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Deep Down (DPDW)

Filed: 27 Mar 18, 8:00pm

 

Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington D.C., 20549

 

FORM 10-K

 

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

For the fiscal year ended December 31, 2017

 

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

 

Commission File No. 0-30351

 

DEEP DOWN, INC.

(Exact name of registrant as specified in its charter)

 

Nevada 75-2263732
(State of other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
   
8827 W. Sam Houston Pkwy North, Suite 100, Houston, Texas 77040
(Address of Principal Executive Office) (Zip Code)

 

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

 

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

 

Securities registered pursuant to Section 12(g) of the Act:Common Stock, $0.001 par value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yeso No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No þ

 

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 (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesþ Noo

 

Indicate by check mark if disclosures of delinquent filers in response to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.þ

 

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 definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o  Accelerated filer o  Non-accelerated filer o Smaller reporting company þ

Emerging growth company o

 

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.o

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yeso Noþ

 

As of June 30, 2017, the aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, was $10,969,184.

 

At March 26, 2018, the registrant had 13,436,243 shares outstanding of common stock, par value $0.001 per share.

 

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

 

   

 

 

TABLE OF CONTENTS

 

 

PART I
 
Item 1Business1
Item 1ARisk Factors7
Item 1BUnresolved Staff Comments7
Item 2Properties7
Item 3Legal Proceedings8
Item 4Mine Safety Disclosures8
   
PART II
 
Item 5Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities9
Item 6Selected Financial Data10
Item 7Management’s Discussion and Analysis of Financial Condition and Results of Operations11
Item 7AQuantitative and Qualitative Disclosures About Market Risk15
Item 8Financial Statements and Supplementary Data16
Item 9Changes in and Disagreements with Accountants on Accounting and Financial Disclosure16
Item 9AControls and Procedures16
Item 9BOther Information16
   
PART III
   
Item 10Directors, Executive Officers and Corporate Governance17
Item 11Executive Compensation19
Item 12Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters22
Item 13Certain Relationships and Related Transactions, and Director Independence23
Item 14Principal Accounting Fees and Services23
   
 PART IV 
Item 15Exhibits, Financial Statement Schedules24
Item 16Form 10-K Summary24
 Signatures25

 

 

 

 i 

 

 

Forward-Looking Information

 

Unless otherwise indicated, the terms “Deep Down, Inc.”, “Deep Down”, “Company”, “we”, “our” and “us” are used in this report to refer to Deep Down, Inc., a Nevada corporation, and its directly and indirectly wholly-owned subsidiaries.

 

In this Annual Report on Form 10-K (the “Report”), we may make certain forward-looking statements (“Statements”), including statements regarding our plans, strategies, objectives, expectations, intentions and resources that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We do not undertake to update, revise or correct any of the Statements. The Statements should also be read in conjunction with our audited consolidated financial statements and the notes thereto.

 

The Statements contained in this Report that are not historical fact 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 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”, “expects”, “may”, “will”, “should”, “intend”, “plan”, “could”, “is likely”, or “anticipates”, or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. We caution the readers that these Statements are only predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. While sometimes presented with numerical specificity, these projections and other Statements are based upon a variety of assumptions relating to the business of the Company, which, although considered reasonable by us, may not be realized. Because of the number and range of assumptions underlying our projections and Statements, many of which are subject to significant uncertainties and contingencies that are beyond our reasonable control, some of the assumptions inevitably will not materialize, and unanticipated events and circumstances may occur subsequent to the date of this Report. These Statements are based on current expectations and we assume no obligation to update this information. Therefore, our actual experience and the results achieved during the period covered by any particular projections or Statements may differ substantially from those projected. Consequently, the inclusion of projections and other Statements should not be regarded as a representation by us or any other person that these estimates and projections will be realized, and actual results may vary materially. There can be no assurance that any of these expectations will be realized or that any of the Statements contained herein will prove to be accurate.

 

 

 

 

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PART I

 

ITEM 1.Business.

 

History

 

Deep Down, Inc. is a Nevada corporation engaged in the oilfield services industry. As used herein, “Deep Down”, “Company”, “we”, “our” and “us” refers to Deep Down, Inc. and/or its subsidiaries. Deep Down, Inc. (OTCQX: DPDW), a publicly traded Nevada corporation, was incorporated on December 14, 2006, through a reverse merger with MediQuip Holdings, Inc., a publicly traded Nevada corporation.

 

Deep Down is the parent company to the following directly and indirectly wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”); Deep Down International Holdings, LLC, a Nevada limited liability company (“DDIH”), and Deep Down Brasil - Solucoes em Petroleo e Gas, Ltda, a Brazilian limited liability company (“Deep Down Brasil”). Our current operations are primarily conducted under Deep Down Delaware.

 

In addition to our strategy of continuing to grow and strengthen our operations, including by expanding our services and products in response to our customers’ demands, we intend to continue to seek strategic acquisitions of complementary service providers, product manufacturers and technologies that are focused primarily on supporting deepwater and ultra-deepwater offshore exploration, development and production of oil and gas reserves and other maritime operations.

 

Our website address iswww.deepdowninc.com. We make available, free of charge on or through our website, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”). Paper or electronic copies of such material may be requested by contacting the Company at our corporate offices. Information filed with the SEC is also available at www.sec.gov or may be read and copied at the SEC’s Public Reference Room at 100 F. Street, NE, Washington, DC 20549. Information regarding operations of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

 

Business Overview

 

We are a global provider of specialized services to the offshore energy industry to support deepwater and ultra-deepwater exploration, development and production of oil and gas and other maritime operations. While we are primarily a service company, we also produce custom engineered products that assist us in fulfilling service objectives for specific projects on a contractual basis. We design and manufacture a broad line of deepwater and ultra-deepwater, surface and offshore equipment solutions which are used by major integrated, large independent, and foreign national oil and gas companies in offshore areas throughout the world. Our products are often developed in direct response to customer requests for solutions to critical problems in the field. We serve the growing offshore petroleum and maritime industries with technical management and support services. One of our greatest strengths is the extensive knowledge base of our service, engineering and management personnel in many aspects of the deepwater and ultra-deepwater industry. Set forth below is a more detailed description of important services and products we provide.

 

Our goal is to provide superior services and products to our customers in a safe, cost-effective and timely manner. We believe there is significant demand for, and brand name recognition of, our established products due to the technological capabilities, reliability, cost-effectiveness, timeliness of delivery and operational efficiency features of these products. Since our formation, we have introduced many new products that continue to broaden the markets we currently serve.

 

For the years ended December 31, 2017 and 2016, we only had one operating and reporting segment, Deep Down Delaware. All of the services and products we provide are interrelated, are performed for the same general customers and are marketed as such.

 

Services and Products

 

Services. We provide a wide variety of engineering and management services, including the design, installation and retrieval of subsea equipment and systems, connection and termination operations, well-commissioning services, as well as construction support and Remotely Operated Vehicle (“ROV”) operations support. We pride ourselves in our ability to collaborate with the engineering functions of oil and gas operators, installation contractors and subsea equipment manufacturers to determine the fastest, safest, and most cost-effective solutions to the full spectrum of complex issues which arise in our industry.

 

 

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Project Management and Engineering. Our project management teams specialize in deepwater subsea developments. Our services are centered on the utilization of standardized hardware, proven, well-tested installation techniques, and experienced, consistent teams that have proven to be safe and skilled in all aspects of the installation process. Many installation contractors find it beneficial to utilize our services to help reduce on-board personnel since our specialized technicians can perform multiple tasks. Our teams have vast experience with the installation of flexible and rigid risers and flowlines, umbilicals, flexible and rigid jumpers, steel tube and thermoplastic hose flying leads, pipeline end terminations and manifolds. Our engineers have experience ranging from the initial conceptual design phases through manufacturing and installation, and concluding with topside connections and commissioning. Our experience provides us with a level of “hands on” and practical understanding that has proven to be indispensable in enabling us to offer custom solutions to the many problems encountered both subsea and topside. Because of our wide knowledge base, our engineering team is often hired by oil and gas operators, installation contractors and subsea equipment manufacturers to provide installation management and engineering support services. Our engineering team has been involved in several of the innovative solutions used today in deepwater subsea systems. We specialize in offshore installation engineering and the writing of practical installation procedures. We deal with issues involving flying leads, compliant umbilical splices, bend stiffener latchers, umbilical hardware, hold-back clamps, and the development of distribution system components.  We are heavily involved in the fabrication of installation aids to simplify offshore executions, and offer hydraulic, fiber optic, and electrical testing services and various contingency testing tools.

 

Spooling Services. Our experienced personnel are involved in the operation of spooling equipment on many projects, including operations for other companies to run their spooling equipment.  We have developed a very efficient (in both time and cost) system for spooling, utilizing our horizontal drive units, under-rollers, tensioners, carousels and rapid deployment cartridges.

 

Testing and Commissioning Services. Umbilical manufacturers, control suppliers, installation contractors, and oil and gas operators utilize our services to perform all aspects of testing, including initial Factory Acceptance Testing (“FAT”), extended factory acceptance testing and System Integration Testing (“SIT”), related to the connecting of the umbilical termination assemblies, the performing of installations, and the completion of the commissioning of the system thereafter. To execute these services, we have assembled a variety of personnel and equipment to ensure that all testing operations are done in a safe and time-efficient manner, ensuring a reduced overall project cost. We also work hard to utilize the most detailed digital testing and monitoring equipment to ensure that the most accurate data is provided to our customers. We have been hired to perform coiled tubing flushing, cleaning, and hydro testing, umbilical filling, flushing, pressure, flow rate, and cleanliness testing, load out monitoring and testing, installation monitoring, post installation testing, system commissioning, umbilical intermediate testing, and umbilical termination assembly cleanliness, flow, and leak testing. We employ a variety of different pumping systems to meet industry needs and offer maximum flexibility. Our philosophy is to flush through the maximum number of lines at the highest flow rate possible to maximize efficiency.  Due to the different requirements for testing and commissioning of subsea systems, we have an assortment of pumps and equipment to deploy to ensure a safe and efficient commissioning program. We have experience handling all types of commissioning fluids, including asphaltine dispersants, diesel, methanol, xylene, corrosion inhibitors, water-based control fluids, oil-based control fluids, 100 percent glycol, paraffin inhibitors, and alcohol.  We have been involved in the design, procurement, testing, installation, and operation of the testing equipment. Our engineers and service technicians can also assist in writing the testing procedures and sequences from simple FAT to very extensive multiple pressures and fluids testing up to full system SIT procedures. We work closely with the project managers and production platform engineers to help ensure that all aspects of the installation or retrieval project, including potential risks and dangers, are identified, planned for, and eliminated prior to arrival on the production platform.

 

Storage Management. Our facility in Houston, Texas covers more than 255,000 square feet on 23 acres, offering internal high quality warehousing capacity, external storage and a strategic location in Houston's Ship Channel area. Our warehouse is designed to provide customers with flexible and cost effective warehousing and storage management alternatives. Our professional and experienced warehouse staff, combined with the very latest in information technology, results in a fully integrated warehousing package designed to deliver effective solutions to customer needs. Among other capabilities, we are capable of providing long-term specialized contract warehousing; long and short-term storage; modern materials handling equipment; covered loading areas; quality security systems; integrated inventory management; packing and repacking; computerized stock controls; and labeling.

 

Our shore-based facility located at Core Industries, Inc. in Mobile, Alabama has 6,500 square feet and houses our 3,400 ton carousel system, and is used to store customers’ products. The site is sufficient to allow for full system integration testing of our customers’ equipment prior to deployment offshore.

 

ROV and ROV Tooling Services.  As part of our ROV services, we have observation and light work class ROV units capable of operating in depths of 10,000 feet. Our services include offering these vehicles to strategic alliance partners who lease our vehicles and provide the actual services of platform inspection, platform installation and abandonment, search and recovery, salvage, subsea sampling, subsea intervention, telecommunication cable inspections, anchor handling, ROV consulting and project management, ROV pilots and technicians, and underwater cinematography. We provide an extensive line of ROV intervention tooling, both used to support our own operations and for rental to our customers. Our ROV tooling equipment includes flying lead orientation tools, class 1-5 torque tools, hot stabs, pipe cutting systems, dredging and pumping systems, ROV clamps and ROV-friendly hooks and shackles that are state-of-the-art in design.

 

 

 

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Equipment Refurbishment and Intervention Services.In addition to the new products we build, we have cultivated expertise in the refurbishment and repurposing of recovered subsea distribution assets and providing support for offshore interventions.

 

Items refurbished and repurposed for customers include Logic Caps (“LC(s)”), intermediate logic caps, and Hydraulic Distribution Manifolds (“HDM(s)”). Once a recovered asset is received, it is cleaned, any production fluids are flushed out with a water-based control fluid, and the asset is moved into storage. As an emergency or intervention arises, we pull the stored asset, reroute and weld the tubing, and then perform FAT per customer specifications. Finally, we send out our service technicians and equipment to support the offshore campaign.

 

Additionally, we perform various tasks in support of offshore interventions. We reconfigure Deep Down Hydrate Remediation Frames and Hydraulic Flying Leads (“HFL(s)”) at either of our facilities or in the field. Our service technicians go offshore to pre-charge and make any changes to the frame needed to remediate hydrates.

