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: September 30, 2018
OR
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  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.
Large accelerated filer
o
Accelerated filer
ý
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
ý
 
 
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
October 29, 2018
Common Stock, par value $0.01 per share
17,737,431



KVH INDUSTRIES, INC. AND SUBSIDIARIES
Form 10-Q
INDEX

 
 
Page No.
 
ITEM 1.
 
 
Consolidated Balance Sheets as of September 30, 2018 (unaudited) and December 31, 2017
 
Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017 (unaudited)
 
Consolidated Statements of Comprehensive (Loss) Income for the three and nine months ended September 30, 2018 and 2017 (unaudited)
 
Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 (unaudited)
 
ITEM 2.
ITEM 4.
 
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 5.
ITEM 6.
 

2



PART I. FINANCIAL INFORMATION
ITEM 1.    Financial Statements
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share and share amounts)
 
September 30,
2018
 
December 31,
2017
ASSETS
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
32,900

 
$
34,596

Marketable securities
336

 
8,319

Accounts receivable, net of allowance for doubtful accounts of $2,786 and $2,852 as of September 30, 2018 and December 31, 2017, respectively
28,971

 
28,316

Inventories
24,676

 
22,732

Prepaid expenses and other current assets
3,741

 
3,816

Current contract assets
3,460

 
—

Total current assets
94,084

 
97,779

Property and equipment, less accumulated depreciation of $55,736 and $51,099 as of September 30, 2018 and December 31, 2017, respectively
52,375

 
43,521

Intangible assets, less accumulated amortization of $23,757 and $20,656 as of September 30, 2018 and
December 31, 2017, respectively
11,637

 
15,120

Goodwill
32,848

 
33,872

Other non-current assets
6,701

 
5,927

Non-current contract assets
6,626

 
—

Non-current deferred income tax asset
201

 
20

Total assets
$
204,472

 
$
196,239

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
14,957

 
$
15,736

Accrued compensation and employee-related expenses
5,598

 
5,358

Accrued other
11,748

 
9,210

Accrued product warranty costs
2,032

 
2,074

Deferred revenue
—

 
6,919

Current portion of long-term debt
22,691

 
2,482

Contract liabilities
10,770

 
—

Liability for uncertain tax positions
1,316

 
1,570

Total current liabilities
69,112

 
43,349

Other long-term liabilities
2,060

 
19

Long-term contract liabilities
8,771

 
—

Long-term debt, excluding current portion
20,252

 
44,572

Non-current deferred income tax liability
2,547

 
2,634

Total liabilities
$
102,742

 
$
90,574

Commitments and contingencies (Note 2, 10, 12, and 19)
 
 
 
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; 19,021,853 and 18,787,816 shares issued at September 30, 2018 and December 31, 2017, respectively; and 17,739,431 and 17,128,825 shares outstanding at September 30, 2018 and December 31, 2017, respectively
190

 
188

Additional paid-in capital
138,731

 
134,361

Accumulated deficit
(13,575
)
 
(4,417
)
Accumulated other comprehensive loss
(13,452
)
 
(11,317
)
 
111,894

 
118,815

Less: treasury stock at cost, common stock, 1,282,422 and 1,658,991 shares as of September 30, 2018 and December 31, 2017, respectively
(10,164
)
 
(13,150
)
Total stockholders’ equity
101,730

 
105,665

Total liabilities and stockholders’ equity
$
204,472

 
$
196,239


See accompanying Notes to Unaudited Consolidated Financial Statements.
3


KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share amounts, unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Sales:
 
 
 
 
 
 
 
Product
$
16,367

 
$
14,169

 
$
46,521

 
$
43,355

Service
27,150

 
26,281

 
80,489

 
77,755

Net sales
43,517

 
40,450

 
127,010

 
121,110

Costs and expenses:
 
 
 
 
 
 
 
Costs of product sales
9,767

 
9,578

 
28,784

 
29,412

Costs of service sales
15,376

 
13,374

 
44,690

 
39,736

Research and development
3,789

 
3,990

 
11,288

 
11,698

Sales, marketing and support
8,421

 
8,234

 
25,856

 
25,098

General and administrative
7,084

 
7,075

 
21,679

 
22,805

Total costs and expenses
44,437

 
42,251

 
132,297

 
128,749

Loss from operations
(920
)
 
(1,801
)
 
(5,287
)
 
(7,639
)
Interest income
161

 
166

 
464

 
491

Interest expense
453

 
379

 
1,290

 
1,081

Other income (expense), net
199

 
(141
)
 
371

 
(321
)
Loss before income tax expense
(1,013
)
 
(2,155
)
 
(5,742
)
 
(8,550
)
Income tax expense
161

 
283

 
668

 
799

Net loss
$
(1,174
)
 
$
(2,438
)
 
$
(6,410
)
 
$
(9,349
)
 
 
 
 
 
 
 
 
Net loss per common share

 

 
 
 
 
Basic and diluted
$
(0.07
)
 
$
(0.15
)
 
$
(0.38
)
 
$
(0.57
)
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic and diluted
17,188

 
16,469

 
17,025

 
16,393



See accompanying Notes to Unaudited Consolidated Financial Statements.
4


KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands, unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(1,174
)
 
$
(2,438
)
 
$
(6,410
)
 
$
(9,349
)
Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities
—

 
2

 
1

 
(1
)
Foreign currency translation adjustment
(763
)
 
1,956

 
(2,185
)
 
4,997

Unrealized gain on derivative instruments, net
12

 
19

 
49

 
64

Other comprehensive (loss) income, net of tax(1)
(751
)
 
1,977

 
(2,135
)
 
5,060

Total comprehensive loss
$
(1,925
)
 
$
(461
)
 
$
(8,545
)
 
$
(4,289
)

(1) Tax impact was nominal for all periods.


See accompanying Notes to Unaudited Consolidated Financial Statements.
5


KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
 
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net loss
$
(6,410
)
 
$
(9,349
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Provision for doubtful accounts
444

 
637

Depreciation and amortization
9,481

 
8,222

Deferred income taxes
22

 
—

Loss on sale of fixed assets
2

 
21

Compensation expense related to stock-based awards and employee stock purchase plan
2,452

 
2,621

Unrealized currency translation gain
(290
)
 
(205
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(1,217
)
 
1,975

Inventories
(1,907
)
 
(896
)
Prepaid expenses, other current assets, and current contract assets
(232
)
 
(200
)
Other non-current assets and non-current contract assets
(1,647
)
 
(685
)
Accounts payable
(992
)
 
2,910

Deferred revenue, contract liabilities, and long-term contract liabilities
701

 
2,167

Accrued compensation, product warranty, and other
1,364

 
2,478

Other long-term liabilities
(10
)
 
(305
)
Net cash provided by operating activities
$
1,761

 
$
9,391

Cash flows from investing activities:
 
 
 
Capital expenditures
(11,463
)
 
(10,234
)
Cash paid for acquisition of intangible asset
(22
)
 
(55
)
Purchases of marketable securities
(2,036
)
 
(9,351
)
Maturities and sales of marketable securities
10,019

 
26,766

Net cash (used in) provided by investing activities
$
(3,502
)
 
$
7,126

Cash flows from financing activities:
 
 
 
Repayments of long-term debt
(136
)
 
