external sales commissions in 2017 based on our current expectations of customer mix for TACNAV product sales. Similar to inertial navigation net sales noted above, operating earnings are expected to be uneven during 2017 as a result of the specific timing of orders.