KVH Industries
Annual Report 2012

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K(Mark One)xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2012OR¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to Commission File Number 0-28082KVH 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)Securities registered pursuant to Section 12(b) of the Act:Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, $0.01 par value per share The NASDAQ Global MarketSecurities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No xIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No xIndicate 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 12months (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 x No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post suchfiles). Yes x No ¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer o Accelerated filer xNon-accelerated filer o Smaller reporting company o(Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No oAs of June 29, 2012, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $163,717,600 based on the closing sale price of$12.50 per share as reported on the NASDAQ Global Market. Shares of common stock held by executiveTable of Contentsofficers and directors of the registrant and their affiliates have been excluded from this calculation because such persons may be deemed affiliates.As of March 28, 2013, the registrant had 15,111,370 shares of common stock outstanding.DOCUMENTS INCORPORATED BY REFERENCEPortions of the registrant’s Proxy Statement relating to its 2013 Annual Meeting of Stockholders are incorporated herein by reference in Part III. Table of ContentsINDEX TO FORM 10-K Page PART I Item 1.Business3Item 1A.Risk Factors11Item 1B.Unresolved Staff Comments22Item 2.Properties23Item 3.Legal Proceedings23Item 4.Mine Safety Disclosures23 PART II Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities23Item 6.Selected Financial Data25Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations26Item 7A.Quantitative and Qualitative Disclosure About Market Risk37Item 8.Financial Statements and Supplementary Data38Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure38Item 9A.Controls and Procedures39Item 9B.Other Information41 PART III Item 10.Directors, Executive Officers and Corporate Governance42Item 11.Executive Compensation42Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters42Item 13.Certain Relationships and Related Transactions and Director Independence42Item 14.Principal Accountant Fees and Services42 PART IV Item 15.Exhibits and Financial Statement Schedules43Signatures462Table of ContentsPART IITEM 1.BusinessCautionary Statement Regarding Forward-Looking InformationIn addition to historical facts, this annual report contains forward-looking statements. Forward-looking statements are merely our current predictions offuture events. These statements are inherently uncertain, and actual events could differ materially from our predictions. Important factors that could causeactual events to vary from our predictions include those discussed in this annual report under the headings “Item 7. Management's Discussion and Analysis ofFinancial Condition and Results of Operations”, and “Item 1A. Risk Factors.” We assume no obligation to update our forward-looking statements to reflectnew information or developments. We urge readers to review carefully the risk factors described in this annual report and in the other documents that we filewith the Securities and Exchange Commission. You can read these documents at www.sec.gov.Additional Information AvailableOur principal Internet address is www.kvh.com. Our website provides a hyperlink to a third-party website through which our annual, quarterly, andcurrent reports, as well as amendments to those reports, are available free of charge. We believe these reports are made available as soon as reasonablypracticable after we electronically file them with, or furnish them to, the SEC. We do not provide any information regarding our SEC filings directly to thethird-party website, and we do not check its accuracy or completeness.IntroductionWe are a leading manufacturer of solutions that provide global high-speed Internet, television, and voice services via satellite to mobile users at sea, onland, and in the air. Our CommBox offers a range of tools designed to increase communication efficiency, reduce costs, and manage network operations. Weare also a premier manufacturer of high-performance navigational sensors and integrated inertial systems for defense and commercial guidance andstabilization applications. Our research and development, manufacturing and quality control capabilities have enabled us to meet the demanding standards ofour military, consumer and commercial customers for performance and reliability. This combination of factors has allowed us to create products offeringimportant differentiating advantages to our customers. We are based in Middletown, Rhode Island, with offices in Illinois, Denmark, Norway, Japan andSingapore.We sell our mobile communications products and airtime services, including the TracVision, TracPhone, and CommBox systems and mini-VSATBroadband airtime, through an extensive international network of distributors and retailers worldwide. In 2011, we completed our initial global coverage planfor our mini-VSAT Broadband Ku-band service, which primarily supports maritime applications along with land-based mobile and aeronautical uses on amore limited basis currently. In addition, in February 2011, we introduced a new addition to our mini-VSAT Broadband-compatible antenna family, the 14.5-inch diameter TracPhone V3. In 2012, we completed the rollout of our C-band VSAT service overlay on our mini-VSAT network to complement our Ku-bandservice by increasing our global coverage from 70°S latitude to 75°N latitude. We also introduced a new dual-mode product, the TracPhone V11, which isable to transmit and receive both C and Ku-band signals from our mini-VSAT Broadband network. We may also pursue expanded coverage in the future tosupport customer, market, or capacity demands. In addition, we are pursuing opportunities to apply our mobile communications expertise to militaryapplications that require affordable, high-bandwidth mobile connections.Our guidance and stabilization products include precision fiber optic gyro (FOG)-based systems that help stabilize platforms, such as gun turrets,remote weapon stations, and radar units, and provide guidance for munitions, as well as tactical navigation systems for a broad range of military vehicles. Wesell our guidance and stabilization products directly to United States (U.S.) and allied governments and government contractors, as well as through aninternational network of authorized independent sales representatives. Our fiber optic products are also used in such commercial applications as train trackgeometry measurement systems, industrial robotics, surveying, optical stabilization, autonomous vehicles, and undersea remotely operated submersibles. InJune 2011, we introduced the DSP-1750, which we believe to be the world's smallest high performance fiber optic gyro and the first to use our new E•CoreThinFiber technology. The small size and weight of the DSP-1750 make it well suited for applications with size and weight restrictions, such as night visionand thermal imaging systems, aircraft-mounted gimbaled cameras for law enforcement and homeland security, and shipboard optical systems.Our Products and ServicesMobile Satellite Communications3Table of ContentsWe believe that there is an increasing demand for mobile access to television, voice services and the Internet on the move. Our objective is to connectmobile users on sea, land, and air to the satellite TV, communications, and Internet services they wish to use. We have developed a comprehensive family ofproducts and services marketed under the TracVision, TracPhone, and CommBox brand names as well as the mini-VSAT Broadband airtime network toaddress the unique needs of our communications markets.Our mobile satellite products are typically installed on mobile platforms and use sophisticated robotics, stabilization and control software, sensingtechnologies, transceiver integration, and advanced antenna designs to automatically search for, identify and point directly at the selected television andcommunications satellite while the vehicle, vessel, or plane is in motion. Our antennas use gyros and inclinometers to measure the pitch, roll and yaw of anantenna platform in relation to the earth. Microprocessors and our proprietary stabilization and control software use that data to compute the antenna movementnecessary for the antenna's motors to point the antenna properly and maintain contact with the satellite. If an obstruction temporarily blocks the satellite signal,our products continue to track the satellite's location according to the movement of the antenna platform in order to carry out automatic, rapid reacquisition ofthe signal when a direct line of sight to the satellite is restored.Our Certified Support Network offers our TracVision and TracPhone customers an international network of skilled technical dealers and supportcenters in many locations where our customers are likely to travel. We have selected distributors based on their technical expertise, professionalism andcommitment to quality and regularly provide them with extensive training in the sale, installation and support of our products.We offer a broad array of products to address the needs of a variety of customers seeking mobile communications in maritime, land mobile andaeronautical applications.Marine. In the marine market, we offer a range of mobile satellite TV and communications products. In December 2009, we began selling theTracVision HD7, a 24-inch diameter satellite TV antenna capable of receiving signals from two DIRECTV Ka-band satellites and one DIRECTV Ku-bandsatellite simultaneously to offer a high-definition TV experience comparable to what a home DIRECTV HDTV subscriber would enjoy. It includes an InternetProtocol-enabled antenna control unit as well as optional antenna controls via a free TracVision application for use on an Apple iPhone. We believe that this isthe first marine antenna to offer this combination of capabilities. In January 2012, we began shipping our TracVision HD11. This system uses a 1-meterantenna to receive both Ku-band and Ka-band satellite television signals without changing out hardware elements. It will work with any modern satellitetelevision service in the world, including DIRECTV HDTV. Like the TracVision HD7, it features a customer application for the Apple iPhone or iPad to enableeasy control of the system. Our marine TracVision M-series satellite TV antennas are designed with the full spectrum of vessel sizes in mind, ranging fromrecreational vessels as small as 20 to 25 feet to large commercial vessels. The award-winning family of marine TracVision products vary in size from a lower-profile elliptical parabolic system similar to those offered for use on recreation vehicles (RV) to the 12.5-inch TracVision M1, 14.5-inch TracVision M3, 18-inch TracVision M5, 24-inch TracVision M7, and 32-inch diameter TracVision M9, each of which employs a high-efficiency circular antenna. Theseproducts are compatible with Ku-band HDTV programming as well as high-powered regional satellite TV services around the globe, based on available signalstrength and antenna size requirements.Broadband Internet. In 2007, we introduced our Ku-band airtime service branded as mini-VSAT Broadband. This service utilizes spread spectrumtechnology and ArcLight modem technology, both of which were developed by ViaSat. This spread spectrum approach reduces the broadcast powerrequirements and the pointing accuracy necessary to track the high-bandwidth Ku-band satellites that carry the service. The resulting efficiencies allowed us todevelop and bring to market the 24-inch diameter TracPhone V7 antenna, which we also introduced in 2007. This antenna is 85% smaller by volume and75% lighter than alternative 1-meter VSAT antennas. In February 2011, we introduced a new addition to our mini-VSAT Broadband-compatible antennafamily, the 14.5-inch diameter TracPhone V3. We believe that the TracPhone V3 is the smallest maritime VSAT system currently available. Its small sizemakes it practical for use on smaller vessels as well as land vehicles.The high bandwidth offered by the Ku-band satellites also permits faster data rates than those supported by Inmarsat's L-band satellites. TracPhoneV7 subscribers may select service packages with Internet data connections offering ship-to-shore satellite data rates as fast as 1 Mbps, or megabits per second,and shore-to-ship satellite data rates as fast as 2 Mbps. The TracPhone V3, due to its smaller dish diameter, offers ship-to-shore data rates as fast as 128kilobits per second, or Kbps, and shore-to-ship satellite data rates as fast as 2 Mbps. In addition, subscriptions include Voice over Internet Protocol (VoIP)telephone services optimized for use over satellite connections. The TracPhone V7 can support two or more simultaneous calls while the TracPhone V3 cansupport one call at a time.4Table of ContentsWe currently offer our Ku-band mini-VSAT Broadband service in the Americas, Europe, the Middle East, Africa, Asia-Pacific, and Australian andNew Zealand waters. We believe that our mini-VSAT Broadband service represents the only global multi-megabit commercial satellite communicationsnetwork for vessels and airplanes.In 2012, we completed the rollout of a major upgrade to the mini-VSAT Broadband network, adding three global C-band transponders to deliver afully global overlay to the Ku-band service. The dual-mode TracPhone V11 antenna seamlessly tracks both C- and Ku-band satellites, making it the only 1-meter maritime VSAT antenna to deliver seamless, fully global coverage outside of the far polar regions. Service for the combined C/Ku band network is soldon both traditional fixed-rate plans, where they are priced incrementally higher than the Ku-band only service, and the new unrestricted plans for the sameprice as the Ku-band service. Unrestricted plans are sold in “buckets,” whereby we provide between 5 and 40 gigabytes of data per month for a fixed price,with the ability to add data for a small incremental charge. The new plans are called “unrestricted” because they allow customers to stream audio or videocontent to or from their vessels or use popular VoIP services like Skype™, protocols often blocked on other VSAT plans due to the large amount of bandwidththey consume.We are actively engaged in sales efforts for the TracPhone V3, V7, and V11 and mini-VSAT Broadband service to government agencies for maritime,military, and emergency responder use. In September 2010, the U.S. Coast Guard awarded us a 10-year, up to $42 million contract to supply TracPhone V7systems and mini-VSAT Broadband airtime to as many as 216 U.S. Coast Guard cutters. We are also taking steps to expand our ability to support thecommercial maritime market. In March 2011, we signed a contract to provide TracPhone V7 and mini-VSAT Broadband service to Vroon B.V. and its fleet ofmore than 125 commercial vessels. In March 2012, V.Ships, the world's largest independent ship manager serving a fleet of over 1,000 vessels, selected ourmini-VSAT Broadband service as its preferred satellite communications solution. In June 2012, Tokyo-based shipping and logistics company, Nippon YusenKaisha (NYK Line), selected our TracPhone V7 and mini-VSAT Broadband service for over 100 vessels.Our unified C/Ku-band Broadband service enables us to offer commercial, leisure and government customers an integrated hardware and servicesolution for mobile communications and seamless region-to-region roaming. It is our long-term plan to continue to invest in and enhance the mini-VSATBroadband network in cooperation with ViaSat under the terms of a 10-year agreement announced in July 2008. In February 2011, we completed a majorcapacity increase which doubled our network capacity in the Asian, African and the West Indian Ocean regions, including waters off the coasts of Australiaand New Zealand. As part of the network expansion to support regions with growing numbers of customers, we plan to continue to acquire, as needed, satellitecapacity from commercial satellite operators and to purchase regional satellite hubs from ViaSat. These hubs use ViaSat's ArcLight spread spectrum mobilebroadband technology and are operated by ViaSat on our behalf. Over the course of the 10-year agreement, we and ViaSat also expect to implement futureenhancements to the mini-VSAT Broadband spread spectrum maritime services and related products. In August 2011, we, along with Viasat, rolled outenhancements to the global spread spectrum network that doubled the maximum uplink speeds and offered significant improvements in the network reliability.In addition, we announced new adaptive return link technology, which enables KVH TracPhone V3 and V7 systems to adjust system operationsautomatically to suit changing conditions. Under the terms of our revenue sharing arrangement with ViaSat, these types of expansions position us to earnrevenue not only from the maritime and land-based use of the mini-VSAT Broadband service but also from aeronautical applications that roam throughout ournetwork.The mini-VSAT Broadband network is an end-to-end solution for offshore connectivity. We design and manufacture the onboard TracPhoneterminals and antennas, own the hub equipment installed in leased earth stations, lease the satellite capacity, manage the network, and provide 24/7/365 after-sale support. Using spread-spectrum modem technology from ViaSat, we can offer terminals with antennas that are 85% smaller than competing maritimeVSAT solutions. Because we manufacture the onboard hardware, we can integrate the full rack of discrete below decks equipment typically used ontraditional VSAT systems into a single, streamlined unit that is significantly easier to deploy than competing VSAT solutions.Our mini-VSAT Broadband network currently uses a combination of 14 Ku-band transponders to provide coverage throughout the northernhemisphere and all of the major continents in the southern hemisphere. This Ku-band capacity can be accessed by any of our TracPhone V-series antennas,and provides the exclusive source of service for the TracPhone V3, V7, and V7-IP. The compact TracPhone V3, with its 15.5" antenna and affordable rateplans (starting at only $49 per month for 50MB of service), is designed for smaller vessels or those with seasonal data needs. The enterprise-grade TracPhoneV7-IP offers a range of airtime service plans, including low-priced metered plans, traditional speed-based, fixed-rate plans, and the company's newunrestricted rate plans. In addition to our TracPhone V3, V7 and V11 and mini-VSAT Broadband service, we also offer a family of Inmarsat-compatibleTracPhone products that provide in-motion access to global satellite communications. These products rely on services offered by Inmarsat, a satellite serviceprovider that supports links for phone, fax and data communications as fast as 432 Kbps. The TracPhone FB150, FB250, and FB500 antennas use theInmarsat FleetBroadband service to offer voice as well as high-speed Internet service. The TracPhone FB150, FB250, and FB500 are manufactured byThrane & Thrane A/S of Denmark and distributed on an OEM basis by us in North America under the KVH5Table of ContentsTracPhone brand and distributed in other markets on a non-exclusive basis. Unlike mini-VSAT Broadband, where we control and sell the airtime, wepurchase Inmarsat airtime from a distributor and resell it to our customers.In September 2010, we acquired Virtek Communication, a Norwegian firm that developed CommBox, a ship-to-shore network management product.CommBox, which comprises shipboard hardware, a KVH-hosted or privately owned shore-based hub, and a suite of software applications, offers a range oftools designed to increase communication efficiency, reduce costs, and manage network operations. Key functions include web and data compression andoptimization to increase network capacity; remote PC management for customer IT departments; integrated e-mail, web compression, firewalls, and security;least-cost routing; and bandwidth management on multiple communication carriers. CommBox is now offered as an option for the TracPhone V3, V7 andV11 and with our Inmarsat-compatible TracPhone and Iridium OpenPort systems. CommBox sales include both the shipboard hardware and optional privateshore-based hub, subscriptions to the selected software applications, and monthly system maintenance fees.We offer Iridium OpenPort hardware and service to be used in conjunction with our mini-VSAT service. Iridium OpenPort service provides data ratesup to 128Kpbs and covers the entire world, including the polar regions. We offer the Iridium hardware and service along with our own mini-VSAT solutionand our CommBox, which will switch over to the Iridium service if the mini-VSAT service is not available. Our customers might choose to add the Iridiumservice to expand the geographic coverage of the system, or as a backup service.Land. We design, manufacture, and sell a range of TracVision satellite TV antenna systems for use on a broad array of vehicles, including recreationalvehicles, trucks, conversion vans, and automobiles.In the RV/truck market, we offer a line-up of our TracVision satellite TV products, including products intended for both stationary and in-motion use.Our TracVision R1 was introduced in 2011, delivering DIRECTV or DISH network service through a small 12.5” diameter dome. The TracVision A7 useshybrid phased-array antenna technology to provide in-motion reception of satellite TV programming in the continental United States using the DIRECTVservice. Our TracVision A7 product includes a mobile satellite television antenna and an integrated 12V mobile DIRECTV receiver/controller designedspecifically for the mobile environment by KVH and DIRECTV. The TracVision A7 stands approximately five inches high and mounts either to a vehicle'sroof rack or directly to the vehicle's roof, making it practical for use aboard minivans, SUVs and other passenger vehicles. The TracVision A7 is alsopopular for tall motor coaches and buses. Automotive customers subscribe to DIRECTV's TOTAL CHOICE MOBILE satellite TV programming package,which is specifically promoted for automotive applications. Local channels and network programming are also available as an option for TracVision A7 usersas a result of the system's integrated GPS and mobile receiver. At this time, we are the only company authorized by DIRECTV to sell, promote, and activatemobile users for the TOTAL CHOICE MOBILE programming package.Aeronautical Applications. We designed, developed, and manufactured DIRECTV-compatible satellite TV antennas for use on narrowbodycommercial aircraft, such as Boeing's 737 and the Airbus A320, operating in the United States.We currently have an agreement with LiveTV that began in September 2011 covering maintenance of existing satellite antennas as well as pricing termsfor potential purchases of new antennas.Guidance and Stabilization ProductsWe offer a portfolio of digital compass and fiber optic gyro-based systems that address the rigorous requirements of military and commercialcustomers. Our systems provide reliable, easy-to-use and continuously available navigation and pointing data. Our guidance and stabilization productsinclude our inertial measurement unit for precision guidance, fiber optic gyros for tactical navigation and stabilization, and digital compasses that provideaccurate heading information for demanding applications.Guidance and Stabilization. Our fiber optic gyro products use an all-fiber design that has no moving parts, resulting in an affordable combination ofprecision, accuracy and durability. Our fiber optic gyro products support a broad range of military applications, including stabilization of remote weaponsstations, antennas, radar, optical devices or turrets; image stabilization and synchronization for shoulder-or tripod-mounted weapon simulators; precisiontactical navigation systems for military vehicles, and guidance for weapons and unmanned autonomous vehicles. Our fiber optic gyro products are also usedin commercial and industrial applications, such as train location control and track geometry measurement systems, robotics, surveying, optical stabilization,autonomous vehicles, and undersea remotely operated submersibles.Our TG-6000 Inertial Measurement Unit (IMU) is a guidance system that provides precise measurement of motion and acceleration in three dimensions.It uses a three-axis configuration of our high-performance DSP-based (digital signal processing) fiber optic gyros integrated with three accelerometers. Webelieve that this configuration provides outstanding performance, high reliability, low maintenance and easy system integration. The TG-6000 IMU is acomponent in the U.S.6Table of ContentsNavy's MK54 lightweight torpedo and is suitable for use in other applications that involve flight control, orientation, instrumentation and navigation, such asunmanned aerial vehicles. In June 2010, we introduced the CG-5100, our first commercial-grade inertial measurement unit. The CG-5100 is focused on a widerange of applications such as 3D augmented reality, mobile mapping, platform navigation and GPS augmentation for unmanned vehicle programs, precisemapping and imagery.In October 2008, we introduced the CNS-5000 continuous navigation system, a self-contained navigation system that combines our fiber optic gyro-based inertial measurement technology with GPS technology from NovAtel. This navigation solution provides precise position and orientation of a hostplatform on a continuous basis, even during periods where GPS signals are blocked by natural or man-made obstructions or conditions. The CNS-5000 isdesigned for demanding commercial applications, such as dynamic surveying, precision agriculture, container terminal management, and autonomous vehiclenavigation, where the ability to determine the precise position and orientation of a piece of equipment or a mobile platform is critical. The CNS-5000 is acommercial-off-the-shelf (COTS) product consisting of a FOG-based inertial measurement unit tightly integrated with GPS within a single enclosure. Thisdesign reduces the operational complexities for customers whose products cross international boundaries.In June 2011, we introduced the DSP-1750, which we believe to be the world's smallest high performance fiber optic gyro and the first to use our newE•Core ThinFiber® technology. This new thin fiber, which is created at our Tinley Park, Illinois manufacturing facility, is only 170 microns in diameter,enabling longer lengths of fiber to be wound into smaller housings. Since the length of the fiber used in a fiber optic gyro directly relates to gyro accuracy andperformance, the new technology enables us to produce smaller and more accurate gyros. The new DSP-1750 is five times faster and has angle random walk(ARW) ten times better than our first small gyro, the DSP-1500, which has been replaced with the new design. The small size and weight of the DSP-1750make it well suited for applications with size and weight restrictions, such as night vision and thermal imaging systems, aircraft-mounted gimbaled camerasfor law enforcement and homeland security, and shipboard optical systems.Our open-loop DSP-1750, DSP-3000 series, and DSP-4000 fiber optic gyros provide precision measurement of the rate and angle of a platform's turningmotion typically for significantly less cost than competing closed-loop gyros. These DSP-based products deliver performance superior to analog signalprocessing devices, which experience greater temperature-sensitive drift and rotation errors. Applications for these products include inertial measurement units,integrated navigation systems, attitude/heading/reference systems, and stabilization of antenna, radar and optical equipment.The DSP-3000 series is slightly larger than a deck of playing cards and offers a variety of interface options to support a range of applications. High-performance 2-axis and 3-axis configurations can be realized by integrating multiple DSP-3000 units. Currently, the DSP-3000 series is used in an array ofpointing and stabilization applications, including the U.S. Army's Common Remotely Operated Weapon Station (CROWS) to provide the image and gunstabilization necessary to ensure that the weapon remains aimed at its target. We estimate that more than 20 companies have developed or are developingstabilized remote weapons stations that we believe will require similar fiber optic gyro stabilization capabilities. Our fiber optic products are also used incommercial and industrial applications, such as train location control and track geometry measurement systems, robotics, precision surveying, augmentedreality systems, optical stabilization, autonomous vehicles, and undersea remotely operated submersibles. The larger, militarized DSP-4000 is designed for usein high-shock and highly dynamic environments, such as gun turret stabilization.In June 2012, we introduced the Series 1750 IMU, an advanced 6-degrees-of-freedom sensor designed to integrate easily into the most demandingstabilization, pointing, and navigation applications, enhancing performance at a lower cost than competing systems. The Series 1750 IMU marries thegroundbreaking E•Core ThinFiber technology of our DSP-1750 with very low noise, solid state MEMS accelerometers to create a commercial-off-the-shelfIMU. The Series 1750 IMU offers exceptional precision in a very small form factor, making it suitable for applications where space is limited, such asunmanned and autonomous systems.Tactical Navigation. Our TACNAV tactical navigation product line employs digital compass sensors and KVH fiber optic gyros to offer vehicle-basednavigation and pointing systems with a range of capabilities, including GPS backup and enhancement, vehicle position, hull azimuth and navigationdisplays. Because our digital compass products measure the earth's magnetic field rather than detect satellite signals from the GPS, they are not susceptible toGPS jamming devices.TACNAV systems vary in size and complexity to suit a wide range of vehicles. The TACNAV Light is a low-cost, digital compass-based battlefieldnavigation system specifically designed for non-turreted vehicles, such as high mobility multi-wheeled vehicles (HMMWVs) and trucks. Turreted vehicles,including reconnaissance vehicles, armored personnel carriers and light armored vehicles, are supported by the TACNAV TLS, a digital compass-basedtactical navigation and targeting system that offers a fiber optic gyro upgrade for enhanced accuracy. We also manufacture the TACNAV II Fiber GyroNavigation7Table of Contentssystem, which offers a compact design, continuous output of heading and pointing data, and a flexible architecture that allows it to function as either a stand-alone navigation module or as the central component of an expanded, multifunctional navigation system.Our navigation systems function as standalone tools and also aggregate, integrate and communicate critical information from a variety of on-boardsystems. TACNAV can receive data from systems such as the vehicle's odometer, military and commercial GPS devices, laser rangefinders, turret angleindicators and laser warning systems. TACNAV can also output this data to an on-board computer for retransmission through the vehicle's communicationssystems to a digital battlefield management application.Our TACNAV digital compass products have been sold for use aboard U.S. Army, Marine Corps, and Navy vehicles as well as to many alliedcountries, including Australia, the United Kingdom, Canada, Germany, Italy, New Zealand, Saudi Arabia, Spain, Sweden, Taiwan, Malaysia andSwitzerland. We believe that we are among the leading manufacturers of such systems. Our standard TACNAV products can be customized to our customers'specifications. At customer request, we offer training and other services on a time-and-materials basis.Sales, Marketing and SupportOur sales, marketing and support efforts target markets that are substantial and require dedicated dealers and distributors to reach end customers.These channels vary from time to time, but currently include targeted efforts to reach the commercial and leisure maritime markets, the RV and high-endautomotive markets, and the commercial, industrial and government markets. We believe our brands are well known and well respected by consumers withintheir respective niches. These brands include:TracVision-satellite television systems for vessels and vehiclesTracPhone-two-way satellite communications systemsmini-VSAT Broadband-broadband mobile satellite communications networkCommBox-network management hardware and software for maritime communicationsAzimuth-digital compass for powerboatsSailcomp-digital compass for sailboatsTACNAV-tactical navigation systems for military vehiclesOur fiber optic gyros and digital compass sensors use an alphanumeric model numbering sequence such as C-100, DSP-1750 IMU, DSP-3000, DSP-4000, CNS-5000, CG-5100, and