Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

þ        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2019

 

OR

 

¨        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File No. 000-30351

 

DEEP DOWN, INC.

(Exact name of registrant as specified in its charter)

 

Nevada   75-2263732
(State or other jurisdiction of incorporation)   (I.R.S. Employer Identification No.)
     

18511 Beaumont Highway,

Houston, Texas

  77049
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (281) 517-5000

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
N/A N/A N/A

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. þ Yes ¨ No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨  
Non-accelerated filer ¨ Smaller reporting company þ  
Emerging growth company ¨    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

 

At November 12, 2019, there were 13,290,680 shares outstanding of Common Stock, par value $0.001 per share.

 

 

 

     

 

 

IMPORTANT INFORMATION REGARDING THIS FORM 10-Q

 

Unless otherwise indicated, references to “we,” “us,” and “our” in this Quarterly Report on Form 10-Q (“Report”) refer collectively to Deep Down, Inc., a Nevada corporation (“Deep Down”), and its wholly-owned subsidiary Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”). Our current operations are primarily conducted under Deep Down Delaware.

 

Readers should consider the following information as they review this Report:

 

Forward-Looking Statements

 

The statements contained or incorporated by reference in this Report that are not historical facts are “forward-looking statements” (as such term is defined in the Private Securities Litigation Reform Act of 1995), within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements. Forward-looking statements include any statement that may project, indicate or imply future results, events, performance or achievements. The forward-looking statements contained herein are based on current expectations that involve a number of risks and uncertainties. These statements can be identified by the use of forward-looking terminology such as “believes,” “expect,” “may,” “will,” “should,” “intend,” “plan,” “could,” “estimate,” or “anticipate,” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties.

 

Given the risks and uncertainties relating to forward-looking statements, investors should not place undue reliance on such statements. Forward-looking statements included in this Report speak only as of the date of this Report and are not guarantees of future performance. Although we believe that the expectations reflected in the forward-looking statements are reasonable, such expectations may prove to be incorrect. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements. The risks and uncertainties mentioned previously relate to, among other matters, the following:

 

  • Economic uncertainty and financial market conditions may impact our customer base, suppliers and backlog;
     
  • Our backlog is subject to unexpected adjustments and cancellations and, therefore, may not be a reliable indicator of our future earnings;
     
  • We measure extent of progress towards completion to recognize revenue on our fixed price contracts, which could result in volatility in our results of operations;
     
  • A portion of our contracts may contain terms with penalty provisions;
     
  • Fluctuations in the price and supply of raw materials used to manufacture our products may reduce our profits and could materially impact our ability to meet commitments to our customers;
     
  • Our operations could be adversely impacted by the continuing effects of government regulations;
     
  • International and political events may adversely affect our operations;
     
  • Our operating results may vary significantly from quarter to quarter;
     
  • We may be unsuccessful at generating profitable internal growth;
     
  • The departure of key personnel could disrupt our business;
     
  • Our business requires skilled labor, and we may be unable to attract and retain qualified employees; and
     
  • Unfavorable legal outcomes could have a negative impact on our business.

 

 

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Document Summaries

 

Descriptions of documents and agreements contained in this Report are provided in summary form only, and such summaries are qualified in their entirety by reference to the actual documents and agreements filed as exhibits to our Annual Report on Form 10-K for the year ended December 31, 2018, other periodic and current reports we have filed with the SEC, or this Report.

 

Access to Filings

 

Access to our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments thereto, filed with or furnished to the SEC pursuant to Section 13(a) of the Exchange Act, as well as reports filed by our executive officers and directors pursuant to Section 16(a) of the Exchange Act, may be obtained through our website (http://www.deepdowninc.com) as soon as reasonably practicable after we, or our executive officers and directors, have filed or furnished such material with the SEC. The contents of our website are not, and shall not be deemed to be, incorporated into this Report.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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TABLE OF CONTENTS

 

    Page No.
     
PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements 1
  Unaudited Condensed Consolidated Balance Sheets at September 30, 2019 and December 31, 2018 1
  Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2019 and 2018 2
  Unaudited Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Three and Nine Months Ended September 30, 2019 and 2018 3
  Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018 4
  Notes to Unaudited Condensed Consolidated Financial Statements 5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 20
   
PART II. OTHER INFORMATION
   
Item 1. Legal Proceedings 21
Item 1A. Risk Factors 21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 21
Item 6. Exhibits 22
     
Signatures 23
Index to Exhibits 24

 

 

 

 

 

 

 

 

 

 

 

 

 

  iii  

 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

DEEP DOWN, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(In thousands, except share and par value amounts)

    September 30, 2019     December 31, 2018  
             
ASSETS                
Current assets:                
Cash   $ 1,782     $ 2,015  
Short term investment (certificate of deposit)     –       1,035  
Accounts receivable, net of allowance of $10 and $10, respectively     6,722       4,388  
Contract assets     1,041       1,931  
Prepaid expenses and other current assets     163       621  
Total current assets     9,708       9,990  
Property, plant and equipment, net     8,661       9,691  
Intangibles, net     52       56  
Right-of-use operating lease assets     4,626       –  
Other assets     388       383  
Total assets   $ 23,435     $ 20,120  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY                
Current liabilities:                
Accounts payable and accrued liabilities   $ 1,439     $ 1,982  
Contract liabilities     530       973  
Current lease liabilities     1,167       –  
Current portion of long-term debt     –       9  
Total current liabilities     3,136       2,964  
                 
Non-current lease liabilities     3,481       –  
Long-term debt (Auto loan)     –       47  
Total long- term liabilities     3,481       47  
Total liabilities     6,617       3,011  
                 
