These consolidated financial statements
are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated
financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight
Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the
U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with
the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required
to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are
required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion
on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures
to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing
procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures
in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates
made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our
audits provide a reasonable basis for our opinion.
The accompanying notes are an integral part
of the consolidated financial statements.
The accompanying notes are an integral part
of the consolidated financial statements.
The accompanying notes are an integral part
of the consolidated financial statements.
The accompanying notes are an integral
part of the consolidated financial statements.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar and share amounts in the
Notes to the Financial Statements are in thousands of dollars and shares, unless otherwise indicated, except per share amounts.
NOTE 1: DESCRIPTION OF BUSINESS
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Description of Business
Deep Down, Inc., a Nevada corporation
(“Deep Down Nevada”), and its directly wholly-owned subsidiary, Deep Down, Inc., a Delaware corporation (“Deep
Down Delaware”); (collectively referred to as “Deep Down”, “we”, “us” or the “Company”),
is 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, flotation
and Remote Operated Vehicles (“ROVs”) and related services. We support subsea engineering, installation, commissioning,
and maintenance projects through specialized, highly experienced service teams and engineered technological solutions. Deep Down’s
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.
Liquidity
As a deepwater service provider, our revenues,
profitability, cash flows, and future rate of growth are generally dependent on the condition of the global oil and gas industry,
and our customers’ ability to invest capital for offshore exploration, drilling and production and maintain or increase levels
of expenditures for maintenance of offshore drilling and production facilities. Oil and gas prices and the level of offshore drilling
and production activity have historically been characterized by significant volatility. At times we enter into large, fixed-price
contracts which may require significant lead time and investment. A decline in offshore drilling and production activity could
result in lower contract volume or delays in significant contracts which could negatively impact our earnings and cash flows. Our
earnings and cash flows could also be negatively affected by delays in payments by significant customers or delays in completion
of our contracts for any reason. While our objective is to enter into contracts with our customers that are cash flow positive,
we may not always be able to achieve this objective. We are dependent on our cash flows from operations to fund our working capital
requirements and the uncertainties noted above create risks that we may not achieve our planned earnings or cash flow from operations,
which may require us to raise additional debt or equity capital. There can be no assurance that we could raise additional debt
or equity capital.
During the fiscal years ended December
31, 2018 and 2017, we financed our capital needs through cash on hand and opportunistic sales of property, plant and equipment.
As of December 31, 2018, our working capital was $7,026 compared to $8,202 as of December 31, 2017.
Summary of Significant Accounting Policies
and Estimates
Principles of Consolidation
The consolidated financial statements include
the accounts of Deep Down and its wholly-owned subsidiaries for the years ended December 31, 2018 and 2017. All intercompany transactions
and balances have been eliminated.
Use of Estimates
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, contract assets and liabilities,
impairments of long-lived assets, including intangibles, income taxes including the valuation allowance for deferred tax assets,
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.
Segments
For the years ended December 31, 2018 and
2017, we only had one operating and reporting segment, Deep Down Delaware.
Cash and Cash Equivalents
We consider all highly liquid investments
with maturities from date of purchase of three months or less to be cash equivalents. Cash and cash equivalents consist of cash
on deposit with domestic banks and, at times, may exceed federally insured limits.
Fair Value of Financial Instruments
Fair value is defined as the exchange price
that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market
for the asset or liability in an orderly transaction between market participants on the measurement date. We utilize
a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring
fair value. The fair value hierarchy has three levels of inputs that may be used to measure fair value:
Level 1 - Unadjusted quoted prices in active markets
that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2 - Quoted prices in markets that are not active;
or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability.
Level 3 - Prices or valuation techniques that require
inputs that are both significant to the fair value measurement and unobservable.
Our financial instruments consist
primarily of cash, accounts receivables and payables, and notes receivable (included in other assets). The carrying values of cash,
accounts receivables and payables approximated their fair values at December 31, 2018 and 2017 due to their short-term
maturities. The carrying values of our notes receivable approximate their fair values at December 31, 2018 and 2017 because
the interest rates approximate current market rates.
Accounts Receivable
Accounts receivable are uncollateralized
customer obligations due under normal trade terms. We provide an allowance for doubtful accounts receivable based on a specific
review of each customer’s accounts receivable balance with respect to their ability to make payments. Generally, we do not charge
interest on past due accounts. When specific accounts are determined to require an allowance, they are expensed by a provision
for bad debts in that period. At December 31, 2018 and 2017, we estimated the allowance for doubtful accounts requirement
to be $10. Bad debt expense (credit) totaled $67 and $(22) for the years ended December 31, 2018 and 2017, respectively.
