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 is www.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 market we currently serve.
For the years ended December 31, 2016 and 2015, 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.
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.
Deep Down Marine Technologies. Deep Down Marine Technologies is a specialized division of Deep Down, Inc. primarily focused on 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.
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.
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
For over a decade, our primary manufacturing facility was in Channelview, Texas, a suburb of Houston. In June of 2013, we reorganized our manufacturing efforts in order to maximize production and satisfy the increasing demand in the oil and gas industry. We are now operational at our 255,000 sq. ft. facility on 23 acres off Beaumont Highway, conveniently located 10 minutes from our former Channelview facility.
In addition to increasing our production capacity, this move also provided the space to build our Steel Tube Flying Lead (“STFL”) Overhead Tracking System. This system will allow 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 ROV’s and ROV operations.
The most substantial benefit to the new 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 invest in 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.
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 1, 2017, we had a total of 73 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.
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.
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 2.
ITEM 2.Description of Property
Our principal corporate offices are located at 8827 W. Sam Houston Parkway North, Suite 100, Houston, Texas 77040. The 89-month lease term began in February 2009 and included an allowance for leasehold improvements by the landlord, plus a charge for monthly common area expenses (“CAM charges”) on a pro-rata basis of the total building expenses (including insurance, security, maintenance, property taxes and utilities). Monthly lease costs ranged from $12,177 to $14,391 plus CAM charges, due to a rent escalation clause over the term of the lease. Effective September 1, 2013, we sub-leased approximately 50% of our space for $9,000 per month for the remainder of the lease term. On August 1, 2016, we transferred our lease to our subtenant and no longer have monthly lease costs, but still office from this location.
During the year ended December 31, 2015, our operating facilities for Deep Down Delaware were located at 15473 East Freeway, Channelview, Texas 77530 (“Channelview”) and at 18511-810 Beaumont Highway, Houston, Texas 77049 (“Highway 90”). Our Channelview facility consisted of approximately 11 acres of land that housed 60,000 square feet of manufacturing space and 7,000 square feet of office space. These manufacturing facilities in Channelview, Texas, were subject to the liens of our lender, Whitney Bank, under our credit agreement. During the first quarter of 2016, we sold our Channelview facility and moved our operations to our Highway 90 facility, which consists of approximately 23 acres of land, and includes 255,000 sq. ft. of indoor manufacturing and storage space. The 10-year lease 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 6,500 square feet monthly of storage space in Mobile, AL to house our 3,400 ton carousel system for $5,000. The 5-year lease commenced in August 2010 at a base rate of $5,000 per month and is currently continuing on a month-to-month basis. We believe that our current space is suitable, adequate and of sufficient capacity to support our current operations.
During the first five months of 2016, Deep Down Delaware also leased property and buildings from Sutton Industries at a base rate of $8,122 per month. The property is located at 125 Mako Lane, Morgan City, Louisiana 70380. The 5-year lease term commenced on June 1, 2006, and was renewed for five additional years in June 2011. As a result of our closure of Mako Technology, LLC’s operations in Morgan City in August 2012, on December 13, 2012, this property was subleased for the remainder of the lease term. This lease expired on May 31, 2016 and was not renewed.
ITEM 3.
ITEM 3.Legal Proceedings
From time to time, we may be involved in legal proceedings arising in the normal course of business. As of the date of this Report, we are involved in one material legal proceeding, arising from the non-payment of equipment rental and services by one of our customers.
In December 2014, at the request of a customer, we delivered a carousel to the customer on a lease or purchase arrangement. We honored this request in order to support its requirement for a critical umbilical project. At the completion of our customer’s requirement, we were advised by the customer it was not going to purchase the carousel, so we picked up the carousel and returned it to our facility. We then invoiced the customer on a rental basis.
The customer has declined to pay the invoices. We are pursuing collection through arbitration.
PART II
ITEM 5.
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 periods indicated, the high and low bid quotations for our common stock as reported by the OTC Markets.
Stockholders of Record
As of March 25, 2017, there were 1,086 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
The table below summarizes information about our purchases of common stock, based on trade date, during the quarter ended December 31, 2016:
(1)On May 23, 2016, we announced our Board of Directors authorized a repurchase program (the “Repurchase Program”) under which we may repurchase up to $1,000,000 of our outstanding stock. The Repurchase Program will expire as of the close of business on March 31, 2017.