 

We also developed the Fast Response Box (“FRB”), a concept cultivated from our vast offshore campaign experience. Our team identified the necessary components for an emergency reroute of a chemical or hydraulic line performed on the deck of a vessel. After the subsea distribution hardware is brought up, our service technicians safely depressurize, flush, cut out tubing, and reroute as required to get the well or field back up and producing. We then pre-charge the system and assist in overboarding and reinstallation. Our ability to provide a fully functional temporary solution is designed to bring the well or field back into production immediately and allows time for a permanent solution to be developed.

 

Our capabilities further include in-house software and hardware engineering to provide innovative solutions from wireless testing and monitoring equipment, to Dynamic Positioning (“DP”) systems. We have also developed camera systems that can be set up at any site, enabling our customers to witness FATs, SITs or vessel load-outs in real-time, from any location in the world.

 

Products. We provide installation support equipment and component parts and assemblies for subsea distribution systems. We believe the key to successful installations of hardware is to design the subsea system by considering installation issues first, working backwards to the design of the hardware itself. This is why we have been instrumental in the development of hardware and techniques to simplify deepwater installations. We design, manufacture, fabricate, inspect, assemble and test subsea equipment, surface equipment and offshore equipment that is used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world.  Our products are used during oil and gas exploration, development and production operations on offshore drilling rigs, such as floating rigs and jack-ups, and for drilling and production of oil and gas wells on offshore platforms, tension leg platforms and moored vessels such as Floating Production Storage and Offloading vessels (“FPSO”).

 

Flying Leads. Deep Down is a leader in flying lead design, manufacture and installation; in particular steel tube flying leads. Our flagship product, the Loose Steel Tube Flying Lead (“LSFL®”), was developed to eliminate the residual memory left in traditional flying leads due to the bundling process. The loose lay of the tubes significantly reduces stiffness of the assembly, allows the bundle to lay flat on the sea floor, follow the prescribed lay path precisely, bend in a tight radius with minimal resistance and offers maximum compliance for easy makeup in lengths up to 1,000’. When greater lengths up to 10,000’ are required, we utilize our patented Non-Helical Umbilical (“NHU®”) in conjunction with a compliant section on each end of the assembly to achieve the same result. We also offer hybrid LSFL® assemblies which can include any number and combination of electrical, optical, hose and steel tube elements. Hybrid LSFL® technology provides installation savings in both time and money as fewer operations are required to install the combined unit.

 

Deep Down employs the patented Moray® termination system on each end of the LSFL®. The Moray® termination is a light weight, high-strength, configurable and field serviceable framework used to connect any commercially available Multi-Quick Connect (“MQC”) plate to the LSFL® bundle. The Moray® termination assembly allows the installation load from the steel tubes or strength member to be transmitted directly to the framework and through to the installation rigging while isolating couplers from the load to maintain maximum compliance. The Moray® termination with compliant section is ideal for umbilical end terminations; it eliminates the need for bulky armor pots and is more manageable than a traditional umbilical end termination. In this application, the Moray® termination can be used to house multiple electrical, optical and auxiliary hydraulic interfaces in integrated ROV panels. Moray® termination assemblies can be outfitted with integrated buoyancy allowing quicker installation times by eliminating the need to recover buoyancy modules. Additionally, this allows for the use of a smaller class ROV on a vessel should the need for rework arise.

 

 

 

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Umbilical Hardware. Our blend of experiences with umbilical manufacturers, subsea engineers and installation contractors has been effective, giving us a unique perspective when fabricating and designing terminations for umbilical manufacturers.  Members of our team were involved with the designs for the armored thermo plastic umbilicals at Oceaneering Multiflex, the first steel tube umbilical in the Gulf of Mexico for the Shell Popeye® umbilical, and the standardization of many steel tube umbilical terminations. We believe our designs are often much lighter in weight and smaller than the typical hardware that has been created and used in the past by our competitors. Our engineering team has designed and fabricated bending restrictors, armor pots, split barrels, tubing fittings and unions, hinging umbilical splices and topside terminations with our unique threaded welded fittings, umbilical compliant splice, and the bend stiffener latcher. We offer both polymer and steel bend limiters. The compliant splice is a patented method of converting spare umbilicals into actual production umbilicals by splicing spare umbilicals together to produce any length required or to repair a damaged umbilical. This termination system eliminates the burdens of dealing with umbilical splices during installation and is capable of housing both electrical and fiber optic termination assemblies while still allowing for the splice to be spooled up onto a reel or carousel. Our Umbilical Termination Assembly (“UTA”) and new compliant UTA allows us to terminate the umbilical with a higher degree of quality and place the critical components of the base unit on the reel or on the carousel and handle it with additional ease and safety.  Then it is combined with the mud mat assembly easily and offers both first end stab and hangover features as well as yoke second end landing. The new compliant version allows the UTA to be expanded for multiple J-plates and yet feature the same compliant features in our compliance splicing increasing the ease of handling on the deployment equipment – overboarding – and landing on the seafloor. Our termination services are becoming popular because they offer the ability to take existing umbilical hang offs from multiple manufacturers, which may have been exposed to terrible environmental conditions, and add them to temporary handling clamps – lifting up the umbilical and providing a completely new hangoff arrangement and thus extending the life of the umbilical and the subsea field. This service is being utilized on a project now.  Bend Stiffener Latchers™ (“BSL™”) are still the leaders in the industry allowing bend stiffeners to be carried by the umbilical topside termination assembly in a more compact and overlapping configuration. BSLs are overboarded with the highest strength and can be installed into an existing I-tube with existing flange or an I-tube with a mating bell mouth. They are then latched in by ROV allowing the bend stiffener to be securely attached to the I-tube transferring all the dynamic bending while the umbilical is pulled up and hung off. This process eliminates the handling of two major pieces of hardware, and the need to have measurements between the components as the system is fully extending and adjustable.

 

Riser Isolation Valves and Subsea Isolation Valve Services. Deep Down's new Riser Isolation Valve (“RIV”) and Subsea Isolation Valve (“SSIV”) control systems are unique solutions providing platform personnel the hydraulic control and electrical indication for subsea production valve manipulation. These systems provide numerous advantages to the customer including: emergency shutdown capabilities, valve positioning monitoring systems, and auxiliary positions for spare and/or future field development. 

 

In addition to fabrication of these systems, Deep Down provides subsea installation engineering, consulting, and service personnel to support customers, installation contractors, valve vendors and more. Our expertise ensures scope is fully defined and delegated allowing for safe and successful installations. The Deep Down team provides commissioning and technical assistance to customers and platform personnel, and seeks to ensure that the systems are working properly and all necessary operational information is handed over to the end users.

 

Capitalizing on our expertise in umbilical manufacturing, Subsea and Topside Umbilical Termination Assemblies (“SUTA” / “TUTA”), hydraulic and electrical flying leads, and super duplex welding, we provide quality products our clients can depend on. We believe our installation friendly project designs help us meet customer specifications. When Deep Down’s expert installation team is on the job, product integrity is preserved, helping us ensure successful installations.

 

Installation Aids.To help our customers and to meet our own internal needs, we have developed an extensive array of installation aids, including steel flying lead installation systems, tensioners, lay chutes, many varieties of buoyancy, clump weights, Vortex Induced Vibration (“VIV”) strakes, mud mats, dual tank skids, gang boxes, work vans, pumping and testing skids, control booths, fluid drum carriers, crimping systems, load cells,  300 and 340-ton under-rollers, powered reels, 200-ton, 400-ton and 3,400-ton and 3,500-ton carousel, UTA and bridging jumper running and parking deployment frames, termination shelters, pipe straighteners, ROV hooks and shackles, stackable SeaStax® tanks, baskets, Subsea Deployment Basket System (SDB®), Horizontal Drive Units (“HDU”) and Rapid Deployment Cartridges (“RDC”).

 

Buoyancy Products. We design, engineer and manufacture deepwater buoyancy systems and support hardware essential to installation and operational requirements. Deep Down's rotational molding operations produce high density polyethylene products including bend restrictors, VIV suppression strakes and fairings, protective outer shells for distributed buoyancy modules and other flotation products. Our unique distributed buoyancy module clamps are designed for quick and easy installation for both "over the stinger" and vertical lay system methods.

 

 

 

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Further expansion of our flotation product line includes drilling riser buoyancy support hardware and installation services and development of a “Buoyant Rod” concept that we hope to have significant applications in the flotation industry.

 

Non-Helical Umbilical®. Deep Down's patented Non-Helical Umbilical (“NHU®”) combines our experience manufacturing miles of loose steel tube flying leads, terminating conventional steel umbilicals, and observing installation behavior of all umbilicals. The NHU® can be manufactured in lengths up to 10 miles using super duplex tubes in standard sizes and in any configuration of hydraulic, electrical or optical elements.  It is intended for long-term infield (static) or short-term dynamic service applications.

 

Multiple tubes may be fed into the patented Deep Down NHU® manufacturing mechanism, bundled, then extruded with a high density polyethylene outer jacket. Umbilicals are not torque balanced on their own, so rather than expending resources to balance and imparting stresses to helically wind them, the NHU® uses the imbalance to its advantage, resulting in a standard bundle.

 

The proprietary NHU® manufacturing concept is fully containerized, portable and easily transported for setup virtually anywhere in the world. The ability to manufacture in close proximity to subsea fields offers the benefits of reduced lead times, the use of smaller installation vessels, use of compact Deep Down equipment, the incorporation of the appropriate percentages of local content, and more favorable economics.

 

Manufacturing

 

Our primary operations are located at a 255,000 sq. ft. facility on 23 acres off Beaumont Highway, on the eastern end of Houston, Texas, where we have been since 2013. In addition to increasing our production capacity, this facility provides the space to build our Steel Tube Flying Lead (“STFL”) Overhead Tracking System. This system allows us to easily move STFLs from station to station during production for welding, X-ray and FAT. We have also significantly expanded our clean, stainless steel welding and tube bending environment, which is separated from all carbon steel fabrication.

 

We have a 12’x60’ wet testing tank, adding the capability to test our products and rigging with buoyancy scenarios in the water. Featuring filtered water and underwater lighting also enables us to launch and test small ROVs and ROV operations.

 

The most substantial benefit of this facility is expected to be realized when the dock on the property is completed. This will allow us to move large equipment and fabricated items by barge, reducing the costs and eliminating the limitations of highway transportation.

 

Our manufacturing plant is ISO 9001 certified. We continue to improve our standards and product quality through the use of quality assurance specialists working with our product manufacturing personnel throughout the manufacturing process. We have the capacity to complete large turn-key projects and still have reserve space for unforeseen emergency projects requiring immediate service and attention oil companies are accustomed to.

 

Customers

 

Demand for our deepwater and ultra-deepwater services, surface equipment and offshore rig equipment is dependent on the condition of the oil and gas industry and its ability and need to make capital expenditures as well as continual maintenance and improvements on its offshore exploration, drilling and production operations. The level of these expenditures is generally dependent upon various factors such as expected prices of oil and gas, exploration and production costs of oil and gas, and the level of offshore drilling and production activity. The prevailing view of future oil and gas prices are influenced by numerous factors affecting the supply and demand for oil and gas. These factors include worldwide economic activity, interest rates, cost of capital, environmental regulation, tax policies, and production levels and prices set and maintained by producing nations and the Organization of the Petroleum Exporting Countries. Capital expenditures are also dependent on the cost of exploring for and producing oil and gas, the sale and expiration dates of domestic and international offshore leases, the discovery rate of new oil and gas reserves in offshore areas and technological advances. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility.

 

Our principal customers are major integrated oil and gas companies, large independent oil and gas companies, foreign national oil and gas companies, subsea equipment manufacturers and subsea equipment installation contractors involved in offshore exploration, development and production. Offshore drilling contractors, engineering and construction companies, and other companies involved in maritime operations represent a smaller customer base.

 

 

 

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We are not dependent on any one customer or group of customers. The number and variety of our products required in a given period by a customer depends upon its capital expenditure budget as well as the results of competitive bids. Consequently, a customer may account for a material portion of revenues in one period and may represent an immaterial portion of revenues in a subsequent period. While we are not dependent on any one customer or group of customers, the loss of one or more of our significant customers could, at least on a short-term basis, have an adverse effect on the results of our operations.

 

Marketing and Sales

 

We market our services and products worldwide through our Houston-based sales force. We periodically advertise in trade and technical publications targeting our customer base. We also participate in industry conferences and trade shows to enhance industry awareness of our products and services. Our customers generally order products and services after consultation with us on their project. Orders are typically completed within two weeks to three months depending on the type of product or service. Larger and more complex products may require four to six months to complete, though we have accepted several longer-term projects, requiring significantly more time to complete. Our customers select our products and services based on the quality, reliability and reputation of the product or service, price, timely delivery and advanced technology. For large production system orders, we engage our project management team to coordinate customer needs with engineering, manufacturing and service organizations, as well as with subcontractors and vendors. Our profitability on projects is dependent on performing accurate and cost-effective bids as well as performing efficiently in accordance with bid specifications. Various factors can adversely affect our performance on individual projects that could potentially adversely affect the profitability of a project.

 

Backlog

 

Information regarding our backlog is incorporated herein by reference from the section entitled, “Industry and Executive Outlook” in Part II, Item 7 of this Report.

 

Product Development and Engineering

 

The technological demands of the oil and gas industry continue to increase as offshore exploration and drilling operations expand into deeper and more hostile environments. Conditions encountered in these environments could soon include well pressures of up to 20,000 psi, mixed flows of oil and gas under high pressure that may also be highly corrosive, and water depths in excess of around 10,000 feet. We are continually engaged in product development activities to generate new products and to improve existing products and services to meet our customers’ specific needs. We also focus our activities on reducing the overall cost to the customer, which includes not only the initial capital cost but also operating costs associated with our products.

