Koil Energy Solutions, Inc. - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2016

OR

Commission File No. 0-30351

DEEP DOWN, INC.

(Exact name of registrant as specified in its charter)

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

Not applicable

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

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

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

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

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

At November 10, 2016, there were 15,493,360 shares of Common Stock outstanding, par value $0.001 per share.

IMPORTANT INFORMATION REGARDING THIS FORM 10-Q

Unless otherwise indicated, references to “we,” “us,” and “our” in this Quarterly Report on Form 10-Q (“Report”) refer collectively to Deep Down, Inc., a Nevada corporation (“Deep Down”), and its directly and indirectly wholly-owned subsidiaries.

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.

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

Forward-Looking Statements

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

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

Document Summaries

Descriptions of documents and agreements contained in this Report are provided in summary form only, and such summaries are qualified in their entirety by reference to the actual documents and agreements filed as exhibits to our Annual Report on Form 10-K for the year ended December 31, 2015, other periodic and current reports we have filed with the SEC or this Report.

Access to Filings

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

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

DEEP DOWN, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

 
DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share amounts)

NOTE 1: BASIS OF PRESENTATION

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Deep Down, Inc. and its directly and indirectly wholly-owned subsidiaries (“Deep Down,” “we,” “us” or the “Company”) were prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC” or the “Commission”) pertaining to interim financial information and instructions to Form 10-Q.  As permitted under those rules, certain footnotes or other financial information that are normally required by United States generally accepted accounting principles (“GAAP”) can be condensed or omitted.  Therefore, these statements should be read in conjunction with the audited consolidated financial statements, and footnotes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2015, filed on March 29, 2016 with the Commission.

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

Certain previously reported amounts have been reclassified to conform to current period presentation.

Principles of Consolidation

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

Segments

We operate one principal deepwater oilfield services business, which provides many solutions to our customers. For the nine months ended September 30, 2016 and 2015, we only had one reporting segment, Deep Down Delaware. All of the services and products we provide are interrelated, performed for the same general customers and marketed as such.

In accordance with ASC Topic 280, Segment Reporting, operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision-maker (“CODM”) in deciding how to allocate resources and in assessing performance. Our CODM primarily evaluates performance based on each project’s gross margin and net income.

In determining the reportable segment, we concluded that all services and products have similar economic and other characteristics, including similar gross margin percentage, production processes, suppliers, regulatory environments, customer type, and underlying demand and supply. Our services and products follow the same accounting policies and are managed by our management team.

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 permits the use of either the retrospective or cumulative effect transition method; we are evaluating the effect that this new guidance will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.

In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). ASU 2014-15 provides guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in ASU 2014-15 are 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.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share amounts)

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 financial position or results of operations.

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: RESTATEMENT OF QUARTERLY INFORMATION

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.

Under SEC Staff Accounting Bulletin No. 101 – Revenue Recognition in Financial Statements (SAB 101), “revenue should not be recognized until it is realized or realizable and earned.” Also according to SAB 101, revenue generally is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, and collectability is reasonably assured.

Based on the facts above and the guidelines of SAB 101, we determined that the revenue in relation to this situation should not have been recognized in the six months ended June 30, 2015. As a result, we have reversed the misstated revenue and related receivable from our unaudited consolidated financial statements.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share amounts)

The following table summarizes the impact of the revenue reversal on our unaudited consolidated statement of operations:

NOTE 3: INVENTORY

The finished goods inventory balance of $3,117 consists of a 3,500 MT portable umbilical carousel, which we fabricated and bought back from a customer in November 2013 and are currently holding for sale.

NOTE 4: BILLINGS, COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

The components of billings, costs and estimated earnings on uncompleted contracts are summarized below:

The balance in costs and estimated earnings in excess of billings on uncompleted contracts at September 30, 2016 and December 31, 2015 consisted of earned but unbilled revenues related to fixed-price projects and time and material projects.

The balance in billings in excess of costs and estimated earnings on uncompleted contracts at September 30, 2016 and December 31, 2015 consisted of unearned billings related to fixed-price projects and time and material projects.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share amounts)

NOTE 5: PROPERTY, PLANT AND EQUIPMENT

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

The reduction in our net property, plant and equipment was due to the sale of our Channelview location in March 2016.

NOTE 6: 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:

Other terms of the Facility included:

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 September 30, 2016, we no longer have these credit facilities available to us.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except 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 common stock and options to purchase common stock granted under the Plan have vesting periods of three years and options are exercisable for two years once fully vested. 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 maximum number of shares issued pursuant to options is 15 percent of issued and outstanding common shares.

Summary of Nonvested Shares of Restricted Stock

For the nine months ended September 30, 2016 and 2015, we recognized a total of $309 and $382, respectively, of share-based compensation expense related to restricted stock awards, which is included in selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations. The unamortized value of nonvested shares of restricted stock awards was $174 at September 30, 2016. These costs are expected to be recognized as expense over a weighted average period of 0.94 years.