Commitments and contingencies (Note 9)     —        —   
                 
Stockholders' equity:                
Common stock, $0.001 par value, 24,500,000 shares authorized, 15,906,010 and 15,706,010 shares issued, respectively     16       16  
Additional paid-in capital     73,471       73,271  
Treasury stock, 2,615,330 and 2,027,217 shares, respectively, at cost     (2,280 )     (2,062 )
Accumulated deficit     (54,389 )     (54,116 )
Total stockholders' equity     16,818       17,109  
Total liabilities and stockholders' equity   $ 23,435     $ 20,120  

 

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 

 

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DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

(In thousands, except per share amounts)

  Three Months Ended     Nine Months Ended  
  September 30,     September 30,  
    2019     2018     2019     2018  
Revenues   $ 4,397     $ 3,912     $ 15,966     $ 11,722  
Cost of sales:                                
Cost of sales     2,274       2,089       9,061       6,518  
Depreciation expense     278       275       837       871  
Total cost of sales     2,552       2,364       9,898       7,389  
Gross profit     1,845       1,548       6,068       4,333  
Operating expenses:                                
Selling, general and administrative     2,136       2,145       6,137       5,804  
Depreciation and amortization     70       57       209       188  
Total operating expenses     2,206       2,202       6,346       5,992  
Operating loss     (361 )     (654 )     (278 )     (1,659 )
Other (loss) income:                                
Interest income, net     –       10       12       28  
(Loss) Gain on sale of property, plant and equipment     (7 )     –       8       439  
Total (loss) other income     (7 )     10       20       467  
Loss before income taxes     (368 )     (644 )     (258 )     (1,192 )
Income tax expense     (5 )     (5 )     (15 )     (15 )
Net loss   $ (373 )   $ (649 )   $ (273 )   $ (1,207 )
                                 
Net loss per share:                                
Basic   $ (0.03 )   $ (0.05 )   $ (0.02 )   $ (0.09 )
Fully diluted   $ (0.03 )   $ (0.05 )   $ (0.02 )   $ (0.09 )
                                 
Weighted-average shares outstanding:                                
Basic     13,330       13,648       13,417       13,507  
Fully diluted     13,330       13,648       13,417       13,507  

 

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 

 

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DEEP DOWN, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE-MONTH ENDED September 30, 2019 and 2018

(Unaudited)

(In thousands)

                Additional                    
    Common Stock     Paid-in     Treasury     Accumulated        
  Shares (#)     Amount ($)     Capital     Stock     Deficit     Total  
Balance at December 31, 2017     15,438     $ 15     $ 73,246     $ (2,040 )   $ (49,374 )   $ 21,847  
                                                 
Net loss     –       –       –       –       (850 )     (850 )
Share-based compensation     –       –       5       –       –       5  
Balance at March 31, 2018     15,438     $ 15     $ 73,251     $ (2,040 )   $ (50,224 )   $ 21,002  
                                                 
Net income     –       –       –       –       292        292  
Share-based compensation     –       –       5       –       –       5  
Balance at June 30, 2018     15,438     $ 15     $ 73,256     $ (2,040 )   $ (49,932 )   $ 21,299  
                                                 
Net loss     –       –       –       –       (649 )     (649 )
Share-based compensation     –       –       5       –       –       5  
Balance at September 30, 2018     15,438     $ 15     $ 73,261     $ (2,040 )   $ (50,581 )   $ 20,655  
                                                 
Balance at December 31, 2018     15,706       16       73,271       (2,062 )     (54,116 )     17,109  
                                                 
Net income     –       –       –       –       212       212  
Treasury shares purchased     –       –       –       (170 )     –       (170 )
Share-based compensation     –       –       104       –       –       104  
Balance at March 31, 2019     15,706     $ 16     $ 73,375     $ (2,232 )   $ (53,904 )   $ 17,255  
                                                 
Net loss     –       –       –       –       (112 )     (112 )
Treasury shares purchased     –       –       –       (48 )     –       (48 )
Share-based compensation     –       –       24       –       –       24  
Balance at June 30, 2019     15,706     $ 16     $ 73,399     $ (2,280 )   $ (54,016 )   $ 17,119  
                                                 
Net loss     –       –       –       –       (373 )   $ (373 )
Restricted stock awards     200       –       –       –       –       –  
Share-based compensation     –       –       72       –       –       72  
Balance at September 30, 2019     15,906     $ 16     $ 73,471     $ (2,280 )   $ (54,389 )   $ 16,818  

 

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 

 

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DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

             

(In thousands)

    Nine Months Ended  
    September 30,  
    2019     2018  
             
Cash flows from operating activities:                
Net loss   $ (273 )   $ (1,207 )
Adjustments to reconcile net income (loss) to net cash used in operating activities:                
Share-based compensation     200       15  
Depreciation and amortization     1,046       1,059  
Gain on sale of property, plant and equipment     (8 )     (439 )
Non-cash lease expense     22       –  
Changes in operating assets and liabilities:                
Accounts receivable, net     (2,334 )     931  
Contract assets     890       (249 )
Prepaid expenses and other current assets     (57 )     180  
Other assets     (31 )     102  
Accounts payable and accrued liabilities     (543 )     (299 )
Contract liabilities     (443 )     (104 )
Net cash used in operating activities     (1,531 )     (11 )
                 
Cash flows from investing activities:                
Proceeds from sale of property, plant and equipment     88       538  
Purchases of property, plant and equipment     (66 )     (759 )
Repayments on note receivable (included in Prepaid expenses and other current assets)     515       12  
Short term investment (certificate of deposit)     1,035       (15 )
Net cash provided by (used in) investing activities     1,572       (224 )
                 
Cash flows from financing activities:                
Principal payment on long-term debt     (56 )     (7 )
Cash paid for treasury shares purchased     (218 )     –  
Net cash used in financing activities     (274 )     (7 )
Change in cash     (233 )     (242 )
Cash, beginning of period     2,015       3,939  
Cash, end of period   $ 1,782     $ 3,697  
                 
Supplemental schedule of non-cash investing and financing activities:                
Addition of property, plant and equipment (non-cash)   $ –     $ 277  

 

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 

 

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts and shares 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 subsidiary (“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, 2018.