 

We have an established track record of introducing new products and product enhancements. Our product development work is conducted at our facility in Houston, Texas, and in the field. Our application engineering staff also provides engineering services to customers in connection with the design and sales of our products. Our ability to develop new products and maintain technological advantages is important to our future success.

 

We believe that the success of our business depends more on the technical competence, creativity and marketing abilities of our employees than on any individual patent, trademark or copyright. Nevertheless, as part of our ongoing product development and manufacturing activities, our policy is to seek patents when appropriate on inventions concerning new products and product improvements. All patent rights for products developed by employees are assigned to us.

 

Competition

 

The principal competitive factors in the petroleum drilling, development and production and maritime equipment markets are quality, reliability and reputation of the product, price, technology, and timely delivery. We face significant competition from other manufacturers of exploration, production, and maritime equipment. Several of our primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources and have a longer history in the manufacturing of these types of equipment.  

 

Employees

 

At March 12, 2018, we had a total of 59 full-time employees. Our employees are not covered by collective bargaining agreements and we generally consider our employee relations to be good. Our operations depend in part on our ability to attract a skilled labor force. While we believe that our wage rates are competitive and that our relationship with our skilled labor force is good, a significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force and increases in the wage rates that we pay or both.

 

 

 

 6 

 

 

Governmental Regulations

 

A significant portion of our business activities are subject to federal, state, local and foreign laws and regulations and similar agencies of foreign governments. The technical requirements of these laws and regulations are becoming increasingly expensive, complex and stringent. These regulations are administered by various federal, state and local health and safety and environmental agencies and authorities, including the Occupational Safety and Health Administration of the U.S. Department of Labor and the U.S. Environmental Protection Agency. From time to time, we are also subject to a wide range of reporting requirements, certifications and compliance as prescribed by various federal and state governmental agencies. Expenditures relating to such regulations are made in the normal course of our business and are neither material nor place us at any competitive disadvantage. We do not currently expect that compliance with such laws will require us to make material additional expenditures.

 

We are also affected by tax policies, price controls and other laws and regulations generally relating to the oil and gas industry, including those specifically directed to offshore operations. Adoption of laws and regulations that curtail exploration and development drilling for oil and gas could adversely affect our operations by limiting demand for our services or products. As of the date of this Report, we are also evaluating the impact recent announcements of increased tariffs on imported raw materials will have on our business.

 

Increased concerns about the environment have resulted in offshore drilling in certain areas being opposed by environmental groups, and certain areas have been restricted. To the extent that new or additional environmental protection laws that prohibit or restrict offshore drilling are enacted and result in increased costs to the oil and gas industry in general, our business could be materially affected. In addition, these laws may provide for "strict liability" for damages to natural resources or threats to public health and safety, rendering a party liable for the environmental damage without regard to negligence or fault on the part of such party. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties and criminal prosecution. Certain environmental laws provide for joint and several liabilities for remediation of spills and releases of hazardous substances. In addition, companies may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources. Such laws and regulations may also expose us to liability for the conduct of or conditions caused by others, or for our acts that were in compliance with all applicable laws at the time such acts were performed. Compliance with environmental laws and regulations may require us to obtain permits or other authorizations for certain activities and to comply with various standards or procedural requirements.

 

We cannot determine to what extent our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations. We believe that our facilities are in substantial compliance with current regulatory standards. Based on our experience to date, we do not currently anticipate any material adverse effect on our business or consolidated financial position as a result of future compliance with existing environmental laws and regulations controlling the discharge of materials into the environment. However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures which may be material.

 

Intellectual Property

 

While we are the holder of various patents, trademarks and licenses relating to our business, we do not consider any individual intellectual property to be material to our business operations.

 

ITEM 1A.RISK FACTORS

 

Not Applicable

 

ITEM 1B.UNRESOLVED STAFF COMMENTS

 

None

 

ITEM 2.Description of Property

 

Our principal corporate offices are located at 8827 W. Sam Houston Parkway North, Suite 100, Houston, Texas, 77040. On August 1, 2016, we transferred our lease to our subtenant and no longer have monthly lease costs, but still office from this location, and are responsible for utilities and other operating costs of the location. As of the date of this Report, we are finalizing plans to permanently relocate out of this location, and fully consolidate all of our corporate administrative activities at our operating facility located at 18511-810 Beaumont Highway, Houston, Texas 77049 (“Highway 90”).

 

 

 

 7 

 

 

Our Highway 90 facility consists of approximately 23 acres of land, and includes 255,000 sq. ft. of indoor manufacturing and storage space. We have a 10-year lease on our Highway 90 facility, which commenced in June 2013 at a base rate of $90,000 per month, adjustable based on the CPI, for the remainder of the lease term. Additionally, we lease, on a month-to-month basis, 6,500 square feet of storage space in Mobile, AL to house our 3,400-ton carousel system for $5,000 per month.

 

We believe that our current space is suitable, adequate and of sufficient capacity to support our current operations.

 

ITEM 3.Legal Proceedings

 

From time to time, we may be involved in legal proceedings arising in the normal course of business. We are not involved in any material legal proceeding.

 

ITEM 4.MINE SAFETY DISCLOSUREs

 

None

 

 

 

 

 

 

 

 8 

 

 

PART II

 

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Price Range for Common Stock

 

Our common stock trades on the QX Tier of the OTC Markets Group (OTCQX) under the symbol OTCQX: DPDW. The following table sets forth, for the quarters ended on the dates indicated below, the high and low bid quotations for our common stock as reported by the OTC Markets.

 

  High Low
Fiscal Year 2017:    
December 31, 2017 $0.99 $0.67
September 30, 2017 $1.11 $0.85
June 30, 2017 $1.25 $1.00
March 31, 2017 $1.45 $1.00
Fiscal Year 2016:    
December 31, 2016 $1.45 $0.75
September 30, 2016 $1.01 $0.80
June 30, 2016 $1.03 $0.71
March 31, 2016 $0.84 $0.40

 

Stockholders of Record

 

As of March 26, 2018, there were 1,098 stockholders of record of our common stock. All common stock held in street names are recorded in the Company’s stock register as being held by one stockholder.

 

Dividend Policy

 

To date, we have not paid any cash dividends and our present policy is to retain earnings for working capital for the growth of our operations.

 

Issuer Purchases of Equity Securities

 

No shares were repurchased in the quarter ended December 31, 2017.

 

On March 26, 2018, the Board of Directors authorized the repurchase of up to $1 million in shares of the Company's common stock. The repurchase program will be funded from cash on hand and cash provided by operating activities.

 

The time of the purchases and amount of stock purchased will be determined at the discretion of management subject to market conditions, business opportunities and other appropriate factors and may include purchases through one or more broker-assisted plans and methods, including, but not limited to, open-market purchases, privately negotiated transactions and Rule 10b5-1 trading plans. The share repurchase program will expire on March 31, 2019.

 

 

 

 9 

 

 

Equity Compensation Plan Information

 

The following table sets forth information regarding our equity compensation plans as of December 31, 2017:

 

           
Plan Category  Number of
securities to be
issued upon exercise
of outstanding
options,
warrants and
rights
    Weighted-
average exercise
price of
outstanding
options,
warrants and
rights
    Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected
in first column)
    
Equity compensation plans approved by security holders    $   2,311,299 (1)
Equity compensation plans not approved by security holders          
TOTAL    $   2,311,299  

 

(1)Represents 2,311,299 shares of common stock available for future grant under the Company’s 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”) as of December 31, 2017. The total number of shares subject to grants and awards under the Plan is 15 percent of issued and outstanding shares of common stock.

 

 

ITEM 6.SELECTED FINANCIAL DATA

 

Not Applicable

 

 

 

 

 

 

 

 

 

 

 10 

 

 

Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes to those consolidated financial statements appearing elsewhere in this Report. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, our actual results may differ materially from those anticipated in our forward-looking statements.

 

General

 

We are an oilfield services company specializing in complex deepwater and ultra-deepwater oil production distribution system support services, serving the worldwide offshore exploration and production industry. Our services and technological solutions include distribution system installation support and engineering services, umbilical terminations, loose-tube steel flying leads, ROVs and related services. We support subsea engineering, installation, commissioning, and maintenance projects through specialized, highly experienced service teams and engineered technological solutions. Our primary focus is on more complex deepwater and ultra-deepwater oil production distribution system support services and technologies, used between the platform and the wellhead.

 

Industry and Executive Outlook

 

The oil and gas industry has largely adapted to lower oil prices, and adjusted operations accordingly. While new deepwater projects are now being sanctioned, we are experiencing the effects of the long period when final investment decisions on new projects were being postponed, and the longer sales cycles of new projects.

 

Despite the recent uptick in new deepwater activity, our results for 2017 were heavily impacted by this slowdown in new projects. However, despite the lower revenues, we are pleased with the higher margins we were able to realize due to performing an increased proportion of higher-margin service work. We continue to engage with our customers in promising discussions about upcoming projects, albeit with longer than ideal horizons.

 

To weather the downturn, we have continued to evaluate and streamline our cost structure and contracting strategies. Towards this effort, we are now at our lowest employee levels in several years and have implemented additional temporary reductions in our payroll spending. We are also finalizing plans to permanently relocate our corporate functions out of our corporate office, and into our primary operating facility.

 

As of March 26, 2018, our committed backlog is $14 million, compared to a backlog of $23 million as of March 31, 2017. We currently expect to realize 90% of this backlog in 2018. Despite our lower backlog of committed work, we are also seeing an increase in inspection, maintenance and repair work, which we do not typically know of well in advance but is a core competence of ours. We expect to continue to perform an increased proportion of this type of higher-margin service work in the near future.

 

In addition to this service work, our efforts to pursue new customers in emerging frontiers are beginning to bear fruit. We expect to make announcements in the near future on new projects in areas we have never worked in before, for new customers. Our local partnerships in different international markets are also showing increased promise.

 

We continue to receive strong interest in our services for non-oil and gas organizations, but in light of our current situation, we intend to focus primarily on our core business in 2018, and only complete our sponsorship initiative for Texas A&M students, in support of their participation in the Shell Ocean Discovery XPRIZE competition.

 

The Texas A&M team is now a finalist in the $7 million global competition challenging teams to advance deep-sea technologies for autonomous, fast and high-resolution ocean exploration, with a top prize of $4 million at stake. The technologies we have developed during this effort, will serve as an enhancement of our ROV services offerings. As of December 31, 2017, we had spent $1.1 million on this effort, and currently expect to spend an additional $0.3 million through the end of the competition. We are also working with Texas A&M and other sponsors, in an effort to have them supplement these costs.

 

We are grateful for our employees’ strong commitment to play their part in our continued success, and remain optimistic about the future of the Company, and our ability to continue to provide sustained value for our employees, customers, and ultimately, our shareholders.

 

 

 

 

 11 

 


All remaining dollar and share amounts in Management’s Discussion and Analysis of Financial Condition and Results of Operations are in thousands of dollars and shares, unless otherwise indicated.

 

Results of Operations

 

Revenues

  Year Ended December 31,  Increase (Decrease)
  2017  2016  $  %
Revenues $19,478  $25,384  $(5,906) (23)%

 

The 23 percent decrease in revenue is primarily due to a reduction in customer orders, resulting from delays in sanctioning of new deepwater projects, following the decline in oil prices.

 

Cost of sales and gross profit

 

  Year Ended December 31,  Increase (Decrease)
  2017  2016  $  %
Cost of sales $10,931  $16,367  $(5,436) (33)%
Gross profit $8,547  $9,017  $(470) (5)%
Gross profit %  44%   36%     8%

 

Despite lower revenues, we were able to realize higher gross margin percentages due to an increased proportion of higher-margin service work.

 

We record depreciation expense related to revenue-generating property, plant and equipment as cost of sales, which totaled $1,077 and $1,335 for the years ended December 31, 2017 and 2016, respectively.

 

Selling, general and administrative expenses

 

  Year Ended December 31,  Increase (Decrease)
  2017  2016  $  %
Selling, general & administrative $9,113  $9,672  $(559) (6)%
Selling, general & administrative as a % of revenues  47%   38%  $  9%

 

The increase in selling, general and administrative expenses (“SG&A”) as a percentage of revenue was due to lower revenues.

 

Interest income (expense), net

 

Net interest income for the year ended December 31, 2017 was $56 compared to net interest expense of ($34) for the year ended December 31, 2016. The increase of $90 is due to the full repayment of our debt in 2016, and the receipt of interest income on cash instruments in 2017.

 

Gain on sale of assets

 

During the year ended December 31, 2017 we sold some equipment, including a Remotely Operated Vehicle (“ROV”) which resulted in gains on sales of assets of $559. This is a decrease from the gain on sale of assets for the year ended December 31, 2016 when we sold our Channelview location resulting in a gain on sale of assets of $1,070.

 

 

 

 12 

 

 

Equity in net income of joint venture

 

In 2017, we received $94 as an earnout distribution from our equity in a joint venture. We no longer have an investment in the joint venture and did not receive any 2016 related distributions.

 

Modified EBITDA

 

Our management evaluates our performance based on a non-GAAP measure, which consists of earnings (net income or loss) available to common shareholders before net interest expense, income taxes, non-cash share-based compensation expense, equity in net income or loss of joint venture, non-cash impairments, depreciation and amortization, other non-cash items and one-time charges (“Modified EBITDA”).  This measure may not be comparable to similarly titled measures employed by other companies and is not a measure of performance calculated in accordance with US GAAP. The measure should not be considered in isolation or as a substitute for operating income, 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 consolidated statements of operations.

