ITEM 1. FINANCIAL STATEMENTS
DEEP DOWN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except par value amounts)
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
Current assets:
|
|
June 30, 2014
|
|
|
December 31, 2013
|
|
Cash and cash equivalents
|
|
$
|
5,713
|
|
|
$
|
5,260
|
|
Accounts receivable, net of allowance of $535 and $1,006, respectively
|
|
|
7,436
|
|
|
|
4,979
|
|
Inventory, net
|
|
|
3,341
|
|
|
|
254
|
|
Costs and estimated earnings in excess of billings on uncompleted contracts
|
|
|
2,684
|
|
|
|
5,847
|
|
Prepaid expenses and other current assets
|
|
|
80
|
|
|
|
274
|
|
Total current assets
|
|
|
19,254
|
|
|
|
16,614
|
|
Property, plant and equipment, net
|
|
|
12,058
|
|
|
|
15,395
|
|
Investment in joint venture
|
|
|
468
|
|
|
|
468
|
|
Intangibles, net
|
|
|
85
|
|
|
|
119
|
|
Goodwill
|
|
|
4,916
|
|
|
|
4,916
|
|
Other assets
|
|
|
268
|
|
|
|
790
|
|
Total assets
|
|
$
|
37,049
|
|
|
$
|
38,302
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$
|
2,616
|
|
|
$
|
2,788
|
|
Billings in excess of costs and estimated earnings on uncompleted contracts
|
|
|
646
|
|
|
|
201
|
|
Current portion of long-term debt
|
|
|
942
|
|
|
|
1,716
|
|
Total current liabilities
|
|
|
4,204
|
|
|
|
4,705
|
|
Long-term debt, net
|
|
|
3,143
|
|
|
|
3,218
|
|
Total liabilities
|
|
|
7,347
|
|
|
|
7,923
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies (Note 10)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par value, 10,000 shares
authorized, 0 shares issued and outstanding
|
|
|
–
|
|
|
|
–
|
|
Common stock, $0.001 par value, 24,500 shares authorized, 15,131 and 15,261 shares issued and outstanding, respectively
|
|
|
15
|
|
|
|
15
|
|
Additional paid-in capital
|
|
|
72,274
|
|
|
|
72,142
|
|
Accumulated deficit
|
|
|
(42,587
|
)
|
|
|
(41,778
|
)
|
Total stockholders' equity
|
|
|
29,702
|
|
|
|
30,379
|
|
Total liabilities and stockholders' equity
|
|
$
|
37,049
|
|
|
$
|
38,302
|
|
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
DEEP DOWN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
(In thousands, except per share amounts)
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
5,847
|
|
|
$
|
9,156
|
|
|
$
|
12,010
|
|
|
$
|
15,314
|
|
Cost of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
3,778
|
|
|
|
5,284
|
|
|
|
7,325
|
|
|
|
8,929
|
|
Depreciation expense
|
|
|
356
|
|
|
|
352
|
|
|
|
723
|
|
|
|
699
|
|
Total cost of sales
|
|
|
4,134
|
|
|
|
5,636
|
|
|
|
8,048
|
|
|
|
9,628
|
|
Gross profit
|
|
|
1,713
|
|
|
|
3,520
|
|
|
|
3,962
|
|
|
|
5,686
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
2,803
|
|
|
|
2,366
|
|
|
|
4,940
|
|
|
|
4,229
|
|
Depreciation and amortization
|
|
|
40
|
|
|
|
33
|
|
|
|
83
|
|
|
|
65
|
|
Total operating expenses
|
|
|
2,843
|
|
|
|
2,399
|
|
|
|
5,023
|
|
|
|
4,294
|
|
Operating (loss) income
|
|
|
(1,130
|
)
|
|
|
1,121
|
|
|
|
(1,061
|
)
|
|
|
1,392
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
(48
|
)
|
|
|
(54
|
)
|
|
|
(109
|
)
|
|
|
(91
|
)
|
Equity in net income of joint venture
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
1
|
|
Other, net
|
|
|
(20
|
)
|
|
|
4
|
|
|
|
353
|
|
|
|
14
|
|
Total other income (expense)
|
|
|
(68
|
)
|
|
|
(50
|
)
|
|
|
244
|
|
|
|
(76
|
)
|
(Loss) income before income taxes
|
|
|
(1,198
|
)
|
|
|
1,071
|
|
|
|
(817
|
)
|
|
|
1,316
|
|
Income tax benefit (expense)
|
|
|
18
|
|
|
|
(49
|
)
|
|
|
9
|
|
|
|
(70
|
)
|
Net (loss) income
|
|
$
|
(1,180
|
)
|
|
$
|
1,022
|
|
|
$
|
(808
|
)
|
|
$
|
1,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.08
|
)
|
|
$
|
0.10
|
|
|
$
|
(0.05
|
)
|
|
$
|
0.12
|
|
Diluted