 

Preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, the disclosed amounts of contingent assets and liabilities, and the reported amounts of revenues and expenses. If the underlying estimates and assumptions upon which the financial statements are based change in future periods, then the actual amounts may differ from those included in the accompanying unaudited condensed consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

Liquidity

 

The Company’s primary and potential sources of liquidity include cash on hand, cash from operating activities, and proceeds from opportunistic sales of property, plant and equipment (“PP&E”). The Company’s cash as of September 30, 2019 and December 31, 2018 was $1,782 and $2,015, respectively. The decrease in cash was largely the result of prolonged payment terms by some of our customers, which resulted in a $2,334 increase in our accounts receivable as of September 30, 2019 compared to December 31, 2018. As of September 30, 2019, our working capital was $6,572 compared to $7,026 as of December 31, 2018.

 

The Company’s plans to mitigate its limited liquidity include: closely monitoring capital expenditures planned for the remainder of 2019 and beyond to conserve capital, potential opportunistic sales of PP&E, further reducing administrative costs, and potentially pursuing a line of credit to further supplement our operating requirements.

 

The Company’s operations are influenced by a number of factors that are beyond its control, including general conditions of the offshore energy sector, oil and gas operators’ willingness to spend development capital, and other factors that could adversely affect the Company’s financial position, results of operations and liquidity.

 

Principles of Consolidation

 

The unaudited condensed consolidated financial statements presented herein include the accounts of Deep Down, Inc. and its wholly-owned subsidiary. All intercompany transactions and balances have been eliminated.

 

Segments

 

For the nine months ended September 30, 2019 and 2018, we had one operating and reporting segment, Deep Down Delaware.

 

 

 

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Recently Issued Accounting Standards Not Yet Adopted

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2016-13, “Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments,” as modified by subsequently issued ASU No. 2018-19, “Codification Improvements to Topic 326, Financial Instruments-Credit Losses.” The guidance introduces a new credit reserving model known as the Current Expected Credit Loss (“CECL”) model, which is based on expected losses, and differs significantly from the incurred loss approach used today. The CECL model requires estimating all expected credit losses for certain types of financial instruments, including trade receivables, held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. These ASUs affect an entity to varying degrees depending on the credit quality for the assets held by the entity, their duration and how the entity applies current US GAAP. These ASUs will become effective for us beginning January 1, 2020. We do not expect these ASUs to have a material impact on our financial statements and related disclosures.

 

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820) Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”), which modifies the disclosure requirements of fair value measurements. ASU 2018-13 is effective for us beginning January 1, 2020. Certain disclosures are required to be applied on a retrospective basis and others on a prospective basis. We do not expect ASU 2018-13 to have a material impact on our financial statement disclosures.

 

All other new accounting pronouncements that have been issued but not yet effective are currently being evaluated to determine if they will have a material impact on our financial position or results of operations.

 

NOTE 2: LEASES: ADOPTION OF ASU 842, “LEASES”

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” and subsequent amendments, which replaced existing lease guidance in US GAAP and requires lessees to recognize right-of-use (“ROU”) assets and lease liabilities on the balance sheet for leases greater than twelve months and disclose key information about leasing arrangements. We adopted the standard on January 1, 2019 using the modified retrospective method and used the effective date as our date of initial application. Financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. There were no adjustments to opening retained earnings on adoption.

 

The Company leases certain properties, buildings and equipment under various arrangements that provide the right to use the underlying asset and require lease payments for the lease term. The Company’s lease portfolio consists of operating leases, which expire at various dates through 2023.

 

The new standard provides a number of optional practical expedients for transition. We elected the package of practical expedients under the transition guidance which permitted us not to reassess under the new standard our prior conclusions for lease identification and lease classification on expired or existing contracts and whether initial direct costs previously capitalized would qualify for capitalization under Topic 842. We also elected the practical expedient related to land easements, which allowed us not to reassess our current accounting treatment for existing agreements on land easements, which are not accounted for as leases. We did not elect the hindsight practical expedient to determine the reasonably certain lease term for existing leases.

 

The new standard also provides practical expedients and recognition exemptions for an entity’s ongoing accounting policy elections. For leases with an initial term of twelve months or less a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities and instead recognize lease expense for such leases generally on a straight line basis over the lease term. We elected this short-term lease recognition exemption for all leases that qualify. We do not separate lease and non-lease components. Some of our agreements contain variable payment provisions (other than those that depend on an index or a rate, such as CPI) which are not included in our future minimum lease payments. These variable lease agreements include usage-based payments for equipment under service contracts and other properties.

 

 

 

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Our long-term lease agreements do not contain any material restrictive covenants. Our equipment leases have remaining terms of between 1 year and 3 years, and property leases have remaining terms of between 1 year and 5 years. Some of these leases may include options to extend the leases, and some may include options to terminate the leases within 30 days. When we are not reasonably certain to exercise these options, the options are not considered in determining the lease term, and associated payments are excluded from future minimum lease payments.

 

ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term and include options to extend or terminate the lease when they are reasonably certain to be exercised. The present value of lease payments is determined primarily using the incremental borrowing rate based on the information available at the lease commencement date. Lease agreements with lease and non-lease components are generally accounted for as a single lease component. The Company’s operating lease expense is recognized on a straight-line basis over the lease term and a portion is recorded in cost of sales, and the remainder is recorded in selling, general and administrative expenses.