(1,606
)
Repayments of term note borrowings
(3,975
)
 
(8,775
)
Payment of employee restricted stock withholdings
—

 
(392
)
Proceeds from stock options exercised and employee stock purchase plan
477

 
1,332

Sale of treasury stock
4,500

 
—

Payment of capital lease
(410
)
 
—

Net cash provided by (used in) financing activities
$
456

 
$
(9,441
)
Effect of exchange rate changes on cash and cash equivalents
(411
)
 
1,877

Net (decrease) increase in cash and cash equivalents
(1,696
)
 
8,953

Cash and cash equivalents at beginning of period
34,596

 
26,422

Cash and cash equivalents at end of period
$
32,900

 
$
35,375

Supplemental disclosure of non-cash investing activities:
 
 
 
Changes in accrued other and accounts payable related to property and equipment additions
$
965

 
$
402

Deferred purchase price consideration related to asset acquisition included in accrued expenses
$
—

 
$
50


See accompanying Notes to Unaudited Consolidated Financial Statements.
6


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) is a leading manufacturer of solutions that provide global high-speed Internet, television, and voice services via satellite to mobile users at sea and on land. KVH is also a leading provider of commercially licensed entertainment, including news, sports, music, and movies, to commercial and leisure customers in the maritime, hotel, and retail markets. In addition, the Company develops and distributes training films and eLearning computer-based training courses to commercial maritime customers. KVH is also a premier manufacturer of high-performance navigational sensors and integrated inertial systems for defense and commercial applications. KVH’s reporting segments are as follows:

•
the mobile connectivity segment and
•
the inertial navigation segment

KVH’s mobile connectivity products enable customers to receive voice services, 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 October 2017, KVH introduced a new 60-cm diameter TracPhone V7-HTS Ku-band antenna which is designed to deliver faster data speeds globally to the maritime market. KVH is able to offer download/upload speeds as fast as 10 Mbps/3 Mbps by combining KVH’s proprietary antenna system design and industry-leading mini-VSAT Broadband network, along with partnering with Intelsat Epic satellite services for high throughput satellite (HTS) capabilities and additional capacity from SKY Perfect JSAT satellites. With the HTS network, the Company added an additional 25 million square miles to our global maritime Ku-band high-speed connectivity footprint.

KVH’s mobile connectivity service sales primarily represent 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 VoIP services, to its TracPhone V-series customers. 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, Voice over Internet Protocol (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 are expensed in the period these costs are incurred. 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, 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). 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.


7


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 technology is 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, 2017 filed on March 2, 2018 with the Securities and Exchange Commission. The results for the three and nine months ended September 30, 2018 are not necessarily indicative of operating results for the remainder of the year.

Significant Estimates and Assumptions and Other Significant Non-Recurring Transactions

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 deferred purchase price consideration related to asset acquisition, 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 nine months ended September 30, 2018.

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.

The only material change to the significant accounting policies disclosed in the Company’s annual report on Form 10-K for the year ended December 31, 2017 was the Company’s adoption of Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers effective January 1, 2018. Please see footnote 16 for further discussion.

On February 27, 2018, the Company entered into a stock purchase agreement with SKY Perfect JSAT Corporation, or SJC, pursuant to which the Company agreed to sell 377 shares of treasury stock to SJC for a purchase price of $11.95 per share, or an aggregate of $4,500, in a private placement. The transaction closed on February 28, 2018.

During the first quarter of 2018, the Company entered into a five-year capital lease for three satellite hubs for the HTS network. Please see footnote 19 for further discussion.

8



(3)     Accounting Standards Issued and Not Yet Adopted

ASC Update No. 2016-02, No. 2018-10 and No. 2018-11

In February 2016, the Financial Accounting Standards Board, or 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.

In July 2018, the FASB issued Update No. 2018-10, Codification Improvements to Topic 842, Leases. Update No. 2018-10 made corrections to and further clarified Topic 842.

In July 2018, the FASB issued Update No. 2018-11, Leases-Targeted Improvements (Topic 842). Update No. 2018-11 allows companies to use the effective date of the new lease standard as the date of initial application on transition and not to apply the new lease standard in the comparative prior periods included in their financial statements in the year of adoption. The new guidance also gives entities the option not to separate non-lease components from the associated lease components when certain criteria are met.

The Company will adopt Topic 842 effective January 1, 2019. The Company established an implementation team to assist with its assessment of the impact of the lease guidance on its operations, consolidated financial statements and related disclosures. To date, this assessment has included (1) identifying the population of lease agreements and currently assessing the impact of other arrangements for embedded leases, (2) performing detailed analyses of the contracts to assess the impact of the noted differences in recognition and measurement that may result from adopting this new standard, and (3) evaluating and designing the necessary changes to its business processes, systems and controls to support recognition and disclosures under the new standard. Based on its current 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. We do not expect a material impact on our consolidated statements of operations or statement of cash flows.

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 adoption of Update No. 2016-13 is not expected to have a material impact on the Company's financial position or results of operations.

ASC Update No. 2017-12

In August 2017, the FASB issued ASC Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The update is effective for annual periods beginning after December 15, 2018. Early adoption is permitted. The purpose of Update No. 2017-12 is to improve the presentation and disclosure requirements for, and simplify the application and increase transparency of hedge accounting. The adoption of Update No. 2017-12 is not expected to have a material impact on the Company's financial position or results of operations.


9


ASC Update No. 2018-07

In June 2018, the FASB issued ASC Update No. 2018-07, Compensation-Stock Compensation (Topic 718) Improvements to Nonemployee Share-Based Payment Accounting. The update is effective for annual periods beginning on or after December 15, 2018. Early adoption is permitted. The purpose of Update No. 2018-07 is to expands the scope of the employee share-based payments guidance to include share-based payments issued to nonemployees. 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.

ASC Update No. 2018-13
    
In August 2018, the FASB issued ASC Update No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The update is effective for annual periods beginning on or after December 15, 2019. Early adoption is permitted upon issuance of this update. The purpose of Update No. 2018-13 is to modify and eliminate some of the disclosure requirements on fair value measurements found in Topic 820, Fair Value Measurement, for both public and nonpublic entities. Through the inclusion of this update, FASB aims to facilitate a clear communication of the information required by GAAP that is most important to users of each entity's financial statements, thus helping to improve the effectiveness of disclosures in the notes to financial statements. Update No. 2018-13 is not expected to have a material impact on the Company's financial position or results of operations.

ASC Update No. 2018-15
    
In August 2018, the FASB issued ASC Update No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Topic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The update is effective for annual periods beginning on or after December 15, 2019. Early adoption of the amendments in this update is permitted, including adoption in any interim period, for all entities. The purpose of Update No. 2018-15 is to provide a new guideline to the accounting of a customer of a cloud computing arrangement hosted by a vendor when the customer incurs costs associated with the implementation, set-up, and other upfront costs. Specifically, customers will follow the same criteria found in an arrangement with a software license when they capitalize the implementation costs. The new guidance also affects the classification of the capitalized implementation costs and related amortization expense found in a company's balance sheet, income statement, and cash flow statement, and the update also requires additional quantitative and qualitative disclosures. Update No. 2018-15 is not expected to have a material impact on the Company's financial position or results of operations.

