Company Quick10K Filing
KVH Industries
Price10.68 EPS2
Shares18 P/E6
MCap193 P/FCF-17
Net Debt-9 EBIT33
TEV184 TEV/EBIT6
TTM 2019-09-30, in MM, except price, ratios
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KVHI 10Q Quarterly Report

Part I. Financial Information
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
EX-31.1 kvhi331201910qex311.htm
EX-31.2 kvhi331201910qex312.htm
EX-32.1 kvhi331201910qex321.htm

KVH Industries Earnings 2019-03-31

Balance SheetIncome StatementCash Flow
240192144964802012201420172020
Assets, Equity
503826142-102012201420172020
Rev, G Profit, Net Income
35217-7-21-352012201420172020
Ops, Inv, Fin

10-Q 1 kvhi331201910q.htm 10-Q 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: March 31, 2019
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
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

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on which Registered
Common Stock, par value $0.01 per share
KVHI
The NASDAQ Stock Market LLC
(NASDAQ Global Select Market)

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
April 30, 2019
Common Stock, par value $0.01 per share
17,879,814





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

 
 
Page No.
 
ITEM 1.
 
 
Consolidated Balance Sheets as of March 31, 2019 (unaudited) and December 31, 2018
 
Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018 (unaudited)
 
Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2019 and 2018 (unaudited)
 
Consolidated Statements of Stockholders' Equity for the three months ended March 31, 2019 and 2018 (unaudited)
 
Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018 (unaudited)
 
ITEM 2.
ITEM 4.
 
ITEM 1.
ITEM 2.
ITEM 6.
 

2




PART I. FINANCIAL INFORMATION
ITEM 1.    Financial Statements
KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
 
March 31,
2019
 
December 31,
2018
ASSETS
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
14,259

 
$
18,050

Marketable securities
25

 
25

Accounts receivable, net of allowance for doubtful accounts of $2,555 and $2,685 as of March 31, 2019 and December 31, 2018, respectively
28,832

 
29,663

Inventories
26,062

 
22,942

Prepaid expenses and other current assets
4,320

 
3,494

Current contract assets
3,678

 
3,566

Total current assets
77,176

 
77,740

Property and equipment, net
53,697

 
53,248

Intangible assets, net
9,807

 
10,518

Goodwill
32,845

 
32,213

Right of use asset operating lease
9,411

 

Other non-current assets
7,021

 
6,736

Non-current contract assets
7,342

 
6,971

Non-current deferred income tax asset
210

 
226

Total assets
$
197,509

 
$
187,652

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
20,270

 
$
17,726

Accrued compensation and employee-related expenses
4,249

 
5,167

Accrued other
10,131

 
10,964

Accrued product warranty costs
2,021

 
1,916

Current portion of long-term debt
10,585

 
9,928

Contract liabilities
12,211

 
9,193

Current operating lease liability
4,749

 

Liability for uncertain tax positions
1,141

 
1,116

Total current liabilities
65,357

 
56,010

Other long-term liabilities
1,752

 
1,920

Long-term operating lease liability
4,672

 

Long-term contract liabilities
9,634

 
9,070

Long-term debt, excluding current portion
18,749

 
19,437

Non-current deferred income tax liability
1,747

 
1,700

Total liabilities
$
101,911

 
$
88,137

Commitments and contingencies (Notes 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; 19,134,469 and 19,026,393 shares issued at March 31, 2019 and December 31, 2018, respectively; and 17,852,047 and 17,743,971 shares outstanding at March 31, 2019 and December 31, 2018, respectively
191

 
190

Additional paid-in capital
140,790

 
139,617

Accumulated deficit
(21,576
)
 
(15,397
)
Accumulated other comprehensive loss
(13,643
)
 
(14,731
)
 
105,762

 
109,679

Less: treasury stock at cost, common stock, 1,282,422 and 1,282,422 shares as of March 31, 2019 and December 31, 2018, respectively
(10,164
)
 
(10,164
)
Total stockholders’ equity
95,598

 
99,515

Total liabilities and stockholders’ equity
$
197,509

 
$
187,652


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
 
March 31,
 
2019
 
2018
Sales:
 
 
 
Product
$
12,874

 
$
13,992

Service
27,098

 
26,109

Net sales
39,972

 
40,101

Costs and expenses:
 
 
 
Costs of product sales
7,853

 
8,923

Costs of service sales
16,697

 
13,816

Research and development
3,868

 
3,934

Sales, marketing and support
9,303

 
8,941

General and administrative
8,080

 
7,667

Total costs and expenses
45,801

 
43,281

Loss from operations
(5,829
)
 
(3,180
)
Interest income
175

 
148

Interest expense
385

 
409

Other expense, net
(106
)
 
(274
)
Loss before income tax expense
(6,145
)
 
(3,715
)
Income tax expense
34

 
178

Net loss
$
(6,179
)
 
$
(3,893
)
 
 
 
 
Net loss per common share

 

Basic and diluted
$
(0.36
)
 
$
(0.23
)
Weighted average number of common shares outstanding:
 
 
 
Basic and diluted
17,302

 
16,742



See accompanying Notes to Unaudited Consolidated Financial Statements.
4



KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands, unaudited)
 
 
Three Months Ended
 
March 31,
 
2019
 
2018
Net loss
$
(6,179
)
 
$
(3,893
)
Other comprehensive income, net of tax:
 
 
 
Unrealized gain on available-for-sale securities

 
1

Foreign currency translation adjustment
1,080

 
2,444

Unrealized gain on derivative instruments, net
8

 
22

Other comprehensive income, net of tax(1)
1,088

 
2,467

Total comprehensive loss
$
(5,091
)
 
$
(1,426
)

(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 STOCKHOLDERS' EQUITY
(in thousands, unaudited)
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Treasury Stock
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
Balance at December 31, 2018
19,026

 
$
190

 
$
139,617

 
$
(15,397
)
 