As of December 31, 2016, we have repurchased a total of 587,847 shares of our Common Stock at an average price of $0.96. See Note 11 “Subsequent Events”, of the Notes to Consolidated Financial Statements, for further explanation of our Repurchase Program.
Equity Compensation Plan Information
The following table sets forth information regarding our equity compensation plans as of December 31, 2016:
(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, 2016. 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 7.
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.
In this Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, all dollar and share amounts are in thousands of dollars and shares, unless otherwise indicated.
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
In light of the challenges in the oil and gas industry, we are pleased with our results for 2016, and are grateful for the confidence our customers continue to place in our ability to assist them solve their problems.
The industry continues to adjust to lower oil and gas prices. As a result of the industry’s focus on lowering project execution costs, major oil and gas projects are beginning to progress at lower break-even points.
Our strategic focus on cost containment, streamlined contracting strategies, and cash management, has enabled us to continue being a preferred service provider. We believe that our size and organizational structure enable us to provide solutions for our customers within a timeframe, and at costs, expected by our customers.
Because we are smaller than many or our competitors, we are optimistic about potential opportunities that might emerge as a result of consolidation and restructuring within the industry. We believe that some of our competitors have sought to achieve lower operating costs by moving operations to locations that typically have lower operating costs, many of which are in locations that are geographically remote from oil and gas projects. We believe that many of our customers are increasingly looking for local providers that can provide solutions in a more timely manner. We expect this trend to continue.
Advances in technology are also permitting a renewed focus in less well established oil and gas producing regions in Africa, Latin America and the Far East. In many cases, interest in these newer fields is being driven by newer and less capitalized companies, who seek lower-cost providers. We believe that we are positioned to benefit from this trend.
In order to mitigate our risks and exposure as we serve these constituencies, we are entering into strategic partnership with complementary service providers. In many cases, these partnerships also serve to satisfy requirements regarding the provision of goods and services by local providers, which are of increasing importance in many countries.
While our current backlog of our core products and services is $23 million, interest in our services for non oil and gas applications continues to increase. We have been approached by various academic and scientific organizations to partner with them as they develop new deepwater technologies for other industries. As a result of the positive outcomes of our initial activities we are optimistic about our future involvement in such initiatives.
We believe that the Company is positioned for future success. Our balance sheet continues to strengthen, our collaborative relationships with new and existing customers continue to increase, and our workforce continues to be highly focused. We are optimistic about both near-term and long-term prospects for the Company, and intend to continue to focus on what we do best, even as we pursue new opportunities.
Results of Operations
Revenues
Revenues in 2016 were $25,384, an increase of 2 percent compared to the revenues in 2015 of $24,848. The increase in revenue was primarily due to work completed on a significant project for one of our customers.
Cost of sales and gross profit
The increase in gross profit and gross profit percentage was primarily due to increased costs incurred on prolonged fixed price projects for a customer that impacted our gross profit and gross profit percentage in 2015, which did not occur in 2016.
We record depreciation expense related to revenue-generating property, plant and equipment as cost of sales, which totaled $1,335 and $1,499 for the years ended December 31, 2016 and 2015, respectively.
Selling, general and administrative expenses
The $559 increase in selling, general and administrative expenses (“SG&A”) was due primarily to a $526 increase in our legal fees and outside services incurred in order to protect our intellectual property, corporate integrity and human resource policies, as well as preparing for arbitration on a disputed contract.
Net interest expense
Net interest expense for the year ended December 31, 2016 was $34 compared to $247 for the year ended December 31, 2015. Net interest expense decreased $213, due to the payoff of our credit facility in March of 2016.
Gain on sale of asset
During the first quarter of 2016, we sold our Channelview location which resulted in a gain on sale of assets of $1,070 compared to $7 in 2015.