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 September 30, 2016, we have purchased approximately 312 shares at a total cost of $305 under this Repurchase Program. The average price per share of treasury stock through September 30, 2016 has been $0.98. Treasury shares are accounted for using the cost method.

NOTE 9: INCOME TAXES

Income tax expense during interim periods is based on applying the estimated annual effective income tax rate to interim period operations. The estimated annual effective income tax rate may vary from the statutory rate due to the impact of permanent items relative to our pre-tax income, as well as by any valuation allowance recorded.  We employ an asset and liability approach that results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial basis and the tax basis of those assets and liabilities. A valuation allowance is established when it is more likely than not that some of the deferred tax assets will not be realized.  Although our future projections indicate that we may be able to realize some of these deferred tax assets, due to the degree of uncertainty of these projections, at September 30, 2016 and December 31, 2015 management has recorded a full deferred tax asset valuation allowance.

NOTE 10: COMMITMENTS AND CONTINGENCIES

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. Refer to Note 12 of the Notes to Consolidated Financial Statements in Part II. Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2015.

Operating Leases

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

Letters of Credit

Certain of our customers could require us to issue a standby letter of credit (“LC”) in the ordinary course of business to ensure performance under terms of a contract or as a form of product warranty. The beneficiary could demand payment from the issuing bank for the amount of the outstanding letter of credit. There was $0 in LC’s outstanding at September 30, 2016 and December 31, 2015.

NOTE 11: EARNINGS PER COMMON SHARE

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

At September 30, 2016 and 2015, there were no potentially dilutive securities outstanding.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis provides information that management believes is relevant for an assessment and understanding of our results of operations and financial condition. This information should be read in conjunction with our audited historical consolidated financial statements, which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, filed with the Securities and Exchange Commission on March 29, 2016 and our unaudited condensed consolidated financial statements, and notes thereto, included with this Quarterly Report on Form 10-Q (“Report”) in Part I. Item 1. “Financial Statements.”

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, buoyancy products and services, remotely operated vehicles (“ROVs”) and toolings. We support subsea engineering, installation, commissioning, and maintenance projects through specialized, highly experienced service teams and engineered technological solutions. 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.

In Part I. Item 2. “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.

Industry and Executive Outlook

More than two years following significant decreases in oil prices, the industry has adjusted to the new normal of lower prices. While there is increasing talk of the inevitable rebound, the prevailing theme in the industry continues to be the pursuit of smarter and more cost-effective solutions. As companies adapt to reduced workforce levels, the industry is transitioning towards focusing on the total cost of a project, rather than simply pushing for reduced prices.

This transition is providing unique opportunities for us, as we are increasingly being invited to assist our traditional and new customers think through their project execution strategies. We are also pursuing multiple opportunities where we seek to leverage our core technologies in non-traditional areas of the energy industry, as well as providing innovative solutions for emerging segments of the oil industry.

Our backlog continues to be dominated by major operators, who are focusing on both developing new offshore fields, as well as modifying and upgrading existing oilfields. While we have seen a reduction in our backlog from recent historic highs, our cost rationalization efforts continue to bear fruit, resulting in as strong a balance sheet as we have ever had.

We intend to continue adjusting our operations to best serve our customers’ needs.

Results of Operations 

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

Revenues. Revenues for the three months ended September 30, 2016 were $9,165 compared to revenues of $6,147 for the three months ended September 30, 2015. The $3,018, or 49 percent, increase is due to the commencement of procurement and manufacturing activities on certain customer orders that were delayed in prior quarters.

Gross profit. Gross profit for the three months ended September 30, 2016 was $3,297, or 36 percent of revenues compared to $1,916, or 31 percent of revenues, for the three months ended September 30, 2015. The $1,381, and 5 percent increases in gross profit and gross profit percentage, respectively, are due primarily to increased costs incurred on prolonged fixed-price projects for a large customer that impacted our gross profit and gross profit percentage for the three months ended September 30, 2015, which did not occur during the three months ended September 30, 2016.

Selling, general and administrative expenses. Selling, general and administrative expenses (“SG&A”) for the three months ended September 30, 2016 were $2,210 compared to $2,465 for the three months ended September 30, 2015. The $255 decrease in SG&A is primarily due to $134 in cost savings related to the sale of our Channelview location in the first quarter of 2016, as well as a $126 bad debt expense recorded in the third quarter 2015 compared to $0 in the third quarter 2016.

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, 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 GAAP. The measure should not be considered in isolation or as a substitute for operating income or loss, net income or loss, cash flows provided by operating, investing or financing activities, or other cash flow data prepared in accordance with GAAP. The amounts included in the Modified EBITDA calculation, however, are derived from amounts included in the accompanying unaudited condensed consolidated statements of operations.