$
(14,731
)
 
(1,282
)
 
$
(10,164
)
 
$
99,515

Net loss

 

 

 
(6,179
)
 

 

 

 
(6,179
)
Other comprehensive income

 

 

 

 
1,088

 

 

 
1,088

Stock-based compensation

 

 
874

 

 

 

 

 
874

Issuance of common stock under employee stock purchase plan
23

 

 
218

 

 

 

 

 
218

Exercise of stock options and issuance of restricted stock awards, net of forfeitures
85

 
1

 
81

 

 

 

 

 
82

Balance at March 31, 2019
19,134

 
$
191

 
$
140,790

 
$
(21,576
)
 
$
(13,643
)
 
(1,282
)
 
$
(10,164
)
 
$
95,598


 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Treasury Stock
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
Balance at December 31, 2017
18,788

 
$
188

 
$
134,361

 
$
(4,417
)
 
$
(11,317
)
 
(1,659
)
 
$
(13,150
)
 
$
105,665

Net loss

 

 

 
(3,893
)
 

 

 

 
(3,893
)
Other comprehensive income

 

 

 

 
2,467

 

 

 
2,467

ASC 606 adoption

 

 

 
(2,748
)
 

 

 

 
(2,748
)
Stock-based compensation

 

 
853

 

 

 

 

 
853

Sale of treasury stock

 

 
1,478

 

 

 
377

 
2,986

 
4,464

Exercise of stock options and issuance of restricted stock awards, net of forfeitures
16

 

 
26

 

 

 

 

 
26

Balance at March 31, 2018
18,804

 
$
188

 
$
136,718

 
$
(11,058
)
 
$
(8,850
)
 
(1,282
)
 
$
(10,164
)
 
$
106,834






See accompanying Notes to Unaudited Consolidated Financial Statements.
6



KVH INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited) 
 
Three Months Ended
 
March 31,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net loss
$
(6,179
)
 
$
(3,893
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Provision for doubtful accounts
(65
)
 
28

Depreciation and amortization
3,527

 
3,050

Deferred income taxes
16

 
9

Loss on disposals of fixed assets
56

 

Compensation expense related to stock-based awards and employee stock purchase plan
874

 
853

Unrealized currency translation loss
47

 
40

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
944

 
(91
)
Inventories
(3,117
)
 
(558
)
Prepaid expenses, other current assets and current contract assets
(891
)
 
(651
)
Other non-current assets and non-current contract assets
(705
)
 
(836
)
Accounts payable
2,627

 
1,067

Contract liabilities and long-term contract liabilities
3,526

 
1,094

Accrued compensation, product warranty and other
(1,719
)
 
(1,303
)
Other long-term liabilities and long-term operating lease liabilities
(15
)
 
(6
)
Net cash used in operating activities
$
(1,074
)
 
$
(1,197
)
Cash flows from investing activities:
 
 
 
Capital expenditures
(3,027
)
 
(3,189
)
Cash paid for acquisition of intangible asset
(25
)
 

Purchases of marketable securities

 
(1,026
)
Maturities and sales of marketable securities

 
6,013

Net cash (used in) provided by investing activities
$
(3,052
)
 
$
1,798

Cash flows from financing activities:
 
 
 
Repayments of long-term debt
(31
)
 
(44
)
Repayments of term note borrowings

 
(2,825
)
Proceeds from stock options exercised and employee stock purchase plan
314

 

Sale of treasury stock

 
4,500

Payment of finance lease
(152
)
 
(107
)
Net cash provided by financing activities
$
131

 
$
1,524

Effect of exchange rate changes on cash and cash equivalents
204

 
1,047

Net (decrease) increase in cash and cash equivalents
(3,791
)
 
3,172

Cash and cash equivalents at beginning of period
18,050

 
34,596

Cash and cash equivalents at end of period
$
14,259

 
$
37,768

Supplemental disclosure of non-cash investing activities:
 
 
 
Changes in accrued other and accounts payable related to property and equipment additions
$
161

 
$
537


See accompanying Notes to Unaudited Consolidated Financial Statements.
7



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 March 2019, KVH introduced a 1-meter Ku/C-band antenna designed to deliver download/upload speeds as fast as 20 Mbps/3Mbps through a dual Ku/C-band design that automatically switches between bandwidths to deliver expanded global coverage on KVH’s mini-VSAT Broadband high-throughput satellite (HTS) network. In March 2019, KVH further expanded the mini-VSAT Broadband HTS network for the entire Pacific Ocean region via the Horizons 3e satellite, which is jointly owned by Intelsat and SKY Perfect JSAT. The high-performance Horizons 3e satellite immediately adds to the global coverage and capacity of KVH’s mini-VSAT Broadband HTS network, which provides connectivity to vessels worldwide.

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. The Company offers AgilePlans, a monthly mini-VSAT Broadband 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 retains ownership of the hardware, it does not accrue any warranty costs for AgilePlans hardware; however, any maintenance costs for 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.


8



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, 2018 filed on March 1, 2019 with the Securities and Exchange Commission. The results for the three months ended March 31, 2019 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 in addition to the valuation of right-of-use assets and lease liabilities, for the three months ended March 31, 2019.

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, 2018 was the Company’s adoption of Accounting Standards Codification (ASC) 842, Leases, effective January 1, 2019. Please see Note 19 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.


9



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 Note 19 for further discussion.

(3)     Accounting Standards Issued and Not Yet Adopted

ASC Update No. 2016-13 and ASC Update No. 2018-19

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.

In November 2018, the FASB issued ASC Update No. 2018-19, Codification Improvements to Topic 326, Financial Instruments—Credit Losses. This update introduced an expected credit loss methodology for the impairment of financial assets measured at amortized cost basis. The amendment also clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases. The adoption of Update No. 2016-13 and 2018-19 is not expected to have a material impact on the Company's financial position or results of operations.

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.