|
|
$
|
(0.08
|
)
|
|
$
|
0.10
|
|
|
$
|
(0.05
|
)
|
|
$
|
0.12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
15,215
|
|
|
|
10,324
|
|
|
|
15,227
|
|
|
|
10,238
|
|
Diluted
|
|
|
15,215
|
|
|
|
10,324
|
|
|
|
15,227
|
|
|
|
10,238
|
|
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
DEEP DOWN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS
(Unaudited)
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
(In thousands)
|
|
2014
|
|
|
2013
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(808
|
)
|
|
$
|
1,246
|
|
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
|
|
|
|
|
Equity in net income of joint venture
|
|
|
–
|
|
|
|
(1
|
)
|
Share-based compensation
|
|
|
435
|
|
|
|
275
|
|
Bad debt expense (credit)
|
|
|
3
|
|
|
|
(62
|
)
|
Depreciation and amortization
|
|
|
806
|
|
|
|
764
|
|
Gain on disposal of property, plant and equipment
|
|
|
(317
|
)
|
|
|
(8
|
)
|
Inventory obsolescence expense
|
|
|
68
|
|
|
|
–
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(2,638
|
)
|
|
|
454
|
|
Costs and estimated earnings in excess of billings on uncompleted contracts
|
|
|
3,163
|
|
|
|
(2,774
|
)
|
Prepaid expenses and other current assets
|
|
|
194
|
|
|
|
203
|
|
Other assets
|
|
|
126
|
|
|
|
13
|
|
Inventory
|
|
|
(38
|
)
|
|
|
(67
|
)
|
Accounts payable and accrued liabilities
|
|
|
(172
|
)
|
|
|
(980
|
)
|
Deferred revenues
|
|
|
–
|
|
|
|
(44
|
)
|
Billings in excess of costs and estimated earnings on uncompleted contracts
|
|
|
445
|
|
|
|
107
|
|
Net cash provided by (used in) operating activities
|
|
|
1,267
|
|
|
|
(874
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment
|
|
|
(665
|
)
|
|
|
(122
|
)
|
Proceeds from sale of property, plant and equipment
|
|
|
906
|
|
|
|
8
|
|
Cash paid for deposits
|
|
|
(47
|
)
|
|
|
(290
|
)
|
Repayments on notes receivable
|
|
|
4
|
|
|
|
3
|
|
Distribution from joint venture
|
|
|
–
|
|
|
|
500
|
|
Net cash provided by investing activities
|
|
|
198
|
|
|
|
99
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Cash paid for purchase of our common stock
|
|
|
(126
|
)
|
|
|
–
|
|
Proceeds from bank term loan
|
|
|
2,200
|
|
|
|
1,021
|
|
Cash paid for deferred financing costs
|
|
|
(37
|
)
|
|
|
(45
|
)
|
Repayments of long-term debt
|
|
|
(3,049
|
)
|
|
|
(618
|
)
|
Net cash (used in) provided by financing activities
|
|
|
(1,012
|
)
|
|
|
358
|
|
Change in cash and equivalents
|
|
|
453
|
|
|
|
(417
|
)
|
Cash and cash equivalents, beginning of period
|
|
|
5,260
|
|
|
|
1,523
|
|
Cash and cash equivalents, end of period
|
|
$
|
5,713
|
|
|
$
|
1,106
|
|
|
|
|
|
|
|
|
|
|
Supplemental schedule of significant noncash transactions:
|
|
|
|
|
|
|
|
|
Common stock surrendered by
employees related to payroll taxes on vested restricted stock awards
|
|
$
|
178
|
|
|
$
|
34
|
|
Reclassification of equipment
from property, plant and equipment to finished goods inventory
|
|
$
|
3,117
|
|
|
$
|
–
|
|
Reclassification of land and
buildings purchase price from deposits in other assets to property, plant and equipment
|
|
$
|
500
|
|
|
$
|
–
|
|
The accompanying notes are an integral part of the unaudited
condensed consolidated financial statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(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 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 notes 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 notes thereto, included in our Annual Report on
Form 10-K for the year ended December 31, 2013, filed on March 28, 2014 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 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.