Concentration of Revenues and Credit
Risk
For the year ended December 31, 2018, our five largest
customers accounted for 33 percent, 15 percent, 15 percent, 11 percent and 11 percent of total revenues. For the year ended
December 31, 2017, our five largest customers accounted for 61 percent, 11 percent, 10 percent, 3 percent and 3 percent of
total revenues. The loss of one or more of these customers could have a material impact on our results of operations and cash
flows.
As of December 31, 2018, three of our customers
accounted for 50 percent, 26 percent and 10 percent of total accounts receivable. As of December 31, 2017, three of our customers
accounted for 37 percent, 17 percent and 12 percent of total accounts receivable.
Property Plant and Equipment
Property, plant and equipment (“PP&E”)
is stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line
method over the estimated useful lives of the respective assets. Replacements and betterments are capitalized, while maintenance
and repairs are expensed as incurred. It is our policy to include amortization expense on assets acquired under capital leases
with depreciation expense on owned assets. Additionally, we record depreciation and amortization expense related to revenue-generating
assets as a component of cost of sales in the accompanying consolidated statements of operations.
If circumstances associated with our PP&E
have changed or a significant event has occurred that may affect the recoverability of the carrying amount of our PP&E,
an impairment indicator exists and we test the PP&E for impairment. Before testing for impairment, we group PP&E with other
finite-lived long-lived assets (“long lived assets”) at the lowest level of identifiable cash flows that are largely
independent of cash flows from other assets or groups of assets. Testing long-lived assets for impairment is a two-step process:
Step 1 - We test the long-lived
asset or asset group for recoverability by comparing the carrying amount of the asset or asset group with the sum of the undiscounted
future cash flows from use and the eventual disposal of the asset or asset group. If the carrying amount of the long-lived asset
or asset group is determined to be greater than the sum of the undiscounted future cash flows from use and disposal, we would need
to perform step 2.
Step 2 - If the long-lived asset
or group of assets fails the recoverability test in step 1, we would record an impairment expense for the difference between the
carrying amount and the fair value of the long-lived asset or asset group.
After considering the recent volatility
in oil prices, our performance over the past few years, and strategic focus on our core business going forward, we conducted an
evaluation of the carrying amount of certain of our long-lived assets. As a result of this evaluation, we recorded impairment charges
in an aggregate amount of $2,320, of which $1,890 is reported as asset impairment and $430 as depreciation expense in cost of sales
in the consolidated statements of operations related to construction in progress and certain equipment.
Additionally, we tested remaining long-lived
assets for impairment but determined no additional impairment.
Equity Method Investments
Equity method investments in joint ventures
are reported as investments in joint venture on the consolidated balance sheets, and our share of earnings or losses in the joint
venture is reported as equity in net income or loss of joint venture in the consolidated statements of operations. We currently
have no remaining investments in joint ventures.
Lease Obligations
We lease land, buildings, vehicles
and certain equipment under non-cancellable operating leases. Deep Down Delaware leases indoor manufacturing
space and leases office, warehouse and operating space in Houston, Texas, under non-cancellable operating leases.
Additionally, we lease space in Mobile, Alabama to house our 3,400 ton carousel system. We also lease certain office and
other operating equipment under capital leases; the related assets are included with property, plant and equipment on the
consolidated balance sheets.
At the inception of a lease, we evaluate
the agreement to determine whether the lease will be accounted for as an operating or capital lease. The term of the lease used
for such an evaluation includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably
assured and failure to exercise such option would result in an economic penalty.
Revenue Recognition
On January 1, 2018, we adopted ASC Topic
606 (“ASC 606”) using the modified retrospective method applied to those contracts which were not completed as of January
1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts
are not adjusted and continue to be reported in accordance with our historic accounting under ASC Topic 605, Revenue Recognition.
See further discussion in Note 2.
Income Taxes
We follow the asset and liability method
of accounting for income taxes. This method takes into account the differences between financial statement treatment and tax treatment
of certain transactions. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect of a change in tax rates is recognized as income or expense in the period that
includes the enactment date.