Equity in net income of joint venture
In 2015, we received $226 as a distribution of equity in net income of 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 income (loss) to Modified EBITDA for the years ended December 31, 2016 and 2015 (certain prior year amounts have been excluded to conform to the current year presentation):
Modified EBITDA increased $362 in 2016 compared to the prior year. Gross profit before depreciation increased $1,306 in 2016 as compared to 2015, due primarily to work completed on a significant project for one of our customers and improving cost controls around our service and production activities. The increase in gross profit was offset by SG&A before share-based compensation of $747 in 2016 as compared to 2015. The remaining modified EBITDA difference is primarily related to the reduced add back of interest expense in 2016.
Liquidity and Capital Resources
Overview
Historically, we have supplemented the financing of our capital needs primarily through debt and equity financings.
Credit Facility
From 2008 through June 30, 2016, we maintained a credit facility (the “Facility”) with Whitney Bank. The Facility was amended and restated several times, most recently effective June 30, 2015 when we entered into the eighth amendment (“Eighth Amendment”).
The relevant terms of the Eighth Amendment included:
•an extension of the maturity date of the revolving credit facility (“Revolving Credit Facility”) to June 30, 2016;
•a modification of the interest rate with respect to the Revolving Credit Facility to 4.0 percent per annum;
•a modification of certain financial covenants; and
•a requirement that we maintain a compensating balance of $3,900 in our existing interest-bearing account at Whitney, to continue until such time as we have regained compliance with all of our covenants under the Facility for two consecutive quarters commencing with the quarter ended June 30, 2015.
Other terms of the Facility included:
•a real estate term facility (“RE Term Facility”) of $2,000, at an interest rate of 4.0 percent per annum, maturing April 15, 2018, with the Company being obligated to make monthly increasing repayments of principal (along with accrued and unpaid interest thereon) at an amount of $9, beginning April 1, 2013, while there is any amount outstanding;
•a carousel term facility (“Carousel Term Facility”) of $2,200, at an interest rate of 3.5 percent per annum, maturing October 15, 2016, with the Company being obligated to make monthly repayments of principal of $65 (along with accrued and unpaid interest thereon) beginning July 1, 2014, while there is any amount outstanding; and
•outstanding balances under the Facility are secured by all of the Company’s assets.
In March 2016, we paid off the RE Term Facility and the Carousel Term Facility with proceeds received from the sale of our Channelview location.
Due to the expiration of Facility on June 30, 2016, we no longer have the requirement of a compensating balance and the $3,900 is now available for use. As of December 31, 2016, we no longer have these credit facilities available to us.
As a result of cash we expect to generate from operations, we believe we will have adequate liquidity to meet our future operating requirements.
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 and liabilities related to costs and estimated earnings in excess of billings on uncompleted contracts, as well as 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
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, 2016 and 2015, we estimated the allowance for doubtful accounts requirement to be $10 and $150, respectively. Bad debt expense totaled $167 and $70 for the years ended December 31, 2016 and 2015, respectively. The change in our allowance for doubtful accounts is a result of certain accounts being written off in 2016.
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 8.
Item 8.Financial Statements AND SUPPLEMENTAL DATA
The financial statements are included herewith commencing on page.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2016 and 2015
Consolidated Statements of Operations - Years ended December 31, 2016 and 2015
Consolidated Statements of Changes in Stockholders’ Equity - Years ended December 31, 2016 and 2015
Consolidated Statements of Cash Flows - Years ended December 31, 2016 and 2015
Notes to Consolidated Financial Statements - Years ended December 31, 2016 and 2015
Item 9.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
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, 2016, 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, 2016.
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, 2016, 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, 2016.
Material Weakness Related to Revenue Recognition. During the audit of our financial statements for the year ended December 31, 2015, we identified a control deficiency related to revenue recognition. We concluded that the Company's processes, procedures and internal controls were not effective to ensure that amounts recognized as revenue would be accounted for in accordance with generally accepted accounting principles and SEC Staff Accounting Bulletin No. 101 - Revenue Recognition in Financial Statements (SAB 101).
Specifically, we determined that there was revenue, related to a disputed contract, recorded prematurely during the first and second quarters of 2015.
We established that this deficiency resulted from the lack of clear communication between the Company and its customer prior to the delivery of a carousel to the customer, along with insufficient evidence that the Company and its customer had reached an agreement.