We believe Modified EBITDA is useful to investors in evaluating our operating performance because it is 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); 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 (EBITDA loss) for the three months ended September 30, 2016 and 2015:

Modified EBITDA for the three months ended September 30, 2016 was $1,492 compared to Modified EBITDA loss of $(9) for the three months ended September 30, 2015. The $1,501 increase in Modified EBITDA was due primarily to the $1,381 increase in gross profit realized in the three months ended September 30, 2016 compared to the three months ended September 30, 2015. This increase is a result of reasons discussed previously.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

Revenues. Revenues for the nine months ended September 30, 2016 were $19,489 compared to $18,516 for the nine months ended September 30, 2015. The $1,333 increase is primarily due to the receipt of orders that were delayed in 2015 and the commencement of production activities on those orders in 2016.

Gross Profit. Gross profit for the nine months ended September 30, 2016 was $6,672, or 34 percent of revenues, compared to $5,152 or 28 percent of revenues for the nine months ended September 30, 2015. The $1,520 increase in gross profit, as well as the increase in gross profit percentage, is a result of approximately $1,000 in costs incurred, during the nine months ended September 30, 2015, on a project whose revenues were not recognized due to a contractual dispute. The remaining increase is primarily due to our increased revenues during the nine months ended September 30, 2016 as compared to 2015.

Selling, general and administrative expenses. Selling, general and administrative expenses (“SG&A”) for the nine months ended September 30, 2016 were $7,376 compared to $6,895 for the nine months ended September 30, 2015. This increase is primarily due to a $253 increase in legal expenses related to fees incurred in order to protect our intellectual property, corporate integrity and human resource policies, as well as an increase of $166 in outside services. The increase in outside services is related to work done to improve our Beaumont Hwy location and non-legal service fees associated with efforts to collect a previously written off receivable.

Other income (expense). We recognized other income of $1,019 for the nine months ended September 30, 2016 compared to other expense of $(85) during the nine months ended September 30, 2015. The 2016 period includes gain on disposal of property, plant and equipment of $1,070 related to the sale of our Channelview location. During the nine months ended September 30, 2016, we recognized a $149 decrease in interest expense compared to the nine months ended September 30, 2015 due to the pay off of our credit facility during the 2016 period.

Modified EBITDA. As noted above, our management evaluates our performance based on 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 GAAP. The measure should not be considered in isolation or as a substitute for operating income or loss, net income or loss, cash flows provided by operating, investing or financing activities, or other cash flow data prepared in accordance with GAAP. The amounts included in the Modified EBITDA calculation, however, are derived from amounts included in the accompanying condensed consolidated statements of operations.

The following is a reconciliation of net loss to Modified EBITDA (EBITDA loss) for the nine months ended September 30, 2016 and 2015:

Modified EBITDA for the nine months ended September 30, 2016 was $587 compared to Modified EBITDA loss of $(107) for the nine months ended September 30, 2015. The $694 increase in Modified EBITDA was due to increased revenues, offset by the increase in SG&A expenses.

Liquidity and Capital Resources

Overview

Historically, we have supplemented the financing of our capital needs through debt and equity financings. With the expiration of our credit facility, we currently plan to finance capital needs with existing cash on hand, cash generated from operations and equity financings.

Credit Facility

From 2008 through June 30, 2016, we maintained a credit facility (the “Facility”) with Whitney Bank. 

In March 2016, we paid all borrowings under the Facility with proceeds received from the sale of our Channelview location.

Due to the expiration of the 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 September 30, 2016, we no longer have the Facility available to us.

Inflation and Seasonality

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

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations is based on our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 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 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 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.

Refer to Part II. Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2015 for a discussion of our Critical Accounting Policies.

Recently Issued Accounting Standards Not Yet Adopted

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

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.   The Company’s disclosure controls and procedures are designed to ensure that such information required to be disclosed by the Company in reports filed or submitted under the Exchange Act, 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 September 30, 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 September 30, 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 September 30, 2016, based on criteria issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) entitled “Internal Control-Integrated Framework.” Upon evaluation, the Company’s management has concluded that the Company’s internal controls over financial reporting were effective as of September 30, 2016.

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 changes were necessary in internal controls over financial reporting during the fiscal quarter ended March 31, 2016 as a result of the following material weakness in internal control as of December 31, 2015.

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 the 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 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 unaudited financial statement filings in our quarterly reports in 2015, we have 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:

PART II. – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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. Refer to Note 12 of the Notes to Consolidated Financial Statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2015.

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

The table below summarizes information about our purchases of common stock, based on trade date, during the quarter ended September 30, 2016:

ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6. EXHIBITS

Information required by this item is incorporated herein by reference from the section entitled “Index of Exhibits” of this Quarterly Report on Form 10-Q for the period ended September 30, 2016.

SIGNATURES

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

INDEX TO EXHIBITS

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* Filed or furnished herewith.