Principles of Consolidation
The unaudited condensed consolidated financial
statements presented herein include the accounts of Deep Down, Inc. and its wholly-owned subsidiaries. All intercompany transactions
and balances have been eliminated.
Segments
For the six months ended June 30, 2014 and
2013, our operating segments have been aggregated into a single reporting segment.
Recently Adopted Accounting Standards
In July 2013, the FASB issued ASU No. 2013-11,
“Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit
Carryforward Exists”. The guidance states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit,
should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a
similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit
carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income
taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require
the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit
should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This guidance
is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, which would be our fiscal
year ended September 30, 2015. This guidance should be applied prospectively to all unrecognized tax benefits that exist at the
effective date. Retrospective application is permitted. The impacts that adoption of the ASU is expected to have on the Company’s
consolidated financial statements and related disclosures are being evaluated.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” 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.
This new standard is effective for us beginning in the year 2017. Early application is not permitted. 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.
NOTE 2: LIQUIDITY AND FINANCIAL CONDITION
Historically, we have supplemented the financing
of our capital needs primarily through debt and equity financings. Since 2008, we have maintained a credit facility with Whitney
Bank, a state chartered bank (“Whitney”); see additional discussion in Note 7, “Long-Term Debt”. During
the third quarter of 2013, we issued an additional 4,444 shares of common stock resulting in net cash proceeds of $7,628. As a
result of our credit facility, the private placement and cash we expect to generate from operations, we believe we will have adequate
liquidity to meet our future operating requirements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(In thousands except per share amounts)
NOTE 3: INVENTORY
The components of inventory are summarized
below:
|
|
June 30, 2014
|
|
|
December 31, 2013
|
|
Spare parts
|
|
$
|
205
|
|
|
$
|
209
|
|
Reserve for obsolescence
|
|
|
(68
|
)
|
|
|
–
|
|
Work in progress
|
|
|
87
|
|
|
|
45
|
|
Finished goods
|
|
|
3,117
|
|
|
|
–
|
|
Inventory, net
|
|
$
|
3,341
|
|
|
$
|
254
|
|
The finished goods inventory balance of $3,117
at June 30, 2014 consists of a 3.5 metric ton portable umbilical carousel which we fabricated and bought back from a customer in
November 2013.
NOTE 4: BILLINGS, COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED
CONTRACTS
The components of billings, costs and estimated earnings on uncompleted
contracts are summarized below:
|
|
June 30, 2014
|
|
|
December 31, 2013
|
|
Costs incurred on uncompleted contracts
|
|
$
|
4,165
|
|
|
$
|
14,496
|
|
Estimated earnings on uncompleted contracts
|
|
|
2,236
|
|
|
|
5,539
|
|
|
|
|
6,401
|
|
|
|
20,035
|
|
Less: Billings to date on uncompleted contracts
|
|
|
(4,363
|
)
|
|
|
(14,389
|
)
|
|
|
$
|
2,038
|
|
|
$
|
5,646
|
|
|
|
|
|
|
|
|
|
|
Included in the accompanying consolidated balance sheets
under the following captions:
|
|
|
|
|
|
|
|
|
Costs and estimated earnings in excess of billings on
uncompleted contracts
|
|
$
|
2,684
|
|
|
$
|
5,847
|
|
Billings in excess of costs and
estimated earnings on uncompleted contracts
|
|
|
(646
|
)
|
|
|
(201
|
)
|
|
|
$
|
2,038
|
|
|
$
|
5,646
|
|
The balances in costs and estimated earnings in excess
of billings on uncompleted contracts at June 30, 2014 and December 31, 2013 consisted primarily of earned but unbilled revenues
related to large fixed-price projects.
The balances in billings in excess of costs
and estimated earnings on uncompleted contracts at June 30, 2014 and December 31, 2013 consisted primarily of unearned billings
related to large fixed-price projects.
NOTE 5: INVESTMENT IN JOINT VENTURE
Effective December 31, 2010, we engaged in
a transaction in which all of the operating assets and substantially all of the liabilities of a former wholly-owned subsidiary,
Flotation Technologies, Inc. (“Flotation”) were contributed, along with other contributions we made, to a joint venture
entity named Cuming Flotation Technologies, LLC (“CFT”) in return for a 20 percent common unit ownership interest in
CFT.