We record a valuation allowance to reduce
the carrying value of our deferred tax assets when it is more likely than not that some or all of the deferred tax assets will
expire before realization of the benefit or that future deductibility is not probable. The ultimate realization of the deferred
tax assets depends upon our ability to generate sufficient taxable income of the appropriate character in the future. This requires
management to use estimates and make assumptions regarding significant future events such as the taxability of entities operating
in the various taxing jurisdictions. In evaluating our ability to recover our deferred tax assets, we consider all reasonably available
positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent years
and our forecast of future taxable income. In estimating future taxable income, we develop assumptions, including the amount of
future state, and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and
prudent tax planning strategies. These assumptions require significant judgment. When the likelihood of the realization of existing
deferred tax assets changes, adjustments to the valuation allowance are charged in the period in which the determination is made,
either to income or goodwill, depending upon when that portion of the valuation allowance was originally created.
We record an estimated tax liability or
tax benefit for income and other taxes based on what we determine will likely be paid in the various tax jurisdictions in which
we operate. We use our best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid
are dependent upon various matters, including resolution of tax audits, and may differ from amounts recorded. An adjustment to
the estimated liability would be recorded as a provision or benefit to income tax expense in the period in which it becomes probable
that the amount of the actual liability or benefit differs from the recorded amount.
Our future effective tax rates could be
adversely affected by changes in the valuation of our deferred tax assets or liabilities or changes in tax laws or interpretations
thereof. If and when our deferred tax assets are no longer fully reserved, we will begin to provide for taxes at the full statutory
rate. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities.
We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision
for income taxes.
Share-Based Compensation
We record share-based awards exchanged
for employee service at fair value on the date of grant and expense the awards in the consolidated statements of operations over
the requisite employee service period. Share-based compensation expense includes an estimate for forfeitures and is
generally recognized over the expected term of the award on a straight-line basis. At December 31, 2018 and 2017, we
had one type of share-based employee compensation: restricted stock.
Earnings or Loss per Common Share
Basic earnings or loss per common share
(“EPS”) is calculated by dividing net earnings or loss by the weighted average number of common shares outstanding
for the period. Diluted EPS is calculated by dividing net earnings or 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 stock options and warrants to purchase common stock were exercised for shares of common stock. In periods where
losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their
inclusion would be anti-dilutive.
Recently Issued Accounting Standards
In February 2016, the Financial Accounting
Standards Board (“FASB”) issued ASU 2016-02, Leases (“ASC Topic 842”). Under this guidance, lessees are
required to recognize on the balance sheet a lease liability and a right-of-use asset for all leases, with the exception of short-term
leases with terms of twelve months or less. The lease liability represents the lessee’s obligation to make lease payments
arising from a lease, and will be measured as the present value of the lease payments. The right-of-use asset represents the lessee’s
right to use a specified asset for the lease term, and will be measured at the lease liability amount, adjusted for lease prepayment,
lease incentives received and the lessee’s initial direct costs.
The new guidance is effective for fiscal
years beginning after December 15, 2018. The Company adopted this guidance in the first quarter of 2019 using the optional transition
method (ASU 2018-11). Consequently, the Company's reporting for the comparative periods presented in the financial statements will
continue to be in accordance with ASC Topic 840, Leases. The Company has substantially completed its evaluation of the impact on
the Company’s lease portfolio.The adoption of this guidance will result in the addition of right-of-use assets and corresponding
lease obligations to the consolidated balance sheet and will not have a material impact on the Company’s results of operations
or cash flows.
ASC Topic 842 provides for certain practical
expedients when adopting the guidance. The Company plans to elect the package of practical expedients allowing the Company, for
all leases that commenced prior to the adoption date, to not reassess whether any expired or existing contracts are, or contain,
leases, the lease classification for any expired or existing leases or initial direct costs for any expired or existing leases.
The Company plans to apply the land easements practical expedient allowing the Company to not assess whether
any expired or existing land easements are, or contain, leases if they were not previously accounted for as leases under the existing
leasing guidance. Instead, the Company will continue to apply its existing accounting policies to historical land easements. The
Company elects to apply the short-term lease exception, therefore the Company will not record a right-of-use asset or corresponding
lease liability for leases with an initial term of twelve months or less that are not reasonably certain of being renewed, and
instead recognize a single lease cost allocated over the lease term, generally on a straight-line basis. The Company plans to elect
the practical expedient to not separate lease components from non-lease components and instead account for both as a single lease
component for all asset classes.
The Company plans to elect to not capitalize
any lease in which the estimated value of the underlying asset at commencement date is less than the company’s capitalization
threshold. A lease would need to qualify for the low value exception based on various criteria.