Because this control deficiency caused material misstatements to our prior unaudited quarterly financial statement filings for the year ended December 31, 2015, we implemented the following internal controls and procedures over our revenue recognition during the first quarter of 2016 to remedy the material weakness:
Management reviews all contracts and invoices to ensure that:
•The work being done has been clearly approved by both the Company and its customer and evidence to that effect has been obtained; and
•Effective communication with accounting personnel during the billing process to ensure proper invoicing to the customer.
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, 2016.
Item 9B.
Item 9B.Other Information
None.
PART III
Item 10.
Item 10.Directors, Executive Officers and Corporate Governance
The following table sets forth the names, ages and positions of our directors and executive officers.
_________________________
(1) Ronald E. Smith and Mary L. Budrunas are married to each other.
Biographical information regarding each of our directors and named 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.
Eugene L. Butler, Executive Chairman and Chief Financial Officer. Mr. Butler has served as Chief Financial Officer and Director with Deep Down since June 2007, and was appointed Executive Chairman of the Board effective September 1, 2009. Mr. Butler was Managing Director of CapSource Services, Inc., an investment banking firm specializing in mergers, acquisitions and restructurings, from 2002 until 2007. Prior to this, Mr. Butler served in various capacities as a director, president, chief executive officer, chief financial officer and chief operating officer for Weatherford International, Inc., a multi-billion dollar multinational service and equipment corporation serving the worldwide energy market, from 1974 to 1991. He was elected to Weatherford’s Board of Directors in May of 1978, elected president and chief operating officer in 1979, and president and chief executive officer in 1984. He successfully developed and implemented a turnaround strategy eliminating debt and returning the company to profitability during a severe energy recession. Mr. Butler also expanded operations into international markets allowing Weatherford to become a major worldwide force with its offshore petroleum products and services. Mr. Butler graduated from Texas A&M University in 1963, and served as an officer in the U.S. Navy until 1969 when he joined Arthur Andersen & Co. Mr. Butler is distinguished by numerous medals and decorations, including the Bronze Star with combat “V” and the Presidential Unit Citation for his service with the river patrol force in Vietnam. Mr. Butler has also served on the Board of Powell Industries, Inc. (Nasdaq: POWL) since 1990, where he is the Chairman of the Audit Committee and member of the Governance Committee and as a member of the OTCQX U.S. Advisory Council since January 2016. Mr. Butler is a Certified Public Accountant.
In addition to his extensive knowledge of Deep Down, Mr. Butler is qualified for service on the Board based on his leadership skills and long-standing senior management experience in the energy and petroleum industries. Additionally, his background in public accounting and investment banking, familiarity with complex accounting issues and financial statements, as well as his service on the board, including various committees, of another public company, provide invaluable financial expertise and overall insight 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 is responsible for our administrative functions, including human resources and accounting. 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.
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 Excutive 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.
Mark Carden, Director. 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.
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.
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, 2016 were in compliance, except Messrs. Smith and Butler did not timely file a Form 4 reporting an aggregate four transactions.
Item 11.
Item 11.Executive Compensation
The following table sets forth information concerning total compensation earned in the years ended December 31, 2016 and 2015 by our Principal Executive Officer (“PEO”), and our two highest compensated executive officers other than our PEO (collectively, our “Named Officers”).
Summary Compensation Tables for the years ended December 31, 2016 and 2015
(1)Amounts in 2016 represent:
·Automobile allowance of $19,500 to Messrs. Smith and Butler and $12,000 to Mr. Auger;
·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.
(2)Amounts in 2015 represent:
·Automobile allowance of $19,500 to Messrs. Smith and Butler;
·Payments for vacation not taken in 2015 of $70,148 and $45,251 for Messrs. Smith and Butler, respectively;
·Reimbursement of $17,500 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.
Narrative Disclosure to Summary Compensation Table
Employment agreements with Named Executive Officers
All of the compensation described in the foregoing table, other than those amounts shown in the “Stock Awards” column, was paid to the Named Officers pursuant to agreements with the Company.
Agreement with Mr. Smith. On January 1, 2016, the Company entered into an employment agreement with Mr. Smith for a term of three years, and is subject to further 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 employment agreement provides that Mr. Smith receive an annual cash compensation of $501,562.