On October 7, 2011, CFT consummated a transaction
pursuant to that certain Stock Purchase Agreement (the “Purchase Agreement”), by and between CFT and a Houston-based
company (“Buyer”) pursuant to which Buyer purchased from CFT (i) all of the issued and outstanding shares
of capital stock of Cuming Corporation (“Cuming”), the principal operating subsidiary of CFT, (ii) the shares of 230
Bodwell Corporation, a Massachusetts corporation and subsidiary of Cuming, and (iii) certain assets that, immediately prior to
closing, were acquired by Cuming, for a purchase price of $60,000 (less certain debt and subject to a purchase price adjustment
for working capital and potential earn-out payments). We are entitled to 20 percent of future potential earn-out proceeds
from the sale. Earn-out proceeds were $0 for the six months ended June 30, 2014 and 2013.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(In thousands except per share amounts)
The components of our Investment in joint venture are summarized
below:
Investment in joint venture, December 31, 2013
|
|
$
|
468
|
|
Equity in net income of CFT for the six months ended June 30, 2014
|
|
|
–
|
|
Investment in joint venture, June 30, 2014
|
|
$
|
468
|
|
NOTE 6: PROPERTY, PLANT AND EQUIPMENT
The components of net property, plant and equipment
are summarized below:
|
|
|
|
|
|
|
|
Range of
|
|
|
|
June 30, 2014
|
|
|
December 31, 2013
|
|
|
Asset Lives
|
|
Land
|
|
$
|
1,582
|
|
|
$
|
1,582
|
|
|
|
–
|
|
Buildings and improvements
|
|
|
1,571
|
|
|
|
1,571
|
|
|
|
7 - 36 years
|
|
Leasehold improvements
|
|
|
602
|
|
|
|
602
|
|
|
|
2 - 5 years
|
|
Equipment
|
|
|
13,745
|
|
|
|
17,840
|
|
|
|
2 - 30 years
|
|
Furniture, computers and office equipment
|
|
|
1,220
|
|
|
|
1,329
|
|
|
|
2 - 8 years
|
|
Construction in progress
|
|
|
1,326
|
|
|
|
189
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property, plant and equipment
|
|
|
20,046
|
|
|
|
23,113
|
|
|
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(7,988
|
)
|
|
|
(7,718
|
)
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
12,058
|
|
|
$
|
15,395
|
|
|
|
|
|
NOTE 7: LONG-TERM DEBT
Long-term debt consisted of the following:
|
|
June 30, 2014
|
|
|
December 31, 2013
|
|
Secured credit agreement - Whitney
|
|
$
|
4,002
|
|
|
$
|
1,917
|
|
Other debt
|
|
|
–
|
|
|
|
2,906
|
|
Capital lease obligations
|
|
|
83
|
|
|
|
111
|
|
Total long-term debt
|
|
|
4,085
|
|
|
|
4,934
|
|
Less: Current portion of long-term debt
|
|
|
(942
|
)
|
|
|
(1,716
|
)
|
Long-term debt, net of current portion
|
|
$
|
3,143
|
|
|
$
|
3,218
|
|
Whitney Credit Agreement
Since 2008, we have maintained a credit facility
(the “Facility”) with Whitney Bank, a state chartered bank (“Whitney”). The Facility has been amended
and restated several times, most recently effective April 15, 2014. The current relevant terms of the Facility include:
|
·
|
a committed amount under the revolving
credit facility (“Revolving Credit Facility”) of $5,000, at an interest rate of 3.5 percent per annum, maturing June
30, 2015;
|
|
·
|
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) starting at $8, beginning
April 1, 2013;
|
|
·
|
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;
and
|
|
·
|
outstanding
balances under the Facility are secured by all of the Company’s assets.
|
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(In thousands except per share amounts)
As of June 30, 2014, the Company’s indebtedness
under the Revolving Credit Facility, the RE Term Facility, and the Carousel Term Facility was $0, $1,867, and $2,135, respectively.
Our credit agreement with Whitney obligates
us to comply with the following financial covenants:
|
·
|
Leverage Ratio
- The ratio of total
debt to consolidated EBITDA must be less than 3.0 to 1.0; actual Leverage Ratio as of June 30, 2014: 29.6 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
1.5 to 1.0; actual Fixed Charge Coverage Ratio as of June 30, 2014: (0.1) 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 June 30, 2014: $24,701.
|
|
·
|
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.
|
On December 31, 2013, we were in
compliance with all of these financial covenants. However, at June 30, 2014, we were not in compliance with the Leverage
Ratio and Fixed Charge Coverage Ratio covenants. We have received a waiver from Whitney for this non-compliance
and
for the possible non-compliance with these covenants for the quarter ending September 30, 2014. In exchange for these
waivers, we are obligated to pay Whitney a $5 fee, and are required to maintain a minimum of $3,900 in our existing
interest-bearing account at Whitney. This requirement will continue until such time as we have regained compliance with these
covenants, which is projected to be December 31, 2014.