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

(4)
Marketable Securities
Marketable securities as of September 30, 2018 and December 31, 2017 consisted of the following:
September 30, 2018
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Money market mutual funds
$
336

 
$
—

 
$
—

 
$
336

Total marketable securities designated as available-for-sale
$
336

 
$
—

 
$
—

 
$
336

 
December 31, 2017
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Money market mutual funds
$
7,318

 
$
—

 
$
—

 
$
7,318

Certificates of deposit
1,002

 
—

 
(1
)
 
1,001

Total marketable securities designated as available-for-sale
$
8,320

 
$
—

 
$
(1
)
 
$
8,319


10


The amortized costs and fair value of marketable securities as of September 30, 2018 and December 31, 2017 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.
September 30, 2018
Amortized
Cost
 
Fair
Value
Due in less than one year
$
—

 
$
—

December 31, 2017
Amortized
Cost
 
Fair
Value
Due in less than one year
$
1,002

 
$
1,001

Interest income from marketable securities was $2 and $25 during the three months ended September 30, 2018 and 2017, respectively, and $17 and $86 during the nine months ended September 30, 2018 and 2017, respectively.

(5)     Stockholder's Equity
(a) Stock Equity and Incentive Plan
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 $785 for the three months ended September 30, 2018 and 2017, respectively, and $2,417 and $2,577 for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, there was $2,621 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 3.00 years. As of September 30, 2018, there was $4,192 of total unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted-average period of 2.26 years.

Stock Options

During the three months ended September 30, 2018, 22 stock options were exercised for common stock. Additionally, during the three months ended September 30, 2018, no stock options were granted and 65 stock options expired, were canceled or were forfeited.

During the nine months ended September 30, 2018, 35 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 nine months ended September 30, 2018, 401 stock options were granted with a weighted average grant date fair value of $3.82 per share and 152 stock options expired, were canceled or 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 nine months ended September 30, 2018 and 2017 were as follows:

 
 
 
 
 
Nine Months Ended
September 30,
 
2018
 
2017
Risk-free interest rate
2.81
%
 
1.96
%
Expected volatility
36.60
%
 
35.53
%
Expected life (in years)
4.29

 
4.22

Dividend yield
0
%
 
0
%

As of September 30, 2018, there were 1,281 options outstanding with a weighted average exercise price of $10.27 per share and 343 options exercisable with a weighted average exercise price of $10.89 per share.


11


Restricted Stock

During the three months ended September 30, 2018, 45 shares of restricted stock were granted with a weighted average grant date fair value of $12.65 per share and no shares of restricted stock were forfeited. Additionally, during the three months ended September 30, 2018, 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 nine months ended September 30, 2018, 199 shares of restricted stock were granted with a weighted average grant date fair value of $11.47 per share and 19 shares of restricted stock were forfeited. Additionally, during the nine months ended September 30, 2018, 247 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.
 
As of September 30, 2018, there were 538 shares of restricted stock outstanding still subject to service-based vesting conditions.

As of September 30, 2018, the Company had no shares of restricted stock that were subject to performance-based or market-based vesting conditions.

(b) Employee Stock Purchase Plan

The Company's Amended and Restated 1996 Employee Stock Purchase Plan (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 nine months ended September 30, 2018, 17 shares were issued under the ESPP plan. During the three and nine months ended September 30, 2017, 0 and 26 shares were issued under the ESPP plan, respectively. The Company recorded compensation charges related to the ESPP of $11 and $24 for the three months ended September 30, 2018 and 2017, respectively, and $35 and $44 for the nine months ended September 30, 2018 and 2017, respectively.

(c) Stock-Based Compensation Expense
    
The following table presents stock-based compensation expense, including expense for the ESPP, in the Company's consolidated statements of operations for the three and nine months ended September 30, 2018 and 2017:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Cost of product sales
$
40

 
$
68

 
$
122

 
$
222

Cost of service sales
—

 
—

 
—

 
1

Research and development
177

 
155

 
496

 
514

Sales, marketing and support
138

 
190

 
485

 
679

General and administrative
505

 
396

 
1,349

 
1,205

 
$
860

 
$
809

 
$
2,452

 
$
2,621


12


(d) Accumulated Other Comprehensive Loss

Comprehensive income (loss) includes net income (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 September 30, 2018 and 2017 are as follows:
 
Foreign Currency Translation
 
Unrealized Gain (Loss) on Available for Sale Marketable Securities
 
Interest Rate Swaps
 
Total Accumulated Other Comprehensive Loss
Balance, June 30, 2018
$
(12,669
)
 
$
—

 
$
(32
)
 
$
(12,701
)
Other comprehensive loss before reclassifications
(763
)
 
—

 
—

 
(763
)
Amounts reclassified from AOCI to Other income, net 
—

 
—

 
12

 
12

Net other comprehensive (loss) income, September 30, 2018
(763
)
 
—

 
12

 
(751
)
Balance, September 30, 2018
$
(13,432
)
 
$
—

 
$
(20
)
 
$
(13,452
)

 
Foreign Currency Translation
 
Unrealized Gain (Loss) on Available for Sale Marketable Securities
 
Interest Rate Swaps
 
Total Accumulated Other Comprehensive Loss
Balance, June 30, 2017
$
(13,610
)
 
$
(3
)
 
$
(113
)
 
$
(13,726
)
Other comprehensive income before reclassifications
1,956

 
2

 
1

 
1,959

Amounts reclassified from AOCI to Other income, net 
—

 
—

 
18

 
18

Net other comprehensive income, September 30, 2017
1,956

 
2

 
19

 
1,977

Balance, September 30, 2017
$
(11,654
)
 
$
(1
)
 
$
(94
)
 
$
(11,749
)

The balances for the nine months ended September 30, 2018 and 2017 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, 2017
$
(11,247
)
 
$
(1
)
 
$
(69
)
 
$
(11,317
)
Other comprehensive (loss) income before reclassifications
(2,185
)
 
1

 
11

 
(2,173
)
Amounts reclassified from AOCI to Other income, net 
—

 
—

 
38

 
38

Net other comprehensive (loss) income, September 30, 2018
(2,185
)
 
1

 
49

 
(2,135
)
Balance, September 30, 2018
$
(13,432
)
 
$
—

 
$
(20
)
 
$
(13,452
)
 

13


 
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
4,997

 
(1
)
 
5

 
5,001

Amounts reclassified from AOCI to Other income, net
—

 
—

 
59

 
59

Net other comprehensive income (loss), September 30, 2017
4,997

 
(1
)
 
64

 
5,060

Balance, September 30, 2017
$
(11,654
)
 
$
(1
)
 
$
(94
)
 
$
(11,749
)

For additional information, see Note 4, "Marketable Securities," and 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 nine months ended September 30, 2018, since there was a net loss, the Company excluded all 932 and 739, respectively, in 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. For the three and nine months ended September 30, 2017, since there was a net loss, the Company excluded all 597 and 995, respectively, in 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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Weighted average common shares outstanding—basic
17,188

 
16,469

 
17,025

 
16,393

Dilutive common shares issuable in connection with stock plans
—

 
—

 
—

 
—

Weighted average common shares outstanding—diluted
17,188

 
16,469

 
17,025

 
16,393



(7)     Inventories

Inventories are stated at the lower of cost and net realizable value using the first-in first-out costing method. Inventories as of September 30, 2018 and December 31, 2017 include the costs of material, labor, and factory overhead. Components of inventories consist of the following:

 
September 30,
2018
 
December 31,
2017
Raw materials
$
14,667

 
$
13,347

Work in process
3,172

 
2,137

Finished goods
6,837

 
7,248

 
$
24,676

 
$
22,732


14


(8)     Property and Equipment

Property and equipment, net, as of September 30, 2018 and December 31, 2017 consist of the following:

 
September 30,
2018
 
December 31,
2017
Land
$
3,828

 
$
3,828

Building and improvements
24,087

 
24,038

Leasehold improvements
480

 
429

Machinery and equipment
25,208

 
24,764

Revenue-generating assets
40,543

 
28,453

Office and computer equipment
13,914

 
13,057

Motor vehicles
51

 
51

 
108,111

 
94,620

Less accumulated depreciation
(55,736
)
 
(51,099
)
 
$
52,375

 
$
43,521


Depreciation expense was $2,235 and $1,649 for the three months ended September 30, 2018 and 2017, respectively, and $6,380 and $4,956 for the nine months ended September 30, 2018 and 2017, respectively.

Certain revenue-generating hardware assets are utilized by the Company in the delivery of the Company's airtime services, media, and other content. These revenue-generating assets were previously included in machinery and equipment and are now presented separately.

(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 September 30, 2018 and December 31, 2017, the Company had accrued product warranty costs of $2,032 and $2,074, respectively.

The following table summarizes product warranty activity during 2018 and 2017:
 
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Beginning balance
$
2,074

 
$
2,280

Charges to expense
1,592

 
845

Costs incurred
(1,634
)
 
(810
)
Ending balance
$
2,032

 
$
2,315


15



(10)     Debt

Long-term debt consisted of the following:
 
September 30,
2018
 
December 31,
2017
2014 term note
$
40,300

 
$
44,275

Mortgage loan
2,643

 
2,779

Total
42,943

 
47,054

Less amounts classified as current
22,691

 
2,482

Long-term debt, excluding current portion
$
20,252

 
$
44,572


Term Note and Line of Credit

On July 1, 2014, the Company entered into (i) a five-year senior credit facility agreement (the 2014 Credit Agreement) with Bank of America, N.A., as Administrative Agent, and the lenders named from time to time as parties thereto (the 2014 Lenders), for an aggregate amount of up to $80,000, including a revolving credit facility (the 2014 Revolver) of up to $15,000 and a term loan (2014 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 2014 Revolving Credit Note) to evidence the 2014 Revolver, (iii) term notes (together, the 2014 Term Note, and together with the 2014 Revolving Credit Note, the 2014 Notes) to evidence the 2014 Term Loan, (iv) a Security Agreement required by the 2014 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 2014 Credit Agreement and the 2014 Notes, and (v) Pledge Agreements required by the 2014 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 2014 Credit Agreement and the 2014 Notes.

Borrowings under the 2014 Revolver were 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 2014 Credit Agreement. As of September 30, 2018, there were no borrowings outstanding under the 2014 Revolver and the full balance of $15,000 was available for borrowing.

On October 30, 2018, the Company amended and restated the 2014 Credit Agreement by entering into (i) a three-year senior credit facility agreement (the 2018 Credit Agreement) with Bank of America, N.A., as Administrative Agent, and the lenders named from time to time as parties thereto (the 2018 Lenders), for an aggregate amount of up to $42,500, including a term loan (2018 Term Loan) of $22,500 and a reducing revolving credit facility (the 2018 Revolver) of up to $20,000 initially and reducing to $15,000 on December 31, 2019, each to be used for general corporate purposes, including the refinancing of the Company’s then-outstanding indebtedness under the 2014 Credit Agreement as described below, (ii) a Security Agreement required by the 2018 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 2018 Credit Agreement, and (iii) Pledge Agreements required by the 2018 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 2018 Credit Agreement. On the closing date, the Company repaid $17,225 on the 2014 Term Loan and refinanced its remaining balance. On the closing date, the Company also borrowed $5,000 under the 2018 Revolver.


16


The Company is required to make principal repayments on the 2018 Term Loan in the amount of $563 at the end of each of the first four three-month periods following the closing (ending with the period ending September 30, 2019); thereafter, the principal repayment amount increases to $703 for the four succeeding three-month periods (ending with the period ending September 30, 2020) and further increases to $844 for each succeeding three-month period (ending with the period ending June 30, 2021) until the maturity of the loan on October 30, 2021. The first principal payment on the 2018 Term Loan is due on December 31, 2018. On October 30, 2021, the entire remaining principal balance of the 2018 Term Loan and the entire principal balance of any outstanding loans under the 2018 Revolver are due and payable, together with all accrued and unpaid interest, fees, and any other amounts due and payable under the 2018 Credit Agreement. The 2018 Credit Agreement contains provisions requiring the mandatory prepayment of amounts outstanding under the 2018 Term Loan and the 2018 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 above certain threshold amounts outside the ordinary course of business. The prepayments are first applied to the 2018 Term Loan, in inverse order of maturity, and then to the 2018 Revolver.

Loans under the 2018 Credit Agreement bear interest at varying rates determined in accordance with the 2018 Credit Agreement. Each Eurodollar Rate Loan, as defined in the 2018 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 Eurodollar Rate, each as defined in the 2018 Credit Agreement, as elected by the Company, plus the Applicable Margin, as defined in the 2018 Credit Agreement, and each Base Rate Loan, as defined in the 2018 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 2018 Credit Agreement, plus the Applicable Margin. The Applicable Margin ranges from 1.50% to 2.375% on Eurodollar Rate Loans and from 0.50% to 1.375% on Base Rate Loans, each depending on the Company’s Consolidated Leverage Ratio, as defined in the 2018 Credit Agreement. The highest Applicable Margin applies initially until the Compliance Certificate, as defined in the 2018 Credit Agreement, is delivered for the quarter ending June 30, 2019 and subsequently when the Consolidated Leverage Ratio exceeds 2.50:1.00. Upon certain defaults, including failure to make payments when due, interest becomes payable at a higher default rate.

Borrowings under the 2018 Revolver are subject to the satisfaction of various 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 2018 Credit Agreement.

The 2018 Credit Agreement contains two financial covenants, a maximum Consolidated Leverage Ratio and a minimum Consolidated Fixed Charge Coverage Ratio, each as defined in the 2018 Credit Agreement. The Consolidated Leverage Ratio initially may not be greater than 3.00:1.00 and declines to 2.75:1.00 on September 30, 2019, to 2.50:1.00 on December 31, 2019 and to 2.00:1.00 on December 31, 2020. The Consolidated Fixed Charge Coverage Ratio may not be less than 1.25:1.00.

The 2018 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, performance of 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 2018 Credit Agreement could be accelerated upon an event of default under its terms, 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 2018 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 Company property loss events, and certain events relating to the impairment of collateral or the 2018 Lenders' security interest therein.

The Company has elected to exclude from current liabilities $20,252 for the 2014 Term Loan as the Company had the ability to refinance the short-term obligation on a long-term basis in accordance with ASC 470-10-45-14.