As part of our assessment, we formed an
implementation work team, conducted training for the relevant staff regarding the potential impacts of ASC Topic 842 and have substantially
concluded our contract analyses and policy review. We engaged external resources to assist us in our efforts of completing the
analysis of potential changes to current accounting practices and are in the process of implementing a new lease accounting system
in connection with the adoption of the updated guidance. We also evaluated the impact of ASC Topic 842 on our internal control
over financial reporting and other changes in business practices and processes. The Company is in the process of finalizing its
catalog of existing lease contracts and implementing changes to its systems.
Upon adoption, the Company expects to record
operating lease right-of-use assets in the range of approximately $4,700 to $5,100, representing the present value of future lease
payments under operating leases with terms of greater than twelve months. The Company is continuing to evaluate the impact the
pronouncement will have on the related disclosures.
NOTE 2: REVENUES: ADOPTION OF ASC 606,
“REVENUE FROM CONTRACTS WITH CUSTOMERS”
On January 1, 2018, we adopted ASC 606
using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for
reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and
continue to be reported in accordance with our historic accounting under ASC Topic 605, Revenue Recognition.
There was no significant impact upon the
adoption of ASC 606. We did not record any adjustments to opening retained earnings as of January 1, 2018 because the Company’s
revenue recognition methodologies for both fixed price contracts (over time using cost to cost as an input measure of performance)
and for service contracts (over time as services are incurred) do not materially change by the adoption of the new standard. Revenues
are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration
we expect to be entitled to in exchange for those goods or services.
To determine the proper revenue recognition
method for our customer contracts, we evaluate whether two or more contracts should be combined and accounted for as one single
contract and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation
requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into
multiple performance obligations could change the amount of revenue and profit recorded in a given period.
For most of our fixed price contracts,
the customer contracts with us to provide a significant service of integrating a complex set of tasks and components into a single
project or capability (even if that single project results in the delivery of multiple units). Hence, the entire contract is accounted
for as one performance obligation. We account for a contract when it has approval and commitment from both parties, the rights
of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration
is probable.
Disaggregation of Revenue
The following table presents our revenues disaggregated by fixed
price and service contracts. Sales taxes are excluded from revenues.
Year Ended
|
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
|
Fixed Price Contracts
|
|
$
|
7,693
|
|
|
$
|
6,599
|
|
|
Service Contracts
|
|
|
8,482
|
|
|
|
12,879
|
|
|
Total
|
|
$
|
16,175
|
|
|
$
|
19,478
|
|
Fixed price contracts
For fixed price contracts, we generally
recognize revenue over time as we perform because of continuous transfer of control to the customer. This continuous transfer of
control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract
for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. Additionally, in other
fixed price contracts, the customer typically controls the work in process as evidenced either by contractual termination clauses
or by our rights to payment for work performed to date plus a reasonable profit to deliver products or services that do not have
an alternative use to the Company.
Because of control transferring over time,
revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method
to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided.
We generally use the cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the
customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, the extent of progress towards
completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance
obligation. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred.
Contracts are often modified to account
for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either
creates new, or changes the existing, enforceable rights and obligations. Most of our contract modifications are for goods or services
that are not distinct from the existing contract due to the significant integration service provided in the context of the contract
and are accounted for as if they were part of that existing contract. The effect of a contract modification on the transaction
price, and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue
(either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
We have a company-wide standard and disciplined
quarterly estimate at completion process in which management reviews the progress and execution of our performance obligations.
As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress
towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of
revenues and costs. Changes in estimates of net sales, cost of sales and the related impact to operating income are recognized
quarterly on a cumulative catch-up basis, which recognizes in the current period the cumulative effect of the changes on current
and prior periods based on a performance obligation’s percentage of completion. A significant change in one or more of these
estimates could affect the profitability of one or more of our performance obligations. When estimates of total costs to be incurred
exceed total estimates of revenue to be earned on a performance obligation related to fixed price contracts, a provision for the
entire loss on the performance obligation is recognized in the period the loss is estimated.
Service Contracts
We recognize revenue for service contracts
measuring progress toward satisfying the performance obligation in a manner that best depicts the transfer of goods or services
to the customer. The control over services is transferred over time when the services are rendered to the customer on a daily basis.
Specifically, we recognize revenue as the services are provided as we have the right to invoice the customer for the services performed.
Services are billed and paid on a monthly basis. Payment terms for services are usually 30 days from invoice receipt.