Other Debt
On November 5, 2013, we entered into a Purchase
and Sale Agreement (“PSA”) with a customer to buy back a 3.5 metric ton portable umbilical carousel, which we had fabricated
specifically for this customer. The PSA calls for purchase price of $3,293 to be paid in 24 monthly installments of approximately
$137, commencing November 5, 2013 through October 5, 2015. We used the proceeds of the Whitney Carousel Term Facility to retire
this obligation, and the balance at June 30, 2014 was $0.
NOTE 8: 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 vesting periods, net of estimated forfeitures. Effective April 1, 2014, we changed
our estimated forfeiture rate from 20 percent to 0 percent. Under the Plan, the total number of options permitted is 15 percent
of issued and outstanding common shares.
Summary of Shares of Restricted Stock
On May 1, 2014, we granted 30 shares of restricted
stock, with a grant date fair value of $1.77 per share, to a newly-appointed director, who is not an employee of the Company or
any of its affiliates. The restrictions on these service-based shares of restricted stock, issued during the six months ended June
30, 2014, will lapse with respect to one-third of the shares on each of the first, second and third anniversaries of the effective
date of grant.
During the six months ended June 30, 2014 and
2013, we recognized a total of $366 and $198, respectively, of share-based compensation expense related to restricted stock awards,
which is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.
The unamortized portion of the estimated fair value of restricted stock awards was $1,002 at June 30, 2014.
Summary of Stock Options
For the six months ended June 30, 2014 and
2013, we recognized a total of $69 and $77, respectively, of share-based compensation expense related to outstanding stock option
awards, which is included in selling, general and administrative expenses in the accompanying condensed consolidated statements
of operations. The unamortized portion of the estimated fair value of non-vested stock options was $0 at June 30, 2014.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(In thousands except per share amounts)
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 June 30, 2014 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 in the normal course of business. As of the date of this Report, we were not involved in any material actual
or pending legal proceedings.
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 $415 in LC’s outstanding at June 30, 2014 and December 31, 2013.
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. Diluted
EPS is calculated by dividing net income (loss) by the weighted-average number of common shares and dilutive common stock equivalents
(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 June 30, 2014 and 2013, there
were outstanding stock options convertible to 325 and 945 shares of common stock, respectively. There were no dilutive
securities included in the computation of diluted earnings per share for the six months ended June 30, 2013 and 2014 because
their inclusion would be anti-dilutive.
NOTE 12: STOCKHOLDERS’ EQUITY
Common Stock
The number of shares of common stock outstanding
is as follows:
Balance, December 31, 2013
|
|
|
15,261
|
|
Shares purchased and retired February 28, 2014
|
|
|
(66
|
)
|
Restricted stock award issued May 1, 2014
|
|
|
30
|
|
Shares surrendered and retired June 30, 2014
|
|
|
(94
|
)
|
Balance, June 30, 2014
|
|
|
15,131
|
|
ITEM 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides
information that management believes is relevant for an assessment and understanding of our results of operations and financial
condition. This information should be read in conjunction with our audited historical consolidated financial statements, which
are included in our Form 10-K for the fiscal year ended December 31, 2013, filed with the Securities and Exchange Commission on
March 28, 2014 and our unaudited condensed consolidated financial statements, and notes thereto, included with this Quarterly Report
on Form 10-Q (“Report”) in Part I. Item 1. “Financial Statements.”
General
We are an oilfield services company specializing
in complex deepwater and ultra-deepwater oil production distribution system support services, serving the worldwide offshore exploration
and production industry. Our services and technological solutions include distribution system installation support and engineering
services, umbilical terminations, loose-tube steel flying leads, buoyancy products and services, remotely operated vehicles (“ROVs”)
and toolings. We support subsea engineering, installation, commissioning, and maintenance projects through specialized, highly
experienced service teams and engineered technological solutions. Our primary focus is on more complex deepwater and ultra-deepwater
oil production distribution system support services and technologies, used between the platform and the wellhead.
In Part I. Item 2 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” all dollar and share amounts are in thousands
of dollars and shares, unless otherwise indicated.