Agreement with Mr. Butler. On January 1, 2016, the Company entered into an employment agreement with Mr. Butler for a term of three years, and is subject to further 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 employment agreement provides that Mr. Butler receive an annual cash compensation of $431,393, including, but not limited to, reimbursement for healthcare premiums and federal and state payroll withholdings customarily withheld for an employee.
Outstanding Equity Awards at December 31, 2016
The following table summarizes nonvested stock awards assuming a market value of $1.40 per share (the closing market price of the Company’s common stock on December 30, 2016). See Note 7, “Share-Based Compensation”, of the Notes to Consolidated Financial Statements included in this Report for additional information.
(1)The restrictions on these shares of nonvested stock will lapse on December 14, 2017, 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
Each of Mr. Butler’s and Mr. Smith’s (the “Executive”) employment agreements contain provisions related to change in control.
In the event of termination of the Executive’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 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 us, 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 the following:
(i) a lump sum in cash equal to one times the Executive’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 the Executive’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 the Executive 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 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 our annual incentive bonus arrangement; provided, however, that such pro rata portion shall be calculated based on the Executive’s annual bonus for the previous fiscal year; but if no previous annual bonus has been paid to the Executive, then the lump sum cash payment for this current pro rata annual bonus obligation shall be no less than fifty percent of Executive’ 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.
Each of the Executives has agreed to not, during the respective term of his employment and for a one-year period after his termination, engage in “Competition” (as defined in the 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.
The Employment Agreements also provide that we, to the extent permitted by applicable law and our by-laws, will defend, indemnify and hold harmless the Executive from any and all claims, demands or causes of action, including reasonable attorneys’ fees and expenses, suffered or incurred by the Executive 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 the Executive pursuant to the Employment Agreement or in the course and scope of the Executive’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 the Executives, to the fullest extent permitted by applicable law.
Compensation of Directors
Determining Director Compensation
The Company’s Compensation Committee of the Board of Directors makes all decisions regarding director compensation. Only directors, who are not employees 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.
The following table provides certain information with respect to the 2016 compensation awarded or earned by the Independent Directors who served in such capacity during the year. 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.
(1)Included in the “Stock Awards” column is the aggregate grant date fair value of restricted stock awards made to our Independent Directors in 2016. 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 and option 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 2016, we granted 30,000 restricted shares, par value $0.001 per share, to Mr. Warner. The shares were valued at $1.02 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 $30,600 over the three-year requisite service period.
(2)The number of nonvested restricted shares held by each of our Independent Directors on December 31, 2016 was: Mr. Warner 30,000; Mr. Carden 10,000.
Item 12.
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Security Ownership of Certain Beneficial Owners and Management
Set forth below is certain information with respect to beneficial ownership of Common Stock as of December 31, 2016 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.
___________
* Indicates ownership of less than 1% of Common Stock outstanding.
(1)As defined by the rules of the SEC, securities beneficially owned for this purpose include securities that the above persons have the right to acquire at any time within 60 days after December 31, 2016.
(2)The percentages in the table are calculated using the total shares outstanding plus the number of securities that can be acquired within 60 days of December 31, 2016 or a total of 15,408,660 shares.
(3)Based on a Schedule 13D filed with the SEC dated February 6, 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, 2016.
(4)Based on a Schedule 13F-HR filed with the SEC dated January 19, 2017, Goldman Capital Management Inc., 767 Third Ave, New York, NY 10017, may be deemed the beneficial owners of 1,161,000 shares outstanding as of December 31, 2016.
(5)Mr. Smith and Ms. Budrunas are married and hold an aggregate of 2,943,616 shares of common stock, or approximately 19 percent of outstanding common stock as of December 31, 2016.
(6)Includes 100,000 shares of nonvested stock, which will vest on December 14, 2017 and 348,632 shares held indirectly through the Company’s Simple IRA Plan.
(7)Includes 23,071 shares held indirectly through the Company’s Simple IRA Plan.
(8)Includes 100,000 shares of nonvested stock, which will vest on December 14, 2017.
(9)Includes 30,000 shares of nonvested stock, which will vest in three equal installments on May 28, 2017, May 28, 2018 and May 28, 2019.
(10)Includes 10,000 shares of nonvested stock, which will vest on May 1, 2017.
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.