 

We believe Modified EBITDA is useful to investors in evaluating our operating performance because it is widely used to measure a company’s operating performance, which can vary substantially from company to company depending upon accounting methods and book value of assets, financing methods, capital structure and the method by which assets were acquired. It helps investors more meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest); asset base (primarily depreciation and amortization); and actions that do not affect liquidity (share-based compensation expense, equity in net income or loss of joint venture) from our operating results; and it helps investors identify items that are within our operational control. Depreciation and amortization charges, while a component of operating income, are fixed at the time of the asset purchase or acquisition in accordance with the depreciable lives of the related asset and as such are not a directly controllable period operating charge.

 

The following is a reconciliation of net (loss) income to Modified EBITDA for the years ended December 31, 2017 and 2016 (certain prior year amounts have been excluded to conform to the current year presentation):

 

  Year Ended December 31, 
  2017  2016 
Net (loss) income $(116) $164 
Deduct gain on sale of assets  (576)  (1,070)
(Deduct) Add interest (income) expense, net  (56)  34 
Add depreciation and amortization  1,348   1,532 
Add income tax expense  5   20 
Add share-based compensation  134   344 
Modified EBITDA $739  $1,024 

 

Modified EBITDA decreased by $285 in 2017 compared to 2016, due primarily to the lower revenues in 2017, which resulted in a net loss for the year.

 

Liquidity and Capital Resources

 

During the fiscal year ended December 31, 2016, we primarily funded our operations from cash on hand and $7,829 we generated in cash flows. We generated $5,614 from operating activities, primarily from increased customer projects, and a 1,070 gain on the sale of our Channelview facility. We also generated $1,644 from investing activities, which primarily consisted of $3,800 from the sale of our Channelview facility, offset by purchases of property, plant and equipment (“PP&E”), and investing of excess funds in a short-term investment. We further generated $571 from our financing activities, primarily due to the release of a compensating balance held as a condition of a credit facility (the “Facility”) we had with Whitney Bank, offset by repayments of the borrowings we had under the Facility in March 2016. We maintained the facility from 2008 through June 30, 2016.

 

 

 

 13 

 

 

During the fiscal year ended December 31, 2017, we used $4,264 of our cash on hand and proceeds generated from sale of PP&E to fund our operating, investing and financing activities. We used $762 in our operating activities, primarily due to decreased customer orders. We also used $2,029 in investing activities, which included $2,940 in purchases of PP&E, offset by $911 in proceeds from the sale of equipment, a cash distribution from a former joint venture and cash receipts from a note receivable. The $2,940 in new PP&E includes $992 in purchases of equipment used in our traditional lines of business and betterments of existing equipment, $914 in equipment developed and built as part of our sponsorship of Texas A&M’s participation in the Shell XPRIZE competition, and $1,034 in new equipment and technologies, which are projected to be new revenue streams for the Company. We also used $1,473 in financing activities, due to repurchases of our outstanding stock. The technology and equipment developed for the XPRIZE competition belongs to the Company, and will be used to enhance our ROV service offerings.

 

Through a combination of cash generated from operations, opportunistic sales of PP&E and reduction in our capital investments budget, we believe we will have adequate liquidity to meet our future operating requirements. To the extent our then current and forecasted liquidity allows, we will continue to repurchase our common stock. See Item 9B. “Other Information” for additional information.

 

Summary of Critical Accounting Policies and Estimates

 

Use of Estimates

 

The preparation of financial statements in accordance with US GAAP requires us to make estimates and judgments that may affect assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition and related allowances, costs incurred and estimated earnings incurred in excess of billings on uncompleted contracts, impairments of long-lived assets, including intangibles, income taxes including the valuation allowance for deferred tax assets, billings in excess of costs incurred and estimated earnings on uncompleted contracts, contingencies and litigation, and share-based payments. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

 

Revenue Recognition

 

We recognize revenue once the following four criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery of the equipment has occurred or services have been rendered, (iii) the price of the equipment or service is fixed or determinable and (iv) collectability of the related receivable is reasonably assured. Service revenue is recognized as the service is provided, and time and materials contracts are billed on a bi-weekly or monthly basis as costs are incurred. Customer billings for shipping and handling charges are included in revenue. Revenues are recorded net of sales taxes.

 

From time to time, we enter into fixed-price contracts. The percentage-of-completion method is used as a basis for recognizing revenue on these contracts. We recognize revenue as costs are incurred because we believe the incurrence of costs reasonably reflects progress made toward project completion.

 

Provisions for estimated losses on uncompleted fixed-price contracts (if any) are recorded in the period in which it is determined it is more likely than not a loss will be incurred.  Changes in job performance, job conditions, and total contract values may result in revisions to costs and income and are recognized in the period in which the revisions are determined.  Unapproved change orders are accounted for in revenue and cost when it is probable that the costs will be recovered through a change in the contract price. In circumstances where recovery is considered probable but the revenues cannot be reliably estimated, costs attributable to change orders are deferred pending determination of contract price.

 

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.

 

Allowance for Doubtful Accounts

 

 

 

 14 

 

 

We provide an allowance for doubtful trade receivables based on a specific review of each customer’s trade receivable balance with respect to its ability to make payments. When specific accounts are determined to require an allowance, they are expensed by a provision for bad debts in that period. At December 31, 2017 and 2016, we estimated the allowance for doubtful accounts requirement to be $10 and $10, respectively. Bad debt (credit) expense totaled $(22) and $167 for the years ended December 31, 2017 and 2016, respectively.

 

Income Taxes

 

We follow the asset and liability method of accounting for income taxes. This method takes into account the differences between financial statement treatment and tax treatment of certain transactions. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

 

We record a valuation allowance to reduce the carrying value of our deferred tax assets when it is more likely than not that some or all of the deferred tax assets will expire before realization of the benefit or that future deductibility is not probable. The ultimate realization of the deferred tax assets depends upon our ability to generate sufficient taxable income of the appropriate character in the future. This requires management to use estimates and make assumptions regarding significant future events such as the taxability of entities operating in the various taxing jurisdictions. In evaluating our ability to recover our deferred tax assets, we consider all reasonably available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions, including the amount of future state, and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment. When the likelihood of the realization of existing deferred tax assets changes, adjustments to the valuation allowance are charged in the period in which the determination is made, either to income or goodwill, depending upon when that portion of the valuation allowance was originally created.

 

We record an estimated tax liability or tax benefit for income and other taxes based on what we determine will likely be paid in the various tax jurisdictions in which we operate. We use our best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent upon various matters, including resolution of tax audits, and may differ from amounts recorded. An adjustment to the estimated liability would be recorded as a provision or benefit to income tax expense in the period in which it becomes probable that the amount of the actual liability or benefit differs from the recorded amount.

 

Our future effective tax rates could be adversely affected by changes in the valuation of our deferred tax assets or liabilities or changes in tax laws or interpretations thereof. If and when our deferred tax assets are no longer fully reserved, we will begin to provide for taxes at the full statutory rate. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

 

Recent Accounting Pronouncements

 

Recent Accounting Pronouncements are included in Note 1, “Description of Business and Summary of Significant Accounting Policies and Estimates”, of the Notes to Consolidated Financial Statements included in this Report.

 

Inflation and Seasonality

 

We do not believe that our operations are significantly impacted by inflation. Our business is not seasonal in nature.

 

Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable

 

 

 

 15 

 

 

Item 8.Financial Statements AND SUPPLEMENTAL DATA

 

The financial statements are included herewith commencing on page F-1.

 

Reports of Independent Registered Public Accounting Firms

F-1

Consolidated Balance Sheets – December 31, 2017 and 2016

F-3

Consolidated Statements of Operations – Years ended December 31, 2017 and 2016

F-4

Consolidated Statements of Changes in Stockholders’ Equity – Years ended December 31, 2017 and 2016

F-5

Consolidated Statements of Cash Flows– Years ended December 31, 2017 and 2016

F-6

Notes to Consolidated Financial Statements – Years ended December 31, 2017 and 2016F-7

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

We retained Hein & Associates LLP (“Hein”) as our principal accountant in 2011. Effective November 16, 2017, Hein combined with Moss Adams LLP (“Moss Adams”). As a result of this transaction, on November 16, 2017, Hein resigned as our independent registered public accounting firm. Concurrent with such resignation, our Audit Committee approved the engagement of Moss Adams as our new independent registered public accounting firm.

 

The Company had no disagreements with accountants on accounting and financial disclosure.

 

Item 9A.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, as amended, 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 December 31, 2017, 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 December 31, 2017.

 

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 December 31, 2017, based on revisions and updates issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to its report 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 December 31, 2017.

 

Changes in Internal Control Over Financial Reporting.   The Company’s management, with the participation of the principal executive and principal financial officer, have concluded that there were no changes in internal control over financial reporting during the fiscal quarter ended December 31, 2017.

 

Item 9B.Other Information

 

On March 26, 2018, the Board of Directors authorized the repurchase of up to $1 million in shares of the Company's common stock. The repurchase program will be funded from cash on hand and cash provided by operating activities.

 

The time of the purchases and amount of stock purchased will be determined at the discretion of management subject to market conditions, business opportunities and other appropriate factors and may include purchases through one or more broker-assisted plans and methods, including, but not limited to, open-market purchases, privately negotiated transactions and Rule 10b5-1 trading plans. The share repurchase program will expire on March 31, 2019.

 

 

 

 16 

 

 

PART III

 

Item 10.Directors, Executive Officers and Corporate Governance

 

The following table sets forth the names, ages and positions of our directors and executive officers.

 

Name Age Position Held With Deep Down
Ronald E. Smith (1) 59 President, Chief Executive Officer and Director
Mary L. Budrunas (1) 66 Vice President, Corporate Secretary and Director
Mark Carden 59 Chairman of the Board of Directors
Randolph W. Warner 70 Director
Charles K. Njuguna 40 Chief Financial Officer

 

_________________________

 

(1)        Ronald E. Smith and Mary L. Budrunas are married to each other.

 

Biographical information regarding each of our directors and executive officers is as follows. The following paragraphs also include specific information about each director’s experience, qualifications, attributes or skills that led the Board of Directors to the conclusion that the individual should serve on the Board as of the time of this filing, in light of our business and structure:

 

Ronald E. Smith, President, Chief Executive Officer and Director. Mr. Smith co-founded Deep Down in 1997 and has served as our Chief Executive Officer, President and Director since December 2006. Prior to December 2006, Mr. Smith was Deep Down’s President. Mr. Smith graduated from Texas A&M University with a Bachelor of Science degree in Ocean Engineering in 1981. Mr. Smith worked both onshore and offshore in management positions for Ocean Drilling and Exploration Company (ODECO), Oceaneering Multiflex, Mustang Engineering and Kvaerner before founding Deep Down. Mr. Smith’s interests include all types of offshore technology, nautical innovations, state of the art communications, diving technology, hydromechanics, naval architecture, dynamics of offshore structures, diving technology and marketing of new or innovative concepts. Mr. Smith is directly responsible for the invention or development of many innovative solutions for the offshore industry, including the first steel tube flying lead installation system. Mr. Smith is also credited for the new patented Loose Steel Tube Flying Leads, subsea deployment systems, new subsea J-plates and the recently patented NHU (Non Helical Umbilical), which is a mobile steel tube umbilical production facility employing a new concept to build Steel Tube Umbilicals.

 

Mr. Smith is qualified for service on the Board due to his extensive background in many aspects of the offshore industry, spanning almost three decades. Mr. Smith’s wide range of knowledge and experience with the various technologies and platforms in the deepwater industry brings invaluable expertise to our Board.

 

Mary L. Budrunas, Vice-President, Corporate Secretary and Director. Ms. Budrunas, co-founder of Deep Down, Inc. along with current chief executive officer Ronald E. Smith, has served as our Vice-President, Corporate Secretary and Director since December 2006. Ms. Budrunas has more than 30 years of logistical management experience in manufacturing, fabrication, and industrial sourcing in the oil and gas industry. Prior to Ms. Budrunas co-founding Deep Down in 1997, she managed the purchasing efforts of many projects over a 10-year period for Mustang Engineering, and previously directed procurement for a large petroleum drilling and production facility project in Ulsan, Korea.

 

Ms. Budrunas is qualified for service on the Board based on her extensive oil and gas industry experience. Such expertise provides valuable insight to the Board.

 

Mark Carden, Chairman of the Board of Directors. Mr. Carden has served as Chairman of the Board since September 30, 2017, when Mr. Eugene L. Butler resigned as Executive Chairman and Chief Financial Officer. Mr. Carden joined the Board as an independent director effective May 1, 2014, and was appointed Chairman of the Audit Committee of the Board of Directors. Mr. Carden was a Partner at Coopers & Lybrand, LLP, now PricewaterhouseCoopers, LLP and held multiple senior-level financial positions specializing in electric and gas utilities from 1981 to 1999; he most recently served as Chief Operating Officer, Global Energy Assurance Practice. Additionally, Mr. Carden was one of three CPAs in the US selected to serve a two year fellowship at the Financial Accounting Standards Board from 1991 to 1993. Mr. Carden holds a BBA from Texas A&M University. He is currently the Executive Pastor and Elder at Clear Creek Community Church, in League City, Texas.

 

 

 

 17 

 

 

Mr. Carden is qualified for service on the Board based on his experience and expertise in management, notably his knowledge of the energy market and business strategy, and is a financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K.