ASC Update No. 2018-18

In November 2018, the FASB issued ASC Update No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606. This update is effective for public business entities for fiscal years beginning after December 15, 2019, and the interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, for public business entities for periods for which financial statements have not yet been issued. The purpose of Update No. 2018-18 is to help make clarifications on the interactions between Topic 808, Collaborative Arrangement, and Topic 606, Revenue from Contracts with Customers. Update No. 2018-18 is not expected to have a material impact on the Company's financial position or results of operation.

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.


10



(4)
Marketable Securities
Marketable securities as of March 31, 2019 and December 31, 2018 consisted of the following:
March 31, 2019
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Money market mutual funds
$
25

 
$

 
$

 
$
25

Total marketable securities designated as available-for-sale
$
25

 
$

 
$

 
$
25

 
December 31, 2018
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Money market mutual funds
$
25

 
$

 
$

 
$
25

Total marketable securities designated as available-for-sale
$
25

 
$

 
$

 
$
25

The amortized costs and fair value of marketable securities as of March 31, 2019 and December 31, 2018 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.
March 31, 2019
Amortized
Cost
 
Fair
Value
Due in less than one year
$

 
$

December 31, 2018
Amortized
Cost
 
Fair
Value
Due in less than one year
$

 
$

Interest income from marketable securities was less than $1 and $12 during the three months ended March 31, 2019 and 2018, 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 $860 and $843 for the three months ended March 31, 2019 and 2018, respectively. As of March 31, 2019, there was $2,152 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 2.68 years. As of March 31, 2019, there was $3,743 of total unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted-average period of 1.93 years.

Stock Options

During the three months ended March 31, 20197 stock options were exercised for common stock, and no shares of common stock were delivered to the Company as payment for the exercise price or related minimum tax withholding obligations for the exercise of such options. During the three months ended March 31, 2019no stock options were granted and 2 stock options expired, were canceled or were forfeited. The Company estimates the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model.

As of March 31, 2019, there were 1,267 options outstanding with a weighted average exercise price of $10.29 per share and 514 options exercisable with a weighted average exercise price of $10.37 per share.


11



Restricted Stock

During the three months ended March 31, 201978 shares of restricted stock were granted with a weighted average grant date fair value of $10.59 per share, and no shares of restricted stock were forfeited. Additionally, during the three months ended March 31, 2019194 shares of restricted stock vested, none of which were surrendered to the Company to satisfy minimum tax withholding obligations for the vesting of such shares.

As of March 31, 2019, there were 409 shares of restricted stock outstanding that were subject to service-based vesting conditions.

As of March 31, 2019, the Company had no unvested outstanding options and 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 months ended March 31, 2019 and 2018, 23 and 0 shares were issued under the ESPP plan, respectively. The Company recorded compensation charges of $14 and $10 for the three months ended March 31, 2019 and 2018, respectively, related to the ESPP.

(c) Stock-Based Compensation Expense
    
The following table presents stock-based compensation expense, including under the ESPP, in the Company's consolidated statements of operations for the three months ended March 31, 2019 and 2018:
 
Three Months Ended
March 31,
 
2019
 
2018
Cost of product sales
$
41

 
$
71

Cost of service sales

 

Research and development
172

 
170

Sales, marketing and support
182

 
181

General and administrative
479

 
431

 
$
874

 
$
853


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. 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).
 
Foreign Currency Translation
 
Unrealized (Loss) Gain on Available for Sale Marketable Securities
 
Interest Rate Swaps
 
Total Accumulated Other Comprehensive Loss
Balance, December 31, 2018
$
(14,720
)
 
$

 
$
(11
)
 
$
(14,731
)
Other comprehensive income before reclassifications
1,080

 

 

 
1,080

Amounts reclassified from AOCI to Other income, net

 

 
8

 
8

Net other comprehensive income, March 31, 2019
1,080



 
8

 
1,088

Balance, March 31, 2019
$
(13,640
)
 
$

 
$
(3
)
 
$
(13,643
)
 
 
Foreign Currency Translation
 
Unrealized (Loss) Gain 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 income before reclassifications
2,444

 
1

 
7

 
2,452

Amounts reclassified from AOCI to Other income, net

 

 
15

 
15

Net other comprehensive income, March 31, 2018
2,444

 
1

 
22

 
2,467

Balance, March 31, 2018
$
(8,803
)
 
$

 
$
(47
)
 
$
(8,850
)
For additional information, see Note 4, "Marketable Securities," and Note 17, "Derivative Instruments and Hedging Activities."

13



(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 months ended March 31, 2019 and 2018, since there was a net loss, the Company excluded 1,042 and 251, 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
 
March 31,
 
2019
 
2018
Weighted average common shares outstanding—basic
17,302

 
16,742

Dilutive common shares issuable in connection with stock plans

 

Weighted average common shares outstanding—diluted
17,302

 
16,742


(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 March 31, 2019 and December 31, 2018 include the costs of material, labor, and factory overhead. Components of inventories consist of the following:
 
March 31,
2019
 
December 31,
2018
Raw materials
$
14,822

 
$
13,698

Work in process
3,513

 
2,489

Finished goods
7,727

 
6,755

 
$
26,062

 
$
22,942

(8)     Property and Equipment

Property and equipment, net, as of March 31, 2019 and December 31, 2018 consist of the following:

 
March 31,
2019
 
December 31,
2018
Land
$
3,828

 
$
3,828

Building and improvements
24,059

 
24,060

Leasehold improvements
483

 
483

Machinery and equipment
17,345

 
17,239

Revenue-generating assets
44,442

 
42,424

Office and computer equipment
14,428

 
13,980

Motor vehicles
31

 
31

 
104,616

 
102,045

Less accumulated depreciation
(50,919
)
 
(48,797
)
 
$
53,697

 
$
53,248


Depreciation expense was $2,568 and $1,953 for the three months ended March 31, 2019 and 2018, respectively.