ITEM 13.
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.
ITEM 14.Principal Accountant Fees and Services
We retained Hein & Associates LLP (“HEIN”) as our principal accountant in 2011. We had no relationship with HEIN prior to their retention as our principal accountant. The following table sets forth the aggregate fees paid to HEIN for audit services rendered in connection with the Company’s consolidated financial statements and reports for the years ended December 31, 2016 and 2015, and for other services rendered during those years on behalf of Deep Down and its subsidiaries:
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.
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 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.
PART IV
ITEM 15.
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.
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/ Eugene L. Butler
Eugene L. Butler
Executive Chairman and 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/ Eugene L. Butler
Executive Chairman and Chief Financial Officer
Eugene L. Butler
(Principal Financial Officer)
/s/ Mary L. Budrunas
Vice-President, Corporate Secretary and Director
Mary L. Budrunas
/s/ Randolph W. Warner
Director
Randolph W. Warner
/s/ Mark Carden
Director
Mark Carden
Date: March 31, 2017
EXHIBIT INDEX
Exhibit Number Description of Exhibit
* Filed herewith.
# Furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Deep Down, Inc.
We have audited the accompanying consolidated balance sheets of Deep Down, Inc. and subsidiaries (collectively the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years 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 audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 audits 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 audits provide 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 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ Hein & Associates LLP
Houston, Texas
March 31,
DEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the consolidated financial statements.
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2016 and 2015
The accompanying notes are an integral part of the consolidated financial statements.
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and 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. 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, 2016 and 2015, we supplemented the financing of our capital needs primarily through debt and operating cash flow. Since 2008, we had 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, 2016 and 2015. 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.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
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.
Segments
For the years ended December 31, 2016 and 2015, 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, note receivable, and debt instruments. The carrying values of cash, trade receivables and payables approximated their fair values at December 31, 2016 and 2015 due to their short-term maturities. The carrying values of our debt instruments and note receivable approximate their fair values at December 31, 2016 and 2015 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, 2016 and 2015, we estimated the allowance for doubtful accounts requirement to be $10 and $150, respectively. Bad debt expense (credit) totaled $167 and $70 for the years ended December 31, 2016 and 2015, respectively.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
Concentration of Credit Risk
As of December 31, 2016, three of our customers accounted for 66 percent, 7 percent and 5 percent of total trade accounts receivable. As of December 31, 2015, three of our customers accounted for 35 percent, 26 percent and 17 percent of total trade accounts receivable.
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. For the year ended December 31, 2015, our five largest customers accounted for 34 percent, 21 percent, 10 percent, 7 percent and 5 percent of total revenues.
The loss of one or more of these customers could have a material impact on our results of operations.
Inventory
Inventory, which consists of a 3.5 MT portable umbilical carousel, is stated at the lower of cost or market, net of reserve for obsolescence. The obsolescence reserve was $0 as of December 31, 2015 and due to a reclassification of our carousel from inventory to other assets, there is no longer an inventory balance at December 31, 2016. The reclassification was made due to the uncertainty of when it will be sold or put on rent.
Long-Lived Assets
Property, plant and equipment. 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 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, but still expect equity distributions from time to time.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
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 assigned our lease for our corporate headquarters to the company we had previously sub-leased a portion of our office space to. Deep Down Delaware leases indoor manufacturing space and leases office, warehouse and operating space in Houston, Texas and in Morgan City, Louisiana, under a non-cancellable operating lease. As a result of the consolidation of Mako Technology, LLC’s operations into Deep Down Delaware in August 2012, in December 2012, we sub-leased our leased property in Morgan City, Louisiana to a third party. This lease expired on May 31, 2016 and we did not renew it. 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 and liabilities 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.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and 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, 2016, we had two types 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.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
Earnings or Loss per Common Share
Basic earnings or loss per common share (“EPS”) is calculated by dividing net earnings or loss by the weighted average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net earnings or loss by the weighted average number of common shares and dilutive common stock equivalents (stock options) outstanding during the period. Diluted EPS reflects the potential dilution that could occur if stock options and warrants to purchase common stock were exercised for shares of common stock. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive.