 

The accounting for some of our leases may require significant judgement, which includes determining whether a contract contains a lease, determining the incremental borrowing rate to utilize in our net present value calculation of lease payments for lease agreements which do not provide an implicit rate and assessing the likelihood of renewal or termination options.

 

During the third quarter ended September 30, 2019, we derecognized $164 in lease liabilities and ROU assets associated with a related party lease that was on a month-to-month basis.

 

As of September 30, 2019, we do not have any finance lease assets or liabilities, nor do we have any subleases.

 

The following tables present information about our operating leases.

 

    September 30, 2019     January 1, 2019  
             
Assets:                
Right-of-use operating lease assets   $ 4,626     $ 5,707  
                 
Liabilities:                
Current lease liabilities     1,167       1,215  
Non-current lease liabilities     3,481       4,492  
Total lease liabilities   $ 4,648     $ 5,707  

 

The components of our lease expense were as follows:

 

    Three Months Ended     Nine Months Ended  
    September 30, 2019     September 30, 2019  
             
Operating lease expense included in Cost of sales   $ 312     $ 926  
Operating lease expense included in SG&A     55       185  
Short term lease expense     41       278  
                 
Total lease expense   $ 408     $ 1,389  

 

As of September 30, 2019, we do not have any finance lease assets or liabilities, nor do we have any subleases.

 

    Nine Months Ended  
    September 30, 2019  
Other information related to operating leases were as follows:      
Operating cash flows from operating leases           $ (1,111 )

 

Lease Term and Discount Rate:   September 30, 2019     January 1, 2019  
             
Weighted-average remaining lease terms (years) on operating leases     3.69       4.5  
Weighted-average discount rates on operating leases     5.374%       5.374%  

 

 

 

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During the third quarter, we did not have any sale/leaseback transactions.

 

Future minimum lease payments under non cancellable operating leases were as follows:   12 Months ending  
      September 30,  
         
2020     $ 1,385  
2021       1,387  
2022       1,403  
2023       942  
Thereafter       –  
Total lease payments       5,117  
Less: Interest       (469 )
Present value of lease liabilities     $ 4,648  

 

NOTE 3: REVENUES: ADOPTION OF ASC 606, “REVENUE FROM CONTRACTS WITH CUSTOMERS”

 

On January 1, 2018, we adopted Accounting Standards Codification (“ASC”) Topic 606 (“ASC 606”) using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. There was no significant impact on the Company’s results of operations or financial position 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 performed) 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 revenue sources of fixed price and service contracts. Sales taxes are excluded from revenues.

 

Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018

 

    September 30, 2019     September 30, 2018  
             
Fixed Price Contracts   $ 3,012     $ 2,115  
Service Contracts     1,385       1,797  
Total   $ 4,397     $ 3,912  

 

 

 

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Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

 

    September 30, 2019     September 30, 2018  
             
Fixed Price Contracts   $ 9,422     $ 5,048  
Service Contracts     6,544       6,674  
Total   $ 15,966     $ 11,722  

 

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 in connection with delivery of 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.

 

 

 

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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 are generally required to be paid on a monthly basis. Payment terms for services are usually 30 days from invoice receipt, but during the recent downturn in the industry, some of our customers have begun instituting new payment terms of up to 60 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. At September 30, 2019 and 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.”

 

    September 30, 2019     December 31, 2018  
             
Costs incurred on uncompleted contracts   $ 1,342     $ 9,697  
Estimated earnings on uncompleted contracts     2,159       10,787  
      3,501       20,484  
Less: Billings to date on uncompleted contracts     (2,990 )     (19,526 )
    $ 511     $ 958  
                 
                 
Included in the accompanying unaudited condensed consolidated balance sheets under the following captions:                
Contract assets   $ 1,041     $ 1,931  
Contract liabilities     (530 )     (973 )
    $ 511     $ 958  

 

 

 

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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.

 

At September 30, 2019 and December 31, 2018, all of our fixed price 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.

 

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.

 

 

 

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NOTE 4: PROPERTY, PLANT AND EQUIPMENT

 

The components of property, plant and equipment, net are summarized below:

 

    September 30, 2019     December 31, 2018     Range of
Asset Lives
                 
Buildings and improvements   $ 285     $ 285     7 - 36 years
Leasehold improvements     896       908     2 - 5 years
Equipment     18,670       18,640     2 - 30 years
Furniture, computers and office equipment     902       1,166     2 - 8 years
Construction in progress     76       158      
Total property, plant and equipment     20,829       21,157      
Less: Accumulated depreciation and amortization     (12,168 )     (11,466 )    
Property, plant and equipment, net   $ 8,661     $ 9,691      

 

NOTE 5: LONG-TERM DEBT

 

In January 2018, we financed a new Company vehicle. The financed amount was $67 and was for a term of six years with an interest rate of 0.9%, with monthly payments of $1. During the quarter ended September 30, 2019, the Company vehicle was sold to our former Chief Executive Officer and the outstanding balance of the debt was paid. The sale of the vehicle resulted in a $7 loss.

 

NOTE 6: SHARE-BASED COMPENSATION

 

On July 27, 2018, we granted 300 shares of restricted stock to our Chief Financial Officer (“CFO”) who is now our current Chief Executive Officer (“CEO”) after our former officer resigned effective August 31, 2019. These shares had a fair value grant price of $0.79 per share, based on the closing price of our common stock on that day. These shares vest over three years in equal tranches on the anniversary date of his appointment to the role of the CFO, subject to continued service as an officer of the Company. For the three months ended September 30, 2019 and 2018, we recognized share based compensation expense of $20 and $14, respectively. We are amortizing the related share-based compensation of $237 over the three-year requisite service period.