17


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 $15, plus interest. 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 nine months ended September 30, 2018, 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. If the Company were to default on the Mortgage Loan, the underlying property and improvements would be used as collateral. As discussed in Note 17 to the consolidated financial statements, the Company entered into two interest rate swap agreements that are intended to hedge its mortgage interest obligations over the term of the Mortgage Loan by fixing the interest rates specified in the Mortgage Loan to 5.91% for half of the principal amount outstanding as of April 1, 2010 and 6.07% for the remaining half.

(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 17% and 18% of the Company's consolidated net sales for the three months ended September 30, 2018 and 2017, respectively, and 19% and 21% of the Company's consolidated net sales for the nine months ended September 30, 2018 and 2017, respectively. Sales of mini-VSAT Broadband airtime service accounted for 41% and 42% of the Company's consolidated net sales for the three months ended September 30, 2018 and 2017, respectively, and 41% of the Company's consolidated net sales for the nine months ended September 30, 2018 and 2017. Sales of content and training services within the mobile connectivity segment accounted for 16% and 20% of the Company's consolidated net sales for the three months ended September 30, 2018 and 2017, respectively, and 18% and 20% of the Company's consolidated net sales for the nine months ended September 30, 2018 and 2017, 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 18% and 13% of the Company's consolidated net sales for the three months ended September 30, 2018 and 2017, respectively, and 16% and 12% of the Company's consolidated net sales for the nine months ended September 30, 2018 and 2017, respectively.

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


18


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 60% of the Company's consolidated net sales for the three months ended September 30, 2018 and 2017, and 59% and 61% of the Company's consolidated net sales for the nine months ended September 30, 2018 and 2017, respectively. No individual foreign country represented 10% or more of the Company's consolidated net sales for the three months ended September 30, 2018 and 2017. No individual foreign country represented 10% or more of the Company's consolidated net sales for the nine months ended September 30, 2018 or 2017.

As of September 30, 2018 and December 31, 2017, 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 income (loss) for the Company's reporting segments and the Company's loss before income tax expense for the three and nine months ended September 30, 2018 and 2017 were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Net sales:
 
 
 
 
 
 
 
Mobile connectivity
$
33,425

 
$
32,762

 
$
99,938

 
$
101,083

Inertial navigation
10,092

 
7,688

 
27,072

 
20,027

Consolidated net sales
$
43,517

 
$
40,450

 
$
127,010

 
$
121,110

 
 
 
 
 
 
 
 
Operating income (loss):
 
 
 
 
 
 
 
Mobile connectivity
$
1,443

 
$
2,067

 
$
3,664

 
$
5,327

Inertial navigation
1,920

 
349

 
3,818

 
667

Subtotal
3,363

 
2,416

 
7,482

 
5,994

Unallocated, net
(4,283
)
 
(4,217
)
 
(12,769
)
 
(13,633
)
Loss from operations
(920
)
 
(1,801
)
 
(5,287
)
 
(7,639
)
Net interest and other income (expense)
(93
)
 
(354
)
 
(455
)
 
(911
)
Loss before income tax expense
$
(1,013
)
 
$
(2,155
)
 
(5,742
)
 
$
(8,550
)

Depreciation expense and amortization expense for the Company's segments are presented in the following table for the periods presented:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Depreciation expense:
 
 
 
 
 
 
 
Mobile connectivity
$
1,842

 
$
1,339

 
$
5,212

 
$
4,212

Inertial navigation
260

 
293

 
766

 
687

Unallocated
133

 
17

 
402

 
57

Total consolidated depreciation expense
$
2,235

 
$
1,649

 
$
6,380

 
$
4,956

 
 
 
 
 
 
 
 
Amortization expense:
 
 
 
 
 
 
 
Mobile connectivity
$
958

 
$
1,096

 
$
3,101

 
$
3,266

Inertial navigation
—

 
—

 
—

 
—

Unallocated
—

 
—

 
—

 
—

Total consolidated amortization expense
$
958

 
$
1,096

 
$
3,101

 
$
3,266





19


(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 September 30, 2018, 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 nine months ended September 30, 2018 and no repurchase programs expired during the period.

During the nine months ended September 30, 2018 and 2017, 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 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.

20


The following tables present financial assets and liabilities at September 30, 2018 and December 31, 2017 for which the Company measures fair value on a recurring basis, by level, within the fair value hierarchy:
September 30, 2018
Total
 
Level 1
 
Level 2
 
Level 3
 
Valuation
Technique
Assets
 
 
 
 
 
 
 
 
 
Money market mutual funds
$
336

 
$
336

 
$
—

 
$
—

 
(a)
Liabilities
 
 
 
 
 
 
 
 
 
Interest rate swaps
20

 
—

 
20

 
—

 
(b)
December 31, 2017
Total
 
Level 1
 
Level 2
 
Level 3
 
Valuation
Technique
Assets
 
 
 
 
 
 
 
 
 
Money market mutual funds
$
7,318

 
$
7,318

 
$
—

 
$
—

 
(a)
Certificates of deposit
1,001

 
1,001

 
—

 
—

 
(a)
Liabilities
 
 
 
 
 
 
 
 
 
Interest rate swaps
69

 
—

 
69

 
—

 
(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 September 30, 2018. 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 nine months ended September 30, 2018:
 
 
Amounts
Balance at December 31, 2017
 
$
33,872

Foreign currency translation adjustment
 
(1,024
)
Balance at September 30, 2018
 
$
32,848



21


In January 2017, the Company early adopted ASC Update No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test of Goodwill Impairment. ASC 350 requires the completion of a goodwill impairment test at least annually based on either an optional qualitative assessment or the first step of comparing the carrying value of a reporting unit to its estimated fair value as of the test date. Any impairment charges would be based on the first step. The Company now performs its annual goodwill impairment test as of October 1st. During the three months ended December 31, 2017, the Company changed its annual impairment assessment date from August 31st to October 1st to better align the timing of the test date with its annual budgeting cycle. In connection with the change in the date of its annual goodwill impairment test, the Company performed a goodwill impairment test as of both August 31, 2017 and October 1, 2017, and concluded that the fair values of its reporting units exceeded their respective carrying values. The Company notes that, as of August 31, 2017, the fair value of all of the Company’s reporting units exceeded their carrying values by more than 10%. For the October 1, 2017 test, the Company performed a qualitative assessment over goodwill impairment concluding it was more-likely-than-not that its reporting units fair value exceeded their carrying value. Accordingly, it was not necessary for the Company to perform the full Step 1 quantitative analysis. To date, the Company has not had accumulated goodwill impairment losses. A negative trend of operating results or material changes to forecasted operating results could result in the requirement for additional interim goodwill impairment tests and the potential of a future goodwill impairment charge, which could be material. 

Intangible Assets

The changes in the carrying amount of intangible assets during the nine months ended September 30, 2018 are as follows:
 
 
Amounts
Balance at December 31, 2017
 
$
15,120

Amortization expense
 
(3,101
)
Intangible assets acquired in asset acquisition
 
22

Foreign currency translation adjustment
 
(404
)
Balance at September 30, 2018
 
$
11,637


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 of September 30, 2018, the carrying value of the intangible assets acquired in the asset acquisition was $155. 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 nine months ended September 30, 2018, $22 additional consideration was earned under the contingent consideration arrangement.