Recently Issued Accounting Standards Not Yet Adopted
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 will now be effective for us beginning January 1, 2018. The standard provides for different application methods during adoption. We are currently in the process of evaluating the potential impact this new pronouncement will have on our financial statements and will not be exercising early adoption. We are reviewing our existing contracts to identify any that may be impacted by this standard, and evaluating new contracts we are negotiating to ensure compliance with this standard. We have not completed our full evaluation and therefore cannot conclude whether the pronouncement will have a significant impact on our financial statements at this time, but we expect requirements of this standard to significantly enhance our revenue disclosures. We currently anticipate that we will utilize the modified retrospective method of adoption, however, this expectation may change following the completion of our evaluation of the impact of this pronouncement on our financial statements.
In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires in scope inventory to be measured at the lower of cost and net realizable value rather than at the lower of cost or market under existing guidance. The amendments in this ASU are effective for us beginning January 1, 2017. We do not anticipate the adoption of ASU 2015-11 will have a material impact on our financial position or results of operations.
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 2014-15 will have a material effect on our results of operations and are still evaluating the impact on our financial position.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). Among other amendments, ASU 2016-09 requires that excess tax benefits or deficiencies are recognized as income tax expense or benefit in the income statement, gives an entity the ability to elect to estimate the number of awards that are expected to vest or account for forfeitures as they occur and permits withholding up to the maximum statutory tax rates as the threshold to qualify for equity classification. The guidance will become effective for us beginning January 1, 2017. We do not anticipate the adoption of ASU 2014-15 will have a material effect on our financial position or results of operations.
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. We are currently evaluating the impact of this ASU on our consolidated financial statements.
NOTE 2:INVENTORY
The finished goods inventory balance of $3,117 at December 31, 2015 consisted of a 3.5 MT portable umbilical carousel, which we fabricated and bought back from a customer in November 2013 and are currently holding for sale or rental. In 2016, the Company reclassified the carousel into other assets until a sale or rental contract is finalized. The reclassification was made due to the uncertainty of when it will be sold or put on rent.
NOTE 3:COSTS, ESTIMATED EARNINGS AND BILLINGS ON UNCOMPLETED CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts are summarized below:
The balance in costs and estimated earnings in excess of billings on uncompleted contracts at December 31, 2016 and 2015 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, 2016 and 2015 consisted primarily of unearned billings related to fixed-price projects.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
NOTE 4:PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
Depreciation expense excluded from cost of sales in the accompanying consolidated statements of operations was $134 and $187 for the years ended December 31, 2016 and 2015, respectively. Depreciation expense included in cost of sales in the accompanying consolidated statements of operations was $1,335 and $1,499 for the years ended December 31, 2016 and 2015, 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
Credit Facility
From 2008 through June 30, 2016, we maintained a credit facility (the “Facility”) with Whitney Bank. The Facility was amended and restated several times, most recently effective June 30, 2015 when we entered into the eighth amendment (“Eighth Amendment”).
The relevant terms of the Eighth Amendment included:
•an extension of the maturity date of the revolving credit facility (“Revolving Credit Facility”) to June 30, 2016;
•a modification of the interest rate with respect to the Revolving Credit Facility to 4.0 percent per annum;
•a modification of certain financial covenants; and
•a requirement that we maintain a compensating balance of $3,900 in our existing interest-bearing account at Whitney, to continue until such time as we have regained compliance with all of our covenants under the Facility for two consecutive quarters commencing with the quarter ended June 30, 2015.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
Other terms of the Facility included:
•a real estate term facility (“RE Term Facility”) of $2,000, at an interest rate of 4.0 percent per annum, maturing April 15, 2018, with the Company being obligated to make monthly increasing repayments of principal (along with accrued and unpaid interest thereon) at an amount of $9, beginning April 1, 2013, while there was any amount outstanding;
•a carousel term facility (“Carousel Term Facility”) of $2,200, at an interest rate of 3.5 percent per annum, maturing October 15, 2016, with the Company being obligated to make monthly repayments of principal of $65 (along with accrued and unpaid interest thereon) beginning July 1, 2014, while there was any amount outstanding; and
•outstanding balances under the Facility are secured by all of the Company’s assets.
In March 2016, we paid off the RE Term Facility and the Carousel Term Facility with proceeds received from the sale of our Channelview location.