Industry and Executive Outlook
The outlook for deepwater and ultra-deepwater
drilling and production continues to be very strong. The Gulf of Mexico (“GOM”) is beginning to strengthen, and as
a result, our business is increasing. Our clients in West Africa and Central America are planning significant expansion programs
to aging fields and are relying on Deep Down’s innovative services and operational flexibility to accommodate their needs
during a period that may be difficult for larger manufacturers to produce.
Recently it has become evident we needed a
locally-based entity in Central America to manage, stage, and execute projects in the Central and South American region. Deep Down
International, SA was established in Panama with the intent to have a staging shop and office. Prior to commencing the build-out
in Panama, several opportunities have presented themselves in the GOM, not yet finalized, but will require all the resources which
were slated for the Panama operation. Due to the value of the opportunities, and the low cost of the diversion, it was decided
to postpone any further development of the Panama operation in lieu of opportunities at the Hwy 90 and Channelview facilities.
Currently, we are working on a recovery project
with an installation contractor to recover, re-configure and re-install equipment at a new location using our patented mobile NHU®
(non-helical umbilical) process and compliant splices. This process helps our customers save substantial time and cost. We have
several jobs pending.
Additionally, we have received recent requests
to refurbish, store and maintain large equipment at our new facility of approximately 20 acres on Hwy 90 in Houston, Texas. This
service is gaining ground and we are slowly expanding the equipment on site to be refurbished and re-configured.
Our backlog was approximately $28,500 at July 31, 2014 and our focus remains on successful execution of our
projects, obtaining new project awards and effective cash management.
Results of Operations
Three Months Ended June 30, 2014 Compared
to Three Months Ended June 30, 2013
Revenues.
Revenues for the three months
ended June 30, 2014 were $5,847. Revenues for the three months ended June 30, 2013 were $9,156. The $3,309 decrease (36 percent)
is the result of the 2013 period being unusually high. Additionally, projects valued in excess of $17,000 were delayed during the
three months ended June 30, 2014, resulting in lower revenues of approximately $7,000.
Gross Profit.
Gross profit for the
three months ended June 30, 2014 was $1,713, or 29 percent of revenues. Gross profit for the three months ended June
30, 2013 was $3,520, or 38 percent of revenues. The nine percentage point decrease in gross profit was due primarily to the
delay of several lump sum projects mentioned above. The delay of these certain projects negatively impacted the gross margin
by approximately $2,600.
Selling, general and administrative expenses.
Selling, general and administrative expenses (“SG&A”) for the three months ended June 30, 2014 was $2,803,
or 48 percent of revenues. SG&A for the three months ended June 30, 2013 was $2,366, or 26 percent of revenues. The $437
increase in SG&A is due primarily to quality, project management, engineering, shop improvements related to safety systems,
increased security costs and an increase in bad debt expense.
A significant portion of the increase was due
to the impact of the decision to delay a Latin America regional operation in Panama, which included a $192 accrual of all related
costs, and an increase in security costs at the new facility of $98.
Modified EBITDA
. Our management evaluates
our performance based on a non-GAAP measure which consists of earnings (net income or loss) available to common shareholders before
net interest expense, income taxes, non-cash share-based compensation expense, equity in net income or loss of joint venture, non-cash
impairments, depreciation and amortization, other non-cash items and one-time charges (“Modified EBITDA”). This
measure may not be comparable to similarly titled measures employed by other companies and is not a measure of performance calculated
in accordance with US GAAP. The measure should not be considered in isolation or as a substitute for operating income or loss,
net income or loss, cash flows provided by operating, investing or financing activities, or other cash flow data prepared in accordance
with US GAAP. The amounts included in the Modified EBITDA calculation, however, are derived from amounts included in the accompanying
condensed consolidated statements of operations.
We believe Modified EBITDA is useful to investors
in evaluating our operating performance because it is widely used to measure a company’s operating performance, which can
vary substantially from company to company depending upon accounting methods and book value of assets, financing methods, capital
structure and the method by which assets were acquired. It helps investors more meaningfully evaluate and compare the results of
our operations from period to period by removing the impact of our capital structure (primarily interest); asset base (primarily
depreciation and amortization); actions that do not affect liquidity (share-based compensation expense, equity in net income or
loss of joint venture) from our operating results; and it helps investors identify items that are within our operational control.
Depreciation and amortization charges, while a component of operating income, are fixed at the time of the asset purchase or acquisition
in accordance with the depreciable lives of the related asset and as such are not a directly controllable period operating charge.