22


Acquired intangible assets are subject to amortization. The following table summarizes acquired intangible assets at September 30, 2018 and December 31, 2017, respectively:


Gross Carrying Amount

Accumulated Amortization

Net Carrying Value
September 30, 2018
 
 
 
 
 
 
Subscriber relationships
 
$
17,662

 
$
9,858

 
$
7,804

Distribution rights
 
4,291

 
1,663

 
2,628

Internally developed software
 
2,327

 
2,327

 
—

Proprietary content
 
8,185

 
7,070

 
1,115

Intellectual property
 
2,284

 
2,284

 
—

Favorable lease
 
645

 
555

 
90

 
 
$
35,394

 
$
23,757

 
$
11,637

December 31, 2017
 
 
 
 
 
 
Subscriber relationships
 
$
17,912

 
$
8,347

 
$
9,565

Distribution rights
 
4,385

 
1,450

 
2,935

Internally developed software
 
2,324

 
2,206

 
118

Proprietary content
 
8,223

 
5,908

 
2,315

Intellectual property
 
2,284

 
2,284

 
—

Favorable lease
 
648

 
461

 
187

 
 
$
35,776

 
$
20,656

 
$
15,120


Amortization expense related to intangible assets for the three and nine months ended September 30, 2018 and 2017 was as follows:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Expense Category
2018
 
2017
 
2018
 
2017
Cost of service sales
$
374

 
$
375

 
$
1,163

 
$
1,097

General and administrative expense
584

 
721

 
1,938

 
2,169

Total amortization expense
$
958

 
$
1,096


$
3,101

 
$
3,266


As of September 30, 2018, the total weighted average remaining useful lives of the definite-lived intangible assets was 3.6 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
4.1
Distribution rights
9.6
Proprietary content
0.8
Favorable lease
0.8

23


Estimated future amortization expense remaining at September 30, 2018 for intangible assets acquired is as follows:

Remainder of 2018
$
957

2019
3,018

2020
2,216

2021
2,216

2022
1,455

Thereafter
1,775

Total future amortization expense
$
11,637

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 third quarter of 2018 which indicated that an assessment of the impairment of goodwill and intangible assets was required.

(16)     Revenue from Contracts with Customers (ASC 606)

The Company adopted ASC 606 on January 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. The reported results for the three and nine months ended September 30, 2018 reflect the application of ASC 606 guidance while the reported results for the three and nine months ended September 30, 2017 were prepared under the guidance of ASC 605, Revenue Recognition (ASC 605), which is also referred to herein as "legacy GAAP" or the "previous guidance". The adoption of ASC 606 represents a change in accounting principle that is expected to more closely align revenue recognition with the delivery of the Company's products and services and is expected to provide financial statement readers with enhanced disclosures. In accordance with ASC 606, revenue is recognized when a customer obtains control of promised products and services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these products and services. To achieve this core principle, the Company applies the following five steps:

1) Identify the contract with a customer

A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the products and services to be transferred and identifies the payment terms related to these products and services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for products and services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors, including the customer’s historical payment pattern or, in the case of a new customer, published credit and financial information pertaining to the customer.

2) Identify the performance obligations in the contract

Performance obligations promised in a contract are identified based on the products and services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the product and service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the product and service is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised products and services, the Company must apply judgment to determine whether promised products and services are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised products and services are accounted for as a combined performance obligation.


24


3) Determine the transaction price

The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring products and services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. None of the Company's contracts as of September 30, 2018 contained a significant financing component. Determining the transaction price requires significant judgment, which is discussed by revenue category in further detail below.

4) Allocate the transaction price to performance obligations in the contract

If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. However, if a series of distinct products or services that are substantially the same qualifies as a single performance obligation in a contract with variable consideration, the Company must determine if the variable consideration is attributable to the entire contract or to a specific part of the contract. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price basis unless the transaction price is variable and meets the criteria to be allocated entirely to a performance obligation or to a distinct product or service that forms part of a single performance obligation. The Company determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.

5) Recognize revenue when or as the Company satisfies a performance obligation

The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised product or service to a customer.

Disaggregation of Revenue

The following table summarizes net sales from contracts with customers for the three and nine months ended September 30, 2018:

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
Mobile connectivity product, transferred at point in time
 
$
6,297

 
$
19,698

Mobile connectivity product, transferred over time
 
1,259

 
3,881

Mobile connectivity service
 
25,869

 
76,359

Inertial navigation product
 
8,811

 
22,942

Inertial navigation service
 
1,281

 
4,130

   Total net sales
 
$
43,517

 
$
127,010


For mobile connectivity product sales, the delivery of the Company’s performance obligations, and associated revenue, are generally transferred to the customer at a point in time, with the exception of certain mini-VSAT contracts which are transferred to customers over time. For mobile connectivity service sales, the delivery of the Company’s performance obligations and associated revenue are transferred to the customer over time. For inertial navigation product sales, the delivery of the Company’s performance obligations, and associated revenue, are generally transferred to the customer at a point in time. For inertial navigation service sales, the Company's performance obligations, and associated revenue, are generally transferred to customers over time.


25


Product sales

Revenue from product sales is recognized when control of the goods is transferred to the customer, which generally occurs at the Company’s plant or warehouse upon delivery to the carrier for shipment. Revenue related to shipping and handling is recognized when the products are shipped and the associated costs are accrued for based on the Company’s election to account for shipping and handling activities as a fulfillment of the promise to transfer the products and not as a combined promise. For certain inertial navigation product sales, customer acceptance or inspection may be required before control of the goods is transferred to the customer. For those sales, revenue is recognized after notification of customer acceptance and the goods have been delivered to the carrier for shipment. In certain circumstances customers may request a bill-and-hold arrangement. Under these bill-and-hold arrangements, revenue is recognized when the Company has fulfilled all of its performance obligations, the Company has received notification of customer acceptance of the goods, the units are segregated for the specific customer only, and the goods are ready for physical transfer to the customer in accordance with their defined contract delivery schedule.

The Company’s standard payment terms are generally Net 30. Under certain limited conditions, the Company, at its sole discretion, provides for the return of goods. No product is accepted for return and no credit is allowed on any returned product unless the Company has granted and confirmed prior written permission by means of appropriate authorization. The Company establishes reserves for potential sales returns, credits, and allowances, and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and expectations for the future.

Contracts with multiple performance obligations

The Company sells products and services through arrangements that in certain instances bundle VSAT equipment, satellite connectivity and other services. For these arrangements, the Company has determined that the performance obligations are not distinct in the context of the contracts with certain customers, including sales-type leases on the VSAT equipment. The Company will recognize product revenue under these arrangements over the estimated satellite connectivity customer life, which is estimated to be five years based on historical evidence. For sales-type leases, interest is charged at market rates and is recognized in other income throughout the lease term, which is typically three to five years.
 
Satellite connectivity and media content service sales

Directly sold and re-sold satellite connectivity service for voice, data and Internet is recognized monthly based upon minutes or megabytes of traffic processed or contracted fixed fee schedules. Typically, subscribers enter into a one-year minimum service agreement. The Company has evaluated whether it obtains control of the services that are being transferred to the customer in assessing gross revenue reporting as principal verse net revenue reporting as agent for its satellite connectivity service sales and its payments to the applicable service providers. Based on the Company's assessment of the indicators, the Company has determined that gross revenue reporting as a principal is appropriate. The applicable indicators of gross revenue reporting included, but were not limited to, the following:

•
The Company is the primary obligor in its arrangements with its subscribers. The Company manages all interactions with the subscribers, while satellite connectivity service providers do not interact with the subscribers. In addition, the Company assumes the entire performance risk under its arrangements with the subscribers and in the event of a performance issue, the Company may incur reductions in fees without regard for any recourse that the Company may have with the applicable satellite connective service providers.