TG-6000 IMU.We sell our mobile satellite communications products through an international network of independent retailers, chain stores and distributors, as wellas to manufacturers of vessels and vehicles.Our European headquarters, which is located in Denmark, coordinates our sales, marketing and support efforts for our mobile satellitecommunications products in Europe, the Middle East, and Africa. Asian (excluding Japanese) and Australia/New Zealand sales are managed through ouroffice located in Singapore. Japanese sales are managed through our office in Japan. All international offices are managed under the oversight of our NorthAmerican sales and marketing office. Standalone CommBox sales are managed by our Norwegian subsidiary in cooperation with members of our satellitesales teams in all offices worldwide. See note 12 of the notes to our consolidated financial statements for information regarding our geographic segments.We sell our guidance and stabilization products directly to U.S. and allied governments and government contractors, as well as through an internationalnetwork of authorized independent sales representatives. This same network also sells our fiber optic products to commercial/industrial entities.In 2012, the U.S. Army Program Office - Saudi Arabian National Guard (SANG) represented 11% of our total sales.BacklogBacklog is not a meaningful indicator for predicting revenue in future periods. Commercial resellers for our mobile satellite communications productsand legacy products do not carry extensive inventories and rely on us to ship products quickly. Generally due to the rapid delivery of our commercialproducts, our backlog for those products is not significant.8Table of ContentsOur backlog for all products and services was approximately $35.0 million, $22.1 million, and $20.8 million on December 31, 2012, 2011 and 2010,respectively. As of December 31, 2012, our backlog was scheduled for fulfillment in 2013, except for $3.0 million scheduled for fulfillment in 2014. Theincrease in backlog of $12.9 million from December 31, 2011 to December 31, 2012 was primarily a result of the order for TACNAV products and servicesreceived in June 2012 for SANG. This increase was partially offset by decreased orders for fiber optic gyros. The increase in backlog of $1.3 million fromDecember 31, 2010 to December 31, 2011 was primarily a result of increased orders for fiber optic gyros, a three-year agreement with LiveTV coveringmaintenance of existing satellite television antennas that began in September 2011, as well as an increase in orders of our mobile satellite communicationsproducts.Backlog consists of orders evidenced by written agreements and specified delivery dates for customers who are acceptable credit risks. We do notinclude satellite connectivity service sales in our backlog even though many of our satellite connectivity customers have signed annual service contractsproviding for a fixed monthly fee. Military orders included in backlog are generally subject to cancellation for the convenience of the customer. When orders arecancelled, we generally recover actual costs incurred through the date of cancellation and the costs resulting from termination. As of December 31, 2012, ourbacklog included approximately $9.3 million in orders that are subject to cancellation for convenience by the customer. Individual orders for guidance andstabilization products are often large and may require procurement of specialized long-lead components and allocation of manufacturing resources. Thecomplexity of planning and executing larger orders generally requires customers to order well in advance of the required delivery date, resulting in backlog.Intellectual PropertyOur ability to compete effectively depends to a significant extent on our ability to protect our proprietary information. We rely primarily on patents andtrade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We own approximately 33 U.S. and foreignpatents and have additional patent applications that are currently pending. We also register our trademarks in the United States and other key markets wherewe do business. Our patents will expire at various dates between March 2013 and May 2031. We enter into confidentiality agreements with our consultants,key employees and sales representatives, and maintain controls over access to and distribution of our technology, software and other proprietary information.The steps we have taken to protect our technology may be inadequate to prevent others from using what we regard as our technology to compete with us.We do not generally conduct exhaustive patent searches to determine whether the technology used in our products infringes patents held by third parties.In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applicationspending, many of which are confidential when filed, with regard to similar technologies.From time to time, we have faced claims by third parties that our products or technologies infringe their patents or other intellectual property rights, andwe may face similar claims in the future. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim isinvalid, and could distract the attention of our management. If any of our products is found to violate third-party proprietary rights, we may be required to paysubstantial damages. In addition, we may be required to re-engineer our products or seek to obtain licenses from third parties to continue to offer our products.Any efforts to re-engineer our products or obtain licenses on commercially reasonable terms may not be successful, which would prevent us from selling ourproducts, and, in any case, could substantially increase our costs and have a material adverse effect on our business, financial condition and results ofoperations.ManufacturingManufacturing operations for our mobile satellite communications and navigation products consist of light manufacture, final assembly and testing.Manufacturing operations for our fiber optic gyro products are more complex. We produce specialized optical fiber, fiber optic components and sensing coilsand combine them with components purchased from outside vendors for assembly into finished goods. We own optical fiber drawing towers with which weproduce the specialized optical fiber that we use in all of our fiber optic products. Excluding the CommBox product, which we manufacture in Norway, wemanufacture, warehouse and distribute our mobile satellite communications products at our headquarters in Middletown, Rhode Island. We manufacture ournavigation and fiber optic gyro products in our facility located in Tinley Park, Illinois.We contract with third parties for fabrication and assembly of printed circuit boards, injection-molded plastic parts, machined metal components,connectors and housings. We believe there are a number of acceptable vendors for the components we purchase. We regularly evaluate both domestic andforeign suppliers for quality, dependability and cost effectiveness. In some instances we utilize sole-source suppliers to develop strategic relationships toenhance the quality of materials and save costs. Our manufacturing processes are controlled by an ISO 9001:2008-certified quality standards program.9Table of ContentsCompetitionWe encounter significant competition in all of our markets, and we expect this competition to intensify in the future. Many of our primary competitorsare well-established companies and some have substantially greater financial, managerial, technical, marketing, operational and other resources than we do.In the market for marine satellite TV equipment, we compete with Intellian, Cobham SATCOM, Raymarine, NaviSystem Marine ElectronicSystems Srl, and King Controls.In the marine market for voice, fax, data and Internet communications equipment and services, we compete with Cobham SATCOM, FurunoElectric Co., Ltd., Globalstar LP, Iridium Satellite LLC, Intellian, Ship Equip and JRC. We also face competition from providers of marine satellite dataservices and maritime VSAT solutions, including Inmarsat/ShipEquip/Stratos, MTN/SeaMobile, Speedcast, CapRock, Schlumberger, and Vizada/Marlink.In the market for land mobile satellite TV equipment, we compete with MotoSAT, King Controls, Cobham TracStar and Winegard Company.In the markets for mobile satellite communications technology, the principal competitive factors are product size, features, design, performance,reliability and price.In the guidance and stabilization markets, we compete primarily with Honeywell International Inc., Kearfott Guidance & Navigation Corporation,Northrop Grumman Corporation, Goodrich Aerospace, IAI, Fizoptica, SAGEM and Systron Donner Inertial. We believe the principal competitive factors inthese markets are performance, size, reliability, durability and price.Research and DevelopmentFocused investments in research and development are critical to our future growth and competitive position in the marketplace. Our research anddevelopment efforts are directly related to timely development of new and enhanced products that are central to our core business strategy. The industries inwhich we compete are subject to rapid technological developments, evolving industry standards, changes in customer requirements, and new productintroductions and enhancements. As a result, our success depends in part upon our ability, on a cost-effective and timely basis, to continue to enhance ourexisting products and to develop and introduce new products that improve performance and meet customers' operational and cost requirements. Our currentresearch and development efforts include projects to achieve additional cost reductions in our products and the development of new products for our existingmarine and land mobile communications markets, and navigation, guidance and stabilization application markets. For example:•in June 2012, we launched our new Series 1750 IMU at trade shows in Europe and the U.S. offering high performance in an ultra compactform factor;•in August 2012, we introduced a new addition to our mini-VSAT Broadband-compatible antenna family, the TracPhone V7-IP, our newonboard terminal with a 3-axis antenna system and integrated below-decks unit incorporating CommBox Ship/Shore Network Manager; and•in September 2012, we introduced the new dual-band TracPhone V11 for mini-VSAT Broadband Global C/Ku-band service.Our research and development activities consist of projects funded by us, projects funded with the assistance of customer-funded contract research andSmall Business Innovative Research (SBIR) grants. Our customer-funded research efforts are made up of contracts with defense and OEM customers, whoseperformance specifications are unique to their product applications. SBIR projects are generally directed towards the discovery of specific informationrequested by the government research sponsor. Many of these grants have enhanced our technologies, resulting in new or improved product offerings. Defenseand OEM research often results in new product offerings. We strive to be the first company to bring a new product to market, and we use our own funds toaccelerate new product development efforts.Government RegulationOur manufacturing operations are subject to various laws governing the protection of the environment and our employees. These laws and regulationsare subject to change, and any such change may require us to improve our technologies, incur expenditures, or both, in order to comply with such laws andregulations.10Table of ContentsWe are subject to compliance with the U.S. Export Administration Regulations. Some of our products have military or strategic applications, and are onthe Munitions List of the U.S. International Traffic in Arms Regulations. These products require an individual validated license to be exported to certainjurisdictions. The length of time involved in the licensing process varies and can result in delays of the shipping of the products. Sales of our products toeither the U.S. government or its prime contractors are subject to the U.S. Federal Acquisition Regulations.We are also subject to the laws and regulations of the U.S. and foreign jurisdictions in which we offer and sell our satellite communication productsand services, including those of the European Union, Brazil, Norway, Singapore and Japan. These laws and regulations, as well as the interpretation andapplication of these laws and regulations, are subject to change and any such change may affect our ability to offer and sell existing and planned satellitecommunications products and services.EmployeesOn December 31, 2012, we employed 355 full-time employees. We also employ temporary or contract personnel, when necessary, to provide short-termand/or specialized support for production and other functional projects.We believe our future success will depend upon the continued service of our key technical and senior management personnel and upon our continuedability to attract and retain highly qualified technical and managerial personnel. None of our employees is represented by a labor union. We have neverexperienced a work stoppage and consider our relationship with our employees to be good.ITEM 1A.Risk FactorsAn investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors in evaluating ourbusiness. If any of these risks, or other risks not presently known to us or that we currently believe are not significant, develops into an actual event,then our business, financial condition and results of operations could be adversely affected. If that happens, the market price of our common stockcould decline.Our revenues and results of operations have been and may continue to be adversely impacted by worldwide economic turmoil, credit tightening,high fuel prices and associated declines in consumer spending.Worldwide economic conditions have experienced a significant downturn over the last several years, including slower economic activity, tightenedcredit markets, inflation and deflation concerns, increased fuel prices, decreased consumer confidence, reduced corporate profits, reduced or canceled capitalspending, adverse business conditions and liquidity concerns. These conditions make it difficult for businesses, governments and consumers to accuratelyforecast and plan future activities. Many governments are experiencing significant deficits that may cause them to curtail spending significantly or reallocatefunds away from defense programs. There can be no assurances that government responses to the disruptions in the economy will remedy these problems. Asa result of these and other factors, customers could slow or suspend spending on our products and services. We may also incur increased credit losses andneed to increase our allowance for doubtful accounts, which would have a negative impact on our earnings and financial condition. For example, our allowancefor doubtful accounts increased from approximately $0.6 million at December 31, 2011 to approximately $0.9 million at December 31, 2012. We cannot predict the timing, duration or ultimate impact of this downturn. We expect our business to continue to be adversely impacted by this downturn.Net sales of many of our mobile communications products are largely generated by discretionary consumer spending, and demand for these productsmay demonstrate slower growth or decline as a result of continuing weak regional and global economic conditions. For example, sales of our land mobileproducts decreased 20% from 2011 to 2012. Consumer spending tends to decline during recessionary periods and may decline at other times. Some consumershave chosen not to purchase our mobile communications products due to a perception that they are luxury items, and this could continue. As global andregional economic conditions change, including uncertainty regarding federal budgetary pressures, overseas sovereign debt crisis, the general level of interestrates, fluctuating oil prices and demand for durable consumer products, demand for our products could continue to be materially and adversely affected.Our financial performance is impacted by U.S. government contracts, which are subject to uncertain levels of funding and termination. We sell a substantial portion of our fiber optic gyro systems and tactical navigation products to the U.S. government, either directly or as a subcontractor toother contractors. The termination of these U.S. government contracts, whether due to11Table of Contentslack of funding, for convenience, or otherwise, or the occurrence of delays, could negatively impact our results of operations and financial condition.The funding of U.S. government programs is subject to congressional appropriations. Congress generally appropriates funds on a fiscal year basiseven though a program may extend over several fiscal years. Consequently, programs are often only partially funded initially and additional funds arecommitted only as Congress makes further appropriations. If appropriations for any program in which we participate become unavailable, or are reduced ordelayed, our contract or subcontract under such program may be terminated or adjusted by the government, which could have a negative impact on our futuresales under such contract or subcontract. When a formal appropriation bill has not been signed into law before the end of the U.S. government's fiscal year,which has become more frequent in recent years, Congress may pass a continuing resolution that authorizes agencies of the U.S. government to continue tooperate, generally at the same funding levels from the prior year, but that typically does not authorize new spending initiatives, during this period.Appropriations can also be impacted by other budgetary considerations, such as failure to increase the statutory debt ceiling of the U.S. government. Duringsuch periods (or until the regular appropriation bills are passed), delays can occur in procurement of products and services due to lack of funding, and thesedelays can affect our results of operations during the period of delay.Appropriations can also be affected by legislation that addresses larger budgetary issues of the U.S. government. Examples include the BudgetControl Act of 2011 and its sequestration provisions which were intended to significantly reduce appropriations below forecasted levels for most federalagencies, including the U.S. Department of Defense, in order to encourage passage of a compromise appropriations bill, as well as legislation that limits thedebt ceiling for the U.S. government.In addition, U.S. government contracts generally also permit the government to terminate the contract, in whole or in part, without prior notice, at thegovernment's convenience or for default based on performance. If one of our contracts is terminated for convenience, we would generally be entitled topayments for our allowable costs and would receive some allowance for profit on the work performed. If one of our contracts is terminated for default, wewould generally be entitled to payments for our work that has been accepted by the government. A termination arising out of our default could expose us toliability and adversely affect our ability to obtain future contracts and orders. Furthermore, on contracts for which we are a subcontractor and not the primecontractor, the U.S. government could terminate the prime contract for convenience or otherwise, irrespective of our performance as a subcontractor.Our results of operations could be adversely affected if unseasonably cold weather, prolonged winter conditions, disasters or similar events occur.Our marine leisure business is highly seasonal and seasonality can also impact our commercial marine business. Historically, we have generated themajority of our marine leisure product revenues during the first and second quarters of each year, and these revenues typically decline in the third and fourthquarters of each year, compared to the first two quarters. Temporary suspensions of our airtime services typically increase in the third and fourth quarters ofeach year as boats are placed out of service during winter months. Our marine leisure business is also significantly affected by the weather. Unseasonably coolweather, prolonged winter conditions, hurricanes, unusual amounts of rain, and natural and other disasters may decrease boating, which could reduce ourrevenues. Specifically, we may encounter a decrease in new airtime activations as well as an increase in the number of cancellations or temporary suspensionsof our airtime service.We expect that we could derive an increasing portion of our revenues from commercial leases of mobile communications equipment, rather thansales, which could increase our credit and collection risk.We are actively seeking to increase revenues from the commercial markets for our mini-VSAT Broadband service, particularly shipping companiesand other companies that deploy a fleet of vessels. In marketing this service, we offer leasing arrangements for the TracPhone antennas to both commercial andleisure customers. If commercial leases become increasingly popular with our customers, we could face increased risks of default under those leases. Defaultscould increase our costs of collection (including costs of retrieving leased equipment) and reduce the amount we collect from customers, which could harm ourresults of operations. Moreover, fleet sales are likely to be less common than, and perhaps substantially larger than, our typical orders, which could lead toincreased variability in our quarterly revenues.Changes in the competitive environment or supply chain issues may require inventory write-downs.From time to time, we have recorded significant inventory reserves and/or inventory write-offs as a result of substantial declines in customer demand.Market or competitive changes could lead to future charges for excess or obsolete inventory, especially if we are unable to appropriately adjust the supply ofmaterial from our vendors.Adverse economic conditions could result in financial difficulties or bankruptcy for any of our suppliers, which could adversely affect our businessand results of operations.12Table of ContentsThe significant downturn in worldwide economic conditions and credit tightening could present challenges to our suppliers, which could result indisruptions to our business, increase our costs, delay shipment of our products and impair our ability to generate and recognize revenue. To address their ownbusiness challenges, our suppliers may increase prices, reduce the availability of credit, require deposits or advance payments or take other actions that mayimpose a burden on us.They may also reduce production capacity, slow or delay delivery of products, face challenges meeting our specifications or otherwise fail to meet ourrequirements. In some cases, our suppliers may face bankruptcy. We may be required to identify, qualify and engage new suppliers, which would require timeand the attention of management. Any of these events could impair our ability to deliver our products to customers in a timely and cost-effective manner, causeus to breach our contractual commitments or result in the loss of customers.Shifts in our product sales mix toward our mobile communications products and services may reduce our overall gross margins.Our mobile communications products and services historically have had lower product and service gross margins than our guidance andstabilization products. For example in 2012, we experienced a 10% year-over-year increase in sales of our mobile communications products versus a 3% year-over-year increase in sales of our guidance and stabilization products. A continued shift in our sales mix towards mobile communications products andservices would likely cause lower gross margins in the future, especially if driven by reduced demand.We must generate a certain level of sales of the TracPhone V3, V7 and V11 and our mini-VSAT Broadband service in order to improve our servicegross margins.As a result of our mini-VSAT Broadband network infrastructure, our cost of service sales includes certain fixed costs that do not generally varywith the volume of service sales, and we have almost no ability to reduce these fixed costs in the short term. These fixed costs will increase if we furtherexpand our network to accommodate additional subscriber demand and/or coverage area expansion. If sales of our TracPhone V3, V7 and V11 and the mini-VSAT Broadband service do not generate the level of revenue that we expect or decline, our service gross margins may remain below historical levels or decline.The failure to improve our mini-VSAT Broadband service gross margins would have a material adverse effect on our overall profitability.Competition may limit our ability to sell our mobile communications products and guidance and stabilization products.The mobile communications markets and defense navigation, guidance and stabilization markets in which we participate are very competitive, andwe expect this competition to persist and intensify in the future. We may not be able to compete successfully against current and future competitors, whichcould impair our ability to sell our products. For example, improvements in the performance of lower cost gyros by competitors could potentially jeopardizesales of our fiber optic gyros. Foreign competition for our mobile satellite communications products has continued to intensify, most notably from companiesthat seek to compete primarily on price. We anticipate that this trend of substantial competition will continue.In the market for marine satellite TV equipment, we compete with Intellian, Cobham SATCOM, Raymarine, NaviSystem Marine ElectronicSystems Srl, and King Controls.In the marine market for voice, fax, data and Internet communications equipment and services, we compete with Inmarsat, Cobham SATCOM,Furuno Electric Co., Ltd., Globalstar LP, Iridium Satellite LLC, Intellian, and JRC. We also face competition from providers of marine satellite data servicesand maritime VSAT solutions, including Inmarsat, MTN/SeaMobile, Speedcast, CapRock, Schlumberger, and Astrium.In the market for land mobile satellite TV equipment, we compete with MotoSAT, King Controls, Cobham TracStar and Winegard Company.In the guidance and stabilization markets, we compete primarily with Honeywell International Inc., Kearfott Guidance & Navigation Corporation,Northrop Grumman Corporation, Goodrich Aerospace, IAI, Fizoptica, SAGEM and Systron Donner Inertial.Among the factors that may affect our ability to compete in our markets are the following:•many of our primary competitors are well-established companies that could have substantially greater financial, managerial, technical,marketing, personnel and other resources than we do;•product improvements, new product developments or price reductions by competitors may weaken customer acceptance of, and reduce demandfor, our products;•new technology or market trends may disrupt or displace a need for our products; and13Table of Contents•our competitors may have lower production costs than we do, which may enable them to compete more aggressively in offering discounts andother promotions.The emergence of a competing small maritime VSAT antenna and complementary service or other similar service could reduce the competitiveadvantage we believe we currently enjoy with our 24-inch diameter TracPhone V7 and 14.5-inch diameter TracPhone V3 antennas along with ourintegrated Ku-band mini-VSAT Broadband service, or with our C/Ku-band mini-VSAT Broadband service and our new TracPhone V11.Our TracPhone V3 and V7 systems offer customers a range of benefits due to their integrated design, hardware costs that are lower than existingmaritime Ku-band VSAT systems, and spread spectrum technology. We currently compete against companies that offer established maritime Ku-band VSATservice using, in some cases, antennas 1-meter in diameter or larger. While we are unaware of any company offering a 14.5-inch VSAT solution comparable toour TracPhone V3, we are encountering regional competition from companies offering 24-inch VSAT systems and services, which are comparable in size toour TracPhone V7. Likewise, our TracPhone V11 is approximately 85% smaller and lighter than competing C-band maritime VSAT systems, which usesantennas in excess of 2.4m in diameter to provide similar global services. We are unaware of any competitor currently offering a similar size solution for globalC-band coverage, but any introduction of such a product could adversely impact our success. In addition, other companies could replicate some of thedistinguishing features of our TracPhone V3, V7 or V11, which could potentially reduce the appeal of our solution, increase price competition and adverselyaffect sales. Moreover, consumers may choose other services such as FleetBroadband or Iridium OpenPort for their service coverage and potentially lowerhardware costs despite higher service costs and slower data rates. Finally, it is possible that sales of our TracPhone V3 antennas will reduce sales of ourTracPhone V7 antennas.Our ability to compete in the maritime airtime services market may be impaired if we are unable to provide sufficient service capacity to meetcustomer demand.The TracPhone V3, V7, and V11 and our mini-VSAT Broadband service offer a range of benefits to mariners, especially in commercial markets,due to the smaller size antenna and faster, more affordable airtime. We have completed the rollout of our original network coverage plan and currently offerservice in the Americas, Europe, the Middle East, Africa, Asia-Pacific, and Australian and New Zealand waters. In the future, we may need to expandcapacity in existing coverage areas to support an expanding subscriber base. If we are unable to reach agreement with third-party satellite providers to supportthe mini-VSAT Broadband service and its spread spectrum technology or transponder capacity is unavailable should we need to increase our capacity to meetgrowing demand in a given region, our ability to support vessels and aeronautical applications globally will be at risk and could reduce the attractiveness ofthe product and service to these customers.The purchasing and delivery schedules and priorities of the U.S. military and foreign governments are often unpredictable.We sell our fiber optic gyro systems and tactical navigation products to U.S. and foreign military and government customers, either directly or as asubcontractor to other contractors. These customers often use a competitive bidding process and have unique purchasing and delivery requirements, whichoften makes the timing of sales to these customers unpredictable. Factors that affect their purchasing and delivery decisions include:•increasing budgetary pressures, that may reduce or delay funding for military programs;•changes in modernization plans for military equipment;•changes in tactical navigation requirements;•global conflicts impacting troop deployment, including troop withdrawals from the Middle East;•priorities for current battlefield operations;•new military and operational doctrines that affect military equipment needs;•sales cycles that are long and difficult to predict;•shifting response time and/or delays in the approval process associated with the export licenses we must obtain prior to the internationalshipment of certain of our military products;•delays in military procurement schedules; and•delays in the testing and acceptance of our products, including delays resulting from changes in customer specifications.14Table of ContentsThese factors can cause substantial fluctuations in sales of our TACNAV and FOG products from period to period. For example, sales of our FOGproducts decreased $17.9 million, or 44%, from 2010 to 2011 and increased $0.7 million, or 3%, from 2011 to 2012. TACNAV product sales, which for2012 include shipments of a portion of the largest TACNAV order in our history, have increased $1.0 million, or 5% from 2011 to 2012. We do not currentlyhave in backlog another TACNAV order of comparable size for 2013 or future years, and as a result we expect that our TACNAV revenues will decline in2013 from 2012. The U.S. government may change defense spending priorities at any time. Moreover, government customers such as the U.S. Coast Guardand their contractors can generally cancel orders for our products for convenience or decline to exercise previously disclosed contract options. Even under firmorders with government customers, funding must often be appropriated in the budget process in order for the government to complete the contract. Thecancellation of or failure to fund orders for our products could further reduce our net sales and results of operations.Sales of our fiber optic gyro systems and TACNAV products generally consist of a few large orders, and the delay or cancellation of a single ordercould substantially reduce our net sales.KVH products sold to customers in the defense industry are purchased through orders that can generally range in size from several hundredthousand dollars to more than one million dollars. For example, we received orders for TACNAV products and services of $7.2 million, $35.6 million and$2.8 million in January 2013, June 2012 and June 2012, respectively, and we received orders for fiber optic gyro products of $2.5 million and $7.6 millionin December 2011. Orders of this size are often unpredictable and difficult to replicate. As a result, the delay or cancellation of a single order could materiallyreduce our net sales and results of operations. We periodically experience repeated and unanticipated delays in defense orders, which make our revenues andoperating results less predictable. Because our guidance and stabilization products typically have relatively higher product gross margins than our mobilecommunications products, the loss of an order for guidance and stabilization products could have a disproportionately adverse effect on our results ofoperations.Only a few customers account for a substantial portion of our guidance and stabilization revenues, and the loss of any of these customers couldsubstantially reduce our net sales.We derive a significant portion of our guidance and stabilization revenues from a small number of customers, many of whom are contractors for theU.S. government. For example, in the year ended December 31, 2012, one customer accounted for approximately 11% of our total sales. The loss of businessfrom any of these customers could substantially reduce our net sales and results of operations and could seriously harm our business. Since we are oftenawarded a contract as a subcontractor to a major defense supplier that is engaged in a competitive bidding process as prime contractor for a major weaponsprocurement program, our revenues depend significantly on the success of the prime contractors with which we align ourselves.Our mobile satellite products currently depend on satellite services and facilities provided by third parties, and a disruption in those servicescould adversely affect sales.Our satellite products include only the equipment necessary to utilize satellite services; we do not broadcast satellite television programming or ownthe satellites to directly provide two-way satellite communications. We currently offer satellite television products compatible with the DIRECTV and DISHNetwork services in the United States, the Bell TV service in Canada, the Sky Mexico service and various other regional satellite TV services in other parts ofthe world.SES, Eutelsat, Sky Perfect-JSAT, GE Satellite, Telesat, EchoStar, Intelsat and Star One currently provide the satellite capacity to support the mini-VSAT Broadband service and our TracPhone V3, V7 and V11. Intelsat also currently provides our C-Band satellite coverage. In addition, we have agreementswith various teleports and Internet service providers around the globe to support the mini-VSAT Broadband service. We rely on Inmarsat for satellitecommunications services for our mini-M, Fleet and FleetBroadband compatible TracPhone products.If customers become dissatisfied with the programming, pricing, service, availability or other aspects of any of these satellite services, or if any oneor more of these services becomes unavailable for any reason, we could suffer a substantial decline in sales of our satellite products. There may be noalternative service provider available in a particular geographic area, and our modem or other technology may not be compatible with the technology of anyalternative service provider that may be available. In addition, the unexpected failure of a satellite could disrupt the availability of programming and services,which could reduce the demand for, or customer satisfaction with, our products.15Table of ContentsWe rely upon spread spectrum communications technology developed by ViaSat and transmitted by third-party satellite providers to permittwo-way broadband Internet via our 24-inch diameter TracPhone V7 antenna, our 14.5-inch diameter TracPhone V3 antenna, and our 1-meterdiameter TracPhone V11, and any disruption in the availability of this technology could adversely affect sales.Our mini-VSAT Broadband service relies on spread spectrum technology developed with ViaSat, Inc., for use with satellite capacity controlled bySES, Eutelsat, Sky Perfect-JSAT, GE Satellite, Telesat, Echostar, Intelsat and Star One. Our TracPhone two-way broadband satellite terminals combines ourstabilized antenna technology with ViaSat’s ArcLight spread spectrum mobile broadband technology, along with ViaSat’s ArcLight spread spectrum modem.The ArcLight technology is also integrated within the satellite hubs that support this service. Sales of the TracPhone V3, V7 and V11 and our mini-VSATBroadband service could be disrupted if we fail to receive approval from regulatory authorities to provide our spread spectrum service in the waters of variouscountries where our customers operate or if there are issues with the availability of the ArcLight maritime modems.High fuel prices, tight credit availability, environmental concerns and ongoing low levels of consumer confidence are adversely affecting sales of ourmobile satellite TV products.Factors such as high fuel prices, tight credit, environmental protection laws and ongoing low levels of consumer confidence can materially andadversely affect sales of larger vehicles and vessels for which our mobile satellite TV products are designed. Many customers finance their purchases of thesevehicles and vessels, and tightened credit availability can reduce demand for both these vehicles and vessels and our mobile satellite TV products. Moreover,in the current credit markets, financing for these purchases has sometimes been unavailable or more difficult to obtain. The increased cost of operating thesevehicles and vessels can adversely affect demand for our mobile satellite TV products.We may continue to increase the use of international suppliers to source components for our manufacturing operations, which could disrupt ourbusiness.Although we have historically manufactured and sourced raw materials for the majority of our products domestically, in order for us to compete withlower priced competitive products while also improving our profitability, we have found it desirable to source raw materials and manufactured componentsand assemblies from Europe, Asia and South America. Our increased reliance on foreign manufacturing and/or raw material supply has lengthened oursupply chain and increased the risk that a disruption in that supply chain could have a material adverse effect on our operations and financial performance.We have single dedicated manufacturing facilities for each of our mobile communications and guidance and stabilization product categories, andany significant disruption to a facility could impair our ability to deliver our products.Excluding the CommBox product, which we manufacture in Norway, we currently manufacture all of our mobile communications products at ourmanufacturing facility in Middletown, Rhode Island, and the majority of our guidance and stabilization products at our facility in Tinley Park, Illinois. Someof our production processes are complex, and we may be unable to respond rapidly to the loss of the use of either production facility. For example, ourproduction facilities use some specialized equipment that may take time to replace if they are damaged or become unusable for any reason. In that event,shipments would be delayed, which could result in customer or dealer dissatisfaction, loss of sales and damage to our reputation. Finally, we have only alimited capability to increase our manufacturing capacity in the short term. If short-term demand for our products exceeds our manufacturing capacity, ourinability to fulfill orders in a timely manner could also lead to customer or dealer dissatisfaction, loss of sales and damage to our reputation.We depend on sole or limited source suppliers, and any disruption in supply could impair our ability to deliver our products on time or atexpected cost.We obtain many key components for our products from third-party suppliers, and in some cases we use a single or a limited number of suppliers.Any interruption in supply could impair our ability to deliver our products until we identify and qualify a new source of supply, which could take severalweeks, months or longer and could increase our costs significantly. Suppliers might change or discontinue key components, which could require us to modifyour product designs. For example, in the past, we have experienced changes in the chemicals used to coat our optical fiber, which changed its characteristicsand thereby necessitated design modifications. In general, we do not have written long-term supply agreements with our suppliers but instead purchasecomponents through purchase orders, which expose us to potential price increases and termination of supply without notice or recourse. It is generally not ourpractice to carry significant inventories of product components, and this could magnify the impact of the loss of a supplier. If we are required to use a newsource of materials or components, it could also result in unexpected manufacturing difficulties and could affect product performance and reliability. Inaddition, from time to time, lead times for certain components can increase significantly due to imbalances in overall market supply and16Table of Contentsdemand. This, in turn, could limit our ability to satisfy the demand for certain of our products on a timely basis, and could result in some customer ordersbeing rescheduled or canceled.Any failure to maintain and expand our third-party distribution relationships may limit our ability to penetrate markets for mobilecommunications products.We market and sell our mobile communications products through an international network of independent retailers, chain stores and distributors, aswell as to manufacturers of marine vessels and recreational vehicles. If we are unable to maintain or improve our distribution relationships, it couldsignificantly limit our sales. Some of our distribution relationships are new, and our new distributors may not be successful in marketing and selling ourproducts and services. In addition, our distribution partners may sell products of other companies, including competing products, and are generally notrequired to purchase minimum quantities of our products.If we are unable to improve our existing mobile communications and guidance and stabilization products and develop new, innovative products,our sales and market share may decline.The markets for mobile communications products and guidance and stabilization products are each characterized by rapid technological change,frequent new product innovations, changes in customer requirements and expectations, and evolving industry standards. If we fail to make innovations in ourexisting products and reduce the costs of our products, our market share may decline. Products using new technologies, or emerging industry standards,could render our products obsolete. If our competitors successfully introduce new or enhanced products that eliminate technological advantages our productsmay have in a market or otherwise outperform our products, or are perceived by consumers as doing so, we may be unable to compete successfully in themarkets affected by these changes.If we cannot effectively manage changes in our rate of growth, our business may suffer.We have previously expanded our operations to pursue existing and potential market opportunities, and we are continuing to expand our internationaloperations. For example, we recently opened a new sales office in Japan to service local customers. This growth placed a strain on our personnel, management,financial and other resources. Our guidance and stabilization product revenue decreased significantly during 2011 and then increased slightly from 2011 to2012. Our mobile communications product revenue showed no growth between 2010 and 2011 but then increased from 2011 to 2012. If any portion of ourbusiness grows more rapidly than we anticipate and we fail to manage that growth properly, we may incur unnecessary expenses, and the efficiency of ouroperations may decline. If we are unable to adjust our operating expenses on a timely basis in response to changes in revenue cycles, our results of operationsmay be harmed. To manage changes in our rate of growth effectively, we must, among other things:•match our manufacturing facilities and capacity to demand for our products in a timely manner;•successfully attract, train, motivate and manage appropriate numbers of employees for manufacturing, sales and customer support activities;•effectively manage our inventory and working capital; and•improve the efficiencies within our operating, administrative, financial and accounting systems, and our procedures and controls.We identified a material weakness in our internal control over financial reporting as of December 31, 2012, and the occurrence of this or any othermaterial weakness could have a material adverse effect on our ability to report accurate financial information in a timely manner.Our management recently concluded that, as described under the heading “Item 9A. Controls and Procedures,” we had a material weakness as ofDecember 31, 2012 and therefore did not maintain effective internal control over financial reporting or effective disclosure controls and procedures, both ofwhich are requirements of the Securities Exchange Act of 1934, as of that date. The material weakness related to our failure to detect misappropriation of fundsby an employee whose employment has been terminated. Although we concluded that the amount misappropriated was not material to our financial statements,it is possible that the internal controls in place on that date would not have detected a larger misappropriation that would have been material to our financialstatements. In any event, the existence of the material weakness prevented us from filing this annual report on Form 10-K on or before its due date. We haveimplemented additional controls, and are taking additional steps, to remediate the material weakness. However, the remedial measures we have taken may notbe adequate to prevent future misappropriation or avoid other control deficiencies or material weaknesses. The effectiveness of our internal control overfinancial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihoodof future events, the soundness of our systems, the possibility of human error, and the risk of17Table of Contentsfraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changesin conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, there can be noassurance that any system of or internal control over financial reporting will be successful in preventing all errors or fraud or in making all materialinformation known in a timely manner to the appropriate levels of management. As a result, it is possible that our financial statements will not comply withgenerally accepted accounting principles, will contain a material misstatement or will not be available on a timely basis, any of which could cause investors tolose confidence in us and lead to, among other things, unanticipated legal, accounting and other expenses, delays in filing required financial disclosures,enforcement actions by government authorities, fines, penalties, the delisting of our common stock and liabilities arising from stockholder litigation.We may be unable to hire and retain the skilled personnel we need to expand our operations.To meet our growth objectives, we must attract and retain highly skilled technical, operational, managerial and sales and marketing personnel. If wefail to attract and retain the necessary personnel, we may be unable to achieve our business objectives and may lose our competitive position, which could leadto a significant decline in net sales. We face significant competition for these skilled professionals from other companies, research and academic institutions,government entities and other organizations.Our success depends on the services of our executive officers.Our future success depends to a significant degree on the skills and efforts of Martin Kits van Heyningen, our co-founder, President, ChiefExecutive Officer, and Chairman of the Board. If we lost the services of Mr. Kits van Heyningen, our business and operating results could be seriouslyharmed. We also depend on the ability of our other executive officers to work effectively as a team. The loss of one or more of our executive officers couldimpair our ability to manage our business effectively.Our international business operations expose us to a number of difficulties in coordinating our activities abroad and in dealing with multipleregulatory environments.Historically, sales to customers outside the United States and Canada have accounted for a significant portion of our net sales. We have foreign salesoffices in Denmark, Singapore, Japan and Norway, as well as a subsidiary in Brazil that manages local sales. We otherwise support our international salesfrom our operations in the United States. Our limited operations in foreign countries may impair our ability to compete successfully in international marketsand to meet the service and support needs of our customers in countries where we have little to no infrastructure. We are subject to a number of risksassociated with our international business activities, which may increase our costs and require significant management attention. These risks include:•technical challenges we may face in adapting our mobile communications products to function with different satellite services and technology inuse in various regions around the world;•satisfaction of international regulatory requirements and delays and costs associated with procurement of any necessary licenses or permits;•restrictions on the sale of certain guidance and stabilization products to foreign military and government customers;•increased costs of providing customer support in multiple languages;•increased costs of managing operations that are international in scope;•potentially adverse tax consequences, including restrictions on the repatriation of earnings;•protectionist laws and business practices that favor local competitors, which could slow our growth in international markets;•potentially longer sales cycles, which could slow our revenue growth from international sales;•potentially longer accounts receivable payment cycles and difficulties in collecting accounts receivable;•losses arising from foreign currency exchange rate fluctuations; and•economic and political instability in some international markets.Exports of certain guidance and stabilization products are subject to the International Traffic in Arms Regulations and require a license from theU.S. Department of State prior to shipment.18Table of ContentsWe must comply with the United States Export Administration Regulations and the International Traffic in Arms Regulations, or ITAR. Certain ofour products have military or strategic applications and are on the munitions list of the ITAR and require an individual validated license in order to be exportedto certain jurisdictions. Any changes in export regulations may further restrict the export of our products, and we may cease to be able to procure exportlicenses for our products under existing regulations. The length of time required by the licensing process can vary, potentially delaying the shipment ofproducts and the recognition of the corresponding revenue. Any restriction on the export of a product line or any amount of our products could cause asignificant reduction in net sales.Our business may suffer if we cannot protect our proprietary technology.Our ability to compete depends significantly upon our patents, our source code and our other proprietary technology. The steps we have taken toprotect our technology may be inadequate to prevent others from using what we regard as our technology to compete with us. Our patents could be challenged,invalidated or circumvented, and the rights we have under our patents could provide no competitive advantages. Existing trade secrets, copyright andtrademark laws offer only limited protection. In addition, the laws of some foreign countries do not protect our proprietary technology to the same extent as thelaws of the United States, which could increase the likelihood of misappropriation. Furthermore, other companies could independently develop similar orsuperior technology without violating our intellectual property rights. Any misappropriation of our technology or the development of competing technologycould seriously harm our competitive position, which could lead to a substantial reduction in net sales.If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome, disruptive and expensive, distractthe attention of management, and there can be no assurance that we would prevail.Also, we have delivered certain technical data and information to the U.S. government under procurement contracts, and it may have unlimitedrights to use that technical data and information. There can be no assurance that the U.S. government will not authorize others to use that data and informationto compete with us.Claims by others that we infringe their intellectual property rights could harm our business and financial condition.Our industries are characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and otherintellectual property rights. We cannot be certain that our products do not and will not infringe issued patents, patents that may be issued in the future, or otherintellectual property rights of others.We do not generally conduct exhaustive patent searches to determine whether the technology used in our products infringes patents held by thirdparties. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patentapplications pending, many of which are confidential when filed, with regard to similar technologies.From time to time we have faced claims by third parties that our products or technology infringe their patents or other intellectual property rights, andwe may face similar claims in the future. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim isinvalid, and could distract the attention of our management. If any of our products are found to violate third-party proprietary rights, we may be required topay substantial damages. In addition, we may be required to re-engineer our products or obtain licenses from third parties to continue to offer our products.Any efforts to re-engineer our products or obtain licenses on commercially reasonable terms may not be successful, which would prevent us from selling ourproducts, and, in any case, could substantially increase our costs and have a material adverse effect on our business, financial condition and results ofoperations.Cybersecurity breaches could expose us to liability, damage our reputation, require us to incur significant costs or otherwise adversely affect ourfinancial results.We retain sensitive data, including intellectual property, proprietary business information and personally identifiable information of our employeesand customers on our computer networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computersystems, software and networks may be vulnerable to unauthorized access, misuse, computer viruses or other malicious code and other events that could havea security impact. Any security breach may compromise information stored on our networks and may result in significant data losses or theft of our, ourcustomers', our business partners' or our employees' intellectual property, proprietary business information or personally identifiable information.If any of these events were to occur, they could lead to the loss of sensitive information, cause us to lose existing customers and fail to attract newcustomers, as well as subject us to regulatory actions, litigation, fines or damage to our reputation, and could have a material adverse effect on our financialposition, results of operations or cash flows.19Table of ContentsFluctuations in our quarterly net sales and results of operations could depress the market price of our common stock.We have at times experienced significant fluctuations in our net sales and results of operations from one quarter to the next. Our future net sales andresults of operations could vary significantly from quarter to quarter due to a number of factors, many of which are outside our control. Accordingly, youshould not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is possible that our net sales or resultsof operations in a quarter will fall below the expectations of securities analysts or investors. If this occurs, the market price of our common stock could fallsignificantly. Our results of operations in any quarter can fluctuate for many reasons, including:•changes in demand for our mobile communications products and services and guidance and stabilization products and services;•the timing and size of individual orders from military customers;•the mix of products we sell;•our ability to manufacture, test and deliver products in a timely and cost-effective manner, including the availability and timely delivery ofcomponents and subassemblies from our suppliers;•our success in winning competitions for orders;•the timing of new product introductions by us or our competitors;•expense incurred in pursuing acquisitions;•market and competitive pricing pressures;•general economic climate; and•seasonality of pleasure boat and recreational vehicle usage.A large portion of our expenses, including expenses for network infrastructure, facilities, equipment, and personnel, are relatively fixed. Accordingly,if our net sales decline or do not grow as much as we anticipate, we might be unable to maintain or improve our operating margins. Any failure to achieveanticipated net sales could therefore significantly harm our operating results for a particular fiscal period.We may have exposure to additional tax liabilities, which could negatively impact our income tax expense, net income and cash flow.We are subject to income taxes and other taxes in both the U.S. and the foreign jurisdictions in which we currently operate. The determination of ourworldwide provision for income taxes and current and deferred tax assets and liabilities requires judgment and estimation. In the ordinary course of ourbusiness, there are many transactions and calculations where the ultimate tax determination is uncertain. We are subject to regular review and audit by bothdomestic and foreign tax authorities and to the prospective and retrospective effects of changing tax regulations and legislation. Although we believe our taxestimates are reasonable, the ultimate tax outcome may materially differ from the tax amounts recorded in our consolidated financial statements and maymaterially affect our income tax benefit or expense, net loss or income, and cash flows in the period in which such determination is made.Deferred tax assets are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases ofassets and liabilities, and for operating losses and tax credit carry forwards. A valuation allowance reduces deferred tax assets to estimated realizable value,which assumes that it is more likely than not that we will be able to generate sufficient future taxable income to realize the net carrying value. We review ourdeferred tax assets and valuation allowance on a quarterly basis. As part of our review, we consider positive and negative evidence, including cumulativeresults in recent years.If, during our quarterly reviews of our deferred tax assets, we determine that it is more likely than not that we will not be able to generate sufficientfuture taxable income to realize the net carrying value of our deferred tax assets, we will record a valuation allowance to reduce the tax assets to estimatedrealizable value. This could result in a material income tax charge.The market price of our common stock may be volatile.Our stock price has historically been volatile. During the period from January 1, 2011 to December 31, 2012, the trading price of our common stockranged from $6.90 to $16.68. Many factors may cause the market price of our common stock to fluctuate, including:•variations in our quarterly results of operations;20Table of Contents•the introduction of new products and services by us or our competitors;•changing needs of military customers;•changes in estimates of our performance or recommendations by securities analysts;•the hiring or departure of key personnel;•acquisitions or strategic alliances involving us or our competitors;•market conditions in our industries; and•the global macroeconomic and geopolitical environment.In addition, the stock market can experience extreme price and volume fluctuations. Major stock market indices experienced dramatic declines in2008 and in the first quarter of 2009. These fluctuations are often unrelated to the operating performance of particular companies. These broad marketfluctuations may adversely affect the market price of our common stock. When the market price of a company’s stock drops significantly, stockholders ofteninstitute securities litigation against that company. Any such litigation could cause us to incur significant expenses defending against the claim, divert the timeand attention of our management and result in significant damages.Compliance with the SEC's new conflict minerals rules will increase our costs and adversely affect our results of operations.We are subject to the SEC's new disclosure requirements for public companies that manufacture, or contract to manufacture, products for whichcertain minerals and their derivatives, namely tin, tantalum, tungsten and gold, known as “conflict minerals,” are necessary to the functionality or productionof those products. These regulations will require us to determine which of our products contain conflict minerals and, if so, to perform an extensive inquiryinto our supply chain in an effort to determine whether or not such conflict minerals originate from the Democratic Republic of Congo, or DRC, or anadjoining country. We expect to incur additional costs to comply with these disclosure requirements, including costs related to determining the source of any ofthe relevant minerals used in our products, which will adversely affect our results of operations. Because our supply chain is complex, the due diligenceprocedures that we implement may not enable us to ascertain the origins of any conflict minerals that we use or determine that these minerals did not originatefrom the DRC or an adjoining country, which may harm our reputation. We may also face difficulties in satisfying customers who may require that ourproducts be certified as DRC conflict-free, which could harm our relationships with these customers and lead to a loss of revenue. These new requirementscould also have the effect of limiting the pool of suppliers from which we source these minerals, and we may be unable to obtain conflict-free minerals atcompetitive prices, which could increase our costs and adversely affect our manufacturing operations and our profitability.Acquisitions may disrupt our operations or adversely affect our results.We evaluate strategic acquisition opportunities to acquire other businesses as they arise. The expenses we incur evaluating and pursuing this andother such acquisitions could have a material adverse effect on our results of operations. If we acquire a business, we may be unable to manage it profitably orsuccessfully integrate its operations with our own. Moreover, we may be unable to realize the strategic, financial, operational and other benefits we anticipatefrom any acquisition. Competition for acquisition opportunities could increase the price we pay for businesses we acquire and could reduce the number ofpotential acquisition targets. Further, our approach to acquisitions may involve a number of special financial and business risks, such as:•charges related to any potential acquisition from which we may withdraw;•diversion of our management’s time, attention, and resources;•loss of key acquired personnel;•increased costs to improve or coordinate managerial, operational, financial, and administrative systems, including compliance with theSarbanes-Oxley Act of 2002;•dilutive issuances of equity securities;•the assumption of legal liabilities; and•losses arising from impairment charges associated with goodwill or intangible assets.Our charter and by-laws and Delaware law may deter takeovers.21Table of ContentsOur certificate of incorporation, by-laws and Delaware law contain provisions that could have an anti-takeover effect and discourage, delay orprevent a change in control or an acquisition that many stockholders may find attractive. These provisions may also discourage proxy contests and make itmore difficult for our stockholders to take some corporate actions, including the election of directors. These provisions relate to:•the ability of our Board of Directors to issue preferred stock, and determine its terms, without a stockholder vote;•the classification of our Board of Directors, which effectively prevents stockholders from electing a majority of the directors at any one annualmeeting of stockholders;•the limitation that directors may be removed only for cause by the affirmative vote of the holders of two-thirds of our shares of capital stockentitled to vote;•the prohibition against stockholder actions by written consent;•the inability of stockholders to call a special meeting of stockholders; and•advance notice requirements for stockholder proposals and director nominations.ITEM 1B.Unresolved Staff CommentsNone.22Table of ContentsITEM 2.PropertiesThe following table provides information about our facilities as of December 31, 2012.Location Type Principal Uses ApproximateSquareFootage Ownership LeaseExpirationMiddletown, Rhode Island Office Corporate headquarters, research anddevelopment, sales and service, marketingand administration 75,000 Owned —Middletown, Rhode Island Plant andwarehouse Manufacturing and warehousing (mobilecommunications products) 75,300 Owned —Tinley Park, Illinois Plant andwarehouse Manufacturing, warehousing, research anddevelopment (guidance and stabilizationproducts) 101,000 Owned —Kokkedal, Denmark Office andwarehouse European headquarters, sales, marketingand support 11,000 Leased May 2014Singapore Office Asian headquarters, sales office 2,000 Leased May 2013Horten, Norway Office Research and development, sales, marketingand support 4,400 Leased December2013Japan Office Japanese, sales office 600 Leased October 2014ITEM 3.Legal ProceedingsFrom time to time, we are involved in litigation incidental to the conduct of our business. In the ordinary course of business, we are a party to inquiries,legal proceedings and claims including, from time to time, disagreements with vendors and customers. We are not a party to any lawsuit or proceeding that, inmanagement’s opinion, is likely to materially harm our business, results of operations, financial condition or cash flows.ITEM 4.Mine Safety DisclosuresNot applicable.PART IIITEM 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket Information. Our common stock trades on the NASDAQ Global Market under the symbol “KVHI”. The following table provides, for theperiods indicated, the high and low sale prices for our common stock as reported on the NASDAQ Global Market. High LowYear Ended December 31, 2012: First quarter$10.98 $7.61Second quarter12.95 8.51Third quarter14.50 11.70Fourth quarter14.66 10.38Year Ended December 31, 2011: First quarter$15.53 $11.40Second quarter16.68 10.27Third quarter12.24 7.26Fourth quarter8.62 6.9023Table of ContentsStockholders. As of March 28, 2013, we had 91 holders of record of our common stock. This number does not include stockholders for whom shareswere held in a nominee or “street” name.Dividends. We have never declared or paid cash dividends on our capital stock, and we have no plan to pay any cash dividends in the foreseeablefuture. We currently intend to retain any future earnings to finance our operations and future growth. In addition, the terms of our bank line of credit placerestrictions on our ability to pay cash dividends on our common stock.Issuer Purchases of Equity Securities. On November 26, 2008, our Board of Directors authorized a program to repurchase up to one million sharesof our common stock. The repurchase program is funded using our existing cash, cash equivalents, marketable securities and future cash flows. Under therepurchase program, at management’s discretion, we may repurchase shares on the open market from time to time, in privately negotiated transactions orblock transactions, or through an accelerated repurchase agreement. The timing of such repurchases depends on availability of shares, price, marketconditions, alternative uses of capital, and applicable regulatory requirements. The program may be modified, suspended or terminated at any time withoutprior notice. The repurchase program has no expiration date. There were no other repurchase programs outstanding during the year ended December 31, 2012and no repurchase programs expired during the period.During the year ended December 31, 2011, we repurchased 457,667 shares of our common stock in open market transactions at a cost of $3.7million. We did not repurchase any shares of our common stock in open market transactions during the years ended December 31, 2012 and 2010.During the year ended December 31, 2012, 34,929 vested restricted shares were surrendered in satisfaction of tax withholding obligations at an averageprice of $9.53 per share.STOCK PERFORMANCE GRAPHThe following graph compares the performance of our cumulative stockholder return with that of the NASDAQ Composite Index, a broad equitymarket index, and the NASDAQ Telecommunications Index, a published industry index. The cumulative stockholder returns for shares of our commonstock and for the market indices are calculated assuming $100 was invested on December 31, 2007. We paid no cash dividends during the periods shown.The performance of the market indices is shown on a total return (dividends reinvested) basis. Measurement points are the last trading days of the years endedDecember 2007, 2008, 2009, 2010, 2011 and 2012.24Table of Contents Value of investments as of December 31, 2007 2008 2009 2010 2011 2012KVH Industries, Inc.