Certain revenue-generating hardware assets are utilized by the Company in the delivery of the Company's airtime services, media, and other content.


14



(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 March 31, 2019 and December 31, 2018, the Company had accrued product warranty costs of $2,021 and $1,916, respectively.
The following table summarizes product warranty activity during 2019 and 2018:
 
 
Three Months Ended
 
March 31,
 
2019
 
2018
Beginning balance
$
1,916

 
$
2,074

Charges to expense
453

 
741

Costs incurred
(348
)
 
(788
)
Ending balance
$
2,021

 
$
2,027


(10)     Debt
Long-term debt consisted of the following:
 
March 31,
2019
 
December 31,
2018
2018 term notes
$
21,938

 
$
21,938

Line of credit
5,000

 
5,000

Mortgage loan
2,551

 
2,597

Total long-term debt
29,489

 
29,535

Less debt issuance costs for 2018 term note(a)
155

 
170

Total long-term debt less debt issuance costs
$
29,334

 
$
29,365

Less amounts classified as current
10,585

 
9,928

Long-term debt, excluding current portion
$
18,749

 
$
19,437

(a)- Debt issuance costs classified as current and long-term are $60 and $95, respectively.

Term Note and Line of Credit

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 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 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.


15



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 was due on December 31, 2018. As of March 31, 2019, due to the timing of the payment schedule, no payment occurred during the three months ended March 31, 2019 and there are five quarters of principal repayments outstanding in the current portion of long-term debt. 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. As of March 31, 2019, there was $5,000 outstanding under the 2018 Revolver and the remaining balance of $15,000 was available for borrowing.

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.

16



Mortgage Loan

As of March 31, 2019, the Company had 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 was ten years, with a principal amortization of 20 years. The interest rate was based on the BBA LIBOR Rate plus 2.00 percentage points. The Mortgage Loan was secured by the underlying property and improvements. The monthly mortgage payment was 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 was due on April 1, 2019.
 
As discussed in Note 17 to the consolidated financial statements, the Company entered into two interest rate swap agreements that were 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. In April 2019, the Company repaid in full the current balance of the Mortgage Loan.

(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 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 18% and 20% of the Company's consolidated net sales for the three months ended March 31, 2019 and 2018, respectively. Sales of mini-VSAT Broadband airtime service accounted for 46% and 41% of the Company's consolidated net sales for the three months ended March 31, 2019 and 2018, respectively. Sales of content and training services within the mobile connectivity segment accounted for 16% and 19% of the Company's consolidated net sales for the three months ended March 31, 2019 and 2018, 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 13% of the Company's consolidated net sales for each of the three months ended March 31, 2019 and 2018.

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

The Company operates in a number of major geographic areas across the globe. The Company generates international net sales, based upon customer location, primarily from customers located in Canada, Europe, Africa, Asia/Pacific, the Middle East, and India. International revenues represented 62% and 58% of the Company's consolidated net sales for the three months ended March 31, 2019 and 2018, respectively. No individual foreign country represented 10% or more of the Company's consolidated net sales for the three months ended March 31, 2019 or 2018.

As of March 31, 2019 and December 31, 2018, 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.


17



Net sales and operating (loss) income for the Company's reporting segments and the Company's loss before income tax expense for the three months ended March 31, 2019 and 2018 were as follows:
 
Three Months Ended
March 31,
 
2019
 
2018
Net sales:
 
 
 
Mobile connectivity
$
32,510

 
$
32,749

Inertial navigation
7,462

 
7,352

     Consolidated net sales
$
39,972

 
$
40,101

 
 
 
 
Operating (loss) income:
 
 
 
Mobile connectivity
$
(1,039
)
 
$
1,072

Inertial navigation
443

 
334

     Subtotal
(596
)
 
1,406

Unallocated, net
(5,233
)
 
(4,586
)
     Loss from operations
(5,829
)
 
(3,180
)
Net interest and other expense
(316
)
 
(535
)
     Loss before income tax expense
$
(6,145
)
 
$
(3,715
)
Depreciation expense and amortization expense for the Company's reporting segments for the three months ended March 31, 2019 and 2018 were as follows:
 
Three Months Ended
March 31,
 
2019
 
2018
Depreciation expense:
 
 
 
Mobile connectivity
$
2,145

 
$
1,470

Inertial navigation
286

 
218

Unallocated
137

 
265

     Total consolidated depreciation expense
$
2,568

 
$
1,953

 
 
 
 
Amortization expense:
 
 
 
Mobile connectivity
$
959

 
$
1,097

Inertial navigation

 

Unallocated

 

     Total consolidated amortization expense
$
959

 
$
1,097



(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.


18



(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 March 31, 2019, 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 three months ended March 31, 2019 and no repurchase programs expired during the period.

During the three months ended March 31, 2019 and 2018, the Company did not repurchase any shares of its common stock in open market transactions.

(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.

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.

19



The following tables present financial assets and liabilities at March 31, 2019 and December 31, 2018 for which the Company measures fair value on a recurring basis, by level, within the fair value hierarchy:
March 31, 2019
Total
 
Level 1
 
Level 2
 
Level 3
 
Valuation
Technique
Assets
 
 
 
 
 
 
 
 
 
Money market mutual funds
$
25

 
$
25

 
$

 
$

 
(a)
Liabilities
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
3

 
$

 
$
3

 
$

 
(b)
December 31, 2018
Total
 
Level 1
 
Level 2
 
Level 3
 
Valuation
Technique
Assets
 
 
 
 
 
 
 
 
 
Money market mutual funds
$
25

 
$
25

 
$

 
$

 
(a)
Liabilities
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
11

 
$

 
$
11

 
$

 
(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 March 31, 2019. 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 three months ended March 31, 2019:

 
 
Amounts
Balance at December 31, 2018
 
$
32,213

Foreign currency translation adjustment
 
632

Balance at March 31, 2019
 
$
32,845

    
Intangible Assets

The changes in the carrying amount of intangible assets during the three months ended March 31, 2019 are as follows:
 
 
Amounts
Balance at December 31, 2018
 
$
10,518

Amortization expense
 
(959
)
Intangible assets acquired in asset acquisition
 
25

Foreign currency translation adjustment
 
223

Balance at March 31, 2019
 
$
9,807


20



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 March 31, 2019, the carrying value of the intangible assets acquired in the asset acquisition was $202. 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 three months ended March 31, 2019, $25 additional consideration was earned under the contingent consideration arrangement.