Contract balances
Costs and estimated earnings in excess
of billings on uncompleted contracts arise when revenues are recorded on a percentage-of-completion basis but cannot be invoiced
under the terms of the contract. Such amounts are invoiced upon completion of contractual milestones. Billings in excess of costs
and estimated earnings on uncompleted contracts arise when milestone billings are permissible under the contract, but the related
costs have not yet been incurred. All contract costs are recognized currently on jobs formally approved by the customer and contracts
are not shown as complete until virtually all anticipated costs have been incurred and the risk of loss has passed to the customer.
Assets related to costs and estimated earnings
in excess of billings on uncompleted contracts, as well as liabilities related to billings in excess of costs and estimated earnings
on uncompleted contracts, have been classified as current. The contract cycle for certain long-term contracts may extend beyond
one year, thus complete collection of amounts related to these contracts may extend beyond one year, though such long-term contracts
include contractual milestone billings as discussed above. As of December 31, 2018, we had no contracts whose term extended beyond
one year.
The following table summarizes our contract
assets, which are “Costs and estimated earnings in excess of billings on uncompleted contracts” and our contract liabilities,
which are “Billings in excess of costs and estimated earnings on uncompleted contracts”.
|
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
|
Costs incurred on uncompleted contracts
|
|
$
|
9,697
|
|
|
$
|
9,564
|
|
|
Estimated earnings on uncompleted contracts
|
|
|
10,787
|
|
|
|
10,741
|
|
|
|
|
|
20,484
|
|
|
|
20,305
|
|
|
Less: Billings to date on uncompleted contracts
|
|
|
(19,526
|
)
|
|
|
(19,992
|
)
|
|
|
|
$
|
958
|
|
|
$
|
313
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in the accompanying consolidated balance sheets under the following captions:
|
|
|
|
|
|
|
|
|
|
Contract assets
|
|
$
|
1,931
|
|
|
$
|
925
|
|
|
Contract liabilities
|
|
|
(973
|
)
|
|
|
(612
|
)
|
|
|
|
$
|
958
|
|
|
$
|
313
|
|
The balance in costs and estimated earnings
in excess of billings on uncompleted contracts at December 31, 2018 and 2017 consisted primarily 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 December 31, 2018 and 2017 consisted primarily of unearned billings related
to fixed-price projects.
Remaining Performance Obligations
Remaining performance obligations represent
the transaction price of firm orders for which work has not been performed and excludes unexercised contract options and potential
orders and also any remaining performance obligations for any sales arrangements that had not fully satisfied the criteria to be
considered a contract with a customer pursuant to the requirements of ASC 606.
As of December 31, 2018, all of our fixed
price contracts are short-term in nature with a contract term of one year or less.
Practical Expedients and Exemptions
We generally expense sales commissions
when incurred because the amortization period would have been one year or less. These costs are recorded within selling, general
and administrative expenses.
Many of our services contracts are short-term
in nature with a contract term of one year or less. For those contracts, we have utilized the practical expedient in ASC 606-10-50-14
exempting the Company from disclosure of the transaction price allocated to remaining performance obligations if the performance
obligation is part of a contract that has an original expected duration of one year or less.
Additionally, our payment terms are short-term
in nature with settlements of one year or less. We have, therefore, utilized the practical expedient in ASC 606-10-32-18 exempting
the Company from adjusting the promised amount of consideration for the effects of a significant financing component given that
the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good
or service will be one year or less.
Further, in many of our service contracts
we have a right to consideration from a customer in an amount that corresponds directly with the value to the customer of our performance
completed to date (for example, a service contract in which we bill a fixed amount for each hour of service provided). For those
contracts, we have utilized the practical expedient in ASC 606-10-55-18, which allows us to recognize revenue in the amount for
which we have the right to invoice.
Accordingly, we do not disclose the value
of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts
for which we recognize revenue at the amount to which we have the right to invoice for services performed.
NOTE 3: PROPERTY, PLANT AND
EQUIPMENT
Property, plant and equipment consisted of the following:
|
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
|
Range of
Asset Lives
|
|
|
Buildings and improvements
|
|
|
285
|
|
|
|
285
|
|
|
|
7 - 36 years
|
|
|
Leasehold improvements
|
|
|
908
|
|
|
|
908
|
|
|
|
2 - 5 years
|
|
|
Equipment
|
|
|
18,640
|
|
|
|
19,012
|
|
|
|
2 - 30 years
|
|
|
Furniture, computers and office equipment
|
|
|
1,166
|
|
|
|
1,166
|
|
|
|
2 - 8 years
|
|
|
Construction in progress
|
|
|
158
|
|
|
|
2,127
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property, plant and equipment
|
|
|
21,157
|
|
|
|
23,498
|
|
|
|
|
|
|
Less: Accumulated depreciation
|
|
|
(11,466
|
)
|
|
|
(11,146
|
)
|
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
9,691
|
|
|
$
|
12,352
|
|
|
|
|
|
Depreciation expense excluded from cost
of sales in the accompanying consolidated statements of operations was $242 and $234 for the years ended December 31, 2018 and
2017, respectively. Depreciation expense included in cost of sales in the accompanying consolidated statements of operations was
$1,590 and $1,077 for the years ended December 31, 2018 and 2017, respectively.