 

On June 24, 2019, the three non-employee members of the Board of Directors (the “Board”) were each granted an option to purchase 50 shares of our common stock at a price of $0.75 per share. Fair value of these stock options was $0.44 per share at the date of grant. The options vested 25% on August 31, 2019, and the remainder is scheduled to vest in three tranches on November 30, 2019, February 29, 2020 and May 31, 2020, subject to the recipient’s continued service on the Board. Once vested, the options are exercisable until June 24, 2024.

 

On September 23, 2019, we granted 200 shares of restricted stock to our Chief Operating Officer (“COO”). These shares had a fair value grant price of $0.65 per share, based on the closing price of our common stock on that day. One fourth of the shares vested immediately and the remaining shares are scheduled to vest over three years in equal tranches on the anniversary date of his appointment to the role, subject to continued service as our COO. We recognized $33 in compensation expense for the quarter ended September 30, 2019 and we are amortizing the remaining share-based compensation of $64 over the three-year requisite service period as the shares vest.

 

 

 

 

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On September 24, 2019, we granted our new CEO an option to purchase 150 shares of our common stock at a price of $0.65 per share. Fair value of these stock options was $0.39 per share at the date of grant. The options are scheduled to vest in two equal tranches on the first and second anniversaries of the grant subject to his continued service as our CEO. We recognized $0 in compensation expense for the quarter ended September 30, 2019 and we are amortizing the related share based compensation of $59 over the two-year requisite service period as the shares vest.

 

Summary of Shares of Restricted Stock

 

For the three months ended September 30, 2019 and 2018, we recognized a total of $55 and $5 respectively, of share based compensation related to restricted stock awards. For the nine months ended September 30, 2019 and 2018, we recognized a total of $183 and $15 respectively, of share-based compensation expense related to restricted stock awards, which is included in selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations. The unamortized estimated fair value of unvested shares of restricted stock was $168 at September 30, 2019 and $222 at December 31, 2018. These costs are expected to be recognized as expense over a weighted-average period of 1.80 years.

 

Summary of Stock Options

 

For the three and nine months ended September 30, 2019, we recognized $17 in compensation expense related to outstanding stock option awards. The share-based compensation expense is recognized over the vesting period and is included in selling, general and administrative expenses in the condensed consolidated statements of operations. The estimated fair value of non-vested stock options was $108 at September 30, 2019 and $0 as of December 31, 2018. This cost is expected to be recognized as an expense over the period ending September 24, 2021.

 

NOTE 7: TREASURY STOCK

 

On March 26, 2018, the Board authorized the repurchase of up to $1,000 of the Company’s outstanding common stock (the “Repurchase Program”). The Repurchase Program was funded from cash on hand. During the three months ended March 31, 2019, 228 shares of our outstanding common stock were purchased at the price of $0.75 under the Repurchase Program. The Repurchase Program expired on March 31, 2019.

 

On May 2, 2019, the Company repurchased 60 shares from a former member of the Board. The shares were repurchased at the price of $0.80 per share, which was the average closing price for the ten trading days prior to the date of repurchase.

 

On September 1, 2019, the Company received 300 shares of common stock from our former CEO in exchange for certain previously impaired Company equipment ($0 carrying value at the time of exchange). No value was recorded to treasury stock because the assets had approximately $0 fair value at the time of the exchange.

 

NOTE 8: INCOME TAXES

 

Income tax expense during interim periods is based on applying the estimated annual effective income tax rate to interim period operations. The estimated annual effective income tax rate may vary from the statutory rate due to the impact of permanent items relative to our pre-tax income, as well as by any valuation allowance recorded. We employ an asset and liability approach that results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial basis and the tax basis of those assets and liabilities. A valuation allowance is established when it is more likely than not that some of the deferred tax assets will not be realized. At September 30, 2019 and December 31, 2018 management has recorded a full deferred tax asset valuation allowance.

 

 

 

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NOTE 9: COMMITMENTS AND CONTINGENCIES

 

From time to time we are involved in legal proceedings arising from the normal course of business. We expense or accrue legal costs as we incur them. A summary of our 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. The dispute involves alleged delays and defects in products manufactured by the Company for GE dating back to 2013. Mediation took place on November 28, 2018, but no resolution was reached. The original amount in dispute was $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 is currently set for April 2020. The Company disputes GE’s allegations and intends to vigorously defend itself against these allegations. 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 April 2020. 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 10: EARNINGS PER COMMON SHARE

 

Basic earnings per share (“EPS”) is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted-average number of common shares and dilutive common stock equivalents (warrants, nonvested stock awards and stock options) outstanding during the period. Diluted EPS reflects the potential dilution that could occur if options to purchase common stock were exercised for shares of common stock and all nonvested stock awards vest.

 

For the three and nine months ended September 30, 2019 and 2018 there were no potentially dilutive securities that were included in the computation of diluted earnings per share because their effect would be anti-dilutive.

 

NOTE 11: RELATED PARTY TRANSACTIONS

 

On August 15, 2019, Mr. Ronald E. Smith, the Company's Founder, resigned as Chief Executive Officer and as a member of the Board, effective as of August 31, 2019.

 

In connection with Mr. Smith's resignation, the Company entered into a Transition Agreement with him, effective as of September 1, 2019 (the “Transition Agreement”). The Transition Agreement provides for Mr. Smith to serve as an independent consultant to the Company from September 1, 2019 through December 31, 2021. The Company agreed to pay Mr. Smith $42 per month, from September 1, 2019 through December 31, 2019, and $15 per month, from January 1, 2020 through December 31, 2021, in exchange for his future services.

 

Under the terms of the Transition Agreement, the Company agreed to pay Mr. Smith a severance payment of $250, which was fully accrued during the nine-month period ended September 30, 2019, and is payable in structured payments through December 31, 2019.