Acquired intangible assets are subject to amortization. The following table summarizes acquired intangible assets at March 31, 2019 and December 31, 2018, respectively:


Gross Carrying Amount

Accumulated Amortization

Net Carrying Value
March 31, 2019
 
 
 
 
 
 
Subscriber relationships
 
$
17,742

 
$
10,825

 
$
6,917

Distribution rights
 
4,290

 
1,799

 
2,491

Internally developed software
 
2,327

 
2,327

 

Proprietary content
 
8,181

 
7,812

 
369

Intellectual property
 
2,284

 
2,284

 

Favorable lease
 
645

 
615

 
30

 
 
$
35,469

 
$
25,662

 
$
9,807

December 31, 2018
 
 
 
 
 
 
Subscriber relationships
 
$
17,570

 
$
10,337

 
$
7,233

Distribution rights
 
4,233

 
1,731

 
2,502

Internally developed software
 
2,327

 
2,327

 

Proprietary content
 
8,164

 
7,439

 
725

Intellectual property
 
2,284

 
2,284

 

Favorable lease
 
643

 
585

 
58

 
 
$
35,221

 
$
24,703

 
$
10,518


Amortization expense related to intangible assets for the three months ended March 31, 2019 and 2018 was as follows:

 
Three Months Ended March 31,
Expense Category
2019
 
2018
Cost of service sales
$
373

 
$
399

General and administrative expense
586

 
698

 Total amortization expense
$
959

 
$
1,097


21



As of March 31, 2019, the total weighted average remaining useful lives of the definite-lived intangible assets was 3.1 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
3.6
Distribution rights
9.1
Proprietary content
0.3
Favorable lease
0.3

Estimated future amortization expense remaining at March 31, 2019 for intangible assets acquired was as follows:

Remainder of 2019
$
2,069

2020
2,225

2021
2,225

2022
1,463

2023
544

Thereafter
1,281

Total future amortization expense
$
9,807

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 first quarter of 2019 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 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.

Disaggregation of Revenue

The following table summarizes net sales from contracts with customers for the three months ended March 31, 2019 and 2018:

 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Mobile connectivity product, transferred at point in time
 
$
5,677

 
$
6,670

Mobile connectivity product, transferred over time
 
1,385

 
1,250

Mobile connectivity service
 
25,448

 
24,829

Inertial navigation product
 
5,812

 
6,072

Inertial navigation service
 
1,650

 
1,280

   Total net sales
 
$
39,972

 
$
40,101



22



Revenue recognized during the three months ended March 31, 2019 and 2018 from amounts included in contract liabilities at the beginning of the period was $1,336 and $1,215, respectively.

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.

Business and Credit Concentrations

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

No single customer accounted for 10% or more of consolidated net sales for the first quarter of 2019 or 2018 or accounts receivable at March 31, 2019 or December 31, 2018.

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

(17)     Derivative Instruments and Hedging Activities

Effective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, the Company entered into two interest rate swap agreements. These interest rate swap agreements were 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 1, 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 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. 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 was 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 ended on April 1, 2019. As of March 31, 2019, 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 March 31, 2019, 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
$
1,275

 
(1
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
5.91
%
Interest rate swap
$
1,275

 
(2
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
6.07
%
As of December 31, 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
$
1,299

 
(5
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
5.91
%
Interest rate swap
$
1,299

 
(6
)
 
April 1, 2010
 
April 1, 2019
 
1-month LIBOR
 
6.07
%

23



(18)     Income Taxes

The Company’s effective tax rate for the three months ended March 31, 2019 was (0.6)% compared with (4.8)% for the corresponding period in the prior year. The effective income tax rate is 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, and the resolution or identification of tax position uncertainties.

For the three months ended March 31, 2019 and 2018, the effective tax rate was 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 taxed at lower rates.

As of March 31, 2019 and December 31, 2018, the Company had reserves for uncertain tax positions of $1,141 and $1,116, respectively. There were no material changes during the three months ended March 31, 2019 to the Company’s reserve for uncertain tax positions. The Company estimates that it is reasonably possible that the balance of unrecognized tax benefits as of March 31, 2019 may decrease $359 in the next twelve months as a result of a lapse of statutes of limitations and settlements with taxing authorities.

The Company’s tax jurisdictions include the United States, the United Kingdom, Denmark, Cyprus, Norway, Brazil, Singapore, Belgium, the Netherlands, Hong Kong, India and Japan. In general, the statute of limitations with respect to the Company's United States federal income taxes has expired for years prior to 2014, and the relevant state and foreign statutes vary. However, preceding years remain open to examination by United States federal and state and foreign taxing authorities to the extent of future utilization of net operating losses and research and development tax credits generated in each preceding year.

(19)     Leases

The Company adopted ASC 842 on January 1, 2019. ASC 842 requires the recognition of lease assets and lease liabilities for leases classified as operating leases. The original guidance required application of ASC 842 on a modified retrospective basis with the earliest period presented. In August 2018, the FASB issued ASU 2018-11, Targeted Improvements to ASC 842, which included an option to not restate comparative periods in transition and elect to use the effective date as the date of initial application of transition. The Company elected not to restate comparative periods and, accordingly, the financial results reported for periods prior to January 1, 2019 have not been restated. In ASC 842, a lease is defined as follows: “[a] contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”

Upon adoption, the Company recognized all leases greater than one year in duration on the balance sheet as right-of-use assets and lease liabilities. The Company made certain assumptions and judgments when applying ASC 842. The Company elected practical expedients available for the transition, such as whether expired or existing contracts contain leases under the new definition of a lease, lease classification for expired or existing leases, and whether previously capitalized initial direct costs would qualify for capitalization under ASC 842. For all asset classes, the Company elected to not separate non-lease components from lease components to which they relate and have accounted for the combined lease and non-lease components as a single lease component.