The following is a reconciliation of net (loss)
income to Modified EBITDA for the three months ended June 30, 2014 and 2013:
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
|
2014
|
|
|
2013
|
|
Net (loss) income
|
|
$
|
(1,180
|
)
|
|
$
|
1,022
|
|
Add back interest expense, net of interest income
|
|
|
48
|
|
|
|
54
|
|
Add back depreciation and amortization
|
|
|
396
|
|
|
|
385
|
|
(Deduct) add back income tax (benefit) expense
|
|
|
(18
|
)
|
|
|
49
|
|
Add back Panama exit costs accrual
|
|
|
192
|
|
|
|
–
|
|
Add back share-based compensation
|
|
|
300
|
|
|
|
235
|
|
Modified EBITDA
|
|
$
|
(262
|
)
|
|
$
|
1,745
|
|
Modified EBITDA for the three months ended
June 30, 2014 was $(262). Modified EBITDA for the three months ended June 30, 2013 was $1,745. Modified EBITDA decreased $2,007
primarily due to decreased gross profit before depreciation expense of $1,803. Additionally, SG&A before Panama exit costs and share-based compensation expense increased
$180.
Six Months Ended June 30, 2014 Compared
to Six Months Ended June 30, 2013
Revenues.
Revenues for the six months
ended June 30, 2014 were $12,010. Revenues for the six months ended June 30, 2013 were $15,314. The $3,304 decrease (22 percent)
is the result of the first quarter of 2013 being unusually high. Additionally, projects valued in excess of $17,000 were delayed
during the six months ended June 30, 2014, resulting in lower revenues of approximately $7,000.
Gross Profit.
Gross profit for the six
months ended June 30, 2014 was $3,962, or 33 percent of revenues. Gross profit for the six months ended June 30, 2013 was
$5,686, or 37 percent of revenues. The four percentage point decrease in gross profit was due primarily to the delay of several
lump sum projects just discussed. The delay of these projects negatively impacted the gross margin by approximately $2,600.
Selling, general and administrative expenses.
Selling, general and administrative expenses (“SG&A”) for the six months ended June 30, 2014 was $4,940, or
41 percent of revenues. SG&A for the six months ended June 30, 2013 was $4,229, or 28 percent of revenues. The $711 increase
in SG&A is due primarily to quality, project management, engineering, shop improvements related to safety systems, increased
security costs and an increase in share-based compensation and legal expense.
A significant portion of the increase was due
to the decision to delay a Latin America regional operation in Panama, which included a $192 accrual of all related costs, the
increase in security costs at the new facility of $205 and increases in share-based compensation and legal expense of $160 and
$148, respectively.
Other income (expense).
The 2014 period
includes gain on the sale of property, plant and equipment of $317.
Modified EBITDA
. As noted above, our
management evaluates our performance based on Modified EBITDA. This measure may not be comparable to similarly titled
measures employed by other companies and is not a measure of performance calculated in accordance with US GAAP. The measure should
not be considered in isolation or as a substitute for operating income or loss, net income or loss, cash flows provided by operating,
investing or financing activities, or other cash flow data prepared in accordance with US GAAP. The amounts included in the Modified
EBITDA calculation, however, are derived from amounts included in the accompanying condensed consolidated statements of operations.
We believe Modified EBITDA is useful to investors
in evaluating our operating performance because it is widely used to measure a company’s operating performance, which can
vary substantially from company to company depending upon accounting methods and book value of assets, financing methods, capital
structure and the method by which assets were acquired. It helps investors more meaningfully evaluate and compare the results of
our operations from period to period by removing the impact of our capital structure (primarily interest); asset base (primarily
depreciation and amortization); actions that do not affect liquidity (share-based compensation expense, equity in net income or
loss of joint venture) from our operating results; and it helps investors identify items that are within our operational control.
Depreciation and amortization charges, while a component of operating income, are fixed at the time of the asset purchase or acquisition
in accordance with the depreciable lives of the related asset and as such are not a directly controllable period operating charge.
The following is a reconciliation of net (loss)
income to Modified EBITDA for the six months ended June 30, 2014 and 2013:
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2014
|
|
|
2013
|
|
Net (loss) income
|
|
$
|
(808
|
)
|
|
$
|
1,246
|
|
Add back interest expense, net of interest income
|
|
|
109
|
|
|
|
91
|
|
Add back depreciation and amortization
|
|
|
806
|
|
|
|
764
|
|
(Deduct) add back income tax (benefit) expense
|
|
|
(9
|
)
|
|
|
70
|
|
Add back Panama exit costs accrual
|
|
|
192
|
|
|
|
–
|
|
Add back share-based compensation
|
|
|
435
|
|
|
|
275
|
|
Deduct equity in net income of joint venture
|
|
|
–
|
|
|
|
(1
|
)
|
Modified EBITDA
|
|
$
|
725
|
|
|
$
|
2,445
|
|
Modified EBITDA for the six months ended June
30, 2014 was $725. Modified EBITDA for the six months ended June 30, 2013 was $2,445. Modified EBITDA decreased $1,720 primarily
due to decreased gross profit before depreciation expense of $1,700. Additionally, SG&A before Panama exit costs and share-based compensation expense increased
$360. Offsetting these items was a $339 increase
in other income due primarily to gain on the sale of property, plant and equipment of $317 in the 2014 period.