 

Randolph W. Warner, Director. Mr. Warner joined the Board as an independent director effective May 28, 2013, and is the Chairman of the Compensation Committee of the Board of Directors. Mr. Warner is currently President and Chief Executive Officer of WHC, LLC. (“WHC”), a multi-state service company which provides pipeline and facilities construction; a position he has held since January 2005. Prior to WHC, Mr. Warner served as Principal of R.W. Warner Consulting Services from July 2000 to January 2005 and was elected to the board of directors of the Houston Chapter of the Associated Builders and Contractors in February 2000. Mr. Warner graduated from the Air Force Academy and served as a captain in the United States Air Force from 1970 to 1976. He served in Vietnam and received numerous awards including the Distinguished Flying Cross. He also received an MBA from University of Houston in 1980.

 

Mr. Warner is qualified for service on the Board based on his senior management experience and expertise in the construction industry, and qualifies as an Audit Committee financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K.

 

Charles K. Njuguna, Chief Financial Officer. Mr. Njuguna has served as the Company’s Chief Financial Officer since September 2017, following Mr. Butler’s resignation. Mr. Njuguna joined the Company in early 2012 to manage the Company’s corporate accounting activities, was later appointed to manage all of the Company’s commercial activities, and most recently served as Business Manager, with oversight for a wide range of financial, operational and administrative functions. Additionally, Mr. Njuguna has over 20 years of international business experience, including various operational and financial management roles in Africa, the UK and the US. Mr. Njuguna holds an MBA from the University of Texas at Austin.

 

Mr. Njuguna is qualified to serve as an officer based on his in-depth knowledge of the Company’s operations and his international business experience.

 

Corporate Governance

 

Code of Ethics

 

The Company has adopted Codes of Ethical Conduct that apply to all its directors, officers (including its chief executive officer, chief financial officer, controller and any person performing such functions) and employees. The Company has previously filed copies of these Codes of Ethical Conduct and they can be located pursuant to the information shown in the Exhibit list items 14.1 and 14.2 to this Report. Copies of the Company’s Codes of Ethical Conduct may also be obtained at the Investors section of the Company’s website, www.deepdowninc.com, or by written request addressed to the Corporate Secretary, Deep Down, Inc., 8827 W. Sam Houston Pkwy North, Suite 100, Houston, Texas 77040. The Company intends to satisfy the requirements under Item 5.05 of Form 8-K regarding disclosure of amendments to, or waivers from, provisions of its code of ethics that apply to the Chief Executive Officer, Chief Financial Officer or Controller by posting such information on the Company’s website. Information contained on the website is not part of this Report.

 

The Company’s Board of Directors is responsible for reviewing and making recommendations concerning the selection of outside auditors, reviewing the scope, results and effectiveness of the annual audit of the Company's financial statements and other services provided by the Company’s independent public accountants. The Board of Directors reviews the Company's internal accounting controls, practices and policies. Our Board of Directors has determined that Messrs. Warner and Carden qualify as independent audit committee financial experts as defined in Item 407(d)(5)(ii) of Regulation S-K.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act requires our officers and directors, and persons who own more than ten percent of a registered class of our equity securities, to file reports of securities ownership and changes in such ownership with the SEC. Officers, directors and greater than ten percent shareholders also are required by rules promulgated by the SEC to furnish us with copies of all Section 16(a) forms they file.

 

Based solely on the Company’s review of the copies of such forms received by it, the Company believes that all Section 16(a) filing requirements applicable to its officers and directors and greater-than ten percent beneficial owners during the year ended December 31, 2017 were in compliance.

 

 

 

 18 

 

 

Item 11.Executive Compensation

 

The following table sets forth information concerning total compensation earned in the years ended December 31, 2017 and 2016 by our Principal Executive Officer (“PEO”), our other executive officer as of December 31, 2017, and our former Executive Chairman and Chief Financial Officer who retired during 2017 (collectively, our “Named Officers”).

 

Summary Compensation Tables for the years ended December 31, 2017 and 2016

 

Name and Principal Position Year Salary  

All Other
Compensaton

(1) (2)

  Total 
Ronald E. Smith, 2017 $501,562  $71,585  $573,147 
President and Chief Executive Officer 2016 $501,562  $56,153  $557,715 
Eugene L. Butler (3) 2017 $331,840  $80,868  $412,708 
Former Executive Chairman and C.F.O. 2016 $431,393  $113,665  $545,058 
Charles K. Njuguna, 2017 $225,674  $13,442  $239,116 
Chief Financial Officer 2016 $195,096  $12,000  $207,096 

 

(1)Amounts in 2017 represent:
·Automobile allowance of $19,500 to Mr. Smith, $15,000 to Mr. Butler, and $13,442 to Mr. Njuguna;
·Payments for vacation not taken in 2017 of $52,085 and $45,616 for Messrs. Smith and Butler, respectively;
·Reimbursement of $10,187 to Mr. Butler for federal and state payroll withholdings customarily withheld for an employee; and
·Reimbursement of $10,065 to Mr. Butler for healthcare premiums.

 

(2)Amounts in 2016 represent:
·Automobile allowance of $19,500 to Messrs. Smith and Butler, and $12,000 to Mr. Njuguna;
·Payments for vacation not taken in 2016 of $36,653 and $58,072 for Messrs. Smith and Butler, respectively;
·Reimbursement of $22,293 to Mr. Butler for federal and state payroll withholdings customarily withheld for an employee; and
·Reimbursement of $13,800 to Mr. Butler for healthcare premiums.

 

(3)Effective September 30, 2017, Mr.. Butler resigned as Executive Chairman and Chief Financial Officer.

 

Narrative Disclosure to Summary Compensation Table

 

On January 1, 2016, the Company entered into an employment agreement with Mr. Smith for a term of three years, and subject to automatic annual renewals, unless at least 90 days prior to the applicable renewal date, the Company shall give notice that the employment agreement shall not be extended. The term of the agreement has been renewed through December 31, 2020. The employment agreement provides that Mr. Smith receive annual cash compensation of $501,562.

 

 

 

 19 

 

 

Outstanding Equity Awards at December 31, 2017

 

The following table summarizes nonvested stock awards assuming a market value of $0.93 per share (the closing market price of the Company’s common stock on December 29, 2017). See Note 7, “Share-Based Compensation”, of the Notes to Consolidated Financial Statements included in this Report for additional information.

 

  STOCK AWARDS 
  Number of Shares or Units of Stock That Have Not Vested  Market Value of Shares or Units of Stock that Have Not Vested 
Name (#)(1)  ($) 
Ronald E. Smith  100,000   93,000 
Eugene L. Butler      
Charles K Njuguna      

 

(1)The restrictions on these shares of nonvested stock will lapse on December 14, 2018, subject to achievement of service-based conditions. The service-based condition requires that the employee must remain employed by the Company continuously through the anniversary date.

 

Benefits payable upon change in control

 

Mr. Smith’s employment agreement contains provisions related to change in control.

 

In the event of termination of Mr. Smith’s employment for any reason, he will be entitled to receive all accrued, unpaid salary and vacation time through the date of termination and all benefits to which Mr. Smith is entitled or vested under the terms of all employee benefit and compensation plans, agreements and arrangements in which Mr. Smith is a participant as of the date of termination. In addition, subject to executing a general release in favor of us, Mr. Smith will be entitled to receive certain severance payments in the event his employment is terminated by the Company “other than for cause” or by Mr. Smith with “good reason.” These severance payments include the following:

 

(i) a lump sum in cash equal to one times Mr. Smith’s annual base salary (at the rate in effect on the date of termination), provided, however, that if such termination occurs prior to the date that is twelve months following a change of control, then such payment will be equal to three times Mr. Smith’s annual base salary (at the rate in effect on the date of termination);

 

(ii) a lump sum in cash equal to the average annual bonus paid to Mr. Smith for the prior two full fiscal years preceding the date of termination; provided, however, that if such termination occurs prior to the date that is twelve months following a change of control, then such payment will be equal to two times the average annual bonus paid to Mr. Smith for the prior two full fiscal years preceding the date of termination;

 

(iii) a lump sum in cash equal to a pro rata portion of the annual bonus payable for the period in which the date of termination occurs based on the actual performance under our annual incentive bonus arrangement; provided, however, that such pro rata portion shall be calculated based on Mr. Smith’s annual bonus for the previous fiscal year; but if no previous annual bonus has been paid to Mr. Smith, then the lump sum cash payment for this current pro rata annual bonus obligation shall be no less than fifty percent of Mr. Smith’s annual base salary; and

 

(iv) if Mr. Smith’s termination occurs prior to the date that is twelve months following a change of control, then each and every share option, restricted share award and other equity-based award that is outstanding and held by Mr. Smith shall immediately vest and become exercisable.

 

Mr. Smith has agreed to not, during the term of his employment and for a one-year period after his termination, engage in “Competition” (as defined in his employment agreement) with us, solicit business from any of our customers or potential customers, solicit the employment or services of any person employed by or a consultant to us on the date of termination or within six months prior thereto, or otherwise knowingly interfere with our business or accounts or any of our subsidiaries.

 

 

 

 20 

 

 

Mr. Smith’s employment agreement also provides that we, to the extent permitted by applicable law and our by-laws, will defend, indemnify and hold harmless Mr. Smith from any and all claims, demands or causes of action, including reasonable attorneys’ fees and expenses, suffered or incurred by Mr. Smith as a result of the assertion or filing of any claim, demand, litigation or other proceedings based upon statements, acts or omissions made by or on behalf of Mr. Smith pursuant to the Employment Agreement or in the course and scope of Mr. Smith’s employment with us.  We will also maintain and pay all applicable premiums for directors’ and officers’ liability insurance which shall provide full coverage for the defense and indemnification of Mr. Smith, to the fullest extent permitted by applicable law.

 

Compensation of Directors

 

The Company’s Compensation Committee of the Board of Directors makes all decisions regarding director compensation. Only directors who are not employees, independent contractors or consultants of the Company or any of its subsidiaries or affiliates (“Independent Directors”), are entitled to receive a fee, plus reimbursement of reasonable out-of-pocket expenses incurred to attend Board meetings.

 

The Company uses a combination of cash and equity-based compensation, in the form of restricted stock, to attract and retain qualified candidates to serve on the Board. We believe our compensation arrangement for Independent Directors is comparable to the standards of peer companies within our industry and geographical location.

 

We pay our Independent Directors meetings’ fees of $1,500 per meeting attended of the Board of Directors. Compensation for our Independent Directors consists of equity and cash as described below. Our Independent Directors, as of the date of this Report, are Messrs. Randolph W. Warner and Mark Carden.

 

On October 1, 2016, the Company entered into a consulting agreement (the “Agreement”), with Ms. Mary L. Budrunas, the spouse of Mr. Smith and a former full-time employee of the Company. Ms. Budrunas retired from being a full-time employee of the Company effective September 30, 2016, but continues to provide services to the Company.

 

The following table provides certain information with respect to the 2017 compensation awarded or earned by the Independent Directors who served in such capacity during the year, and Ms. Budrunas.

 

Name Fees Earned or Paid in Cash ($)  

Stock Awards

($) (1) (2)

  Option Awards
($) (1)
  All Other Compensation
($) (3)
  Total 
Randolph W. Warner $7,500  $  $  $  $7,500 
Mark Carden $7,500  $34,500  $  $  $42,000 
Mary L. Budrunas $  $  $  $210,000  $210,000 

 

(1)

Included in the “Stock Awards” column is the aggregate grant date fair value of restricted stock awards made to Mr. Carden in 2017. The grant date fair value of the award was computed in accordance with FASB ASC Topic 718. For a discussion of the assumptions and methodologies used to value the stock awards reported in the table above, see Note 7, “Share-Based Compensation” to our consolidated financial statements included in this Report. Stock awards are grants of restricted stock representing time-vesting shares.

 

In May 2017, we granted 30,000 restricted shares, par value $0.001 per share, to Mr. Carden. The shares were valued at $1.15 per share and vest over three years in equal tranches on the grant date anniversary, with continued service on our Board of Directors; we are amortizing the related share-based compensation of $34,500 over the three-year requisite service period.

 

(2)The number of nonvested restricted shares held by each of our Independent Directors on December 31, 2017 was: Mr. Warner, 20,000 and Mr. Carden, 30,000.

 

(3)The Agreement provides for Ms. Budrunas to be reasonably available to the Company, up to 60 hours per month, in exchange for compensation of $17,500 per month.

 

 

 

 21 

 

 

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Set forth below is certain information with respect to beneficial ownership of Common Stock as of March 26, 2018, except as otherwise noted below, by (i) each person known by us to beneficially own more than 5 percent of the outstanding shares of our common stock; (ii) each Director; (iii) our “Named Officers” (as determined under Item 402(m) of Regulation S-K); and (iv) all directors and executive officers of Deep Down as a group. To our knowledge, all persons listed in the table have sole voting and investment power with respect to their shares, except to the extent that authority is shared with their respective spouse under applicable law.

Name Number of
Shares of
Common
Stock
Beneficially
Owned
    Percent of
Outstanding
Common Stock
(1)
        
Jamaka Capital Management LLC  1,484,091  (2) 11.0%
Goldman Capital Management, Inc.  1,162,247  (3) 8.7%
         
Directors and Executive Officers:        
Ronald E. Smith (4)  1,934,394  (5) 14.4%
Mary L. Budrunas (4)  953,722  (6) 7.1%
Randolph W. Warner  60,980  (7) *
Mark Carden  60,000  (8) *
Charles K. Njuguna      *
All directors and officers as a group (5 persons)  3,009,096    22.4%
___________________        
* Indicates ownership of less than 1% of Common Stock outstanding.