Many of our lease agreements contain renewal options which are recognized if it is determined that the Company is reasonably certain to renew the lease at inception or when a triggering event occurs. Some of our lease agreements contain rent escalation clauses, rent holidays, capital improvement funding or other lease concessions. The Company recognizes the minimum rental expense on a straight-line basis based on the fixed components of a lease arrangement and amortize such expense over the term of the lease beginning with the commencement date. Variable lease components that are not fixed at the beginning of the lease are recognized as incurred.

Under certain third-party service agreements, the Company controls a specific space or underlying asset used in providing the service by the third-party service provider. These arrangements meet the definition under ASC 842 and therefore are accounted for under ASC 842. Right-of-use assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term and include options to extend or terminate the lease when reasonably certain to be exercised. The present value of lease payments is determined using the incremental borrowing rate based on the information available at the lease commencement date.


24



The Company has operating leases for office facilities, equipment, and satellite service capacity and related equipment. Lease expense for the three months ended March 31, 2019 was $1,310. The future minimum lease payments under our operating leases as of March 31, 2019 are:

Remainder of 2019
$
3,883

2020
2,987

2021
1,275

2022
1,196

2023
386

2024 and thereafter
536

Total minimum lease payments
$
10,263

 
 
Less amount representing interest
$
(842
)
Present value of net minimum operating lease payments
$
9,421

Less current installments of obligation under current-operating lease liabilities
$
4,749

Obligations under long term - operating lease liabilities, excluding current installments
$
4,672

 
 
Weighted-average remaining lease term - operating leases (years)
3.00

Weighted-average discount rate - operating leases
5.50
%

During the first quarter of 2018, the Company entered into a five-year financing lease for three satellite hubs for its HTS network. As of March 31, 2019, the gross costs and accumulated amortization associated with this lease are included in revenue generating assets and amounted to $3,068 and $517, respectively. Property and equipment under capital leases are stated at the present value of minimum lease payments.

The property and equipment held under this financing lease are amortized on a straight‑line basis over the seven-year estimated useful life of the asset, since the lease meets the bargain purchase option criteria. Amortization of assets held under financing leases is included within depreciation expense. Depreciation expense for these capital assets was $110 and $78 for the three months ended March 31, 2019 and 2018, respectively.
 
The future minimum lease payments under this financing lease as of March 31, 2019 are:
Remainder of 2019
$
468

2020
624

2021
624

2022
624

2023
45

2024 and thereafter

Total minimum lease payments
$
2,385

 
 
Less amount representing interest
$
(30
)
Present value of net minimum financing lease payments
$
2,355

Less current installments of obligation under accrued other
$
611

Obligations under other long-term liabilities, excluding current installments
$
1,744

 
 
Weighted-average remaining lease term - finance leases (years)
3.92

Weighted-average discount rate - finance leases
1.53
%



25



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

The statements included in this quarterly report on Form 10-Q, other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include statements regarding our future financial results, operating results, business strategies, projected costs, products and services, competitive positions and plans, customer preferences, consumer trends, anticipated product development, and objectives of management for future operations. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,” or the negative of these terms or other comparable terminology. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in the section entitled “Risk Factors” in Item 1A of Part I of our annual report on Form 10-K for the year ended December 31, 2018. These and many other factors could affect our future financial and operating results, and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by us or on our behalf. For example, our expectations regarding certain items as a percentage of sales assume that we will achieve our anticipated sales goals. The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report.

Overview

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

Mobile Connectivity Segment

Our mobile connectivity segment offers satellite communications products and services. Our mobile connectivity products enable customers to receive voice and Internet services and live digital television via satellite services in marine vessels, recreational vehicles, buses and automobiles. Our CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. We sell and lease our mobile connectivity products through an extensive international network of dealers and distributors. We also sell and lease products directly to end users.

Our mobile connectivity service sales include sales of satellite voice and Internet airtime services, engineering services provided under development contracts, sales from product repairs, and extended warranty sales. Our mobile connectivity service sales also include our distribution of entertainment, including news, sports, music, and movies, to commercial and leisure customers in the maritime, hotel, and retail markets through KVH Media Group, as well as the distribution of training films and eLearning computer-based training courses to commercial customers in the maritime market through our Videotel business. We typically recognize revenue from media content sales ratably over the period of the service contract. We provide, for monthly fixed fees and usage-based fees, satellite connectivity services for broadband Internet, data and Voice over Internet Protocol (VoIP) service to our TracPhone V-series customers. We also earn monthly usage fees for third-party satellite connectivity for voice, data and Internet services to our Inmarsat and Iridium customers who choose to activate their subscriptions with us. As a percentage of our consolidated net sales, our service sales were 68% and 65% for the three months ended March 31, 2019 and 2018, respectively.

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


26



Inertial Navigation Segment

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

We generate sales primarily from the sale of our mobile connectivity systems and services and our inertial navigation products and services. The following table provides, for the periods indicated, our sales by segment:
 
Three Months Ended
 
March 31,
 
2019
 
2018
 
(in thousands)
Mobile connectivity
$
32,510

 
$
32,749

Inertial navigation
7,462

 
7,352

    Net sales
$
39,972

 
$
40,101


Product sales within the mobile connectivity segment accounted for 18% and 20% of our consolidated net sales for the three months ended March 31, 2019 and 2018, respectively. Sales of mini-VSAT Broadband airtime services accounted for approximately 46% and 41% of our consolidated net sales for the three months ended March 31, 2019 and 2018, respectively. Sales of content and training services within the mobile connectivity segment accounted for 16% and 19% of our consolidated net sales for the three months ended March 31, 2019 and 2018, respectively.