Liquidity and Capital Resources
Overview
Historically, we have supplemented the financing
of our capital needs primarily through debt and equity financings.
Credit Facility
Since 2008, we have maintained a credit facility
(the “Facility”) with Whitney Bank, a state chartered bank (“Whitney”). The Facility has been amended and
restated several times, most recently effective April 15, 2014. The current relevant terms of the Facility include:
|
·
|
a committed amount under the revolving
credit facility (“Revolving Credit Facility”) of $5,000, at an interest rate of 3.5 percent per annum, maturing June
30, 2015;
|
|
·
|
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) starting at $8, beginning
April 1, 2013;
|
|
·
|
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 repayment of principal of $65 (along with accrued and unpaid interest thereon) beginning July 1, 2014;
and
|
|
·
|
outstanding balances under the Facility
are secured by all of the Company’s assets.
|
As of June 30, 2014, the Company’s indebtedness
under the Revolving Credit Facility, the RE Term Facility, and the Carousel Term Facility was $0, $1,867, and $2,135, respectively.
Our credit agreement with Whitney obligates
us to comply with the following financial covenants:
|
·
|
Leverage Ratio
- The ratio of total
debt to consolidated EBITDA must be less than 3.0 to 1.0; actual Leverage Ratio as of June 30, 2014: 29.6 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
1.5 to 1.0; actual Fixed Charge Coverage Ratio as of June 30, 2014: (0.1) 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 June 30, 2014: $24,701.
|
|
·
|
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.
|
On December 31, 2013, we were in
compliance with all of these financial covenants. However, at June 30, 2014, we were not in compliance with the Leverage
Ratio and Fixed Charge Coverage Ratio covenants. We have received a waiver from Whitney for this non-compliance
and
for the possible non-compliance with these covenants for the quarter ending September 30, 2014. In exchange for these
waivers, we are obligated to pay Whitney a $5 fee, and are required to maintain a minimum of $3,900 in our existing
interest-bearing account at Whitney. This requirement will continue until such time as we have regained compliance with these
covenants, which is projected to be December 31, 2014.
Other Debt
On November 5, 2013, we entered into a
Purchase and Sale Agreement (“PSA”) with a customer to buy back a 3.5 metric ton portable umbilical carousel,
which we had fabricated specifically for this customer. The PSA calls for purchase price of $3,293 to be paid in 24 monthly
installments of approximately $137, commencing November 5, 2013 through October 5, 2015. We used the proceeds of the
Whitney Carousel Term Facility to retire this obligation, and the balance at June 30, 2014 was $0.
Private Placement
During the third quarter of 2013, we issued
an additional 4,444 shares of common stock in a private placement resulting in net cash proceeds of $7,628.
As a result of the Credit Facility, the private
placement and cash we expect to generate from operations, we believe we will have adequate liquidity to meet our future operating
requirements.
Inflation and Seasonality
We do not believe that our operations are significantly
impacted by inflation. Our business is not significantly seasonal in nature.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that
have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues
or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Critical Accounting Estimates
The discussion and analysis of our financial
condition and results of operations is based on our unaudited condensed consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements
in accordance with US GAAP requires us to make estimates and judgments that may affect assets and liabilities. On an on-going basis,
we evaluate our estimates, including those related to revenue recognition and related allowances, costs and estimated earnings
incurred in excess of billings on uncompleted contracts, impairments of long-lived assets, including intangibles and goodwill,
income taxes including the valuation allowance for deferred tax assets, billings in excess of costs and estimated earnings on uncompleted
contracts, contingencies and litigation, and share-based payments. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying
values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.
Refer to Part II. Item 2 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year
ended December 31, 2013 for a discussion of our Critical Accounting Policies.
Recently Issued Accounting Standards
Management believes that recently issued accounting standards, which
are not yet effective, will not have a material impact on our condensed consolidated financial statements upon adoption.