•
The Company has latitude in establishing pricing, as the pricing under its arrangements with the subscribers is negotiated through a contracting process, and has discretion on establishing pricing. The Company then separately negotiates the fees with the applicable satellite service providers.

•
The Company has complete discretion in determining which satellite service providers it will contract with.

As a result, the Company has determined that it earns revenue (as a principal) from the delivery of satellite connectivity services to its subscribers and records all satellite connectivity service sales to subscribers as gross sales. All associated regulatory service fees and costs are recorded net in the consolidated financial statements.

The Company sells prepaid airtime services in the form of prepaid cards. A liability is established upon purchase equal to the cash paid for the prepaid card. The Company recognizes revenue from the prepaid services upon the use of the prepaid card by the customer. The Company does not offer refunds for unused prepaid services. Prepaid airtime services have not been a significant portion of the Company’s total sales.


26


Media content sales include the Company's distribution of commercially licensed news, sports, movies and music content for commercial and leisure customers in the maritime, hotel, and retail markets as well as training videos to the merchant marine market that are typically based on a contracted fixed fee schedule. The Company typically recognizes revenue from media content sales ratably over the period of the service contract.

The accounting estimates related to the recognition of satellite connectivity and media content service sales require the Company to make assumptions about future billing adjustments for disputes with subscribers as well as unauthorized usage. The Company recognizes the monthly subscription fee as service revenue over the service delivery period. Under AgilePlans, the Company retains ownership of the hardware that it provides to these 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.

Inertial navigation service sales

The Company engages in contracts for development, production, and services activities related to standard product modification or enhancement. The Company considers the nature of these contracts and the types of products and services provided when determining the proper accounting for a particular contract. Customer and government-agency contracted engineering service and sales under development contracts are recognized primarily during the periods in which the Company performs the service or development efforts in accordance with the agreement. Services performed under these types of contracts include engineering studies, surveys, building construction, prototype development, and program management. Performance is determined principally by comparing the accumulated labor hours incurred to date with management’s estimate of the total labor hours to complete the contracted work. Incurred labor hours represent work performed, which corresponds with and best depicts the transfer of control to the customer. This continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay the Company for costs incurred plus a reasonable profit and take control of any work in process. The Company establishes billing terms at the time project deliverables and milestones are agreed. Unbilled revenue recognized in excess of the amounts invoiced to clients are classified within the accompanying consolidated balance sheets as “accounts receivable” as the Company's right to consideration is unconditional.

Product service sales

Product service sales other than under development contracts are recognized when completed services are delivered to the customer. The Company also sells extended warranty contracts on mobile connectivity and inertial navigation products. Sales under these contracts are recognized ratably over the contract term. Product service sales including extended warranties are not a significant portion of the Company’s total sales.


27


Financial Statement Impact of Adopting ASC 606

The Company adopted ASC 606 using the modified retrospective method. The cumulative effect of applying the new guidance to all contracts with customers that were not completed as of January 1, 2018 was recorded as an adjustment to accumulated deficit as of the adoption date. As a result of applying the modified retrospective method to adopt the new revenue guidance, the following adjustments were made to accounts on the consolidated balance sheet as of January 1, 2018:

 
As Reported
 
Adjustments
 
Adjusted
 
December 31, 2017
 
mini-VSAT Product
 
January 1, 2018
Cash, cash equivalent and marketable securities
$
42,915

 
$
—

 
$
42,915

Accounts receivable, net
28,316

 
—

 
28,316

Inventories
22,732

 
—

 
22,732

Contract assets
—

 
3,205

 
3,205

Prepaid expenses and other current assets
3,816

 
—

 
3,816

Long-lived assets
92,513

 
—

 
92,513

Other non-current assets
5,927

 
—

 
5,927

Contract assets, long-term
—

 
5,963

 
5,963

Non-current deferred income tax asset
20

 
202

 
222

          Total assets
$
196,239

 
$
9,370

 
$
205,609

Accounts payable, accrued expenses, and other current liabilities
$
36,430

 
—

 
$
36,430

Deferred revenue, current
6,919

 
(6,919
)
 
—

Contract liabilities
—

 
11,039

 
11,039

Long-term contract liabilities
—

 
7,998

 
7,998

Other long-term liabilities
2,653

 
—

 
2,653

Long-term debt, excluding current portion
44,572

 
—

 
44,572

          Total liabilities
$
90,574

 
$
12,118

 
$
102,692

Accumulated deficit
(4,417
)
 
(2,748
)
 
(7,165
)
Common stock, additional paid-in capital, and accumulated other comprehensive loss
110,082

 
—

 
110,082

          Total stockholders’ equity
$
105,665

 
$
(2,748
)
 
$
102,917

          Total liabilities and stockholders’ equity
$
196,239

 
$
9,370

 
$
205,609


mini-VSAT Broadband

Under the previous guidance, promised products and services under certain contracts were determined to be separate units of accounting. Under ASC 606, the products and services for these contracts are not considered separate performance obligations because they are not distinct in the context of the contract. As a result, under ASC 606 this revenue will be recognized over the estimated customer's life rather than at a point in time under the previous guidance. In conjunction with the January 1, 2018 adoption of ASC 606, the Company increased its accumulated deficit by $2,748, reflecting the deferral of $12,118 in revenue and $9,370 of cost of revenues, for contracts that were not complete as of the date of adoption.

Cost to Obtain a Customer Contract

Prior to the adoption of ASC 606, the Company expensed commissions paid to internal sales representatives and external sales representatives for obtaining mini-VSAT product contracts in the period the commissions were earned. Under ASC 606, for certain contracts in which the products and services are not considered separate performance obligation, the Company currently capitalizes these incremental costs of obtaining customer contracts and amortizes them over the estimated customer life of 5 years. The net impact of these changes to the treatment of commissions resulted in a $191 adjustment to accumulated deficit as of January 1, 2018.


28


Income Taxes

The adoption of ASC 606 primarily resulted in a deferment of revenue as of December 31, 2017, which in turn generated additional deferred tax assets that ultimately increased the Company's net deferred tax asset position by $203 as of January 1, 2018 related to sales made by certain international jurisdictions. As the Company fully reserves its net deferred tax assets generated in the U.S., this impact was offset by a corresponding increase to the valuation allowance.