 

Additionally, under the terms of the Transition Agreement, the Company accepted 300 of Mr. Smith's shares of the Company’s common stock in exchange for certain previously impaired Company equipment ($0 carrying value at the time of the exchange). Because the assets had an approximate fair value of $0 at the time of the exchange no value was recorded to treasury stock. The Transition Agreement also provides for the Company to transfer a Company truck to Mr. Smith with the associated liability assumed by Mr. Smith. We recognized a $7 loss on this transaction.

 

In addition to the other payments provided for under the Transition Agreement, the Company also agreed to pay Mr. Smith 1.5% of the net sale or lease value of two carousels owned by Company, if such sale or lease occurs prior to December 31, 2021, unless those assets are sold or leased in conjunction with a sale of all or substantially all of the assets or stock of Deep Down, in which case no commission is due.

 

As part of the Transition Agreement, Mr. Smith is bound by certain non-disclosure and confidentiality provisions, and a non-compete and non-hire agreement.

 

 

 

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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 Annual Report on Form 10-K for the fiscal year ended December 31, 2018, 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,” and is available on the SEC’s website. Dollar and share amounts are in thousands, except backlog amount.

 

General

 

We are an oilfield products and services company specializing in complex deepwater and ultra-deepwater oil and gas production systems, 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.

 

Industry and Executive Outlook

 

While oil prices are not yet perceived to be at levels ideal for large scale offshore development, we are pleased with our ability to generate almost as much revenue during the first nine months of 2019 as we generated during the entire year of 2018. Our cost rationalization efforts also continue to bear fruit, as evidenced by reductions in our operating expenses, not including certain transaction costs incurred related to the resignation of the Company’s Founder, compared to the same period in 2018.

 

Following the conclusion of our strategic review process, our Company Founder and former Chief Executive Officer resigned as an officer and as a member of our board of directors, effective August 31, 2019 to pursue interests outside the oil and gas industry.

 

His departure coincided with a renewed focus on our core business, providing the opportunity for him to purchase non-core assets from the Company in exchange for some of his shares of the Company’s common stock. Consequently, we also streamlined our workforce to better align our human resources with our areas of focus. Our personnel changes also included the addition of a Chief Operating Officer, a new role for our organization.

 

These changes have also provided the opportunity to engage our employees, customers, and shareholders, in soliciting their feedback on our Company, to ensure our areas of focus are better aligned with their objectives. The feedback has been overwhelmingly positive, with our stakeholders being supportive of our renewed focus on our core business.

 

Our strategy for the future will center around strategic sales efforts, product and service excellence, and financial discipline. While we expect our solid reputation to continue generating incoming requests from customers, we plan to enhance our front end activities to strategically target new opportunities. To better serve our customers, we are also performing a deep dive into the full portfolio of our products, services, and rental equipment, to streamline our project execution and increase our competitiveness in the market. While there are various opportunities we could pursue in different areas, we intend to primarily pursue opportunities which align with our core competencies, and where we see a clear path to financial success.

 

As a result, while we will continue to pursue select international prospects, our immediate focus will be on opportunities we can successfully execute out of our Houston facility, and we expect to scale back our plans for expansion into the West African and Southeast Asian markets.

 

In light of increased bidding activity, a committed backlog of approximately $12 million and working capital of $6.6 million, we remain cautiously optimistic of our ability to create value for our stakeholders.

 

 

 

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Results of Operations

 

Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018

 

Revenues. Revenues for the three months ended September 30, 2019 were $4,397 compared to revenues of $3,912 for the three months ended September 30, 2018. The $485, or 12 percent, increase was primarily the result of more projects during the three months ended September 30, 2019, compared to the three months ended September 30, 2018.

 

Gross profit. Gross profit for the three months ended September 30, 2019 was $1,845, or 42 percent of revenues, compared to $1,548, or 40 percent of revenues, for the three months ended September 30, 2018. The $297 increase in gross profit was due primarily to increased revenues during the three months ended September 30, 2019, compared to the three months ended September 30, 2018.

 

Selling, general and administrative expenses (“SG&A”). SG&A expenses were $2,136, or 49 percent of revenues, for the three months ended September 30, 2019, which included $349 in one-time expenses incurred in relation to the resignation of the Company’s Founder. SG&A expenses were $2,145, or 55 percent of revenues for the three months ended September 30, 2018. Excluding the one-time charges, SG&A expenses for the three months ended September 30, 2019 were $1,787, or 41 percent of revenues. The $358 decrease in regular SG&A expense included a $243 decrease in legal fees, as well as other expense reductions resulting from the Company’s continuous efforts to reduce operating expenses.

 

Modified EBITDA. Our management evaluates our performance based on a non-US GAAP measure which consists of earnings (net income or loss) available to common shareholders before net interest income, income taxes, non-cash share-based compensation expense, 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 unaudited condensed consolidated statements of operations.

 

We believe Modified EBITDA is useful to investors in evaluating our operating performance because it is 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); one-time events; and actions that do not affect liquidity (share-based compensation expense 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.

 

 

 

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The following is a reconciliation of net loss to Modified EBITDA (EBITDA loss) for the three months ended September 30, 2019 and 2018:

 

    Three Months Ended  
    September 30,  
    2019     2018  
             
Net loss   $ (373 )   $ (649 )
Deduct interest income, net     –       (10 )
Add loss on sale of property, plant and equipment     7       –  
Add one-time charges related to Founder’s resignation     349       –  
Add depreciation and amortization     348       332  
Add income tax expense     5       5  
Add share-based compensation     72       5  
Modified EBITDA (EBITDA loss)   $ 408     $ (317 )

 

The $725 increase in Modified EBITDA was due primarily to the increase in revenues, the resulting increase in gross profit and the reduction in SG&A expense during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018.

