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 (“US 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
US GAAP
requires management to make estimates and assumptions that
affect the reported amounts of assets, 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
three months ended March 31,
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 August 2014, the FASB issued ASU 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 annual reporting periods ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted.
The Company will adopt the methodologies prescribed by ASU 2014-15 by the date required, and does not anticipate that the adoption
of ASU 2014-15 will have a material effect on its financial position or results of operations.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
In May 2014, the FASB issued a new standard
on revenue recognition that supersedes previously issued revenue recognition guidance. This standard 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 in 2018. The standard permits the use of either
the retrospective or cumulative effect transition method; therefore 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 February 2016, the FASB issued ASU 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 interim and annual reporting periods beginning after December
15, 2018. We are currently evaluating the impacts of the amendments to our financial statements and accounting practices for leases.
NOTE 2: RESTATEMENT OF QUARTERLY INFORMATION (UNAUDITED)
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 quarter ended March
31, 2015. As a result, we have reversed the misstated revenue and related receivable from our unaudited consolidated financial
statements.
The following table summarizes the impact
of the revenue reversal on our unaudited consolidated statement of operations:
Consolidated Statement of Operations impact:
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2015
|
|
|
|
As Reported
|
|
|
Revenue Adjustment
|
|
|
As Restated
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
6,839
|
|
|
|
(1,005
|
)
|
|
|
5,834
|
|
Gross profit
|
|
|
2,235
|
|
|
|
(1,005
|
)
|
|
|
1,230
|
|
Operating (loss) income
|
|
|
(230
|
)
|
|
|
(1,005
|
)
|
|
|
(1,235
|
)
|
Income (loss) before income taxes
|
|
|
(291
|
)
|
|
|
(1,005
|
)
|
|
|
(1,296
|
)
|
Net income (loss)
|
|
|
(297
|
)
|
|
|
(1,005
|
)
|
|
|
(1,302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per common share
|
|
|
(0.02
|
)
|
|
|
(0.07
|
)
|
|
|
(0.09
|
)
|
Diluted earnings (loss) per common share
|
|
|
(0.02
|
)
|
|
|
(0.07
|
)
|
|
|
(0.09
|
)
|
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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:
|
|
March 31, 2016
|
|
|
December 31, 2015
|
|
Costs incurred on uncompleted contracts
|
|
$
|
3,746
|
|
|
$
|
3,220
|
|
Estimated earnings on uncompleted contracts
|
|
|
2,360
|
|
|
|
2,282
|
|
|
|
|
6,106
|
|
|
|
5,502
|
|
Less: Billings to date on uncompleted contracts
|
|
|
(5,436
|
)
|
|
|
(4,194
|
)
|
|
|
$
|
670
|
|
|
$
|
1,308
|
|
|
|
|
|
|
|
|
|
|
Included in the accompanying condensed consolidated balance sheets under the following captions:
|
|
|
|
|
|
|
|
|
Costs and estimated earnings in excess of billings on uncompleted
contracts
|
|
$
|
910
|
|
|
$
|
1,354
|
|
Billings in excess of costs and estimated earnings on
uncompleted contracts
|
|
|
(240
|
)
|
|
|
(46
|
)
|
|
|
$
|
670
|
|
|
$
|
1,308
|
|
The balance in costs and estimated earnings
in excess of billings on uncompleted contracts at March 31, 2016 and December 31, 2015 consisted of earned but unbilled revenues
related to fixed-price projects.
The balance in billings in excess of
costs and estimated earnings on uncompleted contracts at March 31, 2016 and December 31, 2015 consisted of unearned billings related
to fixed-price projects.