$100 $64 $183 $148 $97 $173NASDAQ Composite100 59 86 100 98 114NASDAQ Telecommunications100 57 85 88 77 78ITEM 6.Selected Financial DataWe have derived the following selected financial data from our audited consolidated financial statements. You should read this data in conjunction with“Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and SupplementaryData.”In September 2010, we acquired Virtek Communication for approximately $6.5 million. See note 1 to our consolidated financial statements for asummary of significant accounting policies and the effects on the year-to-year comparability of the selected financial data. Year Ended December 31, 2012 2011 2010 2009 2008 (in thousands, except per share data)Consolidated Statement of Operations Data: Sales: Product$90,677 $85,136 $92,059 $75,191 $69,941Service46,435 27,400 20,184 13,869 12,463Net sales137,112 112,536 112,243 89,060 82,404Costs and expenses: Costs of product sales51,775 46,598 51,348 46,552 42,552Costs of service sales30,363 20,970 16,086 10,198 6,130Research and development12,147 11,548 10,715 8,805 7,655Sales, marketing and support24,069 23,473 18,469 16,316 16,162General and administrative12,188 10,555 10,084 7,832 7,035Total costs and expenses130,542 113,144 106,702 89,703 79,534Income (loss) from operations6,570 (608) 5,541 (643) 2,870Interest income510 297 301 358 1,220Interest expense323 223 204 89 153Other income (expense)86 910 23 (20) (231)Income (loss) before income taxes6,843 376 5,661 (394) 3,706Income tax expense (benefit)3,262 (484) (2,612) (261) 648Net income (loss)$3,581 $860 $8,273 $(133) $3,058Per share information: Net income (loss) per common share, basic0.24 0.06 0.57 (0.01) 0.21Net income (loss) per common share, diluted0.24 0.06 0.56 (0.01) 0.21Number of shares used in per share calculation: Basic14,777 14,768 14,420 13,996 14,373Diluted15,019 15,072 14,850 13,996 14,37725Table of Contents December 31, 2012 2011 2010 2009 2008 (in thousands)Consolidated Balance Sheet Data: Cash, cash equivalents and marketable securities$38,285 $30,570 $37,307 $41,304 $42,660Working capital65,242 59,778 60,571 60,690 58,222Total assets137,568 128,556 115,198 97,746 93,758Line of credit7,000 9,000 — — —Long-term debt, excluding current portion3,414 3,553 3,684 3,807 —Other long-term obligations139 135 1,263 902 —Total stockholders’ equity105,704 96,668 96,303 81,600 79,069ITEM 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis should be read in conjunction with the other financial information and consolidated financial statementsand related notes appearing elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties.Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors, including thosediscussed under the heading “Item 1A. Risk Factors” and elsewhere in this annual report.OverviewWe design, develop, manufacture and market mobile communications products for the marine, land mobile and aeronautical markets, and navigation,guidance and stabilization products for both the defense and commercial markets.Our mobile communications products enable customers to receive voice and Internet services and live digital television via satellite services in marinevessels, recreational vehicles and automobiles as well as live digital television on commercial airplanes while in motion. Our CommBox offers a range of toolsdesigned to increase communication efficiency, reduce costs, and manage network operations. We sell our mobile communications products through anextensive international network of retailers, distributors and dealers. We also lease products directly to end users.We offer precision fiber optic gyro-based (FOG) systems that enable platform and optical stabilization, navigation, pointing and guidance. Ourguidance and stabilization products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in avariety of military vehicles, including tactical trucks and light armored vehicles. Our guidance and stabilization products are sold directly to U.S. and alliedgovernments and government contractors, as well as through an international network of authorized independent sales representatives. In addition, ourguidance and stabilization products have numerous commercial applications such as precision mapping, dynamic surveying, autonomous vehicles, trainlocation control and track geometry measurement systems, industrial robotics and optical stabilization.Our mobile communications service sales include sales earned from satellite voice and Internet airtime services, engineering services provided underdevelopment contracts, sales from product repairs, and certain DIRECTV account subsidies and referral fees earned in conjunction with the sale of ourproducts and extended warranty sales. We provide, for monthly fixed and usage fees, satellite connectivity services for broadband Internet, data and Voice overInternet Protocol (VoIP) service to our TracPhone V-series customers. We also earn monthly usage fees for third-party satellite connectivity for voice, data andInternet services to our Inmarsat TracPhone customers who choose to activate their subscriptions with us. Under current DIRECTV programs, we are eligibleto receive a one-time commission for each DIRECTV receiver activated for service and a new mobile account activation fee from DIRECTV for each customerwho activates their DIRECTV service directly through us. Our service sales have grown from 18% of our net sales in 2010 to 24% in 2011 to 34% in 2012.Our guidance and stabilization service sales include engineering services provided under development contracts, product repairs and extended warrantysales.We generate sales primarily from the sale of our mobile satellite systems and services and our guidance and stabilization products and services. Thefollowing table provides, for the periods indicated, our sales by industry category:26Table of Contents Year Ended December 31, 2012 2011 2010 (in thousands)Mobile communications$87,685 $70,202 $62,473Guidance and stabilization49,427 42,334 49,770Net sales$137,112 $112,536 $112,243Net sales to SANG accounted for approximately 11% of our net sales for the year ended December 31, 2012, driven by a TACNAV related orderreceived in 2012 for which the majority of the deliverables will be completed in 2013. Net sales to General Dynamics Land Systems—Canada (GeneralDynamics) accounted for approximately 11% of our net sales for the year ended December 31, 2011, and less than 10% of our net sales for each of the yearsended December 31, 2012 and 2010, respectively. The decrease in net sales to General Dynamics from 2011 to 2012 was primarily driven by the timing ofdeliverables in fulfillment of large TACNAV related order. Net sales to Kongsberg accounted for approximately 14% of our net sales for the year endedDecember 31, 2010. In addition, net sales to a subcontractor to Kongsberg accounted for approximately 5% of our net sales for the year ended December 31,2010. Net sales to Kongsberg, including the subcontractor for Kongsberg, were less than 10% of our net sales for the years ended December 31, 2012 and2011, respectively. The decrease in net sales to Kongsberg and this subcontractor was primarily driven by a slowdown of the U.S. Army’s procurement ofCommon Remotely Operated Weapon Stations (CROWS) under existing contracts. The terms and conditions of sales to SANG, General Dynamics,Kongsberg and the subcontractor to Kongsberg are consistent with our standard terms and conditions of product sales as discussed in note 1 of ourconsolidated financial statements. The SANG receivable balance was current as of December 31, 2012 and the outstanding receivable balance has been paidas of the date of this report. No other customer accounted for more than 10% of our net sales for each of the years ended December 31, 2012, 2011 and 2010,respectively.We have historically derived a substantial portion of our revenue from sales to customers located outside the United States and Canada. The followingtable provides, for the periods indicated, sales to specified geographic regions: Year Ended December 31, 2012 2011 2010 (in thousands)Originating from the Americas locations United States$71,489 $62,748 $70,620Canada11,513 17,518 5,923Europe12,210 8,315 17,892Other22,202 7,143 3,950Total Americas117,414 95,724 98,385Originating from European and Asian locations Europe15,255 13,244 10,398Other4,443 3,568 3,460Total Europe and Asia19,698 16,812 13,858Net sales$137,112 $112,536 $112,243See note 12 to our consolidated financial statements for more information on our geographic segments.In addition to our internally funded research and development efforts, we also conduct research and development activities that are funded by ourcustomers. These activities relate primarily to engineering studies, surveys, prototype development, program management and standard productcustomization. In accordance with accounting principles generally accepted in the United States of America, we account for customer-funded research asservice revenue, and we account for the associated research and development costs as costs of service and product sales. As a result, customer-funded researchand development are not included in the research and development expense that we present in our statement of operations. The following table presents our totalannual research and development effort, representing the sum of research costs of service and product sales and the operating expense of research anddevelopment as described in our statement of operations. Our management believes this information is useful because it provides a better understanding of ourtotal expenditures on research and development activities.27Table of Contents Year ended December 31, 2012 2011 2010 (in thousands)Research and development expense presented on the statement of operations$12,148 $11,548 $10,715Costs of customer-funded research and development included in costs of servicesales3,424 412 953Costs of customer-funded research and development included in costs of productsales— — 1,001Total consolidated statements of operations expenditures on research anddevelopment activities$15,572 $11,960 $12,669As of December 31, 2012, we had approximately $38.3 million in cash, cash equivalents and marketable securities and accumulated earnings ofapproximately $7.3 million.Results of OperationsThe following table provides, for the periods indicated, certain financial data expressed as a percentage of net sales: Year Ended December 31, 2012 2011 2010Sales: Product66.1 % 75.6 % 82.0%Service33.9 24.4 18.0Net sales100.0 100.0 100.0Costs and expenses: Costs of product sales37.8 41.4 45.8Costs of service sales22.1 18.6 14.3Research and development8.9 10.2 9.5Sales, marketing and support17.6 20.9 16.5General and administrative8.9 9.4 9.0Total costs and expenses95.3 100.5 95.1Income (loss) from operations4.7 (0.5) 4.9Interest income0.4 0.3 0.3Interest expense0.2 0.2 0.2Other income0.1 0.8 —Income before income taxes5.0 0.4 5.0Income tax (expense) benefit(2.4) 0.4 2.4Net income2.6 % 0.8 % 7.4%Years ended December 31, 2012 and 2011Net SalesProduct sales increased in 2012 by $5.5 million, or 7%, to $90.7 million from $85.1 million in 2011. The primary reason for the increase in 2012was an increase in sales of our mobile communications products of $4.3 million, or 10%. The increase was primarily due to an increase in sales of our marineproducts of $5.7 million, or 15%, driven primarily by increased demand for our TracPhone V7 and TracPhone V3 products, as well as our new HD11 andTracPhone V11 products that were released in first quarter of 2012 and the fourth quarter of 2012, respectively. Also contributing to the marine productsincrease was increased sales of our HD7 product. Partially offsetting this increase was a decrease in land mobile products of $1.3 million, or 20%. Thedecrease in our land mobile products was primarily a result of decreased sales to original equipment manufacturers in the recreational vehicle market. Weremain cautious about the prospects for our leisure mobile communications product28Table of Contentssales as a result of ongoing challenges in the global economy. However, we expect our mini-VSAT product revenue will continue to grow year-over-year.Mobile communications product sales originating from the Americas increased $2.2 million, or 8%, in 2012 as compared to 2011. Mobilecommunications product sales originating from our European and Asian subsidiaries increased $2.1 million, or 13%, in 2012 as compared to 2011.Also contributing to the increase in product sales was an increase of $1.3 million, or 3%, in sales of guidance and stabilization products. Specifically,sales of our TACNAV defense products increased $1.0 million, or 5%, primarily as a result of product sales related to the previously announced SANGcontract. Also contributing to the increase in sales of our guidance and stabilization products was an increase in sales of our FOG products of $0.7 million, or3%. Although we expect that TACNAV sales will continue to grow over the long term, sales on a quarter-to-quarter or a year-to-year basis could continue to bevery uneven. Largely as a result of uncertainty regarding future military expenditures, we expect our TACNAV product sales will decline in 2013 from 2012.Subject to the disruptions that may arise from federal budgetary pressures, we expect our FOG sales to increase on a year-over-year basis as we begin to receiveorders under the U.S. Army's procurement of Common Remotely Operated Weapon Stations (CROWS) III program.Service sales increased in 2012 by $19.0 million, or 69%, to $46.4 million from $27.4 million in 2011. The primary reason for the increase was a$12.6 million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase was a $4.4 million increase in contractedengineering services driven primarily by the SANG order and a separate TACNAV-related development effort, as well as contracted aviation antenna services,and a $1.9 million increase in service repair sales. We expect our mini-VSAT Broadband service revenue will continue to grow year-over-year, although at aslower rate of growth than we experienced from 2011 to 2012. We also expect that a portion of our services revenue in 2013 will be derived from very lowmargin contracted engineering services related to the SANG order.Costs of SalesOur costs of product sales consist primarily of materials, manufacturing overhead and direct labor used to produce our products. Costs of productsales in 2012 increased by $5.2 million, or 11%, to $51.8 million from $46.6 million in 2011. The primary reason for the increase in costs of product saleswas the increase in sales of our mobile communications products discussed above.Our costs of service sales consist primarily of satellite service capacity, depreciation and service network overhead expense associated with our mini-VSAT Broadband network infrastructure, direct network service labor, engineering and related direct costs associated with customer-funded research anddevelopment, service material and direct labor associated with non-warranty product repairs, as well as Inmarsat service costs. Costs of service sales increasedby $9.4 million, or 45%, to $30.4 million in 2012 from $21.0 million in 2011. The primary reason for the increase was a $5.3 million increase in airtimecosts of sales for our mini-VSAT Broadband service. Also contributing to the increase was a $3.0 million increase in engineering services costs of sales dueprimarily to the services provided in connection with the SANG contract as well as a $0.9 million increase in cost of service repair sales.Gross margin from product sales decreased in 2012 to 43% from 45% in 2011. The decrease in our gross margin from product sales was primarily dueto the increase in mobile communications product sales discussed above, which generally have lower margins than our TACNAV defense products.Gross margin from service sales increased in 2012 to 35% from 23% in 2011. The increase in our gross margin from service sales was primarily dueto the increase in gross margin for mini-VSAT Broadband service sales, which increased in 2012 to 31% from 15% in 2011. Although we expect that mini-VSAT Broadband service revenue will continue to grow year-over-year, we do not anticipate the same year-over-year increase in gross margin percentage. Thisexpectation is driven by the larger mini-VSAT Broadband customer installation base as of January 1, 2013 compared to January 1, 2012. This larger installedbase requires a much larger increase in growth in customer installations in order to generate a year-over-year improvement in gross margin percentagecomparable to that realized in 2012 from 2011. Partially offsetting the increase in gross margin for the mini-VSAT Broadband service sales was a decrease ingross margin for contracted engineering services as a result of facility construction services and project management services in Saudi Arabia, as these servicesunder the SANG contract had a gross margin of approximately 10%. We anticipate the gross margin percentage for contracted engineering services willcontinue to decrease for the next several quarters as a result of the facility construction and project management services portion of the SANG TACNAVcontract. The contract value for the services portion of the SANG TACNAV order remaining to be performed as of January 1, 2013 is approximately $11.0million. These project management services are estimated to continue to be performed well into 2014.29Table of ContentsOperating ExpensesSales, 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, other sales and marketing support costs such as advertising, literature and promotional materials, product servicepersonnel and support costs, warranty-related costs and bad debt expense. Sales, marketing and support expense also includes the operating expenses of oursubsidiaries in Denmark, Singapore, Brazil and Japan. Sales, marketing and support expense in 2012 increased by $0.6 million, or 3%, to $24.1 millionfrom $23.5 million in 2011. The primary reasons for the increase in 2012 were a $0.8 million increase in sales, marketing and support expense related to ourDanish and Singaporean subsidiaries driven by the international expansion of our sales channel presence for the mini-VSAT Broadband satellitecommunication service, and a $0.4 million increase in variable sales expense primarily as a result of the sales related to the SANG TACNAV order and relatedfacility construction that commenced in the third quarter of 2012. Also contributing to the increase was a $0.2 million increase in bad debt expense, a $0.2million increase in trade show expenses, and a $0.2 million increase in demonstration equipment. Partially offsetting these increases was a $0.4 milliondecrease in U.S.-based compensation for sales, marketing and support, a $0.4 million decrease in warranty expense, a $0.2 million total decrease in marketingliterature and cooperative advertising, and a $0.2 million decrease in Norwegian-based compensation for sales, marketing and support. As a percentage of netsales, sales, marketing and support expense decreased in 2012 to 18% from 21% in 2011. We expect that our sales, marketing and support expenses willcontinue to grow in 2013 as we hire additional sales, marketing and support personnel but will grow more slowly than our anticipated growth in net sales.Research and development expense consists of direct labor, materials, external consultants and related overhead costs that support our internally fundedproduct development and product sustaining engineering activities. Research and development costs are generally expensed as incurred. Research anddevelopment expense in 2012 increased by $0.6 million, or 5%, to $12.1 million from $11.5 million in 2011. The primary reason for the increase in 2012was a $0.5 million increase in U.S.-based employee compensation. Also contributing to the increase was a $0.2 million increase in research and developmentexpense related to our Norwegian subsidiary. As a percentage of net sales, research and development expense decreased in 2012 to 9% from 10% in 2011.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 in 2012 increased by $1.6 million, or 15%, to $12.2million from $10.6 million in 2011. The primary reason for the increase in 2012 was a $0.9 million increase in U.S.-based employee compensation. Alsocontributing to the increase was a $0.8 million increase in facility expenditures, a $0.2 million increase in equipment lease expense and software maintenanceexpense, and a $0.1 million increase in recruiting expense. Partially offsetting these increases was a $0.5 million decrease in legal expense. As a percentage ofnet sales, general and administrative expense was 9% in 2012, which was consistent with 2011.Interest and Other Income, NetInterest and other income, net decreased by $0.7 million to $0.3 million in 2012 from $1.0 million in 2011. The primary reason for the decrease was a$0.8 million net benefit in other income in September 2011 resulting from reaching agreement with LiveTV regarding the termination of our original antennadevelopment and production agreement.Income Tax (Expense) BenefitIncome tax expense increased by $3.7 million to $3.3 million as compared to an income tax benefit of $0.5 million in 2011. The increase in incometax expense is primarily due to a $6.5 million increase in pre-tax income. Also, in 2011 we completed the construction of our new Rhode Island productionfacility, and as a result we had fewer Rhode Island state investment tax credits in 2012. Further, Congress did not pass the 2012 federal research anddevelopment tax credit until January 2013, which reduced our federal research and development tax credits for 2012. Instead, these credits will be treated as adiscrete tax event that will be accounted for in the first quarter of 2013. Partially offsetting this tax expense was a reduction in income tax expense associatedwith windfalls for non-qualified stock option exercises and restricted stock award vesting. We estimate that our effective tax rate for 2013 will be in the range of35% to 40%, subject to the tax effect of discrete events, such as stock option exercises and restricted stock vesting.Years ended December 31, 2011 and 2010Net SalesProduct sales decreased in 2011 by $6.9 million, or 8%, to $85.1 million from $92.1 million in 2010. The primary reason for the decrease in 2011was a decrease in sales of our guidance and stabilization products of $6.9 million, or 14%. Specifically,30Table of Contentssales of our FOG products decreased $17.9 million, or 44%, driven largely by a slowdown of the U.S. Army’s procurement of Common Remotely OperatedWeapon Stations (CROWS) under existing contracts, as the industry awaits updates on the outcome of the U.S. Army procurement for the next CROWSprogram contract, which is in the solicitation phase. This decrease in FOG product sales was partially offset by an increase in sales of our TACNAV defenseproducts of $11.4 million, or 190%.Mobile communications product sales in 2011 were $43.9 million, which was consistent with 2010. Sales of our marine products increased $4.7million, or 14%, driven primarily by demand for our TracPhone V3 and V7 products and sales of our network management products from our Norwegiansubsidiary, which was acquired in September 2010. Partially offsetting this increase was a $4.3 million, or 97%, decrease in sales of our satellite televisionantenna used on narrowbody commercial aircraft. We began shipping this antenna to LiveTV in the second quarter of 2009. However, this contract wasterminated in March 2011, and we did not have any shipments of this antenna to LiveTV after such termination. Sales of our land mobile products decreased$0.4 million, or 5%, driven primarily by decreased sales to original equipment manufacturers in the recreational vehicle market.Mobile communications product sales originating from the Americas decreased $2.0 million, or 7%, in 2011 as compared to 2010. Mobilecommunications product sales originating from our European and Asian subsidiaries increased $2.0 million, or 14%, in 2011 as compared to 2010.Service sales increased in 2011 by $7.2 million, or 36%, to $27.4 million from $20.2 million in 2010. The primary reason for the increase was a $7.2million increase in airtime sales for our mini-VSAT Broadband service. Also contributing to the increase was a $0.3 million increase in Inmarsat servicerevenue. Partially offsetting this increase was a $0.2 million decrease in DIRECTV account activation fees and service repair sales, primarily related to adecline in guidance and stabilization TACNAV product refurbishment and repair programs.Costs of SalesCosts of product sales in 2011 decreased by $4.8 million, or 9%, to $46.6 million from $51.3 million in 2010. The primary reason for the decreasewas the decrease in sales of FOG and aeronautical products discussed above.Costs of service sales increased by $4.9 million, or 30%, to $21.0 million in 2011 from $16.1 million in 2010. The primary reason for the increasewas a $5.7 million increase in airtime costs of sales for our mini-VSAT Broadband service. This increase was partially offset by a decrease of $0.7 million incontracted engineering services and service repair costs of sales.Gross margin from product sales increased in 2011 to 45% from 44% in 2010. The primary reason for the increase was the increase in TACNAVproduct sales discussed above.Gross margin from service sales increased in 2011 to 23% from 20% in 2010. The increase in our gross margin from service sales was primarilyattributable to increased airtime sales for our mini-VSAT Broadband service and improved profitability on customer-funded engineering projects.Operating ExpensesSales, marketing and support expense in 2011 increased by $5.0 million, or 27%, to $23.5 million from $18.5 million in 2010. The primaryreason for the increase in 2011 was a $2.5 million increase in variable sales expense in part as a result of two large TACNAV orders that occurred in thesecond and fourth quarters. Also contributing to the increase in 2011 were costs related to the global and domestic expansion of our sales channel and supportservices presence for the mini-VSAT Broadband satellite communication service. Specifically, we experienced a $1.3 million increase in sales, marketing andsupport expense related to our Singaporean, Norwegian, Danish and Brazilian subsidiaries, which (other than our Danish subsidiary), were incorporated oracquired during 2010, as well as a $0.5 million increase in U.S.-based compensation for sales, marketing and support, and a $0.3 million increase inwarranty expense. As a percentage of sales, sales, marketing and support expense increased in 2011 to 21% from 16% in 2010.During 2011, research and development costs were expensed as incurred, excluding the aviation antenna development costs that were related to theoriginal development project for LiveTV, which were capitalized from 2009 through the second quarter of 2011 until the original antenna development andproduction agreement with LiveTV was terminated in March 2011. We reached an agreement with LiveTV regarding the termination of the productionagreement in September 2011 and as a result, all such expenditures were expensed to other expense in the third quarter. Prior to the third quarter of 2011 we hada contractual right to recover such costs. Research and development expense in 2011 increased by $0.8 million, or 8%, to $11.5 million from $10.7 million in2010. The primary reason for the increase in 2011 expense was a $0.5 million decrease in customer-funded engineering costs for contracted engineeringservices. Also contributing to the increase was a $0.3 million31Table of Contentsincrease in research and development expense related to our Norwegian subsidiary, which was acquired in September 2010. As a percentage of sales, researchand development expense was 10% in 2011, which was consistent with 2010.General and administrative expense in 2011 increased by $0.5 million, or 5%, to $10.6 million from $10.1 million in 2010. The primary reason forthe increase in 2011 expense was a $0.6 million increase in general and administrative expenses related to our Norwegian subsidiary, which was acquired inSeptember 2010. Also contributing to the increase was a $0.3 million increase in U.S.