The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in thousands except per share
amounts)
NOTE 1:
|
BASIS OF PRESENTATION
|
Basis of Presentation
The accompanying unaudited condensed consolidated
financial statements of Deep Down, Inc. and its 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 non-core equipment.
The Company’s cash as of March 31, 2019 and December 31, 2018 was $1,776 and $2,015, respectively.
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;
possibly selling certain non-core equipment; further reducing administrative costs; and 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 three months ended March 31, 2019
and 2018, we had one operating and reporting segment, Deep Down Delaware.
Recently Issued Accounting Standards
Not Yet Adopted
In June 2016, the Financial
Accounting Standards Board ("FASB") issued ASU No. 2016-13, Financial Instruments-Credit Losses: Measurement of
Credit Losses on Financial Instruments, as modified by subsequently issued ASU No. 2018-19. 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 are currently evaluating the impact the
adoption of this guidance will have 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 are currently evaluating the impact the adoption of this guidance will have 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 ASC 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. Leases with an initial term of
twelve months or less are not recorded on the balance sheet. We recognize lease expense for these leases on a straight-line basis
over the lease term. We do not separate lease and non-lease components. We therefore elected the short-term lease recognition exemption
for all leases that qualify. This means, for those leases that qualify, we do not recognize ROU assets or lease liabilities. Some
of these agreements contain variable payment provisions that depend on an index or rate, initially measured using the index or
rate at the lease commencement date, and are therefore not included in our future minimum lease payments. These variable lease
agreements include usage-based payments for equipment under service contracts and other properties.
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 certain to exercise these renewal 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 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 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.
|
|
March 31, 2019
|
|
|
January 1, 2019
|
|
Assets:
|
|
|
|
|
|
|
|
|
ROU Assets
|
|
$
|
5,403
|
|
|
$
|
5,707
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Current lease liabilities
|
|
|
1,236
|
|
|
|
1,215
|
|
Non-current lease liabilities
|
|
|
4,176
|
|
|
|
4,492
|
|
Total lease liabilities
|
|
$
|
5,412
|
|
|
$
|
5,707
|
|
The components of our
lease expense were as follows:
Operating lease expense included in Cost of sales
|
|
$
|
306
|
|
|
|
|
|
Operating lease expense included in SG&A
|
|
|
66
|
|
|
|
|
|
Short term lease expense
|
|
|
65
|
|
|
|
|
|
Total lease expense
|
|
$
|
437
|
|
|
|
|
|
As of March 31, 2019,
we do not have any finance lease assets or liabilities, nor do we have any subleases
Other information related to operating leases were as follows:
|
|
|
|
|
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
370
|
|
|
|
|
|
Lease Term and Discount Rate:
|
|
March 31, 2019
|
|
|
January 1, 2019
|
|
Weighted average remaining lease (years) terms on operating leases
|
|
|
4.1
|
|
|
|
4.5
|
|
Weighted average discount rates on operating leases
|
|
|
5.374%
|
|
|
|
5.374%
|
|
During the first quarter, we did not have any sale/leaseback transactions.
Future lease payments under operating leases were as follows for the annual periods
ending March 31:
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
1,494
|
|
2021
|
|
|
1,489
|
|
2022
|
|
|
1,395
|
|
2023
|
|
|
1,411
|
|
2024
|
|
|
236
|
|
Thereafter
|
|
|
–
|
|
Total lease payments
|
|
|
6,025
|
|
Less: Interest
|
|
|
(613
|
)
|
Present value of lease liabilities
|
|
|
5,412
|
|
NOTE 3:
|
REVENUES: ADOPTION OF ASC 606, “REVENUE FROM CONTRACTS WITH CUSTOMERS”
|
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. 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.
|
|
March 31, 2019
|
|
|
March 31, 2018
|
|
Fixed Price Contracts
|
|
$
|
3,531
|
|
|
$
|
1,843
|
|
Service Contracts
|
|
|
2,769
|
|
|
|
1,863
|
|
Total
|
|
$
|
6,300
|
|
|
$
|
3,706
|
|
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.
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 March 31, 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”.
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
Costs incurred on uncompleted contracts
|
|
$
|
3,033
|
|
|
$
|
9,697
|
|
Estimated earnings on uncompleted contracts
|
|
|
3,474
|
|
|
|
10,787
|
|
|
|
|
6,507
|
|
|
|
20,484
|
|
Less: Billings to date on uncompleted contracts
|
|
|
(6,717
|
)
|
|
|
(19,526
|
)
|
|
|
$
|
(210
|
)
|
|
$
|
958
|
|
|
|
|
|
|
|
|
|
|
Included in the accompanying unaudited condensed consolidated balance sheets under the following
captions:
|
|
|
|
|
|
|
|
|
Contract assets
|
|
$
|
827
|
|
|
$
|
1,931
|
|
Contract liabilities
|
|
|
(1,037
|
)
|
|
|
(973
|
)
|
|
|
$
|
(210
|
)
|
|
$
|
958
|
|
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 March 31, 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.
NOTE 4:
|
PROPERTY, PLANT AND EQUIPMENT
|
The components of property, plant and equipment,
net are summarized below:
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
Range of
Asset Lives
|
|
Buildings and improvements
|
|
$
|
285
|
|
|
$
|
285
|
|
|
|
7 - 36 years
|
|
Leasehold improvements
|
|
|
896
|
|
|
|
908
|
|
|
|
2 - 5 years
|
|
Equipment
|
|
|
19,016
|
|
|
|
18,640
|
|
|
|
2 - 30 years
|
|
Furniture, computers and office equipment
|
|
|
596
|
|
|
|
1,166
|
|
|
|
2 - 8 years
|
|
Construction in progress
|
|
|
45
|
|
|
|
158
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property, plant and equipment
|
|
|
20,838
|
|
|
|
21,157
|
|
|
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(11,510
|
)
|
|
|
(11,466
|
)
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
9,328
|
|
|
$
|
9,691
|
|
|
|
|
|
In January 2018, we financed a new Company
vehicle. The financed amount was $67 and is for a term of six years with an interest rate of 0.9%, with monthly payments of $1.
The financing company will hold a lien on the vehicle until all payments have been made.
NOTE 6:
|
SHARE-BASED COMPENSATION
|
On July 27, 2018, we granted 300 shares
of restricted stock to our Chief Financial Officer (“CFO”). 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 our CFO. We are amortizing the related share-based
compensation of $237 over the three-year requisite service period.
For the three months ended March 31, 2019
and 2018, we recognized a total of $104 and $4 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 $118 at March 31, 2019 and
$222 at December 31, 2018. These costs are expected to be recognized as expense over a weighted-average period of 2.04 years.
At March 31, 2019 and December 31, 2018
there were no other unvested restricted shares or options.
On March 26, 2018, the Board of Directors
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 under the Repurchase Program. The Repurchase Program expired on March 31, 2019.
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 March 31, 2019 and December 31, 2018 management has recorded a full deferred tax asset valuation
allowance.
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 date has not yet been set. 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 July 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 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.
At March 31, 2019 and 2018, there were
no potentially dilutive securities outstanding.