 

Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

 

Revenues. Revenues for the nine months ended September 30, 2019 were $15,966 compared to revenues of $11,722 for the nine months ended September 30, 2018. The $4,244, or 36 percent, increase was primarily the result of more projects during the nine months ended September 30, 2019, compared to the nine months ended September 30, 2018.

 

Gross profit. Gross profit for the nine months ended September 30, 2019 was $6,068, or 38 percent of revenues, compared to $4,333, or 37 percent of revenues, for the nine months ended September 30, 2018. The $1,735 increase in gross profit was primarily due to increased revenues resulting from a larger number of projects during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.

 

Selling, general and administrative expenses (“SG&A”). SG&A expenses were $6,137, or 38 percent of revenues, for the nine months ended September 30, 2019, which included $349 in one-time expenses incurred in relation to the resignation of the Company’s Founder. SG&A expenses were $5,804, or 50 percent of revenues for the nine months ended September 30, 2018. Excluding the one-time charges, SG&A expenses for the nine months ended September 30, 2019 were $5,788, or 36 percent of revenues. The $16, or 14 percent of revenues, decrease in regular SG&A expense resulted from the Company’s continuous efforts to reduce operating expenses.

 

 

 

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Modified EBITDA.

 

The following is a reconciliation of net loss to Modified EBITDA (EBITDA loss) for the nine months ended September 30, 2019 and 2018:

 

    Nine Months Ended  
    September 30,  
    2019     2018  
             
Net loss   $ (273 )   $ (1,207 )
Deduct gain on sale of property, plant and equipment     (8 )     (439 )
Deduct interest income, net     (12 )     (28 )
Add one-time charges related to Founder’s resignation     349       –  
Add depreciation and amortization     1,046       1,059  
Add income tax expense     15       15  
Add share-based compensation     200       15  
Modified EBITDA (EBITDA loss)   $ 1,317     $ (585 )

 

The $1,902 increase in Modified EBITDA was due primarily to the increase in revenues and the resulting increase in gross profit during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.

 

Liquidity and Capital Resources

 

During the nine months ended September 30, 2019 and September 30, 2018, we primarily financed our operating and capital needs through cash on hand.

 

During the nine months ended September 30, 2019 we used $1,805 to fund our operating and financing activities. We used $1,531 in our operating activities, primarily due to an increase of $2,334 in accounts receivable and $543 decrease in accounts payable. We also used $274 in financing activities, primarily for repurchases of our outstanding stock. We generated $1,572 from our investing activities, primarily due to maturity of our $1,035 certificate of deposit and receipt of $515 in repayments on a note receivable.

 

The increase in accounts receivable was the result of prolonged payment terms by some of our customers. Following the end of the quarter ended September 30, 2019, during October 2019 we collected $3,193 from our customers.

 

Through a combination of our current working capital of $6,572, cash expected to be generated from operations, potential opportunistic sales of property, plant and equipment in the future, reduction in our capital budget, and continuous efforts to reduce our operating expenses, we believe we will have adequate liquidity to meet our future operating requirements.

 

We also continue to engage in discussions with different financial institutions, in the event that we would need credit facilities to further supplement our operating requirements. There can be no assurance that we could obtain credit facilities, if needed.

 

 

 

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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 preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. The most significant estimates used in our financial statements relate to revenue recognition where we measure progress towards completion on cost-to-cost basis on our fixed-price contracts, the allowance for doubtful accounts, and the valuation allowance for deferred income tax assets. These estimates require judgments, which we base on historical experience and on various other assumptions, as well as specific circumstances. Estimates may change as new events occur, additional information becomes available or operating environments change.

 

Refer to Part II. Item 7. “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, 2018 for a discussion of our critical accounting policies and estimates.

 

Recently Issued Accounting Standards

 

Except as set forth in Note 1 to our unaudited condensed consolidated financial statements, management has not yet determined whether recently issued accounting standards, which are not yet effective, will have a material impact on our condensed consolidated financial statements upon adoption.

 

Share Repurchases

 

On March 26, 2018, the Board of Directors (the “Board”) authorized the repurchase of up to $1,000 of the Company’s outstanding common stock (the “Repurchase Program”). The Repurchase Program was funded from cash on hand. During the three months ended March 31, 2019, 228 shares of our outstanding common stock were purchased at the price of $0.75 under the Repurchase Program. The Repurchase Program expired on March 31, 2019.

 

On May 2, 2019, the Company repurchased 60 shares from a former member of the Board. The shares were repurchased at the price of $0.80 per share, which was the average closing price for the ten trading days prior to the date of repurchase.

 

On September 1, 2019, the Company received 300 shares of common stock from our former Chief Executive Officer in exchange for certain previously impaired Company equipment ($0 carrying value at the time of exchange). No value was recorded to treasury stock because the assets had a fair value of approximately $0 at the time of the exchange.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not Applicable

 

 

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures. The Company’s disclosure controls and procedures are designed to ensure that such information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The Company’s disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to management, including the principal executive and the principal financial officer, as appropriate to allow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance that control objectives are attained. The Company’s disclosure controls and procedures are designed to provide such reasonable assurance.

 

The Company’s management, with the participation of the principal executive and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2019, as required by Rule 13a-15(e) of the Exchange Act. Based upon that evaluation, the principal executive and the principal financial officer have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2019.

 

Management’s Report on Internal Control Over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal controls over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Although the internal controls over financial reporting were not audited, the Company’s management, including the principal executive and principal financial officer, assessed the effectiveness of internal controls over financial reporting as of September 30, 2019, based on criteria issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) entitled “Internal Control-Integrated Framework.” Upon evaluation, the Company’s management has concluded that the Company’s internal controls over financial reporting were effective as of September 30, 2019.