 

(1)The percentages in the table are calculated using the total shares outstanding as of March 26, 2018 or a total of 13,436,243 shares.
(2)Based on a Schedule 13D filed with the SEC dated November 17, 2017, Jamaka Capital Management LLC, 3889 Maple Avenue, Dallas, TX 75219, may be deemed the beneficial owners of 1,484,091 shares outstanding as of December 31, 2017.
(3)Based on a Schedule 13F-HR filed with the SEC dated February 14, 2018, Goldman Capital Management Inc., 767 Third Ave, New York, NY 10017, may be deemed the beneficial owners of 1,162,247 shares outstanding as of December 31, 2017.
(4)Mr. Smith and Ms. Budrunas are married and hold an aggregate of 2,888,116 shares of common stock, or approximately 22 percent of outstanding common stock as of March 26, 2018.
(5)Includes 100,000 shares of nonvested stock, which is scheduled to vest on December 14, 2018 and 348,632 shares held indirectly through the Company’s Simple IRA Plan.
(6)Includes 23,071 shares held indirectly through the Company’s Simple IRA Plan.
(7)Includes 30,000 shares of nonvested stock, which is scheduled to vest in equal increments on May 2, 2018, May 2, 2019, and May 2, 2020, and 980 shares held indirectly in retirement and trading accounts owned by Mr. Carden and his wife.
(8)Includes 20,000 shares of nonvested stock, which is scheduled to vest in two equal installments on May 28, 2018 and May 28, 2019.

 

Disclosure regarding our equity compensation plans as required by this item is incorporated by reference to the information set forth under Item 5, “Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Part II of this Report.

 

 

 

 22 

 

 

ITEM 13.Certain Relationships and Related Transactions, and Director Independence

 

Certain Relationships and Related Transactions

 

Our Board of Directors and management recognize that related person transactions present a heightened risk of conflicts of interest, and therefore we review all relationships and transactions in which we and our directors, director nominees and executive officers or their immediate family members, as well as holders of more than 5 percent of any class of our voting securities and their family members, have a direct or indirect material interest. As required under SEC rules, transactions that are determined to be directly or indirectly material to us or a related person are disclosed in the appropriate annual and/or quarterly statements filed with the SEC.

 

Director Independence

 

We believe that Messrs. Warner and Carden are “independent” under the requirements of Rule 303A.02 of the NYSE Listed Company Manual.

 

ITEM 14.Principal Accountant Fees and Services

 

We retained Hein & Associates LLP (“Hein”) as our principal accountant in 2011. Effective November 16, 2017, Hein combined with Moss Adams LLP (“Moss Adams”). As a result of this transaction, on November 16, 2017, Hein resigned as our independent registered public accounting firm. Concurrent with such resignation, our Audit Committee approved the engagement of Moss Adams as our new independent registered public accounting firm.

 

We had no relationship with either Hein or Moss Adams prior to their retention as our principal accountant. The following table sets forth the aggregate fees paid to Hein and Moss Adams for audit services rendered in connection with the Company’s consolidated financial statements and reports for the years ended December 31, 2017 and 2016, and for other services rendered during those years on behalf of Deep Down and its subsidiaries:

 

 

  December 31, 2017  December 31, 2016 
(i) Audit Fees $120,000  $178,063 
(ii) Audit Related Fees      
(iii) Tax Fees  47,655   47,655 
(iv) All Other Fees      

 

Audit Fees: Consists of fees billed for professional services rendered for the audit of Deep Down’s consolidated financial statements, the review of interim condensed consolidated financial statements included in quarterly reports, services that are normally provided in connection with statutory and regulatory filings or engagements and attest services, except those not required by statute or regulation. We paid Hein $66,150 in audit fees for the year ended December 31, 2017, prior to the combination.

 

Audit-Related Fees: Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit and review of Deep Down’s consolidated financial statements and are not reported under "Audit Fees."

 

Tax Fees: Consists of tax compliance, tax preparation and other tax services. Tax compliance and tax preparation consists of fees billed for professional services related to assistance with tax returns. Other tax services consist of fees billed for other miscellaneous tax consulting.

 

All Other Fees: None.

 

Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors

 

The Board of Directors pre-approves all audit and permissible non-audit services provided by Moss Adams and Hein. These services may include audit services, audit-related services, tax services and other services. The Board of Directors may also pre-approve particular services on a case-by-case basis and may delegate pre-approval authority to one or more directors. If so delegated, the director must report any pre-approval decision to the Board of Directors at its first meeting after the pre-approval was obtained.

 

 

 

 23 

 

 

PART IV

 

ITEM 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

Information required by this item is incorporated herein by reference from the section entitled “Exhibit Index” of this Report.

 

ITEM 16.FORM 10-K SUMMARY

 

None

 

 

 

 24 

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.
  
 By:  /s/ Ronald E. Smith              
 Ronald E. Smith
 President and Chief Executive Officer
 (Principal Executive Officer)
  
  
 By:   /s/ Charles K. Njuguna            
 Charles K. Njuguna
 Chief Financial Officer
 (Principal Financial Officer)
  
  
 By:   /s/ Matthew Auger                         
 Matthew Auger
 Controller
 (Principal Accounting Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated:

 

Signature

 

 

Title

 

 
    
/s/ Ronald E. Smith President, Chief Executive Officer and Director 
Ronald E. Smith (Principal Executive Officer 
    
    
/s/ Charles K. Njuguna Chief Financial Officer 
Charles K. Njuguna  (Principal Financial Officer)  
    
    
/s/ Mary L. Budrunas Vice-President, Corporate Secretary and Director 
Mary L. Budrunas   
    
    
/s/ Mark Carden Chairman of the Board of Directors 
Mark Carden   
    
    
/s/ Randolph W. Warner Director 
Randolph W. Warner   
    
    
Date:  March 28, 2018   

 

 

 

 

 25 

 

 

EXHIBIT INDEX

 

Exhibit NumberDescription of Exhibit

 

2.1 Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc. (incorporated by reference from Exhibit 2.1 to our Form 10-KSB/A filed on May 1, 2008).
   
3.1 Articles of Incorporation of Deep Down, Inc., conformed to include the amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008 (incorporated by reference from Exhibit A to our Schedule 14C filed on August 15, 2008).
   
3.2 Amended and Restated By Laws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008).
   
4.1 Securities Purchase Agreement, dated September 9, 2013, between Deep Down, Inc. and the purchaser parties thereto (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on September 16, 2013).
   
4.2 Registration Rights Agreement, dated September 9, 2013, between Deep Down, Inc. and the purchaser parties thereto (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on September 16, 2013).
   
10.1† Stock Option, Stock Warrant and Stock Award Plan (incorporated by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed on July 21, 2008).
   
10.2 Stock Purchase Agreement, dated May 3, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010).
   
10.3 Amendment No. 1 to Stock Purchase Agreement, dated July 13, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on July 14, 2010).
   
10.4† Amendment No. 2 to Stock Purchase Agreement, dated October 4, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on October 4, 2010).

 

14.1 Directors Code of Business Conduct (incorporated by reference from Exhibit 14.1 to our Form 10-K filed on April 15, 2010).
   
14.2 Financial Officer’s Code of Business Conduct.(incorporated by reference from Exhibit 14.2 to our Form 10-K filed on April 15, 2010).
   
21.1* Subsidiary list.
   
31.1* Rule 13a-14(a)/15d-14(a) Certification of the President and Chief Executive Officer of Deep Down, Inc.
   
31.2* Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep Down, Inc.
   
32.1# Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.
   
32.2# Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc.
   
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 herewith.

# Furnished herewith.

† Exhibit constitutes a management contract or compensatory plan or arrangement.

 

 

 

 26 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and the Board of Directors of

Deep Down, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Deep Down, Inc. and subsidiaries (the “Company”) as of December 31, 2017, the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the year then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

 

 

 

/s/ Moss Adams LLP

Houston, Texas

March 28, 2018

 

 

We have served as the Company’s auditor since 2017.

 

 

 

 F-1 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Deep Down, Inc.

 

We have audited the accompanying consolidated balance sheet of Deep Down, Inc. and subsidiaries (collectively the “Company”) as of December 31, 2016, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Deep Down, Inc. and subsidiaries as of December 31, 2016, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.

 

 

 

/s/ Hein & Associates LLP

 

Houston, Texas

March 31, 2017

 

 

 

 F-2 

 

 

DEEP DOWN, INC.

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except share and per share amounts)      
       
ASSETS   
Current assets: December 31, 2017  December 31, 2016 
Cash $3,939  $8,203 
Short term investment (certificate of deposit)  1,017   1,005 
Accounts receivable, net of allowance of $10 and $10, respectively  4,142   5,945 
Costs and estimated earnings in excess of billings on uncompleted contracts  925   1,077 
Prepaid expenses and other current assets  302   864 
Total current assets  10,325   17,094 
Property, plant and equipment, net  12,352   7,938 
Intangibles, net  63   69 
Long-term asset - Carousel     3,117 
Other assets  1,230   211 
Total assets $23,970  $28,429 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
Current liabilities:        
Accounts payable and accrued liabilities $1,511  $1,778 
Billings in excess of costs and estimated earnings on uncompleted contracts  612   3,349 
Total current liabilities  2,123   5,127 
Total liabilities  2,123   5,127 
         
Commitments and contingencies (Note 10)        
         
Stockholders' equity:        
Preferred stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and outstanding      
Common stock, $0.001 par value, 24,500,000 shares authorized, 15,438,660 and 15,408,660 shares issued, respectively  15   15 
Treasury stock, 2,002,417 and 587,847 shares at cost  (2,040)  (567)
Additional paid-in capital  73,246   73,112 
Accumulated deficit  (49,374)  (49,258)
Total stockholders' equity  21,847   23,302 
Total liabilities and stockholders' equity $23,970  $28,429 

 

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

 

 

 

 F-3 

 

 

DEEP DOWN, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

  Year Ended 
  December 31, 
(In thousands, except per share amounts) 2017  2016 
       
Revenues $19,478  $25,384 
Cost of sales:        
Cost of sales  9,854   15,032 
Depreciation expense  1,077   1,335 
Total cost of sales  10,931   16,367 
Gross profit  8,547   9,017 
Operating expenses:        
Selling, general and administrative  9,113   9,672 
Depreciation and amortization  271   197 
Total operating expenses  9,384   9,869 
Operating loss  (837)  (852)
Other income (expense):        
Interest income (expense), net  56   (34)
Gain on sale of assets  576   1,070 
Equity in net income of joint venture  94    
Total other income  726   1,036 
Income (loss) before income taxes  (111)  184 
Income tax expense  (5)  (20)
Net (loss) income $(116) $164 
         
Net (loss) income per share:        
Basic $(0.01) $0.01 
Fully diluted $(0.01) $0.01 
         
Weighted-average shares outstanding:        
Basic  14,233   15,520 
Fully diluted  14,233   15,520 

 

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

 

 

 

 F-4 

 

 

DEEP DOWN, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2017 and 2016

 

  Common Stock  Treasury  

Additional

Paid-in

  Accumulated    
(In thousands) Shares (#)  Amount ($)  Stock  Capital  Deficit  Total 
                   
                   
Balance at December 31, 2015  15,631  $16  $  $72,989  $(49,422) $23,583 
                         
Net income              164   164 
Restricted stock awards  30                
Shares surrendered to settle employee tax liabilities and retired  (253)  (1)     (221)     (222)
Treasury shares purchased        (567)        (567)
Share-based compensation           344      344 
Balance at December 31, 2016  15,408  $15   (567) $73,112  $(49,258) $23,302 
                         
Net loss              (116)  (116)
Restricted stock awards  30                 
Treasury shares purchased        (1,473)         (1,473)
Share-based compensation           134      134 
                         
Balance at December 31, 2017  15,438  $15  $(2,040) $73,246  $(49,374) $21,847 

 

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

 

 

 

 F-5 

 

 

DEEP DOWN, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

  Year Ended 
  December 31, 
(In thousands) 2017  2016 
Cash flows from operating activities:        
Net income (loss) $(116) $164 
Adjustments to reconcile net income (loss) to net cash provided by operating activities:        
Depreciation and amortization  1,348   1,532 
Share-based compensation  134   344 
Bad debt expense     167 
Write off of deferred financing fees     23 
Equity in net income of joint venture and other income  (94)   
Gain on sale of assets  (576)  (1,070)
Changes in operating assets and liabilities:        
Accounts receivable  1,897   1,355 
Costs and estimated earnings in excess of billings on uncompleted contracts  152   277 
Prepaid expenses and other current assets  (6)  (67)
Other assets  (497)  5 
Accounts payable and accrued liabilities  (267)  (419)
Billings in excess of costs and estimated earnings on uncompleted contracts  (2,737)  3,303 
Net cash (used in) provided by operating activities  (762)  5,614 
         
Cash flows from investing activities:        
Proceeds from sale of property, plant and equipment  908   3,800 
Payments received on employee receivable  15   27 
Advances  (94)   
Purchases of property, plant and equipment  (2,940)  (1,339)
Cash used in short term investment  (12)  (1,005)
Cash distribution received from joint venture  94   161 
Net cash (used in) provided by investing activities  (2,029)  1,644 
         
Cash flows from financing activities:        
Proceeds from long-term debt     300 
Repayments of long-term debt     (3,047)
Release of compensating balance     3,900 
Cash paid for deferred financing costs     (15)
Cash paid for purchase of our common stock  (1,473)  (567)

Net cash (used in) provided by financing activities

  (1,473)  571 
Change in cash  (4,264)  7,829 
Cash, beginning of year  8,203   374 
Cash, end of year $3,939  $8,203 
         
Supplemental schedule of operating, investing and financing activities:        
Cash paid for interest $  $47 
Shares of common stock surrendered to settle employee payroll tax liabilities $  $222 
Reclassification of equipment $3,117  $3,117 
Reclassification of a note receivable $553  $568 

 

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

 

 

 

 F-6 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

NOTE 1: DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES

 

Description of Business

 

Deep Down, Inc., a Nevada corporation (“Deep Down Nevada”), and its directly and indirectly wholly-owned subsidiaries, Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”); Deep Down International Holdings, LLC, a Nevada limited liability company; and Deep Down Brasil - Solucoes em Petroleo e Gas, Ltda, a Brazilian limited liability company (“Deep Down Brasil”) (collectively referred to as “Deep Down”, “we”, “us” or the “Company”), is an oilfield services company specializing in complex deepwater and ultra-deepwater oil production distribution system support services, serving the worldwide offshore exploration and production industry. Our services and technological solutions include distribution system installation support and engineering services, umbilical terminations, loose-tube steel flying leads, flotation and Remote Operated Vehicles (“ROVs”) and related services. We support subsea engineering, installation, commissioning, and maintenance projects through specialized, highly experienced service teams and engineered technological solutions. Deep Down’s primary focus is on more complex deepwater and ultra-deepwater oil production distribution system support services and technologies, used between the platform and the wellhead.