Within our inertial navigation segment, net sales of FOG-based guidance and navigation systems accounted for 13% of our consolidated net sales for both the three months ended March 31, 2019 and 2018.

No other single product class accounted for 10% or more of our consolidated net sales for the three months ended March 31, 2019 or 2018. No individual customer accounted for 10% or more of our consolidated net sales for the three months ended March 31, 2019 or 2018.

We operate in a number of major geographic areas across the globe. We generate our international net sales, based upon customer location, primarily from customers located in Canada, Europe, Africa, Asia/Pacific, the Middle East, and India. Our international net sales totaled 62% and 58% of our consolidated net sales for the three months ended March 31, 2019 and 2018, respectively. No individual foreign country represented 10% or more of our consolidated net sales for the three months ended March 31, 2019 or 2018. See Note 11 to our consolidated financial statements for more information on our segments.


27



In addition to our internally funded research and development efforts, we also conduct research and development activities that are funded by our customers. These activities relate primarily to engineering studies, surveys, prototype development, program management, and standard product customization. In accordance with accounting principles generally accepted in the United States of America, we account for customer-funded research as service revenue, and we account for the associated research and development costs as costs of service and product sales. As a result, customer-funded research and development are not included in the research and development expense that we present in our statement of operations. The following table presents our total annual research and development effort, representing the sum of research costs of service and product sales and the operating expense of research and development as described in our statement of operations. Our management believes this information is useful because it provides a better understanding of our total expenditures on research and development activities.
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Research and development expense presented on the statement of operations
$
3,868

 
$
3,934

Costs of customer-funded research and development included in costs of service sales
1,048

 
675

Total consolidated statements of operations expenditures on research and development activities
$
4,916

 
$
4,609


Critical Accounting Policies and Significant Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, sales and expenses, and related disclosure at the date of our financial statements. Our significant accounting policies are summarized in Note 1 to the consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2018.

As described in our annual report on Form 10-K for the year ended December 31, 2018, our most critical accounting policies and estimates upon which our consolidated financial statements were prepared were those relating to revenue recognition, valuation of accounts receivable, valuation of inventory, valuations and purchase price allocations related to business combinations, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of long-lived assets, including goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, key valuation assumptions for its share-based awards, estimated fulfillment costs for warranty obligations, tax reserves and recoverability of our net deferred tax assets and related valuation allowance. We have reviewed our policies and estimates and determined that these remain our most critical accounting policies and estimates for the three months ended March 31, 2019. We have updated our leasing policies in conjunction with our adoption of ASC 842 as of January 1, 2019, as further described in Note 19 to the accompanying financial statements.

Readers should refer to our annual report on Form 10-K for the year ended December 31, 2018 under “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Critical Accounting Policies and Significant Estimates” for descriptions of these policies and estimates, as well as the notes to the consolidated financial statements included elsewhere within this report.

28



Results of Operations
The following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales:
 
Three Months Ended
 
March 31,
 
2019
 
2018
Sales:
 
 
 
Product
32.2
 %
 
34.9
 %
Service
67.8

 
65.1

Net sales
100.0

 
100.0

Cost and expenses:
 
 

Costs of product sales
19.6

 
22.3

Costs of service sales
41.8

 
34.5

Research and development
9.7

 
9.8

Sales, marketing and support
23.3

 
22.3

General and administrative
20.2

 
19.1

Total costs and expenses
114.6

 
108.0

Loss from operations
(14.6
)
 
(8.0
)
Interest income
0.4

 
0.4

Interest expense
1.0

 
1.0

Other expense, net
(0.3
)
 
(0.7
)
Loss before income tax
(15.5
)
 
(9.3
)
Income tax expense
0.1

 
0.4

Net loss
(15.6
)%
 
(9.7
)%
Three Months Ended March 31, 2019 and 2018

Net Sales
As discussed further under the heading "Segment Discussion" below, product sales decreased $1.1 million, or 8%, to $12.9 million for the three months ended March 31, 2019 from $14.0 million for the three months ended March 31, 2018, primarily due to a decrease in mobile connectivity product sales of $0.8 million and a decrease in inertial navigation product sales of $0.3 million. Service sales for the three months ended March 31, 2019 increased $1.0 million, or 4%, to $27.1 million from $26.1 million for three months ended March 31, 2018 due to an increase in mobile connectivity service sales of $0.6 million and an increase in inertial navigation service sales of $0.4 million.

Costs of Sales
    
Costs of sales consists of costs of product sales and costs of service sales. Costs of sales increased $1.8 million, or 8%, in the three months ended March 31, 2019 to $24.5 million from $22.7 million in the three months ended March 31, 2018. The increase in costs of sales was driven by an increase of $2.9 million, or 21%, in costs of service sales, partially offset by a $1.1 million, or 12%, decrease in costs of product sales. As a percentage of net sales, costs of sales were 61% for the three months ended March 31, 2019 and 57% for the three months ended March 31, 2018.

Our costs of product sales consist primarily of materials, manufacturing overhead, and direct labor used to produce our products. For the three months ended March 31, 2019, costs of product sales decreased $1.1 million, or 12%, to $7.8 million from $8.9 million in the three months ended March 31, 2018. As a percentage of product sales, costs of product sales were 60% and 64% for the three months ended March 31, 2019 and 2018, respectively. Mobile connectivity costs of product sales decreased by $0.5 million, or 10%, primarily due to a $0.4 million decrease in our marine mobile connectivity costs of product sales and a $0.1 million decrease in our land mobile connectivity costs of product sales. Mobile connectivity costs of product sales as a percentage of mobile connectivity product sales was 66% for each of the three months ended March 31, 2019 and 2018. Inertial navigation costs of product sales decreased by $0.6 million, or 16%, primarily due to a decrease in FOG costs of product sales. Inertial navigation costs of product sales as a percentage of inertial navigation product sales was 53% and 61% for the three months ended March 31, 2019 and 2018, respectively. The decrease was primarily driven by a change in product mix of our different FOG products.


