The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands, except per share
amounts)
NOTE 1: BASIS OF PRESENTATION
Basis of Presentation
The accompanying
unaudited
condensed
consolidated financial statements of Deep Down, Inc. and its directly and
indirectly wholly-owned subsidiaries (“Deep Down,” “we,” “us” or the “Company”)
were prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC” or the
“Commission”) pertaining to interim financial information and instructions to Form 10-Q. As permitted under those
rules, certain footnotes or other financial information that are normally required by United States generally accepted accounting
principles (“GAAP”) can be condensed or omitted. Therefore, these statements should be read in conjunction
with the audited consolidated financial statements, and footnotes thereto, included in our Annual Report on Form 10-K for the year
ended December 31, 2015, filed on March 29, 2016 with the Commission.
Preparation
of financial statements in conformity with
GAAP
requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, the disclosed amounts of contingent assets and liabilities and the
reported amounts of revenues and expenses. If the underlying estimates and assumptions upon which the financial statements are
based change in future periods, then the actual amounts may differ from those included in the accompanying unaudited condensed
consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered
necessary for a fair presentation have been included.
Certain previously reported amounts have
been reclassified to conform to current period presentation.
Principles of Consolidation
The unaudited condensed consolidated financial
statements presented herein include the accounts of Deep Down, Inc. and
its directly and indirectly
wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated.
Segments
We operate one
principal deepwater oilfield services business, which provides many solutions to our customers. For the
nine months ended
September 30, 2016 and 2015, we only had one reporting segment, Deep Down Delaware. All of the services and products we provide
are interrelated, performed for the same general customers and marketed as such.
In accordance with ASC Topic 280,
Segment Reporting
, operating segments are defined as components of an enterprise for which separate financial information
is available that is evaluated regularly by the chief operating decision-maker (“CODM”) in deciding how to allocate
resources and in assessing performance. Our CODM primarily evaluates performance based on each project’s gross margin and
net income.
In
determining the reportable segment, we concluded that all
services and products
have
similar economic and other characteristics, including similar gross margin percentage, production processes, suppliers, regulatory
environments, customer type, and underlying demand and supply. Our services and products follow the same accounting policies and
are managed by our management team.
Recently Issued Accounting Standards
Not Yet Adopted
In May 2014, the Financial Accounting Standards
Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”).
This update provides a five-step approach to be applied to all contracts with customers and requires expanded disclosures about
the nature, amount, timing and uncertainty of revenue (and the related cash flows) arising from customer contracts, significant
judgments and changes in judgments used in applying the revenue model and the assets recognized from costs incurred to obtain or
fulfill a contract. The effective date for this standard was deferred in July 2015 and will now be effective for us beginning January
1, 2018. The standard permits the use of either the retrospective or cumulative effect transition method; we are evaluating the
effect that this new guidance will have on our consolidated financial statements and related disclosures. We have not yet selected
a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
In August 2014, the FASB issued ASU No.
2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”).
ASU 2014-15 provides guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s
ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required
to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as
a going concern within one year from the date the financial statements are issued. The amendments in ASU 2014-15 are effective
for us beginning January 1, 2017. We do not anticipate the adoption of ASU 2014-15 will have a material effect on our financial
position or results of operations.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands, except per share
amounts)
In July 2015, the FASB issued ASU No. 2015-11,
“Simplifying the Measurement of Inventory”
(“ASU 2015-11”). ASU 2015-11
requires in scope inventory to be measured at the lower of cost and net realizable value rather than at the lower of cost or market
under existing guidance. The amendments in this ASU are effective
for us beginning January 1, 2017
.
We do not
anticipate the adoption of ASU
2015-11
will have
a material impact on our
financial position or results of operations
.
In February 2016, the FASB issued ASU No.
2016-02, “Leases (Topic 842)”. The amendments in this update require, among other things, that lessees recognize the
following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a
lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset,
which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Lessees
and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning
of the earliest comparative period presented in the financial statements. The amendments are effective for us beginning January
1, 2019. We do not anticipate the adoption of ASU 2014-15 will have a material effect on our financial position or results of operations.