Due to the expiration of our credit facility on June 30, 2016, we no longer have the requirement of a compensating balance and the $3,900 is now available for use. As of December 31, 2016, we no longer have these credit facilities available to us.
NOTE 6:EARNINGS OR LOSS PER COMMON SHARE
The following is a reconciliation of the number of shares used in the basic and diluted net earnings or loss per common share calculation:
At December 31, 2016 and 2015, there were outstanding stock options convertible to 0 and 275 shares of common stock, respectively. As of these dates, these options were anti-dilutive.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
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.
Summary of Nonvested Shares of Restricted Stock
The following table summarizes the activity of our nonvested restricted shares for the years ended December 31, 2016 and 2015:
For the years ended December 31, 2016 and 2015, we recognized a total of $344 and $516, 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, 2016. These costs are expected to be recognized as expense over a weighted average period of 0.76 years.
Summary of Stock Options
Based on the shares of common stock outstanding at December 31, 2016, 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.
The following table summarizes our stock option activity for the years ended December 31, 2016 and 2015:
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and per share amounts)
NOTE 8:TREASURY STOCK
On May 23, 2016, our Board of Directors authorized a repurchase program (the “Repurchase Program”) under which we may repurchase up to $1,000 of our outstanding stock. The purchases may be made from time to time in the open market, through privately negotiated transactions and Rule 10b5-1 trading plans in accordance with applicable laws, rules and regulations. The Repurchase Program will be funded from cash on hand and cash provided by operating activities. The Repurchase Program will expire as of the close of business on March 31, 2017. As of December 31, 2016, we have purchased approximately 588 shares at a total cost of $567 under this Repurchase Program. The average price per share of treasury stock through December 31, 2016 has been $0.96. Treasury shares are accounted for using the cost method. See Note 11 “Subsequent Events”, of the Notes to Consolidated Financial Statements, for further explanation of our Repurchase Program.
NOTE 9:INCOME TAXES
The provision for income taxes is comprised of the following:
The provision for income taxes differs from the amount computed by applying the U.S. statutory income tax rate before income taxes for the reasons set forth below.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and 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:
We have $15,745 in federal and state net operating loss (“NOL”) carry forwards and $531 in research and development credits available to offset future taxable income. These federal 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, 2016. 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, 2010 through December 31, 2015 are open to examination by the IRS.
Deferred tax asset of $3,972 as of December 31, 2015 related to investment in joint venture was written off during 2016 against a full valuation allowance. We have determined that this deferred tax asset should not have been reported at December 31, 2015 because the joint venture was liquidated in 2014. We have assessed the impact and determined it was not material to warrant a correction of December 31, 2015. As discussed, there was no impact on our consolidated results of operations, financial position or statement of cash flows for the year ended December 31, 2016 because it had a full valuation allowance.
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, 2016, future minimum contractual lease obligations were as follows:
Rent expense for the years ended December 31, 2016 and 2015 was $1,440 and $1,447, respectively.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2016 and 2015
(Amounts in thousands, except share and 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. Letters of credit outstanding at December 31, 2015 under the Eighth Amendment with Whitney were $0.
Employment Agreements
Certain of our Executives are employed under employment agreements containing severance provisions. In the event of termination of an 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 engaged in one material legal dispute, arising from the non-payment of equipment rental and services by one of our customers.
In December 2014, at the request of a customer, we delivered a carousel to the customer on a lease or purchase arrangement. We honored this request in order to support its requirement for a critical umbilical project. At the completion of our customer’s requirement, we were advised by the customer it was not going to purchase the carousel, so we picked up the carousel and returned it to our facility. We then invoiced the customer on a rental basis.
The customer has declined to pay the invoices. We are pursuing collection through arbitration.
NOTE 11:SUBSEQUENT EVENTS
We have evaluated subsequent events through the date the consolidated financial statements were filed with the Securities and Exchange Commission.
In March 2017, the Board of Directors of the Company renewed and extended the repurchase program for up to an additional $1 million of common stock until March 31, 2018 (the “Repurchase Program”). See Note 8 “Treasury Stock”, of the Notes to Consolidated Financial Statements, for further explanation of our Repurchase Program.