29



Our costs of service sales consist primarily of satellite service capacity, depreciation, service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, Inmarsat service costs, product installation costs, engineering and related direct costs associated with customer-funded research and development, media materials and distribution costs, and service repair materials. For the three months ended March 31, 2019, costs of service sales increased by $2.9 million, or 21%, to $16.7 million from $13.8 million for the three months ended March 31, 2018. As a percentage of service sales, costs of service sales were 62% and 53% for the three months ended March 31, 2019 and 2018, respectively. Mobile connectivity costs of service sales increased by $2.5 million, or 19%, primarily due to a $2.7 million increase in mini-VSAT airtime costs of service sales, including increased HTS network capacity costs, legacy network revenue share minimums and AgilePlans depreciation costs, which was partially offset by a $0.3 million decrease in content and learning costs of service sales. Mobile connectivity costs of service sales as a percentage of mobile connectivity service sales was 61% and 53% for the three months ended March 31, 2019 and 2018, respectively. Inertial navigation costs of service sales increased by $0.4 million, or 57%, primarily due to an increase in contract engineering services revenues. Inertial navigation costs of service sales as a percentage of inertial navigation service sales was 65% and 58% for the three months ended March 31, 2019 and 2018, respectively.

We expect that our costs of sales will generally increase in correlation with our expected growth in our mobile connectivity and inertial navigation net sales. To the extent that customers continue to subscribe to our AgilePlans program, we expect a corresponding decrease in product sales and increase in depreciation expense for AgilePlans equipment.

Operating Expenses
    
Research and development expense consists of direct labor, materials, external consultants, and related overhead costs that support our internally funded product development and product sustaining engineering activities. Research and development expense was $3.9 million for both the three months ended March 31, 2019 and 2018. Engineering expenses funded by customers (which are reflected in costs of service sales rather than research and development expense) increased by $0.3 million, which was offset by a $0.3 million increase in consulting fees. As a percentage of net sales, research and development expense for the three months ended March 31, 2019 and 2018 was 10%.

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

Sales, marketing, and support expense consists primarily of salaries and related expenses for sales and marketing personnel, commissions for both in-house and third-party representatives, costs related to the co-development of certain content, other sales and marketing support costs such as advertising, literature and promotional materials, product service personnel and support costs, warranty-related costs and bad debt expense. Sales, marketing and support expense also includes the operating expenses of our sales office subsidiaries in Denmark, Singapore, Brazil, and Japan. Sales, marketing and support expense for the three months ended March 31, 2019 increased by $0.4 million, or 4%, to $9.3 million from $8.9 million for the three months ended March 31, 2018. The increase primarily resulted from a $0.7 million increase in salaries, benefits, and employment taxes due to an increase in headcount, which was partially offset by a $0.3 million decrease in warranty expense. As a percentage of net sales, sales, marketing and support expense for the three months ended March 31, 2019 and 2018 was 23% and 22%, respectively.

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

General and administrative expense consists of costs attributable to management, finance and accounting, information technology, human resources, certain outside professional services, and other administrative costs. General and administrative expense for the three months ended March 31, 2019 increased by $0.4 million, or 5%, to $8.1 million from $7.7 million for the three months ended March 31, 2018. The increase resulted primarily from a $0.5 million increase in salaries, benefits, and employment taxes, which was partially offset by a $0.1 million decrease in professional fees. As a percentage of net sales, general and administrative expense for the three months ended March 31, 2019 and 2018 was 20% and 19%, respectively.

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


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Interest and Other Expense, Net
    
Interest income represents interest earned on our cash and cash equivalents, as well as from investments. Interest income increased slightly to $0.2 million for the three months ended March 31, 2019 from $0.1 million for the three months ended March 31, 2018. Interest expense was $0.4 million for each of the three months ended March 31, 2019 and 2018. Other expense, net decreased by $0.2 million primarily due to a decrease in foreign exchange losses from our UK operations.

Income Tax Expense

Income tax expense for the three months ended March 31, 2019 was less than $0.1 million and related to taxes on income earned in foreign jurisdictions. The losses we incurred in the U.S. did not generate any income tax benefit during the quarter due to a full valuation allowance on our related deferred tax assets. Income tax expense for the three months ended March 31, 2018 was $0.2 million and related to taxes on income earned in foreign jurisdictions. The losses we incurred in the U.S. and Brazil did not generate any income tax benefit during the quarter due to a full valuation allowance on our related deferred tax assets.

Segment Discussion - Three Months Ended March 31, 2019 and 2018

Our net sales by segment for the three months ended March 31, 2019 and 2018 were as follows:
 
 
 
 
 
Change
 
For the three months ended March 31,
 
2019 vs. 2018
 
2019
 
2018
 
$
 
%
 
(dollars in thousands)
Mobile connectivity sales
 
 
 
 
 
 
 
   Product
$
7,062

 
$
7,920

 
$
(858
)
 
(11
)%
   Service
25,448

 
24,829

 
619

 
2
 %
     Net sales
$
32,510

 
$
32,749

 
$
(239
)
 
(1
)%
 
 
 
 
 
 
 
 
Inertial navigation sales
 
 
 
 
 
 
 
   Product
$
5,812

 
$
6,072

 
$
(260
)
 
(4
)%
   Service
1,650

 
1,280

 
370

 
29
 %
     Net sales
$
7,462

 
$
7,352

 
$
110

 
1
 %

Operating earnings (loss) by segment for the three months ended March 31, 2019 and 2018 were as follows:

 
 
 
 
 
Change
 
For the three months ended March 31,
 
2019 vs. 2018