In March 2016, the FASB issued ASU No.
2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). Among other amendments,
ASU 2016-09 requires that excess tax benefits or deficiencies are recognized as income tax expense or benefit in the income statement,
gives an entity the ability to elect to estimate the number of awards that are expected to vest or account for forfeitures as they
occur and permits withholding up to the maximum statutory tax rates as the threshold to qualify for equity classification. The
guidance will become effective for us beginning January 1, 2017.
We do not anticipate the adoption of
ASU 2014-15 will have a material effect on our financial position or results of operations.
In October 2016, the FASB issued ASU No.
2016-16, “Intra-Entity Transfers of Assets Other Than Inventory.” This update requires that income tax consequences
are recognized on an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this ASU
are effective for us on January 1, 2018. Early application is permitted. We are currently evaluating the impact of this ASU on
our consolidated financial statements.
NOTE 2: RESTATEMENT OF QUARTERLY INFORMATION
In December 2014, at the request of a customer,
we delivered a carousel to the customer on a lease or purchase arrangement. We honored this request in order to support its requirement
for a critical umbilical project. At the completion of our customer’s requirement, we were advised by the customer it was
not going to purchase the carousel, so we picked up the carousel and returned it to our facility. We then invoiced the customer
on a rental basis.
The customer has declined to pay the invoices.
We are pursuing collection through arbitration.
Under SEC Staff Accounting Bulletin No.
101 – Revenue Recognition in Financial Statements (SAB 101), “revenue should not be recognized until it is realized
or realizable and earned.” Also according to SAB 101, revenue generally is realized or realizable and earned when all of
the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered,
the seller's price to the buyer is fixed or determinable, and collectability is reasonably assured.
Based on the facts above and the guidelines
of SAB 101, we determined that the revenue in relation to this situation should not have been recognized in the six months ended
June 30, 2015. As a result, we have reversed the misstated revenue and related receivable from our unaudited consolidated financial
statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands, except per share
amounts)
The following table summarizes the impact
of the revenue reversal on our unaudited consolidated statement of operations:
|
|
Nine Months Ended
|
|
|
|
September 30, 2015
|
|
|
|
As Reported
|
|
|
Revenue Adjustment
|
|
|
As Restated
|
|
Revenues
|
|
|
19,756
|
|
|
|
(1,240
|
)
|
|
|
18,516
|
|
Gross profit
|
|
|
6,392
|
|
|
|
(1,240
|
)
|
|
|
5,152
|
|
Operating loss
|
|
|
(634
|
)
|
|
|
(1,240
|
)
|
|
|
(1,874
|
)
|
Loss before income taxes
|
|
|
(719
|
)
|
|
|
(1,240
|
)
|
|
|
(1,959
|
)
|
Net loss
|
|
|
(730
|
)
|
|
|
(1,240
|
)
|
|
|
(1,970
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
(0.05
|
)
|
|
|
(0.08
|
)
|
|
|
(0.13
|
)
|
Fully diluted
|
|
|
(0.05
|
)
|
|
|
(0.08
|
)
|
|
|
(0.13
|
)
|
NOTE 3: INVENTORY
The finished goods inventory balance of
$3,117 consists of a 3,500 MT portable umbilical carousel, which we fabricated and bought back from a customer in November 2013
and are currently holding for sale.