 

Changes in Internal Control Over Financial Reporting. The Company’s management, with the participation of the principal executive and principal financial officer, have concluded there were no changes in internal control over financial reporting during the fiscal quarter ended September 30, 2019 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

 

 

 

 

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PART II. – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, we may be involved in legal proceedings arising in the normal course of business. We expense or accrue legal costs as we incur them. A summary of our 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. The dispute involves alleged delays and defects in products manufactured by the Company for GE dating back to 2013. Mediation took place on November 28, 2018, but no resolution was reached. The original amount in dispute was $2,630,000, but as of GE’s latest filing with the ICC, the amount in dispute has been reduced to $2,252,000. The parties are in the process of filing preliminary submissions, and the arbitration date is currently set for April 2020. The Company disputes GE’s allegations and intends to vigorously defend itself against these allegations. 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 $270,000 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 $1,000,000, for reimbursement of insurance payments allegedly made for repairs. Trial is scheduled for April 2020. 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.

 

ITEM 1A. RISK FACTORS

 

In July 2018, we announced that our Board of Directors (the “Board”) had initiated a process to explore and evaluate strategic alternatives to maximize stockholder value. During the review process, it was determined that it was in the Company’s best interest to reconstitute the Board, and renew our focus on our core business and on improving our profitability.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Unregistered Sales of Equity Securities

 

On July 27, 2018, we granted 300,000 shares of restricted stock to our Chief Financial Officer and current Chief Executive Officer. These shares have a fair value grant price of $0.79 per share, based on the closing price of our common stock on that day. These shares vest over three years in equal tranches on the anniversary date of his appointment to the role, subject to continued service as an officer of the Company. We are amortizing the related share-based compensation of $237,000 over the three-year requisite service period. The issuance was exempt from registration pursuant to Section 4(a)(2) of the Securities Act, which exempts issuances not involving a public offering.

 

 

 

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On June 24, 2019, the three non-employee members of the Board were each granted an option to purchase 50,000 shares of our common stock at a price of $0.75 per share. Fair value of these stock options was $0.44 per share at the grant date. The options vested 25 percent on August 31, 2019, and the remainder is scheduled to vest in three tranches on November 30, 2019, February 29, 2020 and May 31, 2020, subject to the recipient’s continued service on the Board. Once vested, the options are exercisable until June 24, 2024. We are amortizing the related share-based compensation of $66,000 over the one year requisite service period. The issuance was exempt from registration pursuant to Section 4(a)(2) of the Securities Act, which exempts issuances not involving a public offering.

 

On September 23, 2019, we granted 200,000 shares of restricted stock to our Chief Operating Officer. These shares have a fair value grant price of $0.65 per share, based on the closing price of our common stock on that day. One-fourth of the shares vested immediately and the remaining shares are scheduled to vest over three years in equal tranches on the anniversary date of his appointment to the role, subject to continued service as our Chief Operating Officer. We are amortizing the related share-based compensation of $97,500 over the three-year requisite service period as the shares vest. The issuance was exempt from registration pursuant to Section 4(a)(2) of the Securities Act, which exempts issuances not involving a public offering.

 

On September 24, 2019, we granted our Chief Executive Officer an option to purchase 150,000 shares of our common stock at a price of $0.65 per share. Fair value of these stock options was $0.39 per share at the grant date. The options are scheduled to vest in two equal tranches on the first and second anniversaries of the grant, subject to his continued service as our Chief Executive Officer. We are amortizing the related share-based compensation of $58,500 over the two-year requisite service period as the shares vest. The issuance was exempt from registration pursuant to Section 4(a)(2) of the Securities Act, which exempts issuances not involving a public offering.

 

Repurchases

 

On March 26, 2018, the Board authorized the repurchase of up to $1,000,000 of the Company’s outstanding common stock (the “Repurchase Program”). The Repurchase Program was funded from cash on hand. During the three months ended March 31, 2019, 228,000 shares of our outstanding commons stock were purchased at the price of $0.75 under the Repurchase Program. The Repurchase Program expired on March 31, 2019.

 

On May 2, 2019, the Company repurchased 60,000 shares from a former member of the Board. The shares were repurchased at the price of $0.80 per share, which was the average closing price for the ten trading days prior to the date of repurchase.

 

On September 1, 2019, the Company received 300,000 shares of common stock from our former Chief Executive Officer in exchange for certain previously impaired Company equipment ($0 carrying value at the time of exchange). No value was recorded to treasury stock because the assets had a fair value of approximately $0 at the time of the exchange.

 

ITEM 6. EXHIBITS

 

Exhibits required to be attached by Item 601 of Regulation S-K are listed in the Index to Exhibits of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  DEEP DOWN, INC.
  (Registrant)
     
Date: November 12, 2019    
  By: /s/ Charles K. Njuguna
    Charles K. Njuguna
    President, Chief Executive Officer and Chief Financial Officer
    (Principal Executive and Financial Officer)
     
  By: /s/ Matthew A. Auger
    Matthew A. Auger
    Controller
    (Principal Accounting Officer)

 

 

 

 

 

 

 

 

 

 

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INDEX TO EXHIBITS

 

31.1* Certification of Charles K. Njuguna, President, Chief Executive Officer and Chief Financial Officer, furnished pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
   
32.1*

Statement of Charles K. Njuguna, President, Chief Executive Officer and Chief Financial Officer, furnished pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   
101.INS* XBRL Instance Document
   
101.SCH* XBRL Schema Document
   
101.CAL* XBRL Calculation Linkbase Document
   
101.DEF* XBRL Definition Linkbase Document
   
101.LAB* XBRL Label Linkbase Document
   
101.PRE* XBRL Presentation Linkbase Document
   

 

 

______________________________

* Filed or furnished herewith.

 

 

 

 

 

 

 

 

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