Construction in progress represents assets
that are not ready for service or are in the construction stage. Assets are depreciated once they are placed in service. See discussion
in Note 1 related to impairment of these assets.
NOTE 4: INCOME OR LOSS PER COMMON SHARE
The following is a reconciliation of the
number of shares used in the basic and diluted net income or loss per common share calculation:
|
|
|
Year Ended
|
|
|
|
|
December 31,
|
|
|
|
|
2018
|
|
|
2017
|
|
|
Numerator:
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,742
|
)
|
|
$
|
(116
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
|
13,553
|
|
|
|
14,233
|
|
|
Denominator for diluted earnings per share
|
|
|
13,553
|
|
|
|
14,233
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share outstanding, basic and fully diluted
|
|
$
|
(0.35
|
)
|
|
$
|
(0.01
|
)
|
At December 31, 2018 and 2017, there were
no outstanding stock options convertible to shares of common stock, or any other potentially dilutive securities.
NOTE 5: SHARE-BASED COMPENSATION
The following table summarizes the activity
of our nonvested restricted shares for the years ended December 31, 2018 and 2017:
|
|
|
|
Restricted Shares
|
|
|
Weighted-Average Grant-Date
Fair Value
|
|
|
Nonvested at December 31, 2016
|
|
|
|
240
|
|
|
$
|
0.88
|
|
|
Granted
|
|
|
|
30
|
|
|
|
1.15
|
|
|
Vested
|
|
|
|
(20
|
)
|
|
|
1.18
|
|
|
Nonvested at December 31, 2017
|
|
|
|
250
|
|
|
$
|
0.50
|
|
|
Granted
|
|
|
|
300
|
|
|
|
0.79
|
|
|
Vested
|
|
|
|
(120
|
)
|
|
|
0.83
|
|
|
Nonvested at December 31, 2018
|
|
|
|
430
|
|
|
$
|
0.83
|
|
For the years ended December 31, 2018 and
2017, we recognized a total of $56 and $134, respectively, of share-based compensation expense related to restricted stock awards,
which is included in selling, general and administrative expenses in the accompanying consolidated statements of operations. The
unamortized estimated fair value of nonvested shares of restricted stock awards was $222 at December 31, 2018. These costs are
expected to be recognized as expense over a weighted average period of 2.28 years. The unamortized estimated fair value of nonvested shares of restricted stock awards was $139 at December
31, 2017.
NOTE 6: TREASURY STOCK
On December 31, 2017, we had 2,002 shares
of our outstanding common stock held in treasury.
On March 26, 2018, our Board of Directors
authorized a repurchase program (the “Repurchase Program”) under which we could repurchase up to $1,000 of our outstanding
stock. The Repurchase Program was funded from cash on hand and cash provided by operating activities.
During the quarter ended December 31, 2018,
we repurchased 25 shares of our outstanding common stock at a total cost of $21 under this Repurchase Program. The average price
per share of treasury stock purchased under the Repurchase program through December 31, 2018 was $0.86. Treasury shares are accounted
for using the cost method.
On December 31, 2018, we had 2,027 shares
of our outstanding common stock held in treasury.
An additional 228 shares of our outstanding
common stock were repurchased in the quarter ended March 31, 2019, for an aggregate amount of $170.
The Repurchase Program expired on March
31, 2019.