NOTE 4:
BILLINGS,
COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
The components of billings, costs and estimated earnings on
uncompleted contracts are summarized below:
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Costs incurred on uncompleted contracts
|
|
$
|
9,879
|
|
|
$
|
3,220
|
|
Estimated earnings on uncompleted contracts
|
|
|
5,896
|
|
|
|
2,282
|
|
|
|
|
15,775
|
|
|
|
5,502
|
|
Less: Billings to date on uncompleted contracts
|
|
|
(15,828
|
)
|
|
|
(4,194
|
)
|
|
|
$
|
(53
|
)
|
|
$
|
1,308
|
|
|
|
|
|
|
|
|
|
|
Included in the accompanying consolidated balance sheets under the following captions:
|
|
|
|
|
|
|
|
|
Costs and estimated earnings in excess of billings on uncompleted contracts
|
|
$
|
2,202
|
|
|
$
|
1,354
|
|
Billings in excess of costs and estimated earnings on uncompleted
contracts
|
|
|
(2,255
|
)
|
|
|
(46
|
)
|
|
|
$
|
(53
|
)
|
|
$
|
1,308
|
|
The balance in costs and estimated earnings
in excess of billings on uncompleted contracts at September 30, 2016 and December 31, 2015 consisted of earned but unbilled revenues
related to fixed-price projects and time and material projects.
The balance in billings in excess of costs
and estimated earnings on uncompleted contracts at September 30, 2016 and December 31, 2015 consisted of unearned billings related
to fixed-price projects and time and material projects.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands, except per share
amounts)
NOTE 5: PROPERTY, PLANT AND EQUIPMENT
The components of net property, plant and
equipment are summarized below:
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
|
Range of Asset Lives
|
|
Land
|
|
$
|
–
|
|
|
$
|
1,582
|
|
|
|
–
|
|
Buildings and improvements
|
|
|
5
|
|
|
|
1,447
|
|
|
|
7 - 36 years
|
|
Leasehold improvements
|
|
|
893
|
|
|
|
825
|
|
|
|
2 - 5 years
|
|
Equipment
|
|
|
16,298
|
|
|
|
15,435
|
|
|
|
2 - 30 years
|
|
Furniture, computers and office equipment
|
|
|
1,246
|
|
|
|
1,468
|
|
|
|
2 - 8 years
|
|
Construction in progress
|
|
|
497
|
|
|
|
341
|
|
|
|
–
|
|
Total property, plant and equipment
|
|
|
18,939
|
|
|
|
21,098
|
|
|
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(10,980
|
)
|
|
|
(10,336
|
)
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
7,959
|
|
|
$
|
10,762
|
|
|
|
|
|
The reduction in our net property, plant and equipment was due
to the sale of our Channelview location in March 2016.
NOTE 6: LONG-TERM DEBT
Credit Facility
From 2008 through June 30, 2016, we maintained
a credit facility (the “Facility”) with Whitney Bank. The Facility was amended and restated several times, most
recently effective June 30, 2015 when we entered into the eighth amendment (“Eighth Amendment”).
The relevant terms of the Eighth Amendment
included:
|
·
|
an extension of the maturity date of the revolving credit facility (“Revolving Credit Facility”)
to June 30, 2016;
|
|
·
|
a modification of the interest rate with respect to the Revolving Credit Facility to 4.0 percent
per annum;
|
|
·
|
a modification of certain financial covenants; and
|
|
·
|
a requirement that we maintain a compensating balance of $3,900 in our existing interest-bearing
account at Whitney, to continue until such time as we have regained compliance with all of our covenants under the Facility for
two consecutive quarters commencing with the quarter ended June 30, 2015.
|
Other terms of the Facility included:
|
·
|
a real estate term facility (“RE Term Facility”) of $2,000, at an interest rate of
4.0 percent per annum, maturing April 15, 2018, with the Company being obligated to make monthly increasing repayments of principal
(along with accrued and unpaid interest thereon) at an amount of $9, beginning April 1, 2013, while there is any amount outstanding;
|
|
·
|
a carousel term facility (“Carousel Term Facility”) of $2,200, at an interest rate
of 3.5 percent per annum, maturing October 15, 2016, with the Company being obligated to make monthly repayments of principal of
$65 (along with accrued and unpaid interest thereon) beginning July 1, 2014, while there is any amount outstanding; and
|
|
·
|
outstanding balances under the Facility are secured by all of the Company’s assets.
|
In March 2016, we paid off the RE Term
Facility and the Carousel Term Facility with proceeds received from the sale of our Channelview location.