NOTE 5: PROPERTY, PLANT AND EQUIPMENT
The components of net property, plant and equipment
are summarized below:
|
|
|
|
|
|
|
|
Range of
|
|
|
|
March 31, 2016
|
|
|
December 31, 2015
|
|
|
Asset Lives
|
|
Land
|
|
$
|
–
|
|
|
$
|
1,582
|
|
|
|
–
|
|
Buildings and improvements
|
|
|
–
|
|
|
|
1,447
|
|
|
|
7 - 36 years
|
|
Leasehold improvements
|
|
|
825
|
|
|
|
825
|
|
|
|
2 - 5 years
|
|
Equipment
|
|
|
15,435
|
|
|
|
15,435
|
|
|
|
2 - 30 years
|
|
Furniture, computers and office equipment
|
|
|
1,362
|
|
|
|
1,468
|
|
|
|
2 - 8 years
|
|
Construction in progress
|
|
|
445
|
|
|
|
341
|
|
|
|
–
|
|
Total property, plant and equipment
|
|
|
18,067
|
|
|
|
21,098
|
|
|
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(10,346
|
)
|
|
|
(10,336
|
)
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
7,721
|
|
|
$
|
10,762
|
|
|
|
|
|
The reduction in our net property, plant and equipment was due to
the sale of our Channelview location in March 2016.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
NOTE 6: LONG-TERM DEBT
Long-term debt consisted of the following:
|
|
March 31, 2016
|
|
|
December 31, 2015
|
|
Whitney credit facility
|
|
$
|
–
|
|
|
$
|
2,747
|
|
Total long-term debt
|
|
|
–
|
|
|
|
2,747
|
|
Less: Current portion of long-term debt
|
|
|
–
|
|
|
|
(2,747
|
)
|
Long-term debt, net of current portion
|
|
$
|
–
|
|
|
$
|
–
|
|
Credit Facility
Since 2008, we have maintained a credit facility
(the “Facility”) with Whitney Bank. The Facility has been 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
include:
|
·
|
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,
specifically the Leverage Ratio and Fixed Charge Coverage Ratio (see further discussion below); 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 current relevant terms of the Facility
include:
|
·
|
a committed amount of $5,000 under the
Revolving Credit Facility, subject to a borrowing base limitation based on eligible trade accounts receivable; the Revolving
Credit Facility may be used to borrow cash (at an interest rate of 4.0 percent per annum) or to issue bank letters of credit
(at a fee of 1.0 percent per annum); both cash borrowings and the issuance of bank letters of credit reduce the available
capacity under the Revolving Credit Facility; the available borrowing and letter of credit capacity under the Revolving Credit
Facility at March 31, 2016 was $3,044;
|
|
·
|
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.
|
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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. As of March 31, 2016, the Company’s
indebtedness under the Facility was $0.
As mentioned above, our Facility obligates
us to comply with certain financial covenants. They are as follows:
|
·
|
Leverage Ratio - The ratio of total net
debt to consolidated EBITDA must be less than 3.0 to 1.0; actual Leverage Ratio as of March 31, 2016: 0.00 to 1.0. Having
no debt outstanding at March 31, 2016 resulted in our ratio of 0.00 to 1.0.
|
|
·
|
Fixed Charge Coverage Ratio - The ratio
of consolidated EBITDA to consolidated net interest expense, plus principal payments on total debt, must be greater than 1.4 to
1.0; actual Fixed Charge Coverage Ratio as of March 31, 2016: 1.41 to 1.0.
|
|
·
|
Tangible Net Worth - Our consolidated
net worth, after deducting other assets as are properly classified as “intangible assets,” plus 50 percent of net income,
after provision for taxes, must be in excess of $16,700; actual Tangible Net Worth as of March 31, 2016: $23,183.
|
|
·
|
Moreover, we continue to have obligations
for other covenants, including, among others, limitations on issuance of common stock, liens, transactions with affiliates, additional
indebtedness and permitted investments.
|
As of March 31, 2016, we were in compliance
with all of our financial covenants.
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 total number of options permitted is 15 percent of issued and outstanding common shares.
Summary of Nonvested Shares of Restricted
Stock
For the three months ended March 31, 2016 and
2015, we recognized a total of $155 and $126, 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. There were no new stock grants during the three months ended March 31, 2016. The unamortized estimated fair value
of nonvested shares of restricted stock awards was $300 at March 31, 2016. These costs are expected to be recognized as expense
over a weighted average period of 1.15 years.
Summary of Stock Options
For the three months ended March 31, 2016 and
2015, we did not recognize any share-based compensation expense related to outstanding stock option awards. The unamortized portion
of the estimated fair value of non-vested stock options was
$0
at March 31, 2016.
NOTE 8: 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 March 31, 2016 and December 31, 2015 management
has recorded a full deferred tax asset valuation allowance.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
NOTE 9:
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 were $0 in LC’s outstanding at March 31, 2016 and December 31, 2015.
NOTE 10: 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. 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. Diluted EPS reflects the potential dilution that could
occur if options to purchase common stock were exercised for shares of common stock.
At March 31, 2016 and 2015, there were outstanding
stock options convertible to
0
and 325 shares of common stock, respectively, all of which were
anti-dilutive.