NOTE 7: INCOME TAXES
Income tax expense is comprised of the
following:
|
|
|
Year Ended
December 31,
|
|
|
|
|
2018
|
|
|
2017
|
|
|
Federal:
|
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
–
|
|
|
$
|
–
|
|
|
Deferred
|
|
|
2
|
|
|
|
1
|
|
|
Total
|
|
$
|
2
|
|
|
$
|
1
|
|
|
State:
|
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
8
|
|
|
$
|
5
|
|
|
Deferred
|
|
|
(2
|
)
|
|
|
(1
|
)
|
|
Total
|
|
$
|
6
|
|
|
$
|
4
|
|
|
Total income tax expense (benefit)
|
|
$
|
8
|
|
|
$
|
5
|
|
Income taxes expense differs from the amount computed by applying
the U.S. statutory income tax rate to loss before income taxes for the reasons set forth below.
|
|
|
Year Ended
December 31,
|
|
|
|
|
2018
|
|
|
2017
|
|
|
Income tax expense at federal statutory rate
|
|
|
21.00
|
%
|
|
|
34.00
|
%
|
|
State taxes, net of federal benefit
|
|
|
(0.10
|
) %
|
|
|
2.52
|
%
|
|
Valuation allowance
|
|
|
(25.08
|
) %
|
|
|
1,662.43
|
%
|
|
Remeasurement of deferred taxes from 34% to 21%
|
|
|
0.00
|
%
|
|
|
(1,710.52
|
) %
|
|
Research and development credits
|
|
|
3.87
|
%
|
|
|
2.21
|
%
|
|
Other permanent differences
|
|
|
(0.31
|
) %
|
|
|
(15.63
|
) %
|
|
Other, net
|
|
|
0.42
|
%
|
|
|
20.84
|
%
|
|
Total effective rate
|
|
|
(0.20
|
) %
|
|
|
(4.15
|
) %
|
Comprehensive tax reform legislation enacted
in December 2017, commonly referred to as the Tax Cuts and Jobs Acts (“2017 Tax Act”), has significantly changed U.S.
federal income tax laws. The 2017 Tax Act, among other things, reduced the corporate income tax rate from 34% to 21%, limits the
deductibility of business interest expense and net operating losses, provides additional limitations on the deductibility of executive
compensation, imposes a one-time tax on unrepatriated earnings from certain foreign subsidiaries, taxes offshore earnings at reduced
rates regardless of whether they are repatriated, and allows the immediate deduction of certain new investments instead of deductions
for depreciation expense over time. As a result of the 2017 Tax Act, the Company recorded deferred tax expense of $1,900 (1,710.52%)
related to the remeasurement of its net deferred tax assets from 34% to 21%, which was substantially offset by a corresponding
$1,900 (1,662.43%) reduction in its deferred tax valuation allowance. The Company does not believe that the 2017 Tax Act will further
impact its consolidated financial statements, however, its consolidated financial statements may change due to changes in interpretation
of the 2017 Tax Act and additional regulatory guidance that may be issued.
Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes, as well as operating loss and tax credit carry forwards. The tax effects of the temporary
differences and carry forwards are as follows:
|
|
|
As of
|
|
|
|
|
December 31,
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
4,245
|
|
|
$
|
3,255
|
|
|
R&D & other credit carryforwards
|
|
|
685
|
|
|
|
501
|
|
|
Share-based compensation
|
|
|
730
|
|
|
|
741
|
|
|
Intangible amortization
|
|
|
16
|
|
|
|
21
|
|
|
Allowance for bad debt
|
|
|
2
|
|
|
|
2
|
|
|
Other
|
|
|
16
|
|
|
|
8
|
|
|
Total deferred tax assets
|
|
$
|
5,694
|
|
|
$
|
4,528
|
|
|
Less: valuation allowance
|
|
|
(4,837
|
)
|
|
|
(3,649
|
)
|
|
Net deferred tax assets
|
|
$
|
857
|
|
|
$
|
879
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
|
Depreciation on property and equipment
|
|
$
|
(857
|
)
|
|
$
|
(879
|
)
|
|
Amortization of intangibles
|
|
|
–
|
|
|
|
–
|
|
|
Total deferred tax liabilities
|
|
$
|
(857
|
)
|
|
$
|
(879
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax position
|
|
$
|
–
|
|
|
$
|
–
|
|
We have $19,809 of federal and $1,096
of state net operating loss (“NOL”) carryforwards and $685 in research and development and other credits
available to offset future taxable income. These federal and state NOL’s will expire at various dates through 2036.
Management analyzed its current operating results and future projections and determined that a full valuation allowance was
needed due to our cumulative losses in recent years. We have no uncertain tax positions at December 31, 2018. Accordingly, we
do not have any accruals for penalties or interest related to our tax returns. Should an examination or audit arise, we would
evaluate the need for an accrual and record one, if necessary. Our tax returns from the tax years ended December 31, 2012
through December 31, 2017 are open to examination by the IRS.