-based employee compensation for the general and administrativedepartment, and a $0.1 million increase in computer maintenance expense. Partially offsetting these increases was a $0.6 million decrease in merger andacquisition costs related to the acquisition of our Norwegian subsidiary, which was acquired in September 2010. As a percentage of sales, general andadministrative expense was 9% in 2011, which was consistent with 2010.Interest and Other Income, NetInterest and other income, net increased by $0.9 million to $1.0 million in 2011 from $0.1 million in 2010. The primary reason for the increase was a$0.8 million net benefit in other income resulting from reaching agreement with LiveTV relative to the termination of our original antenna development andproduction agreement in September 2011.Income Tax BenefitThe income tax benefit decreased by $2.1 million to $0.5 million in 2011 from $2.6 million in 2010. The primary reason for the decrease in 2011 wasbased upon our conclusion in 2010 that $3.3 million of our deferred tax asset valuation allowance was no longer required which led us to reverse a portion ofthe allowance, resulting in a substantial benefit. In 2011, our tax benefit was driven by Rhode Island state tax credits relating to the construction of our newproduction facility. Partially offsetting this tax benefit was income tax expense associated with tax shortfalls for non-qualified stock options expirations andcertain non-qualified stock option exercises, as well as shortfalls associated with restricted stock awards vesting in 2011 and losses in certain foreignjurisdictions for which we recorded no tax benefit.Critical Accounting Policies and Significant EstimatesThe discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure at the date of ourfinancial statements. Our significant accounting policies are summarized in note 1 to our consolidated financial statements. The significant accounting policiesthat we believe are the most critical in understanding and evaluating our reported financial results include the following:Revenue RecognitionProduct sales. Product sales are recognized when persuasive evidence of an arrangement exists, goods are shipped, title has passed and collectability isreasonably assured. Our standard sales terms require that:•All sales are final;•Terms are generally Net 30;•Shipments are tendered and shipped FOB (or as may be applicable, FCA or EXW) our plant or warehouse; and•Title and risk of loss or damage passes to the dealer or distributor at the point of shipment when delivery is made to the possession of the carrier.For certain guidance and stabilization product sales, customer acceptance or inspection may be required before title and risk of loss transfers to thecustomer. For those sales, revenue is recognized after transfer of title and risk of loss and after notification of customer acceptance.Under certain limited conditions, we, at our sole discretion, provide for the return of goods. No product is accepted for return and no credit is allowedon any returned product unless we have granted and confirmed prior written permission by means of appropriate authorization. We establish reserves forpotential sales returns, credits and allowances, and evaluate, on a monthly basis, the adequacy of those reserves based upon historical experience and ourexpectations for the future.Multiple-element revenue arrangements. Some of our sales involve multiple-element arrangements that include both hardware-related products andcontracted service, or satellite connectivity. We analyze revenue arrangements with multiple deliverables to determine if the deliverables should be divided intomore than one unit of accounting. For contracts with more32Table of Contentsthan one unit of accounting, we allocate the consideration we receive among the separate units of accounting based on a selling price hierarchy for determiningthe selling price of each deliverable, which includes: (1) vendor-specific objective evidence (VSOE) if available; (2) third-party evidence (TPE) if VSOE is notavailable; and (3) best estimated selling price (BESP), if neither VSOE nor TPE is available. Best estimate selling price is determined based on prices of thedeliverables if sold on a stand-alone basis, or if not sold on a stand-alone basis, the prices we would charge if sold on a stand-alone basis. We recognizerevenue for each deliverable based on the revenue recognition policies described in this section.We have accounted for our $35.6 million contract received in June 2012 from SANG to purchase TACNAV defense products and services as amultiple-element arrangement. The total contract value associated with TACNAV defense products is $21.2 million for which shipments are estimated tocontinue through the first half of 2013. The total contract value associated with all services is $14.4 million which are estimated to continue through 2014. Therevenue for these services is recognized using the percentage of completion accounting method. Total revenue recognized on the SANG contract in 2012 wasapproximately $15.2 million.Contracted service sales. We also have contracts for development, production and services activities that are recognized primarily under thepercentage of completion method of revenue recognition. The use of contract accounting requires significant judgment relative to estimating total contractrevenues and costs, including assumptions relative to the length of time to complete the contract, the nature and complexity of the work to be performed, andprices for subcontractor services and materials. Our estimates are based upon the professional knowledge and experience of our engineers, program managersand other personnel, who review each long-term contract monthly to assess the contract's schedule, performance, technical matters and estimated cost atcompletion. A cancellation, schedule delay, or modification of a fixed-price contract which is accounted for using the percentage of completion method mayadversely affect our gross margins for the period in which the contract is modified. Changes in estimates are applied when adjustments in estimated contractcosts are identified, such revisions may result in current period adjustments to earnings applicable to performance in prior periods.Satellite connectivity sales. Directly sold and re-sold satellite connectivity service for voice, data and Internet is recognized monthly based uponminutes or megabytes of traffic processed or contracted fixed fee schedules. Typically, all subscribers enter into a contracted one-year minimum serviceagreement. We record all satellite connectivity service sales to subscribers as gross sales, as we are the primary obligor in the contracted service arrangement.All associated regulatory service fees and costs are recorded net in our consolidated financial statements. The accounting estimates related to the recognition ofsatellite connectivity service sales in our results of operations require us to make assumptions about future billing adjustments for disputes with subscribersas well as unauthorized usage.Accounts Receivable AllowanceOur estimate of allowance for doubtful accounts related to trade receivables is primarily based on specific and historical criteria. We evaluate specificaccounts where we have information that the customer may have an inability to meet its financial obligations. We make judgments, based on facts andcircumstances, regarding the need to record a specific reserve for that customer against amounts owed to reduce the receivable to the amount that we expect tocollect. We also provide for a reserve based on an aging analysis of our accounts receivable. We evaluate these reserves on a monthly basis and adjust them aswe receive additional information that impacts the amount reserved. If circumstances change, we could change our estimates of the recoverability of amountsowed to us by a material amount.We wrote off approximately $0.2 million, $0.2 million and $0.5 million of our accounts receivable in 2012, 2011 and 2010, respectively. The write-offs in both years were driven largely by the financial deterioration of a couple of our mobile communications product distributors as well as a few of ourairtime customers. The current economic downturn could continue to adversely impact the financial condition of our customers, which could result inadditional write-offs and increases in our allowance for doubtful accounts and have a negative impact on our results of operations.InventoriesInventory is valued at the lower of cost or market. We generally must order components for our products and build inventory in advance of productshipments. We regularly review current quantities on hand, actual and projected sales volumes and anticipated selling prices on products and write down, asappropriate, slow-moving and/or obsolete inventory to its net realizable value. In 2012, 2011 and 2010, we wrote off approximately $0.2 million, $0.2 millionand $0.6 million respectively, of fully reserved inventory. However, if we overestimate projected sales or anticipated selling prices, our inventory might beoverstocked or overvalued, and we would have to reduce our inventory valuation accordingly.Accounting for Income Taxes33Table of ContentsAs part of the process of preparing our financial statements, we are required to estimate our provision for income taxes in each of the jurisdictions inwhich we operate. This involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessingtemporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets andliabilities. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and record a valuation allowance to reduce thedeferred tax assets to an amount that, in our judgment, is more likely than not to be recovered.Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowancerecorded against our deferred tax assets. The valuation allowance is based on our estimates of future taxable income and the period over which we expect thedeferred tax assets to be recovered. Our assessment of future taxable income is based on historical experience and current and anticipated market and economicconditions and trends. In the event that actual results differ from these estimates or we adjust our estimates in the future, we may need to adjust our valuationallowance, which could materially impact our consolidated financial position and results of operations. For example, in the year ended December 31, 2010, wedetermined that a $3.3 million reversal of our valuation allowance was appropriate, which resulted in a substantial income tax benefit. At December 31, 2012,we had valuation allowances of $2.1 million to offset gross deferred tax assets of $10.4 million.Warranty ProvisionWe typically offer a one to two year warranty for all of our base products. We provide for the estimated cost of product warranties at the time productrevenue is recognized. Factors that affect our warranty reserves include the number of units sold, historical and anticipated rates of warranty repairs and thecost per repair. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of ourcomponent suppliers, our estimated warranty obligation is affected by ongoing product failure rates, specific product class failures outside our baselineexperience, material usage and service delivery costs incurred in correcting a product failure. If actual product failure rates, material usage or service deliverycosts differ from our estimates, revisions to the estimated warranty liability would be required. Assumptions and historical warranty experience are evaluatedto determine the appropriateness of such assumptions. We assess the adequacy of the warranty provision on a quarterly basis and we adjust this provisionwhen necessary.Stock-Based CompensationOur stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisiteservice period, which is generally the vesting period.We use the Black-Scholes valuation model for estimating the fair value on the date of grant of compensatory stock options. Determining the fair value ofstock option awards at the grant date requires judgment regarding certain valuation assumptions, including the volatility of our stock price, expected term ofthe option, risk-free interest rate and expected dividends. Changes in these assumptions and estimates could result in different fair values and could thereforeimpact our earnings. These changes would not impact our cash flows. The fair value of restricted stock awards is based upon our stock price on the grantdate.The amount of stock-based compensation expense recorded in any period for unvested awards requires estimates of the amount of stock-based awardsthat are expected to be forfeited prior to vesting.Compensation costs for awards subject only to service conditions that vest ratably are recognized on a straight-line basis over the requisite serviceperiod for the entire award.Goodwill and Intangible AssetsGoodwill and intangible assets with indefinite lives are tested at least annually for impairment. Intangible assets with estimated lives and other long-lived assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.Recoverability of intangible assets with estimated lives and other long-lived assets is measured by comparing the carrying amount of the asset to future netundiscounted cash flows expected to be generated by the asset. If these comparisons indicate that an asset is not recoverable, we will recognize an impairmentloss for the amount by which the carrying value of the asset exceeds the related estimated fair value. Estimated fair value is based on either discounted futureoperating cash flows or appraised values, depending on the nature of the asset. Considerable judgment is required to estimate discounted future operating cashflows. Judgment is also required in determining whether an event has occurred that may impair the value of goodwill or identifiable intangible or other long-lived assets. Factors that could indicate an impairment may exist include significant underperformance relative to plan or long-term projections, changes inbusiness strategy, significant negative industry or economic trends, a significant change in circumstances relative to a large customer, a significant decline inour stock price for a sustained period and a decline in our market capitalization to below net book value.34Table of ContentsWe must make assumptions about future cash flows, future operating plans, discount rates and other factors in our models and valuation reports. To theextent these future projections and estimates change, the estimated amounts of impairment could differ from current estimates. Our annual testing forimpairment of goodwill is completed as of August 31 of each year. As of December 31, 2012, all goodwill and intangible assets are associated with thepurchase of Virtek Communication in September 2010.ContingenciesWe are subject to ongoing business risks arising in the ordinary course of business. An estimated loss contingency is accrued when it is probable that aliability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We regularly evaluate current informationavailable to determine whether such amounts should be adjusted and record changes in estimates in the period they become known. We reserve for legalcontingencies and legal fees when the amounts are probable and reasonably estimable. At December 31, 2012, we have not recorded any material losscontingencies.Liquidity and Capital ResourcesWe have historically funded our operations primarily from cash flows from operations, net proceeds from public and private equity offerings, bankfinancings and proceeds received from exercises of stock options. As of December 31, 2012, we had $38.3 million in cash, cash equivalents and marketablesecurities, of which $0.8 million, $0.5 million and $2.1 million in cash equivalents were held in a local currency by our foreign subsidiaries located inDenmark, Brazil and Norway, respectively. There were no marketable securities held by our foreign subsidiaries as of December 31, 2012. As ofDecember 31, 2012, we had $65.2 million in working capital.Net cash provided by operations for 2012 was $15.1 million as compared to net cash provided by operations of $1.9 million for 2011. The increase isprimarily due to a $6.3 million decrease in cash outflows as a result of decreased inventory levels, a $5.2 million increase in cash inflows attributable toaccounts receivable, as well as a $2.7 million increase in net income, which reflected a $2.8 million reduction in non-cash benefits related to deferred incometaxes . Also contributing to the increase was a decrease in cash outflows of approximately $1.7 million related to accrued expenses and a $1.1 million decreasein cash outflows related to other long-term liabilities. Partially offsetting the increase in cash inflows is an increase in cash outflows of $2.6 million related toother non-current assets and a $2.5 million decrease in cash inflows related to deferred revenue. In addition, there was an increase in cash outflows of $1.3million related to accounts payables and a $0.9 million increase in cash outflows related to prepaid expenses and other current assets.Net cash used in investing activities for 2012 was $12.3 million as compared to net cash used in investing activities of $7.6 million for 2011. Theincrease in cash outflows is due to a $12.3 million increase in our net investment in marketable securities. Partially offsetting the increase in cash outflows is adecrease in capital expenditures of approximately $7.6 million, which in 2011 included expenditures relating to the construction of our new manufacturingfacility in Middletown, Rhode Island.Net cash used in financing activities for 2012 was $0.9 million as compared to net cash provided by financing activities of $5.5 million for 2011.The decrease in cash provided by financing activities is primarily the result of repayments on our line of credit of $2.0 million in 2012, in comparison to $9.0million in borrowings under our line of credit in 2011, which were used to finance the construction of our new manufacturing facility in Middletown, RhodeIsland. Partially offsetting this decrease was a $3.7 million decrease in common stock repurchases, a $0.6 million increase in proceeds from exercises of stockoptions and purchases of shares under our employee stock purchase plan, as well as a $0.3 million decrease in payments related to employee restricted stockwithholdings.On April 6, 2009, we entered into a mortgage loan in the amount of $4.0 million related to our headquarters facility in Middletown, Rhode Island. Theloan term is 10 years, with a principal amortization of 20 years, and the interest rate will be a rate per year adjusted periodically based on a defined interestperiod equal to the BBA LIBOR Rate plus 2.25 percentage points. On June 9, 2011, we entered into an amendment to the mortgage loan, providing for anadjustment of the interest rate from the BBA LIBOR Rate plus 2.25 percentage points to the BBA LIBOR Rate plus 2.00 points. Land, building andimprovements with an approximate carrying value of $4.4 million as of December 31, 2012 secure the mortgage loan. The monthly mortgage payment isapproximately $11,000, plus interest and increases in increments of $1,000 each year throughout the life of the mortgage. Due to the difference in the term ofthe loan and amortization of the principal, a balloon payment of $2.6 million is due on April 1, 2019. The loan contains one financial covenant, a FixedCharge Coverage Ratio, which applies in the event that our consolidated cash, cash equivalents and marketable securities balance falls below $25.0 million atany time. As our consolidated cash, cash equivalents and marketable securities balance was above $25.0 million throughout 2012, the Fixed Charge CoverageRatio did not apply. Under the mortgage loan we may prepay our outstanding loan balance subject35Table of Contentsto certain early termination charges as defined in the mortgage loan agreement. If we were to default on our mortgage loan, the land, building and improvementswould be used as collateral. As discussed in note 15 to the consolidated financial statements, effective April 1, 2010, in order to reduce the volatility of cashoutflows that arise from changes in interest rates, we entered into two interest rate swap agreements that are intended to hedge our mortgage interest obligationsby 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 principalamount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019.We currently have a revolving loan agreement with a bank that provides for a maximum available credit of $15.0 million and will expire onDecember 31, 2014. We pay interest on any outstanding amounts at a rate equal to the BBA LIBOR Daily Floating Rate plus 1.25%. The line of creditcontains two financial covenants, a Liquidity Covenant, which requires us to maintain at least $20.0 million in unencumbered liquid assets, as defined in theloan agreement, and a Fixed Charge Coverage Ratio. As of December 31, 2012, we were not in default of either covenant. Subject to the terms of the agreementand so long as no event of default has occurred, until September 30, 2013, we have the option of converting up to $12.0 million of revolving loans into one ormore term loans at a floating interest rate equal to LIBOR plus 1.75%. We may terminate the loan agreement prior to its full term without penalty, provided wegive 30 days’ advance written notice to the bank. As of December 31, 2012, we had borrowed $7.0 million under the facility, the repayment of which is due nolater than the maturity date of December 31, 2014.On November 26, 2008, our Board of Directors authorized a program to repurchase up to one million shares of our common stock. The sharerepurchase program is funded using our existing cash, cash equivalents, marketable securities and future cash flows. As of December 31, 2012, 341,009shares of our common stock remain available for repurchase under the program. We did not purchase any shares of our common stock in 2012.It is our intent to continue to invest in the mini-VSAT Broadband network on a global basis in cooperation with ViaSat under the terms of a 10-yearagreement announced in July 2008. As part of the future potential capacity expansion, we would plan to seek to acquire additional satellite capacity fromsatellite operators, expend funds to seek regulatory approvals and permits, develop product enhancements in anticipation of the expansion, and hire additionalpersonnel. In addition, in December 2011, we entered into a five-year agreement to lease C-band satellite capacity from a satellite operator, effective February 1,2012, and in 2012 we also purchased three satellite hubs to support this C-band service. The total cost of the five-year satellite capacity agreement, the satellitehubs, and teleport services is approximately $12.2 million, of which approximately $2.7 million related to the total cost of the three hubs. On January 30,2013, we borrowed $4.7 million from a bank and pledged as collateral six satellite hubs and related equipment, including the three hubs purchased in 2012.The term of the equipment loan is five years, at a fixed interest rate of 2.76%. The monthly payment is $83,000 including interest expense.We believe that the $38.3 million we hold in cash, cash equivalents and marketable securities, together with our other existing working capital and cashflows from operations, will be adequate to meet planned operating and capital requirements through at least the next twelve months. However, as the need oropportunity arises, we may seek to raise additional capital through public or private sales of securities or through additional debt financing. There are noassurances that we will be able to obtain any additional funding or that such funding will be available on terms acceptable to us.Contractual Obligations and Other Commercial CommitmentsAs of December 31, 2012, our contractual commitments consisted of satellite service capacity, near-term purchase commitments, line of creditborrowings, a mortgage note payable, and equipment and facility leases. Our purchase commitments include unconditional purchase orders for inventory,manufacturing materials and fixed assets extending out over various periods throughout 2014. We are also obligated under satellite service capacity leases andmulti-year facility leases that terminate at various times between 2013 and 2017.36Table of ContentsThe following table summarizes our obligations under these commitments, excluding interest, at December 31, 2012: Payment Due by PeriodContractual Obligations Total Less than1 Year 1-3 Years 3-5 Years More than5 Years (in thousands)Satellite service capacity and equipment lease obligations $33,618 $12,430 $15,441 $5,207 $540Inventory and fixed asset purchase commitments 21,160 17,035 4,125 — —Line of credit borrowings 7,000 — 7,000 — —Mortgage note payable 3,553 138 300 335 2,780Facility lease obligations 243 190 53 — —Total $65,574 $29,793 $26,919 $5,542 $3,320We did not have any off-balance sheet commitments, guarantees or standby repurchase obligations as of December 31, 2012.Recent Accounting PronouncementsSee note 1 of our accompanying audited consolidated financial statements for a description of recent accounting pronouncements including the dates ofadoption and effects on our results of operations, financial position and disclosures.ITEM 7A.Quantitative and Qualitative Disclosure About Market RiskOur primary market risk exposure is in the area of foreign currency exchange risk. We are exposed to currency exchange rate fluctuations related to oursubsidiary operations in Brazil, Denmark, Norway, Singapore and Japan. Certain transactions in these locations are made in the local currency, yet arereported in the U.S. dollar, the functional currency. For foreign currency exposures existing at December 31, 2012, a 10% unfavorable movement in the foreignexchange rates for our subsidiary locations would not expose us to material losses in earnings or cash flows.From time to time, we purchase foreign currency forward contracts generally having durations of no more than five months. These forward contractsare intended to offset the impact of exchange rate fluctuations on cash flows of our foreign subsidiaries. Foreign exchange contracts are accounted for as cashflow hedges and are recorded on the balance sheet at fair value until executed. Changes in the fair value are recognized in earnings. We did not enter into anysuch contracts during 2011 or 2012.The primary objective of our investment activities is to preserve principal and maintain liquidity, while at the same time maximize income. We have notentered into any instruments for trading purposes. Some of the securities that we invest in may have market risk. To minimize this risk, we maintain ourportfolio of cash equivalents and short-term investments in a variety of securities that can include government agency bonds, money market mutual funds,corporate notes, and certificates of deposit. As of December 31, 2012, a hypothetical 100 basis-point increase in interest rates would result in an immaterialdecrease in the fair value of our investments that have maturities of greater than one year. Due to the conservative nature of our investments and the relativelyshort duration of their maturities, we believe interest rate risk is substantially mitigated. As of December 31 2012, 77% of the $29.3 million classified asavailable-for-sale marketable securities will mature or reset within one year. Accordingly, long-term interest rate risk is not considered material. We did notinvest in any financial instruments denominated in foreign currencies as of December 31, 2012.To the extent that we borrow against our variable-rate credit facility, we will be subject to interest rate risk, as we will pay interest on any outstandingamounts at a rate equal to the BBA LIBOR Daily Floating Rate plus 1.25%. There was $7 million in borrowings outstanding under this facility atDecember 31, 2012. Subject to the terms of the agreement and so long as no event of default has occurred, until September 30, 2013, we have the option ofconverting up to $12.0 million of outstanding amounts against our variable-rate facility into one or more term loans at a floating interest rate equal to LIBORplus 1.75%.As discussed in note 15 to the consolidated financial statements, effective April 1, 2010, in order to reduce the volatility of cash outflows that arisefrom changes in interest rates, we entered into two interest rate swap agreements. These interest rate swap agreements are intended to hedge our mortgage loanrelated to our headquarters facility in Middletown, Rhode Island by fixing the interest rates specified in the mortgage loan to 5.9% for half of the principalamount outstanding and 6.1% for the remaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16,2019.37Table of ContentsITEM 8.Financial Statements and Supplementary DataOur consolidated financial statements and supplementary data, together with the report of KPMG LLP, our independent registered public accountingfirm, are included in Part IV of this annual report on Form 10-K.ITEM 9.Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone.38Table of ContentsITEM 9A.Controls and ProceduresEvaluation of Disclosure Controls and ProceduresWe maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,or the Exchange Act, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that suchinformation is accumulated and communicated to our management, including our President, Chief Executive Officer and Chairman of the Board, or CEO,and Chief Financial and Accounting Officer, or CFO, as appropriate to allow timely decisions regarding required disclosure.Under the supervision and with the participation of our CEO and CFO, our management has evaluated the effectiveness of our disclosure controls andprocedures as of December 31, 2012, the end of the period covered by this annual report. Based on that evaluation, our CEO and CFO concluded that ourdisclosure controls and procedures were not effective as of December 31, 2012 due to the material weakness in our internal control over financial reportingdescribed below.BackgroundIn March 2013, our management identified that the most senior member of our accounting staff at our Danish subsidiary had engaged in a fraudulentscheme to misappropriate assets from us over a period of at least three years. The scheme included fraudulent wire transfers to a personal bank account,fraudulent documentation, forged signatures and use of a corporate credit card for personal expenses. For the three years ended December 31, 2012, theaggregate amount of misappropriated funds in any year ranged from approximately $118,000 to $250,000. Management is seeking to determine whether anyof the losses may be covered by our insurance policies.Management's Report on Internal Control over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financialreporting is the process designed by and under the supervision of our CEO and CFO to provide reasonable assurance regarding the reliability of our financialreporting and the preparation of our financial statements for external reporting in accordance with accounting principles generally accepted in the United Statesof America. Management has evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.Under the supervision and with the participation of our CEO and CFO, our management has assessed the effectiveness of our internal control overfinancial reporting as of December 31, 2012 and concluded that it was not effective because of the material weakness described below.A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonablepossibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Management'sassessment identified the following control deficiencies in our internal control over financial reporting at our Danish subsidiary as a material weakness:•override of access controls over banking security devices and personal identification numbers enabling the unauthorized execution of wire transfers;•ineffective review controls over the supporting documentation by the subsidiary country general manager over expenditures and expenses; and•override of review controls designed to address the accuracy and approval of manual journal entries at the Danish subsidiary.The material weakness resulted in immaterial misstatements related to cost of goods sold and sales and marketing expenses and, as a result, weconcluded that, as of December 31, 2012, there was a reasonable possibility that material misstatements could occur in the consolidated financial statements.Our independent registered public accounting firm, KPMG LLP, has issued an adverse report regarding the effectiveness of our internal control overfinancial reporting as of December 31, 2012, and that report is included in Item 8 in this annual report.39Table of ContentsEvaluation of Changes in Internal Control over Financial ReportingUnder the supervision and with the participation of our CEO and CFO, our management has evaluated changes in our internal control over financialreporting that occurred during the fourth quarter of 2012. Based on that evaluation, our CEO and CFO did not identify any change in our internal control overfinancial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.However, following the identification of the foregoing control deficiencies in March 2013, management implemented a remediation plan. Managementbelieves that the implementation of this plan will remediate the control deficiencies described above. The following steps of the remediation plan have beencompleted as of the filing of this annual report:•termination of the employment of the individual involved and reassignment of his duties to an interim controller for our Danish subsidiary;•implementation of a new corporate-level control to review manual journal entries of foreign subsidiaries; and•implementation of new controls regarding the physical safekeeping of banking security devices and personal identification numbers, which aredesigned to prevent one person from gaining access to two devices and personal identification numbers required to execute wire transfers.The following steps of the remediation plan are currently in process, and management may determine to enhance existing controls and/or implementadditional controls as the implementation progresses:•management is in the process of reviewing the design and operation of our process-level and transaction-level controls at our foreign subsidiaries inrelation to cash management and manual journal entry review and approvals; and•management also intends to conduct training sessions at its various locations to reinforce control consciousness.Important ConsiderationsThe effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations,including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, thepossibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controlsmay become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time.Because of these limitations, there can be no assurance that any system of disclosure controls and procedures or internal control over financial reporting willbe successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.Report of Independent Registered Public Accounting FirmThe Board of Directors and StockholdersKVH Industries, Inc.:We have audited KVH Industries, Inc.'s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control -Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). KVH Industries, Inc.'s management isresponsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financialreporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinionon the Company's internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, andtesting and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such otherprocedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting andthe preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control overfinancial reporting includes those policies and procedures40Table of Contentsthat (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations ofmanagement and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibilitythat a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. A material weaknessrelated to control activities over the execution of wire transfers, approval of cash disbursements and other purchase transactions and review and approval ofmanual journal entries has been identified and included in management's assessment. We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the consolidated balance sheet of KVH Industries, Inc. and subsidiaries as of December 31, 2012 andthe related consolidated statements of operations, comprehensive income, stockholders' equity and accumulated other comprehensive income (loss), and cashflows for the year ended December 31, 2012. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in ouraudit of the 2012 consolidated financial statements, and this report does not affect our report dated April 2, 2013, which expressed an unqualified opinion onthose consolidated financial statements. In our opinion, because of the effect of the aforementioned material weakness on the achievement of the objectives of the control criteria, KVH Industries, Inc.has not maintained effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - IntegratedFramework issued by the Committee of Sponsoring Organizations of the Treadway Commission./s/ KPMG LLPProvidence, Rhode IslandApril 2, 2013ITEM 9B.Other InformationNone.41Table of ContentsPART IIIWe have omitted the information required in Part III of this annual report because we intend to include that information in our definitive proxy statementfor our 2013 annual meeting of stockholders, which we expect to file before 120 days after the end of fiscal 2012. We incorporate the information required inPart III of this annual report by reference to our 2013 proxy statement.ITEM 10.Directors, Executive Officers and Corporate GovernanceExcept as set forth below, the information required by this item is incorporated by reference to our 2013 proxy statement.Our Board of Directors has adopted a Code of Business Conduct and Ethics that applies to our directors, executive officers and employees. Our Codeof Business Conduct and Ethics can be found on our website, which is located at www.kvh.com. We intend to make all required disclosures concerning anyamendments to or waivers from, our Code of Business Conduct and Ethics on our website. Any person may request a copy of the Code of Business Conductand Ethics, at no cost, by writing to us at the following address: KVH Industries, Inc., 50 Enterprise Center, Middletown, Rhode Island, 02842, Attention:Investor Relations.ITEM 11.Executive CompensationThe information required by this item is incorporated by reference to our 2013 proxy statement.ITEM 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersThe information required by this item is incorporated by reference to our 2013 proxy statement.ITEM 13.Certain Relationships and Related Transactions and Director IndependenceThe information required by this item is incorporated by reference to our 2013 proxy statement.ITEM 14.Principal Accountant Fees and ServicesThe information required by this item is incorporated by reference to our 2013 proxy statement.42Table of ContentsPART IVITEM 15.Exhibits and Financial Statement Schedules Page(a)1.Financial Statements Report of Independent Registered Public Accounting Firm47 Consolidated Balance Sheets as of December 31, 2012 and 201148 Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 201049 Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011 and 201049 Consolidated Statements of Stockholders’ Equity and Accumulated Other Comprehensive Income (Loss) for the years endedDecember 31, 2012, 2011 and 201051 Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 201052 Notes to Consolidated Financial Statements53 (a)2.Financial Statement Schedules None. 3.Exhibits 43Table of ContentsExhibit No. Description Filed withthis Form10-K Incorporated by Reference Form Filing Date Exhibit No.3.1 Amended and Restated Certificate of Incorporation, as amended 10-Q August 6,2010 3.13.2 Amended, Restated and Corrected Bylaws of KVH Industries,Inc. 8-K July 31, 2007 34.1 Specimen certificate for the common stock S-1/A March 22,1996 4.1*10.1 Amended and Restated 1996 Incentive and Nonqualified StockOption Plan 8-K July 31, 2007 10.3*10.2 Amended and Restated 1996 Employee Stock Purchase Plan 8-K June 2, 2010 10.2*10.3 Second Amended and Restated 2003 Incentive and NonqualifiedStock Option Plan 10-Q May 6, 2009 10.21*10.4 Third Amended and Restated 2006 Stock Incentive Plan 8-K June 2, 2010 10.1*10.5 Form of Nonqualified Stock Option agreement granted under theSecond Amended and Restated 2003 Incentive and NonqualifiedStock Option Plan 10-K March 15,2005 10.14*10.6 Form of Incentive Stock Option agreement granted under theSecond Amended and Restated 2003 Incentive and NonqualifiedStock Option Plan 10-K March 15,2005 10.15*10.7 Form of Incentive Stock Option agreement granted under theThird Amended and Restated 2006 Stock Incentive Plan 8-K August 28,2006 10.1*10.8 Form of Non-Statutory Stock Option agreement granted underthe Third Amended and Restated 2006 Stock Incentive Plan 8-K August 28,2006 10.2*10.9 Form of Restricted Stock Agreement granted under the ThirdAmended and Restated 2006 Stock Incentive Plan 8-K August 16,2007 10.1*10.10 Policy Regarding Automatic Grants to Non-Employee Directors 10-Q May 6, 2009 10.2310.11 Amended and Restated Credit and Security Agreement datedJuly 17, 2003 with Fleet Capital Corporation 8-K July 18, 2003 99.110.12 Assignment and Assumption and Amendment and NoteModification Agreement, dated July 17, 2006 by and amongKVH Industries, Inc., Banc of America Leasing & Capital,LLC (successor-by-merger to Fleet Capital Corporation)(“assignor”), and Bank of America, N.A. (successor-by-mergerto Fleet National Bank) (“assignee”) 8-K July 20, 2006 10.110.13 Second Amendment and Note Modification Agreement, datedDecember 28, 2006 by and among KVH Industries, Inc., andBank of America, N.A. 8-K January 3,2007 10.144Table of ContentsExhibit No.Description Filed withthis Form10-K Incorporated by Reference Form Filing Date Exhibit No.10.14Third Amendment and Note Modification Agreement, dated August20, 2007 by and among KVH Industries, Inc., and Bank ofAmerica, N.A. 10-K March 8,2010 10.15Fourth Amendment and Note Modification Agreement, datedDecember 31, 2008 by and among KVH Industries, Inc., andBank of America, N.A. 8-K January 2,2009 10.110.16Fifth Amendment and Note Modification Agreement, dated June 9,2011 by and between KVH Industries, Inc. and Bank of America,N.A. 8-K June 14,2011 10.110.17Sixth Amendment, dated March 1, 2012 by and between KVHIndustries, Inc. and Bank of America, N.A. 8-K March 6,2012 10.110.18Seventh Amendment, dated September 17, 2012 by and betweenKVH Industries, Inc. and Bank of America, N.A. 8-K September 19,2012 10.110.19Loan Agreement dated April 6, 2009 by and among KVHIndustries, Inc., and Bank of America, N.A. 8-K April 8,2009 10.110.20Second Amendment, dated June 9, 2011 by and between KVHIndustries, Inc. and Bank of America, N.A., amending the LoanAgreement, dated April 6, 2009, as amended 8-K June 14,2011 10.221.1List of Subsidiaries X 23.1Consent of KPMG LLP X 31.1Rule 13a-14(a)/15d-14(a) certification of principal executive officer X 31.2Rule 13a-14(a)/15d-14(a) certification of principal financial officer X 32.1Rule 1350 certification X **101.1Interactive Data File regarding (a) our Consolidated Balance Sheetsas of December 31, 2012 and 2011, (b) our ConsolidatedStatements of Operations for the years ended December 31, 2012,2011 and 2010, (c) our Consolidated Statements of ComprehensiveIncome for the years ended December 31, 2012, 2011 and 2010, (d)our Consolidated Statements of Stockholders' Equity andAccumulated Other Comprehensive Income (Loss) for the yearsended December 31, 2012, 2011 and 2010, (e) our ConsolidatedStatements of Cash Flows for the years ended December 31, 2012,2011 and 2010 and (e) the Notes to such Consolidated FinancialStatements X *Management contract or compensatory plan.**Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files included as Exhibit 101.1 hereto are deemed not filed or part of a registrationstatement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 ofthe Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections45Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized. KVH Industries, Inc. Date: April 2, 2013By:/S/ MARTIN A. KITS VAN HEYNINGEN Martin A. Kits van HeyningenPresident, Chief Executive Officer and Chairman of the BoardPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and onthe dates indicated.Name Title Date /S/ MARTIN A. KITS VAN HEYNINGEN President, Chief Executive Officer and Chairman of the Board (PrincipalExecutive Officer) April 2, 2013Martin A. Kits van Heyningen /S/ PETER RENDALL Chief Financial Officer (Principal Financial and Accounting Officer) April 2, 2013Peter Rendall /S/ ROBERT W.B. KITS VAN HEYNINGEN Director April 2, 2013Robert W.B. Kits van Heyningen /S/ MARK S. AIN Director April 2, 2013Mark S. Ain /S/ STANLEY K. HONEY Director April 2, 2013Stanley K. Honey /S/ BRUCE J. RYAN Director April 2, 2013Bruce J. Ryan /S/ CHARLES R. TRIMBLE Director April 2, 2013Charles R. Trimble 46Table of ContentsReport of Independent Registered Public Accounting FirmThe Board of Directors and StockholdersKVH Industries, Inc.:We have audited the accompanying consolidated balance sheets of KVH Industries, Inc. and subsidiaries (the “Company”) as of December 31, 2012and 2011, and the related consolidated statements of operations, comprehensive income, stockholders' equity and accumulated other comprehensive income(loss), and cash flows for each of the years in the three-year period ended December 31, 2012. These consolidated financial statements are the responsibility ofthe Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as ofDecember 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2012, inconformity with U.S. generally accepted accounting principles.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internalcontrol over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 2, 2013 expressed an adverse opinion on the effectiveness ofthe Company's internal control over financial reporting./s/ KPMG LLPProvidence, Rhode IslandApril 2, 201347Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS December 31, 2012 2011ASSETS Current assets: Cash and cash equivalents$8,978,156 $7,017,198Marketable securities29,306,444 23,553,203Accounts receivable, net of allowance for doubtful accounts of $929,294 as of December 31, 2012 and $622,687as of December 31, 201127,654,094 25,958,516Inventories16,203,380 18,614,726Prepaid expenses and other assets3,264,175 2,552,146Deferred income taxes1,145,600 1,281,327Total current assets86,551,849 78,977,116Property and equipment, less accumulated depreciation of $31,657,385 as of December 31, 2012 and $27,508,397 asof December 31, 201136,733,118 34,009,872Intangible assets, less accumulated amortization of $825,639 as of December 31, 2012 and $434,318 as ofDecember 31, 20111,683,676 1,902,771Goodwill4,711,942 4,425,711Other non-current assets4,363,531 3,834,752Deferred income taxes3,523,691 5,405,492Total assets$137,567,807 $128,555,714LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable$7,086,552 $6,140,589Accrued compensation and employee-related expenses6,785,234 4,284,837Accrued other4,594,730 5,026,159Accrued product warranty costs813,802 933,184Deferred revenue1,891,792 2,683,982Current portion of long-term debt138,239 130,857Total current liabilities21,310,349 19,199,608Other long-term liabilities139,411 135,166Line of credit7,000,000 9,000,000Long-term debt, excluding current portion3,414,440 3,552,679Total liabilities31,864,200 31,887,453Commitments and contingencies (notes 1, 5, 6 and 16) 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, 16,563,836 and 16,207,268 shares issued;14,904,845 and 14,548,277 shares outstanding at December 31, 2012 and December 31, 2011, respectively165,726 162,160Additional paid-in capital111,513,635 106,592,491Accumulated earnings7,307,480 3,726,865Accumulated other comprehensive loss(132,988) (663,009) 118,853,853 109,818,507Less: treasury stock at cost, common stock, 1,658,991 shares as of December 31, 2012 and December 31, 2011,respectively(13,150,246) (13,150,246)Total stockholders’ equity105,703,607 96,668,261Total liabilities and stockholders’ equity$137,567,807 $128,555,714See accompanying Notes to Consolidated Financial Statements.48Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2012 2011 2010Sales: Product$90,677,292 $85,135,618 $92,058,745Service46,434,918 27,400,246 20,184,049Net sales137,112,210 112,535,864 112,242,794Costs and expenses: Costs of product sales51,774,588 46,598,595 51,347,555Costs of service sales30,362,866 20,969,805 16,086,394Research and development12,147,998 11,548,247 10,714,889Sales, marketing and support24,069,079 23,472,521 18,470,019General and administrative12,187,794 10,555,026 10,083,851Total costs and expenses130,542,325 113,144,194 106,702,708Income (loss) from operations6,569,885 (608,330) 5,540,086Interest income510,471 296,953 301,352Interest expense323,431 223,061 204,076Other income86,247 909,619 23,448Income before income tax (expense) benefit6,843,172 375,181 5,660,810Income tax (expense) benefit(3,262,557) 484,468 2,612,402Net income$3,580,615 $859,649 $8,273,212Per share information: Net income per share, basic$0.24 $0.06 $0.57Net income per share, diluted$0.24 $0.06 $0.56Number of shares used in per share calculation: Basic14,777,175 14,767,606 14,419,599Diluted15,018,951 15,072,342 14,850,325See accompanying Notes to Consolidated Financial Statements.49Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, 2012 2011 2010Net income$3,580,615 $859,649 $8,273,212Other comprehensive income (loss), net of tax: Unrealized loss on marketable securities(1,303) (1) (47,141)Currency translation adjustment562,568 (415,447) 260,256Unrealized loss on interest rate swaps(31,244) (267,378) (242,880)Other comprehensive income (loss), net of tax530,021 (682,826) (29,765)Total comprehensive income$4,110,636 $176,823 $8,243,447See accompanying Notes to Consolidated Financial Statements.50Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY ANDACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Common Stock AdditionalPaid-inCapital Accumulated(Deficit)Earnings AccumulatedOtherComprehensiveIncome (Loss) TreasuryStock TotalStockholders’Equity Shares Amount Balance at December 31, 200914,154,278 $153,644 $96,274,199 $(5,405,996) $49,582 $(9,471,119) $81,600,310Comprehensive income: Net loss— — — 8,273,212 — — 8,273,212Currency translationadjustment 260,256 260,256Unrealized loss on interest rateswaps (242,880) (242,880)Unrealized loss on marketablesecurities— — — — (47,141) — (47,141)Comprehensive income— — — — — — 8,243,447Stock-based compensation— — 2,522,737 — — — 2,522,737Registration fees— — (6,962) — — — (6,962)Tax benefit from exercise of stockoptions 478,947 478,947Common stock issued under benefitplan21,654 217 259,767 — — — 259,984Acquisition of treasury stock— — — — — — —Payment of restricted stockwithholdings(37,726) (377) (480,409) — — — (480,786)Exercise of stock options, vesting ofrestricted stock awards550,553 5,505 3,679,482 — — — 3,684,987Balance at December 31, 201014,688,759 $158,989 $102,727,761 $2,867,216 $19,817 $(9,471,119) $96,302,664Comprehensive income: Net income— — — 859,649 — — 859,649Currency translationadjustment— — — — (415,447) — (415,447)Unrealized loss on interest rateswaps— — — — (267,378) — (267,378)Unrealized loss on marketablesecurities— — — — (1) — (1)Comprehensive income— — — — — — 176,823Stock-based compensation— — 3,541,501 — — — 3,541,501Registration fees— — (10,000) — — — (10,000)Tax benefit from exercise of stockoptions— — 19,396 — — — 19,396Common stock issued under benefitplan38,718 387 288,790 — — — 289,177Acquisition of treasury stock(457,667) (3,679,127) (3,679,127)Payment of restricted stockwithholdings(46,444) (465) (624,068) — — — (624,533)Exercise of stock options, vesting ofrestricted stock awards324,911 3,249 649,111 — — — 652,360Balance at December 31, 201114,548,277 $162,160 $106,592,491 $3,726,865 $(663,009) $(13,150,246) $96,668,261Comprehensive income: Net income— — — 3,580,615 — — 3,580,615Currency translationadjustment— — — — 562,568 — 562,568Unrealized loss on interest rateswaps— — — — (31,244) — (31,244)Unrealized loss on marketablesecurities— — — — (1,303) — (1,303)Comprehensive income— — — — — — 4,110,636Stock-based compensation— — 3,679,248 — — — 3,679,248Tax benefit from exercise of stockoptions— — 619,138 — — — 619,138Common stock issued under benefitplan27,308 273 270,225 — — — 270,498Payment of restricted stockwithholdings(34,929) (349) (332,361) — — — (332,710)Exercise of stock options, vesting ofExercise of stock options, vesting ofrestricted stock awards364,189 3,642 684,894 — — — 688,536Balance at December 31, 201214,904,845 $165,726 $111,513,635 $7,307,480 $(132,988) $(13,150,246) $105,703,607See accompanying Notes to Consolidated Financial Statements.51Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2012 2011 2010Cash flows from operating activities: Net income$3,580,615 $859,649 $8,273,212Adjustments to reconcile net income to net cash provided by operating activities: Provision for doubtful accounts535,617 275,526 280,578Depreciation and amortization4,609,654 4,374,169 3,845,016Deferred income taxes2,046,278 (737,496) (3,133,858)Loss on interest rate swaps128,102 132,589 102,572Compensation expense related to stock-based awards and employee stock purchase plan3,679,248 3,532,909 2,523,799Changes in operating assets and liabilities: Accounts receivable(2,230,743) (7,438,392) (2,660,238)Inventories2,420,196 (3,850,824) (1,215,185)Prepaid expenses and other assets(716,697) 164,089 (1,078,556)Other non-current assets(557,820) 2,028,341 645,674Accounts payable942,852 2,223,153 178,539Deferred revenue(785,415) 1,683,950 (43,713)Accrued expenses1,400,873 (253,089) 1,499,612Other long-term liabilities4,245 (1,127,359) 360,411Net cash provided by operating activities$15,057,005 $1,867,215 $9,577,863Cash flows from investing activities: Capital expenditures(6,504,094) (14,064,106) (11,010,756)Net cash paid for business acquired— — (6,365,518)Purchases of marketable securities(21,944,408) (49,541,143) (87,886,677)Maturities and sales of marketable securities16,189,864 56,053,571 93,207,446Net cash used in investing activities$(12,258,638) $(7,551,678) $(12,055,505)Cash flows from financing activities: Repayments of long-term debt(130,857) (123,870) (117,256)Proceeds from stock options exercised and employee stock purchase plan1,578,172 941,537 4,423,918Repurchase of common stock— (3,679,127) —Payment of employee restricted stock withholdings(332,710) (624,533) (480,786)Repayments of line of credit borrowings(2,000,000) — —Proceeds from line of credit borrowings— 9,000,000 —Payment of stock registration fee— (10,000) (6,962)Net cash (used in) provided by financing activities(885,395) 5,504,007 3,818,914Effect of exchange rate changes on cash and cash equivalents47,986 (43,534) 29,145Net increase (decrease) in cash and cash equivalents1,960,958 (223,990) 1,370,417Cash and cash equivalents at beginning of period7,017,198 7,241,188 5,870,771Cash and cash equivalents at end of period$8,978,156 $7,017,198 $7,241,188Supplemental disclosure of cash flow information: Cash paid for interest$200,624 $267,281 $189,931Cash paid for income taxes$322,856 $57,968 $881,025Supplemental disclosure of noncash investing activity: Changes in accrued liabilities related to fixed asset additions$435,000 $944,649 $—See accompanying Notes to Consolidated Financial Statements.52Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2012, 2011 and 2010(in thousands except share and per share amounts) (1)Summary of Significant Accounting Policies(a)Description of BusinessKVH Industries, Inc. (the Company or KVH) designs, develops, manufactures and markets mobile communications products for the marine, landmobile and aeronautical markets, and navigation, guidance and stabilization products for both the defense and commercial markets.KVH’s mobile communications products enable customers to receive voice and Internet services, and live digital television via satellite services inmarine vessels, recreational vehicles and automobiles as well as live digital television on commercial airplanes while in motion. KVH’s CommBox offers arange of tools designed to increase communication efficiency, reduce costs, and manage network operations. KVH sells its mobile communications productsthrough an extensive international network of retailers, distributors and dealers. KVH also leases products directly to end users.KVH offers precision fiber optic gyro-based (FOG) systems that enable platform and optical stabilization, navigation, pointing and guidance. KVH’sguidance and stabilization products also include tactical navigation systems that provide uninterrupted access to navigation and pointing information in avariety of military vehicles, including tactical trucks and light armored vehicles. KVH’s guidance and stabilization products are sold directly to U.S. andallied governments and government contractors, as well as through an international network of authorized independent sales representatives. In addition,KVH’s guidance and stabilization products have numerous commercial applications such as precision mapping, dynamic surveying, autonomous vehicles,train location control and track geometry measurement systems, industrial robotics and optical stabilization.KVH’s mobile communications service sales include sales earned from satellite voice and Internet airtime services, engineering services provided underdevelopment contracts, sales from product repairs, certain DIRECTV account subsidies and referral fees earned in conjunction with the sale of its productsand extended warranty sales. KVH provides, for monthly fixed and usage fees, satellite connectivity sales from broadband Internet, data and Voice overInternet Protocol (VoIP) service to its TracPhone V7 customers. KVH also earns monthly usage fees for third-party satellite connectivity for voice, data andInternet services to its Inmarsat TracPhone customers who choose to activate their subscriptions with KVH. Under current DIRECTV programs, KVH iseligible to receive a one-time commission for each DIRECTV receiver activated for service and a new mobile account activation fee from DIRECTV for eachcustomer who activates their DIRECTV service directly through KVH.KVH’s guidance and stabilization service sales include product repairs, engineering services provided under development contracts and extendedwarranty sales.(b)Principles of ConsolidationThe accompanying consolidated financial statements of KVH Industries, Inc. and its wholly-owned subsidiaries, KVH Industries A/S, KVHIndustries Pte. Ltd., KVH Industries Brasil Comunicacao Por Satelite Ltda., KVH Industries Japan Co. Ltd., and KVH Industries Norway A/S (collectively,KVH or the Company), have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company hasevaluated all subsequent events through the date of this filing. Given that KVH Industries A/S, KVH Industries Pte. Ltd., KVH Industries Japan Co. Ltd.,and KVH Industries Brasil Comunicacao Por Satelite Ltda. operate as the Company’s European, Singaporean, Japanese and Brazilian internationaldistributors, all of their operating expenses are reflected within sales, marketing and support within the accompanying consolidated statements of operations.KVH Industries Norway A/S, a subsidiary of KVH Industries A/S that was purchased in September 2010, develops and distributes middleware softwaresolutions known as CommBox technology, which is included in the Company’s satellite communications products and services. All significant intercompanyaccounts and transactions have been eliminated in consolidation.(c)Significant Estimates and AssumptionsThe preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities asof the date of the financial statements and the reported amounts of sales and53Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)expenses during the reporting periods. Significant estimates and assumptions by management affect the Company’s revenue recognition, valuation of accountsreceivable, valuation of inventory, assumptions used to determine fair value of goodwill and intangible assets, deferred tax assets and related valuationallowance, stock-based compensation, warranty and accounting for contingencies.Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recordedin the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to bereasonable under the circumstances.The Company has accounted for its $35,600 contract received in June 2012 from SANG to purchase TACNAV products and services under ASC605-25, Multiple-Element Arrangements. See section (e) of this note for estimates and assumptions related to multiple-element-arrangements and completedcontract sales accounting.The total contract value associated with TACNAV products is $21,200 for which shipments are estimated to continue through the first half of 2013.Revenue is recognized for these product sales after transfer of title and risk of loss after inspection occurs. The total contract value associated with all servicesis $14,400 which are estimated to continue through 2014. The revenue for these services is recognized using the percentage of completion accounting method.The Company limits the amount of revenue recognized for delivered elements to the amount that is not contingent on the future delivery of products or services,future performance obligations, or subject to customer-specific return or refund privileges. Total revenue recognized on the SANG contract in 2012 wasapproximately $15,200.(d)Concentration of Credit Risk and Single Source SuppliersCash, cash equivalents and marketable securities. The Company is potentially subject to financial instrument concentration of credit risk through itscash, cash equivalent and marketable securities investments. To mitigate these risks the Company maintains cash, cash equivalents and marketable securitieswith reputable and nationally recognized financial institutions. As of December 31, 2012, $29,306 classified as marketable securities was held by WellsFargo and substantially all of the cash and cash equivalents were held by Bank of America, N.A. See note 2 for a description of marketable securities.Trade accounts receivable. Concentrations of risk (see note 11) with respect to trade accounts receivable are generally limited due to the large numberof customers and their dispersion across several geographic areas. Although the Company does not foresee credit risk associated with these receivables todeviate from historical experience, repayment is dependent upon the financial stability of those individual customers. The Company establishes allowances forpotential bad debts and evaluates, on a monthly basis, the adequacy of those reserves based upon historical experience and its expectations for futurecollectability concerns. Activity within the Company’s allowance for doubtful accounts for the periods presented is as follows: 2012 2011 2010Beginning balance$623 $592 $844Additions charged to expense536 276 281Deductions (write-offs/recoveries) from reserve(230) (245) (533)Ending balance$929 $623 $592Certain 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 theCompany’s revenues and operating results.(e)Revenue RecognitionProduct sales. Product sales are recognized when persuasive evidence of an arrangement exists, goods are shipped, title has passed and collectability isreasonably assured. The Company’s standard sales terms require that:•All sales are final;•Terms are generally Net 30;•Shipments are tendered and shipped FOB (or as may be applicable, FCA, or EXW) the Company’s plant or warehouse; and54Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)•Title and risk of loss or damage passes to the dealer or distributor at the point of shipment when delivery is made to the possession of the carrier.For certain guidance and stabilization product sales, customer acceptance or inspection may be required before title and risk of loss transfers. For thosesales, revenue is recognized after transfer of title and risk of loss and after notification of customer acceptance.Under certain limited conditions, the Company, at its sole discretion, provides for the return of goods. No product is accepted for return and no creditis allowed on any returned product unless the Company has granted and confirmed prior written permission by means of appropriate authorization. TheCompany establishes reserves for potential sales returns, credits, and allowances, and evaluates, on a monthly basis, the adequacy of those reserves basedupon historical experience and expectations for the future.Multiple-element revenue arrangements. Some of our sales involve multiple-element arrangements that include both hardware-related products andcontracted service, or satellite connectivity that are accounted under ASC 605-25, Multiple-Element Arrangements.Multiple elements, arrangement consideration is allocated to each element based on the relative selling prices of all of the elements in the arrangementusing the fair value hierarchy as required by “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements,” (Accounting Standards Update“ASU” 2009-13). The Company adopted the provisions of ASU 2009-13 as of January 1, 2010. ASU 2009-13 requires the Company establish VSOE of fairvalue based upon the price charged when the same element is sold separately or established by management having the relevant pricing authority. When VSOEexists it is used to determine the selling price of a deliverable. When VSOE is not established, the Company attempts to establish the selling price of eachelement based on TPE. When the Company is unable to establish selling price using VSOE or TPE, the Company uses BESP in the allocation of arrangementconsideration for the relevant deliverables. The objective of BESP is to determine the price at which the Company would transact a sale if a product or servicewas sold on a stand-alone basis. The Company determines BESP for our products and certain services by considering multiple factors including, but notlimited to, overall market conditions, including geographic or regional-specific market factors and profit objectives for such deliverables.Each deliverable within the Company's multiple-deliverable revenue arrangements is accounted for as a separate unit of accounting under the guidance ofASU 2009-13 if both of the following criteria are met: the delivered item or items have value to the customer on a standalone basis; and for an arrangement thatincludes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially inthe control of the Company. The Company considers a deliverable to have standalone value if the item is sold separately by the Company or another vendor orif the item could be resold by the customer. Further, the Company's revenue arrangements generally do not include a general right of return relative to deliveredproducts.Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriateallocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting.Satellite connectivity sales. Directly sold and re-sold satellite connectivity service for voice, data and Internet is recognized monthly based uponminutes or megabytes of traffic processed or contracted fixed fee schedules. Typically subscribers enter into a contracted one year minimum service agreement.The Company records all satellite connectivity service sales to subscribers as gross sales, as the Company is the primary obligor in the contracted servicearrangement. All associated regulatory service fees and costs are recorded net in the consolidated financial statements. The accounting estimates related to therecognition of satellite connectivity service sales in the results of operations require the Company to make assumptions about future billing adjustments fordisputes with subscribers as well as unauthorized usage.Lease financing. Lease financing consists of sales-type leases primarily of the TracPhone V7. The Company records the leases at a price typicallyequivalent to normal selling price and in excess of the cost or carrying amount. Upon delivery, the Company records the present value of all payments underthese leases as revenues, and the related costs of the product are charged to cost of sales. Interest income is recognized throughout the lease term (typically 3years) using an implicit interest rate. Through December 31, 2012, lease sales have not been a significant portion of the Company’s total sales.Contracted service sales. The Company engages in contracts for development, production and services activities which it accounts for consistent withFASB ASC 605-35, Accounting for Performance of Construction-Type and Certain Production-55Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)Type Contracts, and other relevant revenue recognition accounting literature. The Company considers the nature of these contracts and the types of productsand services provided when determining the proper accounting for a particular contract. Customer and government-agency contracted engineering service andgrant sales under development contracts are recognized primarily under the percentage of completion method during the period in which the Company performsthe service or development efforts in accordance with the agreement. Services performed under these types of contracts include engineering studies, surveys,building construction, prototype development and program management. Performance is determined principally by comparing the accumulated costs incurredto date with management’s estimate of the total cost to complete the contracted work. The Company establishes billing terms at the time project deliverables andmilestones are agreed. Revenues recognized in excess of the amounts invoiced to clients are classified within the accompanying consolidated balance sheets inthe caption “prepaid expenses and other assets.”Sales related to customer contracts that call for standard product modification or enhancement are recognized upon the complete delivery and titletransfer of all customer-approved products. Costs of contracts in progress are accumulated within the accompanying consolidated balance sheets in the caption“prepaid expenses and other assets” and relieved upon product delivery or when billed.The use of contract accounting requires significant judgment relative to estimating total contract revenues and costs, including assumptions relative tothe length of time to complete the contract, the nature and complexity of the work to be performed, and prices for subcontractor services and materials. Therisk to the Company on a fixed-price contract is that if estimates to complete the contract change from one period to the next, profit levels will vary from periodto period. The Company's estimates are based upon the professional knowledge and experience of its engineers, program managers and other personnel, whoreview each long-term contract monthly to assess the contract's schedule, performance, technical matters and estimated cost at completion. Changes inestimates are applied when adjustments in estimated contract costs are identified, such revisions may result in current period adjustments to earningsapplicable to performance in prior periods. Any advance payments arising from such extended-term development contracts are recorded as deposits. If, in anyperiod, estimated total costs under a contract indicate an expected loss, then such loss is provided for in that period. Through December 31, 2012, contractedservice revenue has not been a significant portion of the Company’s total sales.Product service sales. Product service sales other than under development contracts are recognized when completed services are provided to thecustomer and collectability is reasonably assured. The Company establishes reserves for potential sales returns, credit and allowances, and evaluates, on amonthly basis, the adequacy of those reserves based upon historical experience and its expectations for the future. Through December 31, 2012, productservice sales have not been a significant portion of the Company’s total sales.DIRECTV subsidies and commissions. One-time subsidies and new mobile account activation fees from DIRECTV for customers who activate theirDIRECTV service directly through KVH are recognized in the month of activation. The Company establishes reserves for potential credits for early customercancellations, on a quarterly basis. The adequacy of those reserves is based upon historical experience. Through December 31, 2012, such payments fromDIRECTV have not been a significant portion of the Company’s total sales.Extended warranty sales. The Company sells extended warranty contracts on mobile communications and guidance and stabilization products. Salesunder these contracts are recognized ratably over the contract term. Through December 31, 2012, warranty sales have not been a significant portion of theCompany’s total sales.(f)Fair Value of Financial InstrumentsThe carrying amounts of the Company’s financial instruments, which include cash equivalents, investments, accounts receivable, accounts payableand accrued expenses approximate their fair values due to the short maturity of these instruments. The carrying amount of the Company’s mortgage loanapproximates fair value based on currently available quoted rates of similarly structured mortgage facilities. See note 2 for more information on the fair valueof the Company’s marketable securities.(g)Cash, Cash Equivalents and Marketable SecuritiesIn accordance with the Company’s investment policy, cash in excess of operational needs is invested in money market mutual funds, governmentagency bonds, United States treasuries, corporate notes, and certificates of deposit, which are reflected within marketable securities in the accompanyingconsolidated balance sheets. The Company determines the56Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)appropriate classification of marketable securities at each balance sheet date. As of December 31, 2012 and 2011, all of the Company’s marketable securitieshave been designated as available-for-sale and are carried at their fair value with unrealized gains and losses included in accumulated other comprehensive(loss) income in the accompanying consolidated balance sheets.The Company reviews investments in debt securities for other than temporary impairment whenever the fair value of an investment is less thanamortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. To determine whether animpairment is other-than-temporary, the Company considers whether it intends to sell the security, whether it expects to recover the credit loss, and if it is morelikely than not that the Company will be required to sell the security prior to recovery. Evidence considered in this assessment includes the reasons for theimpairment, compliance with the Company’s investment policy, the severity and duration of the impairment, changes in value subsequent to year-end andforecasted performance of the investee. The Company has reviewed its securities with unrealized losses as of December 31, 2012 and 2011, and hasconcluded that no other-than-temporary impairments exist.(h)InventoriesInventories are stated at the lower of cost or market using the first-in first-out costing method. The Company provides inventory reserves based onexcess and obsolete inventory determined primarily by future demand forecasts. The Company records inventory charges to costs of product sales.(i)Property and EquipmentProperty and equipment are stated at cost. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of therespective assets. The principal lives used in determining the depreciation rates of various assets are: buildings and improvements, 5-40 years; machinery,satellite hubs and equipment, 5-10 years; office and computer equipment, 3-7 years; and motor vehicles, 5 years.(j)Goodwill and Long-lived AssetsAll of the Company’s goodwill and intangible assets are associated with the purchase of Virtek Communication in September 2010.Goodwill is recorded when the consideration for an acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired. Goodwillis not amortized, but instead is tested for impairment at least annually, or if indicators of potential impairment exist by comparing the fair value of theCompany’s reporting unit to its carrying value. The Company estimates the fair value of the Virtek Communication reporting unit using a discounted cashflow model or other valuation models, such as comparative transactions and market multiples. The Company performed its annual impairment test as ofAugust 31, 2012 and noted no indicators of potential goodwill impairment.Intangible assets are comprised of intellectual property, which is amortized over its estimated useful life of seven years. Intangible assets are reviewedfor impairment when events or changes in circumstances indicate that their carrying amounts may not be recoverable based upon the estimated undiscountedcash flows. No events or changes in circumstances indicated that any of the carrying amounts of the Company’s intangible assets may not be recoverableduring 2012.Intangible assets with estimated lives and other long-lived assets are reviewed for impairment when events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability of intangible assets with estimated lives and other long-lived assets is measured by acomparison of the carrying amount of an asset or asset group to future net undiscounted cash flows expected to be generated by the asset or asset group. If thesecomparisons indicate that an asset is not recoverable, the Company will recognize an impairment loss for the amount by which the carrying value of the assetor asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future operating cash flows or appraised values,depending on the nature of the asset. See note 9 for further discussion of goodwill and intangible assets.(k)Other Non-Current AssetsOther non-current assets are primarily comprised of long-term lease receivables, prepaid expenses, and deposits.57Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)(l)Product WarrantyThe Company’s products carry limited warranties that range from one to four years and vary by product. The warranty period begins on the date ofretail purchase or lease by the original purchaser. The Company accrues estimated product warranty costs at the time of sale and any additional amounts arerecorded when such costs are probable and can be reasonably estimated. Factors that affect the Company’s warranty liability include the number of units soldor leased, historical and anticipated rates of warranty repairs and the cost per repair. Warranty and related costs are reflected within sales, marketing andsupport in the accompanying statements of operations. As of December 31, 2012 and 2011, the Company had accrued product warranty costs of $814 and$933, respectively. The following table summarizes product warranty activity during 2012 and 2011: 2012 2011Beginning balance$933 $887Charges to expense419 772Costs incurred(538) (726)Ending balance$814 $933(m)Shipping and Handling CostsShipping and handling costs are expensed as incurred and included in cost of sales. Billings for shipping and handling are reflected within net sales inthe accompanying statements of operations.(n)Research and DevelopmentExpenditures for research and development, including customer-funded research and development, are expensed as incurred. Revenue and relateddevelopment costs from customer-funded research and development are as follows: Year Ended December 31, 2012 2011 2010Customer-funded product sales$— $— $4,478Customer-funded service sales5,470 1,061 1,062Customer-funded costs included in costs of service sales3,424 412 953Customer-funded costs included in costs of product sales— — 1,001(o)Advertising CostsCosts related to advertising are expensed as incurred. Advertising expense was $2,523, $2,081, and $2,171 for the years ended December 31, 2012, 2011,and 2010, respectively, and is included in sales, marketing, and support expense in the accompanying consolidated statements of operations.(p)Foreign Currency TranslationThe financial statements of the Company’s foreign subsidiaries located in Denmark and Singapore are maintained using the United States dollar as thefunctional currency. Exchange rates in effect on the date of the transaction are used to record monetary assets and liabilities. Revenue and other expenseelements are recorded at rates that approximate the rates in effect on the transaction dates. Realized foreign currency remeasurement gains and losses arerecognized within “other income (expense)” in the accompanying consolidated statements of operations. For the years ended December 31, 2012, 2011, and2010, the Company experienced foreign currency losses of $37, $79 and $22, respectively.The financial statements of the Company’s Brazilian, Norwegian and Japanese subsidiaries use the foreign subsidiaries’ respective local currencies asthe functional currency. The Company translates the assets and liabilities of these foreign subsidiaries at the exchange rates in effect at year-end. Net sales,costs and expenses are translated using average exchange rates in effect during the year. Gains and losses from foreign currency translation are credited orcharged to accumulated other comprehensive (loss) income included in stockholders' equity in the accompanying consolidated balance sheets.58Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)(q)Income TaxesIncome taxes are accounted for under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and theirrespective tax bases.Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the periodthat includes the enactment date. The Company records valuation allowances to reduce deferred income tax assets to the amount that is more likely than not tobe realized. The Company determines whether it is more likely than not that a tax position will be sustained upon examination. If it is not more likely than notthat a position will be sustained, no amount of the benefit attributable to the position is recognized. The tax benefit to be recognized of any tax position thatmeets the more likely than not recognition threshold is calculated as the largest amount that is more than 50% likely of being realized upon resolution of thecontingency. See note 8 for further discussion of income taxes.(r)Net Income per Common ShareBasic net income per share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net income pershare incorporates the dilutive effect of common stock equivalent options, warrants and other convertible securities, if any, as determined in accordance withthe treasury stock accounting method. Common stock equivalents related to options and restricted stock awards for 861,823, 597,463, and 196,076 sharesof common stock for the years ended December 31, 2012, 2011, and 2010 respectively, have been excluded from the fully diluted calculation of net income pershare, as inclusion would be anti-dilutive.A reconciliation of the basic and diluted weighted average common shares outstanding is as follows: 2012 2011 2010Weighted average common shares outstanding—basic14,777,175 14,767,606 14,419,599Dilutive common shares issuable in connection with stock plans241,776 304,736 430,726Weighted average common shares outstanding—diluted15,018,951 15,072,342 14,850,325(s)Contingent LiabilitiesThe Company estimates the amount of potential exposure it may have with respect to claims, assessments and litigation in accordance with ASC 450,Contingencies. The Company is not 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, as described in note 16. It is not always possible to predict the outcome of litigation, as it is subject tomany uncertainties. Additionally, it is not always possible for management to make a meaningful estimate of the potential loss or range of loss associated withsuch litigation. As of December 31, 2012, no losses have been accrued with respect to pending litigation.(t)Operating SegmentsThe Company operates in a single segment. Operating segments are identified as components of an enterprise about which separate discrete financialinformation is available for evaluation by the chief operating decision maker in making decisions regarding resource allocation and assessing performance. Todate, the chief operating decision maker has made such decisions and assessed performance at the company level, as one segment. The Company’s chiefoperating decision maker is its President, Chief Executive Officer and Chairman of the Board.(u)Recent Accounting Pronouncements Adopted During the Year Ended December 31, 2012In May 2011, the Financial Accounting Standards Board, or FASB issued Accounting Standards Update 2011-04, “Fair Value Measurement (Topic820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”, which amended ASC 820, “FairValue Measurements and Disclosures.” This guidance addresses efforts to achieve convergence between U.S. GAAP and International Financial ReportingStandards (IFRS) requirements for measurement of and disclosures about fair value. The amendments are not expected to have a significant impact oncompanies applying U.S. GAAP. Key provisions of the amendment include: a prohibition on grouping financial instruments for purposes59Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; an extension of theprohibition against the use of a blockage factor to all fair value measurements (that prohibition currently applies only to financial instruments with quotedprices in active markets); and a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservableinputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fairvalue but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair valuemeasurement disclosed. This guidance is effective for the Company in its interim and annual reporting periods beginning after December 15, 2011. Adoptionof this guidance did not have a significant impact on the determination or reporting of the Company's financial results.In June 2011, the FASB issued Accounting Standards Update 2011-05, “Comprehensive Income (ASC Topic 220): Presentation of ComprehensiveIncome,” (ASU 2011-05) which amends current comprehensive income guidance. This accounting update eliminates the option to present the components ofother comprehensive income as part of the statement of shareholders’ equity. Instead, the Company must report comprehensive income in either a singlecontinuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutivestatements. ASU 2011-05 is effective for public companies during the interim and annual periods beginning after December 15, 2011 with early adoptionpermitted. The adoption of ASU 2011-05 did not have an impact on the Company’s consolidated financial position, results of operations or cash flows as itonly requires a change in the format of the current presentation.In September 2011, the FASB issued Accounting Standards Update 2011-08, “Intangibles—Goodwill and Other (Topic 350): Testing for GoodwillImpairment,” (ASU 2011-8). ASU 2011-8 gives companies the option to perform a qualitative assessment to determine whether it is more likely than not (alikelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, and in some cases, skip the two-step impairment test. Theobjective of the revised standard is to simplify how an entity tests goodwill for impairment and to reduce the cost and complexity of the annual goodwillimpairment test. ASU 2011-8 is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of ASU 2011-8 didnot have a significant impact on the determination or reporting of the Company's financial results.In December 2011, the FASB issued Accounting Standards Update No. 2011-12, "Deferral of the Effective Date for Amendments to the Presentationof Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-5," (ASU 2011-12). ASU 2011-12 defers the provisions of ASU 2011-05 that relate to the presentation of reclassification adjustments. The amendments in this update are effective for fiscalyears beginning after December 15, 2011. The Company adopted the deferral provisions of this pronouncement as of January 1, 2012. The adoption did nothave an impact on the Company's financial position or results of operations.In July 2012, the FASB issued Accounting Standards Update 2012-02, "Testing Indefinite-Lived Intangible Assets for Impairment," which allowsan organization to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test for indefinite-lived intangibleassets. An organization that elects to perform a qualitative assessment no longer is required to calculate the fair value of an indefinite-lived intangible assetunless it determines that it is more likely than not that the asset is impaired. The guidance, which applies to all public, private, and not-for-profitorganizations, is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoptionpermitted. The adoption of this guidance did not have a significant impact on the Company's financial position or results of operations.60Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)(2)Marketable SecuritiesIncluded in marketable securities as of December 31, 2012 and 2011 are the following:December 31, 2012AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses FairValueMoney market mutual funds$9,921 $— $— $9,921Government agency bonds6,816 1 — 6,817United States treasuries6,089 — — 6,089Corporate notes4,682 (3) 4,679Certificates of deposit1,800 — — 1,800Total marketable securities designated as available for sale$29,308 $1 $(3) $29,306 December 31, 2011AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses FairValueMoney market mutual funds$8,818 $— $— $8,818Government agency bonds9,014 1 — 9,015United States treasuries— — — —Corporate notes3,019 — — 3,019Certificates of deposit2,701 — — 2,701Total marketable securities designated as available for sale$23,552 $1 $— $23,553The amortized costs and fair value of debt securities as of December 31, 2012 and 2011 are shown below by effective maturity. Effective maturitiesmay differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.December 31, 2012AmortizedCost FairValueDue in less than one year$22,485 $22,485Due after one year and within two years6,823 6,821 $29,308 $29,306December 31, 2011AmortizedCost FairValueDue in less than one year$15,538 $15,538Due after one year and within two years8,014 8,015 $23,552 $23,553No realized gains or losses were recognized on the Company’s marketable securities during the years ended December 31, 2012 and 2011.61Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)(3)InventoriesInventories as of December 31, 2012 and 2011 include the costs of material, labor, and factory overhead. Inventories consist of the following: December 31, 2012 2011Raw materials$9,173 $11,039Work in process1,789 1,805Finished goods5,241 5,771 $16,203 $18,615(4)Property and EquipmentProperty and equipment, net, as of December 31, 2012 and 2011 consist of the following: December 31, 2012 2011Land$3,827 $3,827Building and improvements21,297 19,815Leasehold improvements286 222Machinery and equipment32,266 27,701Office and computer equipment10,663 9,887Motor vehicles51 66 68,390 61,518Less accumulated depreciation(31,657) (27,508) $36,733 $34,010Depreciation for the years ended December 31, 2012, 2011, and 2010 amounted to $4,216, $4,043, and $3,744, respectively.(5)Debt and Line of CreditOn April 6, 2009, the Company entered into a mortgage loan in the amount of $4,000 related to its headquarters facility in Middletown, Rhode Island.The loan term is ten years, with a principal amortization of twenty years, and the interest rate will be a rate per year adjusted periodically based on a definedinterest period equal to the BBA LIBOR Rate plus 2.25 percentage points. On June 9, 2011, the Company entered into an amendment to the mortgage loan,providing for an adjustment of the interest rate from the BBA LIBOR Rate plus 2.25 percentage points to the BBA LIBOR Rate plus 2.00 points. Land,building and improvements with an approximate carrying value of $4,362 as of December 31, 2012 secure the mortgage loan. The monthly mortgage paymentis approximately $11 plus interest and increases in increments of approximately $1 each year throughout the life of the mortgage. Due to the difference in theterm of the loan and amortization of the principal, a balloon payment of $2,551 is due on April 1, 2019. The loan contains one financial covenant, a FixedCharge Coverage Ratio, which applies in the event that the Company’s consolidated cash, cash equivalents and marketable securities balance falls below$25,000 at any time. As the Company’s consolidated cash, cash equivalents and marketable securities balance was above $25,000 throughout the year endedDecember 31, 2012, the Fixed Charge Coverage Ratio did not apply. Under the mortgage loan, the Company may prepay its outstanding loan balance subjectto certain early termination charges as defined in the mortgage loan agreement. If the Company were to default on its mortgage loan, the land, building andimprovements would be used as collateral.62Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)The following is a summary of future principal payments under the mortgage:Year ending December 31, PrincipalPayment2013 $1382014 1462015 1542016 1632017 172Thereafter 2,780Total outstanding at December 31, 2012 $3,553The Company currently has a revolving loan agreement with a bank that provides for a maximum available credit of $15,000 and will expire onDecember 31, 2014. The Company pays interest on any outstanding amounts at a rate equal to the BBA LIBOR Daily Floating Rate plus 1.25%. The line ofcredit contains two financial covenants, a Liquidity Covenant, which requires the Company to maintain at least $20,000 in unencumbered liquid assets, asdefined in the loan agreement, and a Fixed Charge Coverage Ratio. As of December 31, 2012, the Company was not in default of either covenant. Subject to theterms of the agreement and so long as no event of default has occurred, until September 30, 2013, the Company has the option of converting up to $12,000 ofrevolving loans into one or more term loans at a floating interest rate equal to LIBOR plus 1.75%. The Company may terminate the loan agreement prior to itsfull term without penalty, provided the Company gives 30 days' advance written notice to the bank. As of December 31, 2012, the Company had borrowed$7,000 under the facility, the repayment of which is due no later than the maturity date of December 31, 2014.Total commitment fees related to the line of credit were $27, $49, and $49 for the years ended December 31, 2012, 2011, and 2010, respectively.(6)Commitments and ContingenciesThe Company has certain operating leases for satellite capacity, various equipment, and facilities. The following reflects future minimum paymentsunder operating leases that have initial or remaining non-cancelable lease terms at December 31, 2012:Years ending December 31,OperatingLeases2013$12,620201410,04020155,45420163,17320172,034Thereafter540Total minimum lease payments$33,861Total rent expense incurred under facility operating leases for the years ended December 31, 2012, 2011, and 2010 amounted to $302, $745, and$754, respectively.In the normal course of business, the Company enters into unconditional purchase order obligations with its suppliers for inventory and otheroperational purchases. Outstanding and unconditional purchase order obligations were $21,200 as of December 31, 2012.The Company did not have any off-balance sheet commitments, guarantees, or standby repurchase obligations as of December 31, 2012.63Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)(7)Stockholders’ Equity(a)Employee Stock OptionsOptions are granted with an exercise price equal to the fair market value of the common stock on the date of grant and generally vest in equal annualamounts over four years beginning on the first anniversary of the date of the grant. No options are exercisable for periods of more than 5 years after date ofgrant. Under the Company’s Amended and Restated 2006 Stock Incentive Plan, each share issued under awards other than options will reduce the number ofshares reserved for issuance by two shares. Shares issued under options will reduce the shares reserved for issuance on a share-for-share basis. All plans wereapproved by the Company’s shareholders, pursuant to which 7,165,000 shares of the Company’s common stock were reserved for issuance. As ofDecember 31, 2012, 6,028,661 options and awards to purchase shares of common stock had been issued or expired and 1,136,339 were available for futuregrants. The Compensation Committee of the Board of Directors administers the plans, approves the individuals to whom options will be granted anddetermines the number of shares and exercise price of each option. Outstanding options under the plans at December 31, 2012 expire from January 2013through November 2017. None of the Company’s outstanding options includes performance-based or market-based vesting conditions as of December 31,2012.The Company has estimated the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model. The expectedvolatility assumption is based on the historical daily price data of the Company’s common stock over a period equivalent to the weighted average expected lifeof the Company’s options. The expected term of options granted is derived using assumed exercise rates based on historical exercise patterns and represents theperiod of time the options granted are expected to be outstanding. The risk-free interest rate is based on the actual U.S. Treasury zero-coupon rates for bondsmatching the expected term of the option as of the option grant date. The dividend yield of zero is based upon the fact that the Company has not historicallydeclared or paid cash dividends, and does not expect to declare or pay dividends in the foreseeable future.The per share weighted-average fair values of stock options granted during 2012, 2011 and 2010 were $4.97, $6.36, and $6.54, respectively. Theweighted-average assumptions used to value options as of their grant date were as follows: Year EndedDecember 31, 2012 2011 2010Risk-free interest rate0.69% 1.65% 0.95%Expected volatility64.6% 60.4% 60.0%Expected life (in years)4.22 4.23 4.18Dividend yield0% 0% 0%The changes in outstanding stock options for the year ended December 31, 2012, are as follows: Number of Options Weighted AverageExercise Price Weighted AverageRemainingContractual Life(in Years) Aggregate IntrinsicValueOutstanding at December 31, 2011816,077 $11.28 Granted496,240 9.92 Exercised(80,255) 8.58 Expired, canceled or forfeited(154,264) 10.72 Outstanding at December 31, 20121,077,798 $10.93 3.28 $3,391Exercisable at December 31, 2012290,911 $10.52 1.78 $1,032The total intrinsic value of options exercised was $173, $183, and $1,157 in 2012, 2011 and 2010, respectively. The total aggregate intrinsic value ofoptions outstanding at December 31, 2011 and 2010 was $112 and $1,254, respectively. The total aggregate intrinsic value of options exercisable atDecember 31, 2011 and 2010 was $85 and $851, respectively. As of December 31, 2011 and 2010, the number of options exercisable was 361,994 and 416,710, respectively, and the weighted average exercise priceof those options was $9.36 and $10.06 per share, respectively. The weighted average64Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)remaining contractual term for options exercisable at December 31, 2011 and 2010 was 1.18 and 1.44 years, respectively. The weighted average remainingcontractual term for options outstanding at December 31, 2011 and 2010 was 2.63 and 2.28 years, respectively.As of December 31, 