Impact of New Revenue Guidance on Financial Statement Line Items

The following tables compare the reported consolidated balance sheet, statement of operations and cash flows, as of and for the three months ended September 30, 2018, to the pro forma amounts that would have been reported if the previous guidance had been in effect:
 
 
As of September 30, 2018
Balance Sheet
 
As reported
 
Pro forma as if
the previous accounting
guidance had been in effect
Cash, cash equivalent and marketable securities
 
$
33,236

 
$
33,236

Accounts receivable, net
 
28,971

 
28,971

Inventories
 
24,676

 
24,676

Contract assets
 
3,460

 
—

Prepaid expenses and other current assets
 
3,741

 
3,741

Long-lived assets
 
96,860

 
96,860

Other non-current assets
 
6,701

 
6,701

Contract assets, long-term
 
6,626

 
—

Non-current deferred income tax asset
 
201

 
46

  Total assets
 
$
204,472

 
$
194,231

Accounts payable, accrued expenses, and other current liabilities
 
$
58,342

 
$
58,342

Deferred revenue, current
 
—

 
6,424

Contract liabilities
 
10,770

 
—

Long-term contract liabilities
 
8,771

 
—

Other long-term liabilities
 
4,607

 
4,607

Long-term debt, excluding current portion
 
20,252

 
20,252

  Total liabilities
 
$
102,742

 
$
89,625

Accumulated deficit
 
(13,575
)
 
(10,699
)
Common stock, additional paid-in capital, and accumulated other comprehensive loss
 
115,305

 
115,305

  Total stockholders’ equity
 
$
101,730

 
$
104,606

  Total liabilities and stockholders’ equity
 
$
204,472

 
$
194,231


Total reported assets and reported liabilities were $10,241 and $13,117, respectively, greater than the pro forma balance sheet, which assumes that the previous guidance remained in effect as of September 30, 2018. This difference was largely due to the deferral of revenue and associated contract costs in connection with the treatment of certain mini-VSAT customer contracts in which the products and services were not distinct in the context of the contract. 


29


 
 
Three Months Ended
September 30, 2018
 
Nine Months Ended
September 30, 2018
Consolidated Statement of Operations
 
As reported
 
Pro forma as if
the previous accounting
guidance had been in effect
 
As reported
 
Pro forma as if
the previous accounting
guidance had been in effect
Sales:
 
 
 
 
 
 
 
 
 Product
 
$
16,367

 
$
16,775

 
$
46,521

 
$
47,519

 Service
 
27,150

 
27,150

 
80,489

 
80,489

  Net Sales
 
43,517

 
43,925

 
127,010

 
128,008

Costs and expenses:
 
 
 
 
 
 
 
 
Costs of product sales
 
9,767

 
10,177

 
28,784

 
29,670

Costs of service sales
 
15,376

 
15,376

 
44,690

 
44,690

Research and development
 
3,789

 
3,789

 
11,288

 
11,288

Sales, marketing and support
 
8,421

 
8,412

 
25,856

 
25,888

General and administrative
 
7,084

 
7,084

 
21,679

 
21,679

  Total operating expenses
 
44,437

 
44,838

 
132,297

 
133,215

  Loss from operations
 
(920
)
 
(913
)
 
(5,287
)
 
(5,207
)
 Other income (expense), net
 
(93
)
 
(93
)
 
(455
)
 
(455
)
  Loss before income tax expense
 
(1,013
)
 
(1,006
)
 
(5,742
)
 
(5,662
)
Income tax expense
 
161

 
138

 
668

 
620

 Net loss
 
$
(1,174
)
 
$
(1,144
)
 
$
(6,410
)
 
$
(6,282
)
 
 
 
 
 
 
 
 
 
Net loss per common share:
 
 
 
 
 
 
 
 
Basic and diluted
 
$
(0.07
)
 
$
(0.07
)
 
$
(0.38
)
 
$
(0.37
)

The following paragraphs summarize the significant changes to the Company’s consolidated statement of operations for the three and nine months ended September 30, 2018 resulting from the adoption of ASC 606 on January 1, 2018 compared to the results the Company would have reported under the prior guidance:

•
ASC 606 deferred the recognition of revenue and fulfillment costs related to mini-VSAT contracts in which the performance obligations for products and services are not distinct in the context of the contract. The deferred revenue and associated fulfillment costs will be recognized over the estimated customer life of five years. Under the previous guidance, these promised products and services were determined to be separate units of accounting, as a result of which the product revenue was recognized at the time of sale. As a result of the adoption of ASC 606, revenues and related cost of revenues were $408 and $410 lower, respectively, for the three months ended September 30, 2018 and $998 and $886 lower, respectively, for the nine months ended September 30, 2018 than they would have been under legacy GAAP as a result of the adoption of ASC 606.

•
ASC 606 resulted in the amortization of capitalized commission costs that were recorded as part of the cumulative effect adjustment upon adoption. Amortization of these capitalized costs to selling and marketing expenses, net of commission costs that were capitalized in the quarter, resulted in no meaningful impact on selling and marketing expenses in the quarter.

The net impact of accounting for revenue under the new guidance increased net loss by $30 and $128 for the three and nine months ended September 30, 2018, respectively. For the three months ended September 30, 2018, there was no change in basic and diluted loss per share. For the nine months ended September 30, 2018, there was a $0.01 increase in basic and diluted loss per share.

30


 
 
Nine Months Ended
September 30, 2018
Statement of Cash Flows
 
As reported
 
Pro forma as if
the previous accounting
guidance had been in effect
Net loss
 
$
(6,410
)
 
$
(6,282
)
 Non cash adjustments to reconcile net loss to net cash used in operating activities
 
12,111

 
12,063

Changes in operating assets and liabilities:
 
 
 
 
 Accounts receivable and inventories
 
(3,124
)
 
(3,124
)
 Prepaid expenses, other assets, and contract assets
 
(1,879
)
 
(961
)
 Deferred revenue, contract liabilities, and long-term contract liabilities
 
701

 
(297
)
 Accounts payable, accrued compensation, warranty, other, and other long-term liabilities
 
362

 
362

Net cash used in operating activities
 
$
1,761

 
$
1,761


The adoption of ASC 606 had no impact on the Company’s cash flows from operations. The aforementioned impacts resulted in offsetting shifts in cash flows throughout net loss and various changes in working capital balances.
 
 
Contract Assets
 
Contract Liabilities
 
 
Current
Non-Current
 
Current
Non-Current
Balance at January 1, 2018
 
$
3,205

$
5,963

 
$
11,039

$
7,998

Balance at September 30, 2018
 
$
3,460

$
6,626

 
$
10,770

$
8,771


Revenue recognized during the three and nine months ended September 30, 2018 from amounts included in deferred revenue at the beginning of the fiscal year was approximately $1,117 and $3,525, respectively.

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 the Company's consolidated net sales for three and nine months ended September 30, 2018 or 2017 or accounts receivable at September 30, 2018 or December 31, 2017.

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.


31


(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 operations. 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 September 30, 2018, 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 September 30, 2018, 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
$
1,322

 
$
(9
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
5.91
%
Interest rate swap
$
1,322

 
$
(11
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
6.07
%

As of December 31, 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
$
1,389

 
$
(33
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
5.91
%
Interest rate swap
$
1,389

 
$
(36
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
6.07
%

(18)     Income Taxes

The Company’s effective tax rate for the three and nine months ended September 30, 2018 was (15.9)% and (11.6)%, respectively, compared with (13.1)% and (9.3)% 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 nine months ended September 30, 2018 and 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 to the composition of income from foreign jurisdictions that were taxed at lower rates.
 
The 2017 Tax Cuts and Jobs Act (the “Tax Act”), which was signed into law on December 22, 2017, has resulted in significant changes to the U.S. corporate income tax system. These changes include a federal statutory rate reduction from 35%