 

Liquidity

 

As a deepwater service provider, our revenues, profitability, cash flows, and future rate of growth are generally dependent on the condition of the global oil and gas industry, and our customers’ ability to invest capital for offshore exploration, drilling and production and maintain or increase levels of expenditures for maintenance of offshore drilling and production facilities. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility. At times we enter into large, fixed-price contracts which may require significant lead time and investment. A decline in offshore drilling and production activity could result in lower contract volume or delays in significant contracts which could negatively impact our earnings and cash flows. Our earnings and cash flows could also be negatively affected by delays in payments by significant customers or delays in completion of our contracts for any reason. While our objective is to enter into contracts with our customers that are cash flow positive, we may not always be able to achieve this objective. We are dependent on our cash flows from operations to fund our working capital requirements and the uncertainties noted above create risks that we may not achieve our planned earnings or cash flow from operations, which may require us to raise additional debt or equity capital. There can be no assurance that we could raise additional capital.

 

During the fiscal years ended December 31, 2017 and 2016, we financed our capital needs through cash on hand and operating cash flow. As of December 31, 2017, our working capital was $8.2 million, compared to $12 million as of December 31, 2016. Between 2008 and June 2016, we maintained a credit facility with Whitney Bank, a state chartered bank (“Whitney”); see additional discussion in Note 5, “Long-Term Debt”, of the Notes to Consolidated Financial Statements.

 

Summary of Significant Accounting Policies and Estimates

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Deep Down and its wholly-owned subsidiaries for the years ended December 31, 2017 and 2016. All intercompany transactions and balances have been eliminated.

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications have not resulted in any changes to previously reported net income (loss) or cash flows.

 

Use of Estimates

 

The preparation of these financial statements in accordance with US GAAP requires us to make estimates and judgments that may affect assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition and related allowances, costs incurred and estimated earnings incurred in excess of billings on uncompleted contracts, impairments of long-lived assets, including intangibles, income taxes including the valuation allowance for deferred tax assets, billings in excess of costs incurred and estimated earnings on uncompleted contracts, contingencies and litigation, and share-based payments. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

 

 

 

 

 F-7 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Segments

 

For the years ended December 31, 2017 and 2016, we only had one operating and reporting segment, Deep Down Delaware.

 

Cash and Cash Equivalents

 

We consider all highly liquid investments with maturities from date of purchase of three months or less to be cash equivalents. Cash and cash equivalents consist of cash on deposit with domestic banks and, at times, may exceed federally insured limits.

 

Fair Value of Financial Instruments

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  We utilize a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.  The fair value hierarchy has three levels of inputs that may be used to measure fair value:

 

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

Level 2 - Quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

 

Our financial instruments consist primarily of cash, trade receivables and payables, and notes receivable.  The carrying values of cash, trade receivables and payables approximated their fair values at December 31, 2017 and 2016 due to their short-term maturities. The carrying values of our notes receivable approximate their fair values at December 31, 2017 and 2016 because the interest rates approximate current market rates.

 

Accounts Receivable

 

Trade receivables are uncollateralized customer obligations due under normal trade terms. We provide an allowance for doubtful trade receivables based on a specific review of each customer’s trade receivable balance with respect to their ability to make payments. Generally, we do not charge interest on past due accounts. When specific accounts are determined to require an allowance, they are expensed by a provision for bad debts in that period. At December 31, 2017 and 2016, we estimated the allowance for doubtful accounts requirement to be $10 and $10, respectively. Bad debt expense (credit) totaled $(22) and $167 for the years ended December 31, 2017 and 2016, respectively.

 

Concentration of Credit Risk

 

As of December 31, 2017, three of our customers accounted for 37 percent, 17 percent and 12 percent of total trade accounts receivable. As of December 31, 2016, three of our customers accounted for 66 percent, 7 percent and 5 percent of total trade accounts receivable.  

 

For the year ended December 31, 2017, our five largest customers accounted for 61 percent, 11 percent, 10 percent, 3 percent and 3 percent of total revenues.  For the year ended December 31, 2016, our five largest customers accounted for 60 percent, 10 percent, 7 percent, 3 percent and 3 percent of total revenues.

 

The loss of one or more of these customers could have a material impact on our results of operations and cash flows.

 

 

 

 

 F-8 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Long-Lived Assets

 

Property, plant and equipment is stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the respective assets. Replacements and betterments are capitalized, while maintenance and repairs are expensed as incurred. It is our policy to include amortization expense on assets acquired under capital leases with depreciation expense on owned assets. Additionally, we record depreciation and amortization expense related to revenue-generating assets as a component of cost of sales in the accompanying consolidated statements of operations.

 

Equity Method Investments

 

Equity method investments in joint ventures are reported as investments in joint venture on the consolidated balance sheets, and our share of earnings or losses in the joint venture is reported as equity in net income or loss of joint venture in the consolidated statements of operations. We currently have no remaining investment.

 

Lease Obligations

 

We lease land, buildings, vehicles and certain equipment under non-cancellable operating leases.  Since February 2009, we have leased our corporate headquarters in Houston, Texas, under a non-cancellable operating lease. As of August 1, 2016, we transferred our lease to our subtenant and no longer have monthly lease costs. Deep Down Delaware leases indoor manufacturing space and leases office, warehouse and operating space in Houston, Texas, under non-cancellable operating leases. Additionally, we lease space in Mobile, Alabama to house our 3.4 ton carousel system. We also lease certain office and other operating equipment under capital leases; the related assets are included with property, plant and equipment on the consolidated balance sheets.

 

At the inception of a lease, we evaluate the agreement to determine whether the lease will be accounted for as an operating or capital lease. The term of the lease used for such an evaluation includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured and failure to exercise such option would result in an economic penalty.

 

Revenue Recognition

 

We recognize revenue once the following four criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery of the equipment has occurred or services have been rendered, (iii) the price of the equipment or service is fixed or determinable and (iv) collectability of the related receivable is reasonably assured. Service revenue is recognized as the service is provided, and time and materials contracts are billed on a bi-weekly or monthly basis as costs are incurred. Customer billings for shipping and handling charges are included in revenue. Revenues are recorded net of sales taxes.

 

From time to time, we enter into fixed-price contracts. The percentage-of-completion method is used as a basis for recognizing revenue on these contracts. We recognize revenue as costs are incurred because we believe the incurrence of cost reasonably reflects progress made toward project completion.

 

Provisions for estimated losses on uncompleted large fixed-price contracts (if any) are recorded in the period in which it is determined it is more likely than not a loss will be incurred.  Changes in job performance, job conditions, and total contract values may result in revisions to costs and income and are recognized in the period in which the revisions are determined.  Unapproved change orders are accounted for in revenue and cost when it is probable that the costs will be recovered through a change in the contract price. In circumstances where recovery is considered probable but the revenues cannot be reliably estimated, costs attributable to change orders are deferred pending determination of contract price.

 

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.

 

 

 

 

 F-9 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Income Taxes

 

We follow the asset and liability method of accounting for income taxes. This method takes into account the differences between financial statement treatment and tax treatment of certain transactions. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

 

We record a valuation allowance to reduce the carrying value of our deferred tax assets when it is more likely than not that some or all of the deferred tax assets will expire before realization of the benefit or that future deductibility is not probable. The ultimate realization of the deferred tax assets depends upon our ability to generate sufficient taxable income of the appropriate character in the future. This requires management to use estimates and make assumptions regarding significant future events such as the taxability of entities operating in the various taxing jurisdictions. In evaluating our ability to recover our deferred tax assets, we consider all reasonably available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions, including the amount of future state, and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment. When the likelihood of the realization of existing deferred tax assets changes, adjustments to the valuation allowance are charged in the period in which the determination is made, either to income or goodwill, depending upon when that portion of the valuation allowance was originally created.

 

We record an estimated tax liability or tax benefit for income and other taxes based on what we determine will likely be paid in the various tax jurisdictions in which we operate. We use our best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent upon various matters, including resolution of tax audits, and may differ from amounts recorded. An adjustment to the estimated liability would be recorded as a provision or benefit to income tax expense in the period in which it becomes probable that the amount of the actual liability or benefit differs from the recorded amount.

 

Our future effective tax rates could be adversely affected by changes in the valuation of our deferred tax assets or liabilities or changes in tax laws or interpretations thereof. If and when our deferred tax assets are no longer fully reserved, we will begin to provide for taxes at the full statutory rate. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

 

Share-Based Compensation

 

We record share-based awards exchanged for employee service at fair value on the date of grant and expense the awards in the consolidated statements of operations over the requisite employee service period. Share-based compensation expense includes an estimate for forfeitures and is generally recognized over the expected term of the award on a straight-line basis. At December 31, 2017, we had one type of share-based employee compensation: restricted stock.

 

Key assumptions used in the Black-Scholes model for stock option valuations include (1) expected volatility, (2) expected term, (3) discount rate and (4) expected dividend yield. Volumes are low and small trades can have a major impact on prices, so we based our estimates of volatility on a representative peer group consisting of companies in the same industry, with similar market capitalizations and similar stage of development. Additionally, we continue to use the simplified method related to employee option grants.

 

Earnings or Loss per Common Share

 

Basic earnings or loss per common share (“EPS”) is calculated by dividing net earnings or loss by the weighted average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net earnings or loss by the weighted average number of common shares and dilutive common stock equivalents (stock options) outstanding during the period. Diluted EPS reflects the potential dilution that could occur if stock options and warrants to purchase common stock were exercised for shares of common stock. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive.

 

 

 

 F-10 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). This update provides a five-step approach to be applied to all contracts with customers and requires expanded disclosures about the nature, amount, timing and uncertainty of revenue (and the related cash flows) arising from customer contracts, significant judgments and changes in judgments used in applying the revenue model and the assets recognized from costs incurred to obtain or fulfill a contract. The effective date for this standard was deferred in July 2015 and is effective for us beginning January 1, 2018. The standard provides for different application methods during adoption. We evaluated the potential impact this new pronouncement will have on our financial statements, and reviewed our existing contracts to identify any that may be impacted by this standard. We are also evaluating new contracts we are negotiating to ensure compliance with this standard.

 

We formed a project team to implement the new revenue recognition standard and the team has scoped, identified the relevant revenue streams and documented the procedures and control changes required to address the impacts that ASU 2014-09 may have on our business. Our implementation efforts included the identification of revenue streams with similar contract structures, performing a detailed review of key contracts by revenue stream and comparing historical policies and practices to the new standard. From our analyses, we have identified two main revenue streams from contracts with customers: fixed-price contracts and service contracts. The Company’s revenue recognition methodology for fixed price contracts does not materially change by the adoption of the new standard (over time using cost to cost as an input measure of performance) and for service contracts (over time as services are incurred), which principally charge on a day rate basis and are primarily short-term in nature. Therefore, based on the assessment, the Company has determined the adoption of this ASU will not have a material impact on its consolidated financial statements. We have adopted the new standard effective January 1, 2018 using the modified retrospective method of adoption.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. The amendments in this update require, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The amendments are effective for us beginning January 1, 2019. We do not anticipate the adoption of ASU 2016-02 will have a material effect on our results of operations. We are still evaluating the full impact on our financial position, but currently expect to change the way we account for long-term leases. Upon adoption of the new standard, we expect to reflect leased assets and related lease liabilities on the balance sheet.

 

In October 2016, the FASB issued ASU No. 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory.” This update requires that income tax consequences are recognized on an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this ASU are effective for us on January 1, 2018. Early application is permitted. The adoption of ASU 2016-16 will not have a material effect on our financial position or results of operations.

 

In February 2017, the FASB issued ASU No. 2017-05, “Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets” (“ASU 2017-05”). This update clarifies the scope of accounting for the derecognition or partial sale of nonfinancial assets to exclude all businesses and nonprofit activities. ASU 2017-05 also provides a definition for in-substance nonfinancial assets and additional guidance on partial sales of nonfinancial assets. We evaluated the effect of ASU No. 2017-05 on our consolidated financial statements and adopted ASU 2017-05 in conjunction with ASU 2014-09 effective January 1, 2018. The adoption of ASU 2017-05 will not have a material impact on our consolidated financial position or results of operations.