2012, there was $2,913 of total unrecognized compensation expense related to stock options, which is expected to be recognizedover a weighted-average period of 2.83 years. In 2012, 2011 and 2010, the Company recorded compensation charges of $1,130, $709 and $514, respectively,related to stock options. Compensation costs for options subject only to service conditions that vest ratably are recognized on a straight-line basis over therequisite service period for the entire award. During 2012, 2011 and 2010, cash received under stock option plans for exercises was $689, $652 and$3,685, respectively. (b)Restricted StockThe Company granted 43,340, 167,500 and 324,321 restricted stock awards to employees under the terms of the Amended and Restated 2006 StockIncentive Plan for the years ended December 31, 2012, 2011, and 2010, respectively. The restricted stock awards vest annually over four years from the dateof grant subject to the recipient remaining an employee through the applicable vesting dates. Compensation expense for restricted stock awards is measured atfair value on the date of grant based on the number of shares granted and the quoted market closing price of the Company’s common stock. Such value isrecognized as expense over the vesting period of the award, net of estimated forfeitures. The weighted-average grant-date fair value of restricted stock grantedduring 2012, 2011 and 2010 was $12.53, $13.29 and $13.12 per share, respectively.As of December 31, 2012, there was $2,448 of total unrecognized compensation expense related to restricted stock awards, which is expected to berecognized over a weighted-average period of 1.16 years. Compensation costs for awards subject only to service conditions that vest ratably are recognized on astraight-line basis over the requisite service period for the entire award. Compensation cost for awards initially subject to certain performance conditions arerecognized on a ratable basis over the requisite service period for the entire award. In 2012, 2011 and 2010, the Company recorded compensation charges of$2,495, $2,728 and $1,942, respectively, related to restricted stock awards.Restricted stock activity under the Amended and Restated 2006 Stock Incentive Plan for 2012 is as follows: Number ofShares Weighted-averagegrant datefair valueOutstanding at December 31, 2011, nonvested615,848 $10.10Granted43,340 12.53Vested(283,934) 9.23Forfeited(3,643) 10.33Outstanding at December 31, 2012, nonvested371,611 $11.05 (c)Employee Stock Purchase PlanUnder the Company’s Amended and Restated Employee Stock Purchase Plan (ESPP), the Company is authorized to issue up to 600,000 shares ofcommon stock, of which 36,100 shares remain available as of December 31, 2012.The ESPP covers all of the Company’s employees. Under the terms of the ESPP, eligible employees can elect to have up to six percent of their pre-taxcompensation withheld to purchase shares of the Company’s common stock on a semi-annual basis. The ESPP allows eligible employees the right to purchasethe Company’s common stock on a semi-annual basis at 85% of the market price at the end of each purchase period. During 2012, 2011 and 2010, 27,308,38,718, and 21,654 shares, respectively, were issued under this plan. The Company utilizes the Black-Scholes option-pricing model to calculate the fairvalue of these discounted purchases. The fair value of the 15% discount is recognized as compensation expense over the purchase period. The Companyapplies a graded vesting approach because the ESPP provides for multiple purchase periods and is, in substance, a series of linked awards. In 2012, 2011and 2010, the Company recorded compensation charges of $54, $96 and $68, respectively, related to the ESPP. During 2012, 2011 and 2010, cash receivedunder the ESPP was $270, $289 and $260, respectively.65Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)(8)Income TaxesIncome tax expense (benefit) for the years ended December 31, 2012, 2011, and 2010 attributable to income (loss) from operations is presented below. Current Deferred TotalYear ended December 31, 2012 Federal$715 $2,036 $2,751State146 254 400Foreign248 (137) 111 $1,109 $2,153 $3,262Year ended December 31, 2011 Federal$(16) $120 $104State179 (955) (776)Foreign212 (24) 188 $375 $(859) $(484)Year ended December 31, 2010 Federal$217 $(2,142) $(1,925)State136 (998) (862)Foreign154 21 175 $507 $(3,119) $(2,612)The actual income tax expense (benefit) differs from the “expected” income tax expense (benefit) computed by applying the United States Federalcorporate income tax rate of 35% to income before tax expense (benefit) as follows: Year Ended December 31, 2012 2011 2010Computed “expected” tax expense$2,395 $131 $1,981Decrease in income taxes resulting from: State income tax expense, net of federal benefit674 83 636State research and development, investment credits(301) (1,006) (342)Non-deductible expenses116 101 268Foreign tax rate differential(27) (42) (28)Federal research and development credits— (351) (378)Adjustments to operating loss carry-forwards and other deferred taxes, net(33) (44) (346)Stock-based compensation(30) 306 146Change in valuation allowance468 338 (4,549)Net income tax expense (benefit)$3,262 $(484) $(2,612)66Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)The components of results of income from operations before income tax expense (benefit) determined by tax jurisdiction, are as follows: Year Ended December 31, 2012 2011 2010United States$7,917 $971 $5,458Denmark(295) (161) 390Norway570 726 61Brazil(1,375) (1,210) (260)Singapore25 49 12Japan1 — —Total$6,843 $375 $5,661The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of the dates presented are as follows: December 31, 2012 2011Deferred tax assets: Accounts receivable, due to allowance for doubtful accounts$313 $355Inventories289 283Operating loss carry-forwards1,011 2,674Stock-based compensation expense1,194 1,197Intangible assets due to differences in amortization74 56Research and development, alternative minimum tax credit carry-forwards3,507 3,838Foreign tax credit carry-forwards1,111 1,146State tax credit carry-forwards2,228 2,415Accrued expenses688 741Gross deferred tax assets10,415 12,705Less valuation allowance(2,136) (2,576)Total deferred tax assets8,279 10,129Deferred tax liabilities: Purchased intangible assets(433) (543)Property and equipment, due to differences in depreciation(3,176) (2,900)Total deferred tax liabilities(3,609) (3,443)Net deferred tax assets$4,670 $6,686Net deferred tax asset—current$1,146 $1,281Net deferred tax asset—noncurrent$3,524 $5,405As of December 31, 2012, the Company had federal net operating loss carry-forwards available to offset future taxable income of $521. The Companyalso had foreign net operating loss carry-forwards available to offset future foreign income of $2,936. The federal net operating loss carry-forwards expire inyears 2024 through 2031. The foreign net operating loss carry-forwards have no expiration. The tax benefit related to $521 of federal net operating loss carry-forwards would occur upon utilization of these deferred tax assets to reduce taxes payable and would result in a credit to additional paid-in capital withinstockholders’ equity rather than the provision for income taxes.As of December 31, 2012, the Company had federal research and development tax credit carry-forwards in the amount of $3,916 that expire in years2021 through 2031, and foreign tax credit carry-forwards in the amount of $1,146 that expire in years 2015 through 2021. The Company also had alternativeminimum tax credits of $223 that have no expiration date. As of67Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)December 31, 2012, the Company had state research and development tax credit carry-forwards in the amount of $2,936 that expire in years 2012 through2018. The Company also had other state tax credit carry-forwards of $714 available to reduce future state tax expense that expire in years 2012 through 2018.The tax benefit related to $1,870 of federal and state tax credits would occur upon utilization of these deferred tax assets to reduce taxes payable and wouldresult in a credit to additional paid-in capital within stockholders’ equity rather than the provision for income taxes.The Company’s ability to utilize these net operating loss carry-forwards and tax credit carry-forwards may be limited in the future if the Companyexperiences an ownership change pursuant to Internal Revenue Code Section 382. An ownership change occurs when the ownership percentages of 5% orgreater stockholders change by more than 50% over a three-year period.For the years ended December 31, 2012, 2011, and 2010, the Company generated income before income taxes of $6,843, $375 and $5,661,respectively. In assessing the realizability of its net deferred tax assets, the Company considered whether it is more likely than not that some portion or all ofthe deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during theperiods in which those temporary differences become deductible. As of December 31, 2012, based upon an evaluation of the positive and negative evidence, theCompany concluded that a reduction of $440 of the deferred tax asset valuation allowance was appropriate, resulting in a remaining valuation allowance of$2,136 as of December 31, 2012. The net decrease in valuation allowance of $440 resulted in additional tax expense of $267 primarily from net operatinglosses incurred in 2012 that the Company does not expect to realize the tax benefit. The valuation allowance change also includes the expiration of previouslyreserved state tax credit carryforwards, and a decrease in net operating losses and credit carryforwards attributed to tax deductions in excess of recognizedstock compensation expense that did not impact tax expense. For the year ended December 31, 2012, the Company has recorded valuation allowances ofapproximately $1,086 against certain state tax credits and foreign net operating loss carryforwards, and intends to maintain the valuation allowance untilsufficient evidence exists to support the reversal of all or a portion of these valuation allowances.In addition, the Company continues to maintain a $1,050 valuation allowance against net operating losses and credits carryforwards attributed to taxdeductions in excess of recognized compensation cost from employee stock compensation awards that existed as of the adoption of ASC 718. The Companywill recognize the net deferred tax asset and corresponding benefit to additional paid-in capital for these windfall tax benefits once such amounts reduce incometaxes payable, in accordance with the requirements of ASC 718.The Company's income taxes currently payable for federal and state purposes have been reduced by the benefit of the tax deduction in excess ofrecognized compensation cost from employee stock compensation transactions in the amount of $619 which has been recorded as an increase to additionalpaid-in capital for the year ended December 31, 2012.As of December 31, 2012, the Company has not provided for U.S. deferred income taxes on undistributed earnings of its foreign subsidiaries ofapproximately $1,692 since these earnings are expected to be indefinitely reinvested. Upon distribution of those earnings in the form of dividends orotherwise, the Company will be subject to additional U.S. and state income taxes (less foreign tax credits), as well as withholding taxes in its foreign locations.The amount of taxes attributable to the undistributed earnings is not practicably determinable.On January 2, 2013, the President signed into law The American Taxpayer Relief Act of 2012. Under the prior law, a taxpayer was entitled to a researchtax credit for qualifying amounts paid or incurred on or before December 31, 2011. The 2012 American Taxpayer Relief Act extends the research credit for twoyears to December 31, 2013. The extension of the research credit is retroactive and includes amounts paid or incurred after December 31, 2011. As a result ofthe retroactive extension, we expect to recognize a benefit of approximately $128 for qualifying amounts incurred in 2012. The benefit will be recognized in theperiod of enactment, which is the first quarter of 2013.The Company establishes reserves for uncertain tax positions based on management’s assessment of exposure associated with tax deductions,permanent tax differences and tax credits. The tax reserves are analyzed periodically and adjustments are made as events occur to warrant adjustment to thereserve.The Company did not have any material unrecognized tax benefits at December 31, 2012, 2011 or 2010. The Company’s policy is to recognize interestand penalties related to unrecognized tax benefits as a component of income tax expense. The Company’s tax jurisdictions include the United States, Denmark,Brazil, Norway, Singapore and Japan. In general, the statute of limitations with respect to the Company’s United States federal income taxes has expired foryears prior to 2008, and the68Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)relevant state and foreign statutes vary. However, preceding years remain open to examination by United States federal and state and foreign taxing authoritiesto the extent of future utilization of net operating losses and research and development tax credits generated in each preceding year. The Company is no longersubject to income tax examinations by the Danish tax authorities for years prior to 2009.(9)Goodwill and Intangible AssetsOn September 13, 2010, the Company’s Danish subsidiary, KVH Europe A/S, completed the purchase of Virtek Communication for approximately$6,500. The purchase was made using existing cash, cash equivalents and marketable securities. In connection with this acquisition, the Company recorded$4,517 of goodwill, primarily related to expected synergies from combining operations and the value of the existing workforce, and $2,372 of intangibleassets related to intellectual property.December 31, 2012Useful Life Cost AccumulatedAmortization ForeignCurrencyTranslationAdjustment Net CarryingValueIntellectual property7 years $2,372 $826 $138 $1,684The Company amortizes its intangible assets over the estimated useful lives of the respective assets. Amortization expense related to intangible assetswas $394, $333 and $101 for years ended December 31, 2012, 2011, and 2010, respectively.Estimated future amortization expense for intangible assets recorded by the Company at December 31, 2012 is as follows:Years ending December 31,AmortizationExpense2013$3582014358201535820163582017252Thereafter—Total amortization expense$1,684Goodwill is recorded when the consideration for an acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired. Thechanges in the carrying amount of goodwill during the year ended December 31, 2012 is as follows: 2012Balance at January 1$4,426Foreign currency translation adjustment286Balance at December 31$4,712(10)401(k) PlanThe Company has a 401(k) Plan (the Plan) for all eligible employees. Participants may defer a portion of their pre-tax earnings subject to limitsdetermined by the Internal Revenue Service. Participants age 50 or older may be eligible to make additional contributions. As of December 31, 2012, theCompany matches one half of the first 4% contributed by the Plan participants. The Company’s contributions vest over a five-year period from the date ofhire. Total Company matching contributions were $352, $335 and $326 for the years ended December 31, 2012, 2011, and 2010, respectively. In addition,the Company may make contributions to the Plan at the discretion of the Compensation Committee of the Board of Directors. There were no discretionarycontributions in 2012, 2011, or 2010.69Table of Contents(11)Business and Credit ConcentrationsSignificant portions of the Company’s net sales are as follows: Year EndedDecember 31, 2012 2011 2010Net sales to foreign customers outside the U.S. and Canada40% 29% 32%Net sales to SANG11% * *Net sales to General Dynamics Land Systems-Canada* 11% *Net sales to Kongsberg Defence & Aerospace AS (Kongsberg)* * 14% *Represents less than 10% of net sales.The terms and conditions of sales to SANG, General Dynamics and Kongsberg are consistent with the Company’s standard terms and conditions ofproduct sales as discussed in note 1 of the Company’s consolidated financial statements. All receivable balances outstanding for these customers as ofDecember 31, 2012 were paid as of the date of this report. No other individual customer accounted for more than 10% of the Company’s net sales for the yearsended December 31, 2012, 2011, and 2010, respectively.(12)Segment ReportingUnder common operational management, the Company designs, develops, manufactures and markets its navigation, guidance and stabilization andmobile communications products for use in a wide variety of applications. Products are generally sold directly to third-party consumer electronic dealers andretailers, original equipment manufacturers, government contractors or to U.S. and other foreign government agencies. Primarily, sales originating in theAmericas consist of sales within the United States and Canada and, to a lesser extent, Mexico and some Latin and South American countries. The Americas’sales also include all guidance and stabilization product sales throughout the world. Sales originating from the Company’s European and Asian subsidiariesprincipally consist of sales into all European countries, both inside and outside the European Union, as well as Africa, Asia/Pacific, the Middle East andIndia.The Company operates in two geographic segments, exclusively in the mobile communications, navigation and guidance and stabilization equipmentindustry, which it considers to be a single business activity. The Company has two primary product categories: mobile communication and guidance andstabilization. Mobile communication sales and services include marine, land mobile, automotive, and aeronautical communication equipment and satellite-based voice, television and Broadband Internet connectivity services, as well as DIRECTV account subsidies and referral fees earned in conjunction with thesale of our products. Guidance and stabilization sales and services include sales of defense-related navigation and guidance and stabilization equipment basedupon digital compass and fiber optic sensor technology. Mobile communication and guidance and stabilization sales also include development contractrevenue, product repairs and extended warranty sales.70Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)The following table summarizes information regarding the Company’s operations by geographic segment: Sales Originating FromYear ended December 31, 2012Americas Europeand Asia TotalMobile communication sales to the United States$62,857 $— $62,857Mobile communication sales to Canada777 — 777Mobile communication sales to Europe417 15,255 15,672Mobile communication sales to other geographic areas3,936 4,443 8,379Guidance and stabilization sales to the United States8,632 — 8,632Guidance and stabilization sales to Canada10,736 — 10,736Guidance and stabilization sales to Europe11,793 — 11,793Guidance and stabilization sales to other geographic areas18,266 — 18,266Intercompany sales8,485 2,064 10,549Subtotal125,899 21,762 147,661Eliminations(8,485) (2,064) (10,549)Net sales$117,414 $19,698 $137,112Segment net income (loss)$4,317 $(736) $3,581Depreciation and amortization$4,116 $494 $4,610Total assets$118,076 $19,492 $137,568 Sales Originating FromYear ended December 31, 2011Americas Europeand Asia TotalMobile communication sales to the United States$50,797 $— $50,797Mobile communication sales to Canada875 — 875Mobile communication sales to Europe438 13,244 13,682Mobile communication sales to other geographic areas1,280 3,568 4,848Guidance and stabilization sales to the United States11,951 — 11,951Guidance and stabilization sales to Canada16,643 — 16,643Guidance and stabilization sales to Europe7,877 — 7,877Guidance and stabilization sales to other geographic areas5,863 — 5,863Intercompany sales7,793 1,084 8,877Subtotal103,517 17,896 121,413Eliminations(7,793) (1,084) (8,877)Net sales$95,724 $16,812 $112,536Segment net income$396 $464 $860Depreciation and amortization$3,948 $426 $4,374Total assets$112,557 $15,999 $128,55671Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts) Sales Originating FromYear ended December 31, 2010NorthAmerica Europe TotalMobile communication sales to the United States$46,358 $— $46,358Mobile communication sales to Canada571 — 571Mobile communication sales to Europe524 10,398 10,922Mobile communication sales to other geographic areas1,162 3,460 4,622Guidance and stabilization sales to the United States24,262 — 24,262Guidance and stabilization sales to Canada5,353 — 5,353Guidance and stabilization sales to Europe17,368 — 17,368Guidance and stabilization sales to other geographic areas2,787 — 2,787Intercompany sales6,528 413 6,941Subtotal104,913 14,271 119,184Eliminations(6,528) (413) (6,941)Net sales$98,385 $13,858 $112,243Segment net (loss) income$8,201 $72 $8,273Depreciation$3,711 $134 $3,845Total assets$101,116 $14,082 $115,198(13)Share Buyback ProgramOn November 26, 2008, the Company’s Board of Directors authorized a program to repurchase up to one million shares of the Company’s commonstock. As of December 31, 2012, 341,009 shares of the Company’s common stock remain available for repurchase under the authorized program. Therepurchase program is funded using the Company’s existing cash, cash equivalents, marketable securities and future cash flows. Under the repurchaseprogram, the Company, at management’s discretion, may repurchase shares on the open market from time to time, in privately negotiated transactions orblock transactions, or through an accelerated repurchase agreement. The timing of such repurchases depends on availability of shares, price, marketconditions, alternative uses of capital, and applicable regulatory requirements. The program may be modified, suspended or terminated at any time withoutprior notice. The repurchase program has no expiration date. There were no other repurchase programs outstanding during the year ended December 31, 2012and no repurchase programs expired during the period.During the years ended December 31, 2012, 2011, and 2010 the Company repurchased 0, 457,667 and 0 shares of its common stock in open markettransactions at a cost of $0, $3,679 and $0, respectively.(14)Fair Value MeasurementsEffective January 1, 2008, the Company adopted the required provisions of ASC 820, Fair Value Measurements and Disclosures. ASC 820 definesfair 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 forthe asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy, whichrequires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes threelevels 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. TheCompany’s Level 1 assets are investments in money market mutual funds, government agency bonds, United States treasuries, corporatenotes, and certificates of deposit.Level 2:Quoted prices for similar assets or liabilities in active markets; or observable prices that are based on observable market data, based ondirectly or indirectly market-corroborated inputs. The Company’s Level 2 liabilities are interest rate swaps.72Table of ContentsLevel 3:Unobservable inputs that are supported by little or no market activity, and are developed based on the best information available given thecircumstances. The Company has no Level 3 assets.Assets and liabilities measured at fair value are based on one or more of four valuation techniques. The four valuation techniques are identified in thetable below and are as follows:(a)Market approach—prices and other relevant information generated by market transactions involving identical or comparable assets(b)Cost approach—amount that would be required to replace the service capacity of an asset (replacement cost)(c)Income approach—techniques to convert future amounts to a single present amount based on market expectations (including present valuetechniques, option-pricing and excess earnings models)(d)The valuations of the interest rate swaps intended to mitigate the Company’s interest rate risk are determined with the assistance of a third-partyfinancial institution using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of eachinstrument. This analysis utilizes observable market-based inputs, including interest rate curves and interest rate volatility, and reflects thecontractual terms of these instruments, including the period to maturity.The following tables present financial assets at December 31, 2012 and December 31, 2011 for which the Company measures fair value on a recurringbasis, by level, within the fair value hierarchy: December 31, 2012Total Level 1 Level 2 Level 3 ValuationTechniqueAssets Money market mutual funds$9,921 $9,921 $— $— (a)Government agency bonds6,817 6,817 — — (a)United States treasuries6,089 6,089 — — (a)Corporate notes4,679 4,679 — — (a)Certificates of deposit1,800 1,800 — — (a)Liabilities Interest rate swaps$542 $— $542 $— (d)December 31, 2011Total Level 1 Level 2 Level 3 ValuationTechniqueAssets Money market mutual funds$8,818 $8,818 $— $— (a)Government agency bonds9,015 9,015 — — (a)United States treasuries— — — — Corporate notes3,019 3,019 — — (a)Certificates of deposit2,701 2,701 — — (a)Liabilities Interest rate swaps$510 $— $510 $— (d)Certain financial instruments are carried at cost on the consolidated balance sheets, which approximates fair value due to their short-term, highly liquidnature. These instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses.(15)Derivative Instruments and Hedging ActivitiesEffective April 1, 2010, in order to reduce the volatility of cash outflows that arise from changes in interest rates, the Company entered into two interestrate swap agreements. These interest rate swap agreements are intended to hedge the Company’s mortgage loan related to its headquarters facility inMiddletown, Rhode Island by fixing the interest rates specified in the mortgage loan to 5.91% for half of the principal amount outstanding and 6.07% for theremaining half of the principal amount outstanding as of April 1, 2010 until the mortgage loan expires on April 16, 2019.73Table of ContentsKVH INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2012, 2011 and 2010(in thousands except share and per share amounts)As required by ASC Topic 815, Derivatives and Hedging, the Company records all derivatives on the balance sheet at fair value. As of December 31,2012, the fair value of the derivatives is included in other accrued liabilities and the unrealized loss is included in other comprehensive loss.As of December 31, 2012, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest raterisk:Interest Rate DerivativesNotional(in thousands) Asset(Liability) Effective Date Maturity Date Index Strike RateInterest rate swap$1,776 (263) April 1, 2010 April 1, 2019 1-month LIBOR 5.91%Interest rate swap$1,776 (279) April 1, 2010 April 1, 2019 1-month LIBOR 6.07%(16)Legal MattersFrom time to time, the Company is involved in litigation incidental to the conduct of its business. In the ordinary course of business, KVH is a party toinquiries, legal proceedings and claims including, from time to time, disagreements with vendors and customers. The Company is not a party to any lawsuitor proceeding that, in management’s opinion, is likely to materially harm the Company’s business, results of operations, financial condition or cash flows.(17)Quarterly Financial Results (Unaudited)Financial information for interim periods was as follows: FirstQuarter SecondQuarter ThirdQuarter FourthQuarter (in thousands, except per share amounts)2012 Product sales$17,083 $21,041 $24,529 $28,024Service sales9,645 10,978 14,293 11,519Gross profit9,943 12,451 15,490 17,090Net (loss) income$(1,375) $453 $1,745 $2,757Net (loss) income per share (a): Basic$(0.09) $0.03 $0.12 $0.19Diluted$(0.09) $0.03 $0.12 $0.182011 Product sales$18,884 $24,331 $17,987 $23,933Service sales5,525 6,241 7,634 8,000Gross profit9,078 11,995 10,412 13,481Net (loss) income(1,534) 190 600 1,604Net (loss) income per share (a): Basic$(0.10) $0.01 $0.04 $0.11Diluted$(0.10) $0.01 $0.04 $0.11 (a)Net (loss) income per share is computed independently for each of the quarters. Therefore, the net (loss) income per share for the four quarters may notequal the annual net income (loss) per share data.This financial information includes transactions which affect the comparability of the quarterly results for the year ended December 31, 2011. Duringthe third quarter of 2011, the Company reached agreement with LiveTV regarding the termination of a long-term antenna production agreement. The Companyrecorded a charge to other expense of $2,868 in the third quarter of 2011 to write off all of the remaining capitalized aviation antenna research and developmentcosts. This charge was offset by74Table of Contentsa termination fee paid to the Company by LiveTV that resulted in a net benefit of $841, which is reflected in other income as of September 30, 2011.(18) Subsequent EventOn January 30, 2013, the Company entered into an equipment security note in the amount of $4,700 to finance satellite hubs that were originallypurchased with cash in 2012 and 2010. The term of the equipment note is five years, at a fixed interest rate of 2.76%. The monthly payment is $83 includinginterest expense.75 Exhibit 21.1List of Subsidiaries KVH Industries A/SDenmark KVH Industries Pte. Ltd.Singapore KVH Industries Brasil Comunicacao Por Satelite Ltda.Brazil KVH Industries Norway A/SNorway KVH Industries Japan Co. Ltd.Japan Exhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMThe Board of DirectorsKVH Industries, Inc.:We consent to the incorporation by reference in the Registration Statement Nos. 333-168406, 333-160230, 333-141404, 333-112341, 333-67556 and 333-08491on Form S-8 of KVH Industries, Inc. of our reports dated April 2, 2013, with respect to the consolidated balance sheets of KVH Industries, Inc. andsubsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, stockholders' equity andaccumulated other comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2012, and the effectivenessof internal control over financial reporting as of December 31, 2012, which reports appear in the December 31, 2012 Annual Report on Form 10-K of KVHIndustries, Inc. Our report dated April 2, 2013 on the effectiveness of internal control over financial reporting as of December 31, 2012, expresses an opinion that KVHIndustries, Inc. did not maintain effective internal control over financial reporting as of December 31, 2012 because of the effect of a material weakness on theachievement of the objectives of the control criteria and contains an explanatory paragraph that states that a material weakness related to control activities overthe execution of wire transfers, approval of cash disbursements and other purchase transactions and review and approval of manual journal entries has beenidentified and included in management's assessment. /s/ KPMG LLP Providence, Rhode IslandApril 2, 2013Exhibit 31.1CertificationI, Martin A. Kits van Heyningen, certify that:1. I have reviewed this annual report on Form 10-K of KVH Industries, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrantand have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles;(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness ofthe disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s Board of Directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the registrant’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control overfinancial reporting.Date: April 2, 2013 /s/ Martin A. Kits van Heyningen Martin A. Kits van Heyningen President, Chief Executive Officer and Chairman of the Board Exhibit 31.2CertificationI, Peter Rendall, certify that:1. I have reviewed this annual report on Form 10-K of KVH Industries, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrantand have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles;(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness ofthe disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s Board of Directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the registrant’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control overfinancial reporting.Date: April 2, 2013 /s/ Peter Rendall Peter Rendall Chief Financial Officer Exhibit 32.1CERTIFICATION PURSUANT TO18 U.S.C. 1350AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report on Form 10-K of KVH Industries, Inc. (the “Company”) for the year ended December 31, 2012, as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), each of the undersigned President, Chief Executive Officer and Chairman of theBoard, and Chief Financial Officer of the Company, certifies, to the best knowledge and belief of the signatory, pursuant to 18 U.S.C 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Act of 1934; and2.The information contained in the Report fairly presents, in all material respects, the by /s/ Martin A. Kits van Heyningen /s/ Peter Rendall Martin A. Kits van Heyningen Peter Rendall President, Chief Executive Officer and Chief Financial Officer Chairman of the Board Date:April 2, 2013 Date:April 2, 2013

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