Due to the expiration of our credit facility
on June 30, 2016, we no longer have the requirement of a compensating balance and the $3,900 is now available for use. As of September
30, 2016, we no longer have these credit facilities available to us.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands, except per share
amounts)
NOTE 7: SHARE-BASED COMPENSATION
We have a share-based compensation plan,
the “2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan” (the “Plan”).
Awards of common stock and options to purchase common stock granted under the Plan have vesting periods of three years and options
are exercisable for two years once fully vested. Share-based compensation expense related to awards is based on the fair value
at the date of grant, and is recognized over the requisite expected service period, net of estimated forfeitures. Under the Plan,
the maximum number of shares issued pursuant to options is 15 percent of issued and outstanding common shares.
Summary of Nonvested Shares of Restricted
Stock
For the nine months ended September 30,
2016 and 2015, we recognized a total of $309 and $382, respectively, of share-based compensation expense related to restricted
stock awards, which is included in selling, general and administrative expenses in the accompanying unaudited condensed consolidated
statements of operations. The unamortized value of nonvested shares of restricted stock awards was $174 at September 30, 2016.
These costs are expected to be recognized as expense over a weighted average period of 0.94 years.
NOTE 8: TREASURY STOCK
On May 23, 2016, our Board of Directors
authorized a repurchase program (the “Repurchase Program”) under which we may repurchase up to $1,000 of our outstanding
stock. The purchases may be made from time to time in the open market, through privately negotiated transactions and Rule 10b5-1
trading plans in accordance with applicable laws, rules and regulations. The Repurchase Program will be funded from cash on hand
and cash provided by operating activities. The Repurchase Program will expire as of the close of business on March 31, 2017. As
of September 30, 2016, we have purchased approximately 312 shares at a total cost of $305 under this Repurchase Program. The average
price per share of treasury stock through September 30, 2016 has been $0.98. Treasury shares are accounted for using the cost method.
NOTE 9: INCOME TAXES
Income tax expense during interim periods
is based on applying the estimated annual effective income tax rate to interim period operations. The estimated annual effective
income tax rate may vary from the statutory rate due to the impact of permanent items relative to our pre-tax income, as well as
by any valuation allowance recorded. We employ an asset and liability approach that results in the recognition of deferred
tax assets and liabilities for the expected future tax consequences of temporary differences between the financial basis and the
tax basis of those assets and liabilities. A valuation allowance is established when it is more likely than not that some of the
deferred tax assets will not be realized. Although our future projections indicate that we may be able to realize some
of these deferred tax assets, due to the degree of uncertainty of these projections, at September 30, 2016 and December 31, 2015
management has recorded a full deferred tax asset valuation allowance.
NOTE 10:
COMMITMENTS
AND CONTINGENCIES
Litigation
From time to time we are involved in legal
proceedings arising from the normal course of business. As of the date of this Report, we are engaged in one material legal dispute,
arising from the non-payment of equipment rental and services by one of our customers. Refer to Note 12 of the Notes to Consolidated
Financial Statements in Part II. Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2015.
Operating Leases
We lease certain offices, facilities, equipment
and vehicles under non-cancellable operating and capital leases expiring at various dates through 2023.
Letters of Credit
Certain of our customers could require
us to issue a standby letter of credit (“LC”) in the ordinary course of business to ensure performance under terms
of a contract or as a form of product warranty. The beneficiary could demand payment from the issuing bank for the amount of the
outstanding letter of credit. There was $0 in LC’s outstanding at September 30, 2016 and December 31, 2015.
NOTE 11: EARNINGS PER COMMON SHARE
Basic earnings per share (“EPS”)
is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Fully diluted
EPS is calculated by dividing net income (loss) by the weighted-average number of common shares and dilutive common stock equivalents
(warrants, stock awards and stock options) outstanding during the period. Fully diluted EPS reflects the potential dilution that
could occur if options to purchase common stock were exercised for shares of common stock.
At September 30, 2016 and 2015, there were
no potentially dilutive securities outstanding.