NOTE 8: COMMITMENTS
AND CONTINGENCIES
Operating Leases
We lease certain offices, facilities, equipment
and vehicles under non-cancellable operating and capital leases expiring at various dates through 2023.
At December 31, 2018, future minimum contractual lease obligations
were as follows:
|
Years ending December 31,:
|
|
|
Operating Leases
|
|
|
2019
|
|
|
|
1,372
|
|
|
2020
|
|
|
|
1,357
|
|
|
2021
|
|
|
|
1,350
|
|
|
2022
|
|
|
|
1,350
|
|
|
2023
|
|
|
|
571
|
|
|
Thereafter
|
|
|
|
–
|
|
|
Total minimum lease payments
|
|
|
$
|
6,000
|
|
Rent expense for the years ended December
31, 2018 and 2017 was $1,373 and $1,445, respectively.
See discussion about our expected adoption
of ASC 842 in Note 1.
Letters of Credit
Certain customers could require us to issue
standby letters of credit in the normal course of business to ensure performance under terms of contracts or as a form of product
warranty. The beneficiary of a letter of credit could demand payment from the issuing bank for the amount of the outstanding letter
of credit. We had no outstanding letters of credit at December 31, 2018 or 2017.
Employment Agreements
Our Chief Executive Officer and Chief Financial
Officer (“Executives”) are employed under employment agreements containing severance provisions. In the event of termination
of the Executives’ employment for any reason, the Executives will be entitled to receive all accrued, unpaid salary and vacation
time through the date of termination and all benefits to which the Executives are entitled or vested under the terms of all employee
benefit and compensation plans, agreements and arrangements in which the Executives are participants as of the date of termination.
In addition, subject to executing a general
release in favor of the Company, the Executives will be entitled to receive certain severance payments in the event their employment
is terminated by the Company “other than for cause” or by the Executives with “good reason.” These severance
payments include: (i) a lump sum in cash equal to one to three times the Executives’ annual base salary; (ii) a lump sum
in cash equal to one to two times the average annual bonus paid to the Executives for the prior two full fiscal years preceding
the date of termination; (iii) a lump sum in cash equal to a pro rata portion of the annual bonus payable for the period in which
the date of termination occurs based on the actual performance under the Company’s annual incentive bonus arrangement, but
no less than fifty percent of Executives’ annual base salary; and (iv) if the Executives’ termination occurs prior
to the date that is twelve months following a change of control, then each and every share option, restricted share award and
other equity-based award that is outstanding and held by the Executives shall immediately vest and become exercisable.
Litigation
From time to time, the Company is party
to various legal proceedings arising in the ordinary course of business. The Company expenses or accrues legal costs as incurred.
A summary of the Company’s material legal proceedings is as follows:
On August 6, 2018, GE Oil and Gas UK Ltd
(“GE”) requested that the Company mediate a dispute between the parties in the ICC International Centre for ADR (“ICC”).
The dispute involves alleged delays and defects in products manufactured by the Company for GE dating back to 2013. The Company
disputes GE’s allegations and intends to vigorously defend itself against these allegations. Mediation took place on November
28, 2018, but no resolution was found. On February 22, 2019, GE initiated arbitration proceedings with the ICC. The total amount
in dispute was originally $2,630, but as of GE’s latest filing with the ICC, the amount in dispute has been reduced to $2,252.
The parties are in the process of filing preliminary submissions, and the arbitration date has not yet been set. At this point
in the legal process, we do not believe a loss to us is probable therefore we have not recorded a liability related to this matter.
In November 2011, the Company delivered
equipment to Aker Solutions, Inc. (“Aker”), but Aker declined to pay the final invoice in the aggregate amount of
$270 alleging some warranty items needed to be repaired. The Company made repairs, but Aker continued to claim further work was
required. The Company repeatedly attempted to collect on the receivable, and ultimately filed suit on November 16, 2012, in the
Harris County District Court. Aker subsequently filed a counter-claim on March 20, 2013 in the aggregate amount of $1,000, for
reimbursement of insurance payments allegedly made for repairs. Trial is scheduled for the week of April 22, 2019. At this point
in the legal process, we do not believe a loss to us is probable therefore we have not recorded a liability related to this matter.
NOTE 9: SUBSEQUENT EVENTS
We have evaluated subsequent events through
the date the consolidated financial statements were filed with the Securities and Exchange Commission.
On February 26, 2019, we received a payment
of $500 on our note receivable reported in prepaid and other current assets in the accompanying consolidated balance sheet as of
December 31, 2018. The remaining portion of the note receivable of $37 is expected to be collected during 2019.