 

In May 2017, the FASB issued ASU No. 2017-09, “Scope of Modification Accounting” (“ASU 2017-09”), which amends the scope of modification accounting for share-based payment arrangements. This update clarifies when a change to the terms or conditions of a share-based payment award should be accounted for as a modification. An entity should account for the effects of a modification unless the fair value, vesting conditions and classification, as an entity instrument or a liability instrument, of the modified award are the same before and after a change to the terms or conditions of the share-based payment award. The new standard is effective for us January 1, 2018. We do not expect ASU 2017-09 to have a material impact on our consolidated financial position or results of operations.

 

 

 

 F-11 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

NOTE 2: LONG-TERM ASSET – CAROUSEL

 

The long-term asset - Carousel balance of $3,117 at December 31, 2016 consisted of a 3.5 MT portable umbilical carousel, which we fabricated and bought back from a customer in November 2013 and were holding for sale or rental. In 2016, the Company reclassified the carousel from inventory into other assets until a sale was finalized. The reclassification was made due to the uncertainty of when it will be sold. As of December 31, 2017, a decision was made to reclassify the carousel into fixed assets, similar to other equipment in the Company’s rental pool, which are depreciated whether on rent contract or not. This is due to current ongoing discussions with customers for rental projects, rather than sales.

 

NOTE 3: COSTS, ESTIMATED EARNINGS AND BILLINGS ON UNCOMPLETED CONTRACTS

 

Costs, estimated earnings and billings on uncompleted contracts are summarized below:

 

       
  December 31, 2017  December 31, 2016 
Costs incurred on uncompleted contracts $9,564  $8,858 
Estimated earnings on uncompleted contracts  10,741   6,777 
   20,305   15,635 
Less: Billings to date on uncompleted contracts  (19,992)  (17,907)
  $313  $(2,272)
         
Included in the accompanying consolidated balance sheets under the following captions:        
Costs and estimated earnings in excess of billings on uncompleted contracts $925  $1,077 
Billings in excess of costs and estimated earnings on uncompleted contracts  (612)  (3,349)
  $313  $(2,272)

 

The balance in costs and estimated earnings in excess of billings on uncompleted contracts at December 31, 2017 and 2016 consisted primarily of earned but unbilled revenues related to fixed-price projects.

 

The balance in billings in excess of costs and estimated earnings on uncompleted contracts at December 31, 2017 and 2016 consisted primarily of unearned billings related to fixed-price projects.

 

NOTE 4: PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following:

 

  December 31, 2017  December 31, 2016  

Range of

Asset Lives

 
Buildings and improvements $285  $5   7 - 36 years 
Leasehold improvements  908   908   2 - 5 years 
Equipment  18,933   16,360   2 - 30 years 
Furniture, computers and office equipment  1,245   1,274   2 - 8 years 
Construction in progress  2,127   586    
Total property, plant and equipment  23,498   19,133     
Less: Accumulated depreciation and amortization  (11,146)  (11,195)    
Property, plant and equipment, net $12,352  $7,938     

 

 

 

 F-12 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Depreciation expense excluded from cost of sales in the accompanying consolidated statements of operations was $234 and $134 for the years ended December 31, 2017 and 2016, respectively. Depreciation expense included in cost of sales in the accompanying consolidated statements of operations was $1,077 and $1,335 for the years ended December 31, 2017 and 2016, respectively.

 

Construction in progress represents assets that are not ready for service or are in the construction stage. Assets begin being depreciated once they are placed in service.

 

NOTE 5: LONG-TERM DEBT

 

From 2008 through June 30, 2016, we maintained a credit facility (the “Facility”) with Whitney Bank.  In March 2016, we paid all borrowings under the Facility with proceeds received from the sale of our Channelview location. Following the expiration of the Facility on June 30, 2016, we no longer have any credit facilities available to us.

 

NOTE 6: INCOME OR LOSS PER COMMON SHARE

 

The following is a reconciliation of the number of shares used in the basic and diluted net income or loss per common share calculation:

 

  Year Ended 
  December 31, 
  2017  2016 
Numerator:      
Net (loss) income $(116) $164 
         
Denominator:        
Weighted average number of common shares outstanding  14,233   15,520 
Denominator for diluted income per share  14,233   15,520 
        
Net income (loss) per common share outstanding, basic and fully diluted $(0.01) $0.01 

 

At December 31, 2017 and 2016, there were no outstanding stock options convertible to shares of common stock, or any other potentially dilutive securities, respectively.

 

NOTE 7: SHARE-BASED COMPENSATION

 

We have a share-based compensation plan, the “2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan” (the “Plan”). Awards of stock options and stock granted under the Plan have vesting periods of three years. Once vested, stock options may be exercised for up to five years. Share-based compensation expense related to awards is based on the fair value at the date of grant, and is recognized over the requisite expected service period, net of estimated forfeitures. Under the Plan, the total number of options permitted is 15 percent of issued and outstanding common shares.

 

 

 

 F-13 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Summary of Nonvested Shares of Restricted Stock

 

The following table summarizes the activity of our nonvested restricted shares for the years ended December 31, 2017 and 2016:

 

   Restricted Shares  Weighted-Average Grant-Date Fair Value 
Nonvested at December 31, 2015   864  $0.88 
Granted   30   0.91 
Vested   (654)  1.02 
Nonvested at December 31, 2016   240  $0.88 
Granted   30   1.15 
Vested   (20)  1.18 
Nonvested at December 31, 2017   250  $0.50 

 

For the years ended December 31, 2017 and 2016, we recognized a total of $134 and $344, respectively, of share-based compensation expense related to restricted stock awards, which is included in selling, general and administrative expenses in the accompanying consolidated statements of operations. The unamortized estimated fair value of nonvested shares of restricted stock awards was $139 at December 31, 2017. These costs are expected to be recognized as expense over a weighted average period of 1.87 years.

 

Summary of Stock Options

 

Based on the shares of common stock outstanding at December 31, 2017, there were approximately 2,311 options available for grant under the Plan as of that date. We determine the fair value of stock options on the date of the grant using the Black-Scholes option pricing model. As of December 31, 2017, there were no unvested stock options.

 

NOTE 8: TREASURY STOCK

 

On March 26, 2018, our Board of Directors authorized a repurchase program (the “Repurchase Program”) under which we can repurchase up to $1,000 of our outstanding stock. The Repurchase Program will be funded from cash on hand and cash provided by operating activities.

 

The time of the purchases and amount of stock purchased will be determined at the discretion of management subject to market conditions, business opportunities and other appropriate factors and may include purchases through one or more broker-assisted plans and methods, including, but not limited to, open-market purchases, privately negotiated transactions and Rule 10b5-1 trading plans. The Repurchase Program will expire on March 31, 2019.

 

 

 

 F-14 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

NOTE 9: INCOME TAXES

 

The provision for income taxes is comprised of the following:

 

  Year Ended 
  December 31, 
  2017  2016 
Federal:      
Current $  $7 
Deferred  1   (3)
  Total $1  $4 
State:        
Current $5  $13 
Deferred  (1)  3 
  Total $4  $16 
  Total income tax expense $5  $20 

 

The provision for income taxes differs from the amount computed by applying the U.S. statutory income tax rate to income (loss) before taxes for the reasons set forth below

 

  

Year Ended

December 31,

 
  2017  2016 
Income tax benefit (expense) at federal statutory rate  34.00%   (34.00)% 
State taxes, net of federal expense  2.52%   (6.36)% 
Valuation allowance  1662.43%   29.12% 
Remeasurment of deferred taxes from 34% to 21%  (1,710.52)%   0.00% 
Research and development (“R&D”) credits  2.21%   6.01% 
Other permanent differences  (15.63)%   (4.88)% 
Other, net  20.84%   (0.76)% 
Total effective rate  (4.15)%   (10.87)% 

 

Comprehensive tax reform legislation enacted in December 2017, commonly referred to as the Tax Cuts and Jobs Acts (“2017 Tax Act”), has significantly changed U.S. federal income tax laws. The 2017 Tax Act, among other things, reduced the corporate income tax rate from 34% to 21%, limits the deductibility of business interest expense and net operating losses, provides additional limitations on the deductibility of executive compensation, imposes a one-time tax on unrepatriated earnings from certain foreign subsidiaries, taxes offshore earnings at reduced rates regardless of whether they are repatriated, and allows the immediate deduction of certain new investments instead of deductions for depreciation expense over time. As a result of the 2017 Tax Act, the Company recorded deferred tax expense of $1.9 million (1,710.52%) related to the remeasurement of its net deferred tax assets from 34% to 21%, which was substantially offset by a corresponding $1.9 million (1,662.43%) reduction in its deferred tax valuation allowance. The Company does not believe that the 2017 Tax Act will further impact its consolidated financial statements, however, its consolidated financial statements may change due to changes in interpretation of the 2017 Tax Act and additional regulatory guidance that may be issued.

 

 

 

 F-15 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as operating loss and tax credit carry forwards.  The tax effects of the temporary differences and carry forwards are as follows: 

 

  As of 
  December 31, 
  2017  2016 
Deferred tax assets:        
Net operating loss (“NOL”) carryfowards $3,255  $5,439 
R&D & other credit carryfowards  501   531 
Share-based compensation  741   1,137 
Intangible amortization  21   68 
Allowance for bad debt  2    
Other  8   43 
  Total deferred tax assets $4,528  $7,218 
Less: valuation allowance  (3,649)  (5,499)
  Net deferred tax assets $879  $1,719 
Deferred tax liabilities:        
Depreciation on property and equipment $(879) $(1,664)
Amortization of intangibles     (55)
  Total deferred tax liabilities $(879) $(1,719)
         
  Net deferred tax position $  $ 

 

We have $15,107 of federal and $1,049 state NOL carry forwards and $501 in R&D and other credits available to offset future taxable income. These federal and state NOL’s will expire at various dates through 2035. Management analyzed its current operating results and future projections and determined that a full valuation allowance was needed due to our cumulative losses in recent years. We have no uncertain tax positions at December 31, 2017. Accordingly, we do not have any accruals for penalties or interest related to our tax returns. Should an examination or audit arise, we would evaluate the need for an accrual and record one, if necessary. Our tax returns from the tax years ended December 31, 2011 through December 31, 2016 are open to examination by the IRS.

 

NOTE 10:  COMMITMENTS AND CONTINGENCIES

 

Operating Leases

 

We lease certain offices, facilities, equipment and vehicles under non-cancellable operating and capital leases expiring at various dates through 2023.

 

At December 31, 2017, future minimum contractual lease obligations were as follows:

 

Years ending December 31  Operating Leases 
 2018   1,455 
 2019   1,455 
 2020   1,455 
 2021   1,395 
 2022   1,174 
 Thereafter   1,663 
 Total minimum lease payments  $8,597 

 

Rent expense for the years ended December 31, 2017 and 2016 was $1,445 and $1,440, respectively.

 

 

 

 F-16 

 

 

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017 and 2016

(Amounts in thousands, except per share amounts)

 

Letters of Credit

 

Certain customers could require us to issue standby letters of credit in the normal course of business to ensure performance under terms of contracts or as a form of product warranty. The beneficiary of a letter of credit could demand payment from the issuing bank for the amount of the outstanding letter of credit. We had no outstanding letters of credit at December 31, 2017 or 2016.

 

Employment Agreements

 

One of our executives is employed under an employment agreement containing severance provisions. In the event of termination of the executive’s employment for any reason, the executive will be entitled to receive all accrued, unpaid salary and vacation time through the date of termination and all benefits to which the executive is entitled or vested under the terms of all employee benefit and compensation plans, agreements and arrangements in which the executive is a participant as of the date of termination.

 

In addition, subject to executing a general release in favor of the Company, the executive will be entitled to receive certain severance payments in the event his employment is terminated by the Company “other than for cause” or by the executive with “good reason.” These severance payments include: (i) a lump sum in cash equal to one to three times the executive’s annual base salary; (ii) a lump sum in cash equal to one to two times the average annual bonus paid to the executive for the prior two full fiscal years preceding the date of termination; (iii) a lump sum in cash equal to a pro rata portion of the annual bonus payable for the period in which the date of termination occurs based on the actual performance under the Company’s annual incentive bonus arrangement, but no less than fifty percent of executive’s annual base salary; and (iv) if the executive’s termination occurs prior to the date that is twelve months following a change of control, then each and every share option, restricted share award and other equity-based award that is outstanding and held by the executive shall immediately vest and become exercisable.

 

Litigation

 

From time to time we are involved in legal proceedings arising from the normal course of business. As of the date of this report, we are not engaged in any material legal dispute.

 

NOTE 11:  SUBSEQUENT EVENTS

 

We have evaluated subsequent events through the date the consolidated financial statements were filed with the Securities and Exchange Commission.

 

On March 26, 2018, our Board of Directors authorized the repurchase of up to $1 million in shares of the Company's outstanding stock. The repurchase program will be funded from cash on hand and cash provided by operating activities.

 

The time of the purchases and amount of stock purchased will be determined at the discretion of management subject to market conditions, business opportunities and other appropriate factors and may include purchases through one or more broker-assisted plans and methods, including, but not limited to, open-market purchases, privately negotiated transactions and Rule 10b5-1 trading plans. The share repurchase program will expire on March 31, 2019.

 

 

 

 F-17