UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C., 20549
FORM 10-K
T ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 20082010
£ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-30351
DEEP DOWN, INC.
(Exact name of registrant as specified in its charter)
| Nevada | | 75-2263732 |
| (State of other jurisdiction of incorporation) | | (I.R.S. Employer Identification No.) |
| | | |
| 8827 W. Sam Houston Pkwy N., Suite 100, Houston, Texas | | 77040 |
| (Address of Principal Executive Office) | | (Zip Code) |
Registrant’s telephone number, including area code: (281) 517-5000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock $0.001 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No þ
Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirementrequirements for the past 90 days. Yes þ No £o
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 o No o
Indicate by check mark if disclosures of delinquent filers in response to Item 405 of Regulations S-K is not contained in this form, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £o
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 definition of “large accelerated filer,”filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer oAccelerated filer þo Non-accelerated filer oSmaller reporting company þ
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £o No þ
The aggregate market value of the voting stock and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of June 30, 2008,2010, the last business day of our most recently completed second quarter, was approximately $98,131,000.$8,521,700.
At MarchApril 13, 2009,2011, the issuer had 206,399,155 shares outstanding 177,350,630 shares of Common Stock, par value $0.001 per share.
DOCUMENTS INCORPORATED BY REFERENCE
None.
Explanatory Note
Pursuant to subsection (3) of “Accelerated Filer and Large Accelerated Filer” as defined under Rule 12(b)-2 of the Exchange Act, Deep Down, Inc. is filing this Annual Report on Form 10-K for its fiscal year ended December 31, 2008 with a determination that we have become an “accelerated filer” after having been a “smaller reporting company” for Exchange Act reporting purposes. However, in accordance with subsection (4) of “Smaller Reporting Company”, Deep Down, Inc. is continuing to reflect its status as a smaller reporting company in the disclosure we provide in this Annual Report (as such subsection (4) requires us to reflect the determination that we are no longer a “smaller reporting company” in the information we provide in our quarterly report on Form 10-Q for the first fiscal quarter of 2009).
TABLE OF CONTENTS
| PART I |
| |
| Item 1 | Description of Business | 3 |
Item 1A | Risk Factors | 13 |
Item 1B | Unresolved Staff Comments | 134 |
| Item 2 | Description of PropertyProperties | 13 |
| Item 3 | Legal Proceedings | 14 |
Item 4 | Submission of Matters to a Vote of Security Holders | 1413 |
| | | |
| PART II |
| |
| Item 5 | Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 1514 |
| Item 6 | Selected Financial Data | 1615 |
| Item 7 | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 |
| Item 7A | Quantitative and Qualitative Disclosures About Market Risk | 2726 |
| Item 8 | Financial Statements and Supplementary Data | 2726 |
| Item 9 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 2726 |
| Item 9A | Controls and Procedures | 27 |
| Item 9B | Other Information | 28 |
| | | |
| PART III |
| | | |
| Item 10 | Directors, Executive Officers Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of the Exchange ActGovernance | 29 |
| Item 11 | Executive Compensation | 3132 |
| Item 12 | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 3438 |
| Item 13 | Certain Relationships and Related Transactions, and Director Independence | 3539 |
| Item 14 | Principal Accountant Fees and Services | 3539 |
| Item 15 | Exhibits Financial Statement Schedules | 3641 |
| | Signatures | 3745 |
Forward-Looking Information
Unless otherwise indicated, the terms “Deep Down, Inc.”, “Deep Down”, “Company,” “we,”“Company”, “we”, “our” and “us” are used in this report to refer to Deep Down, Inc., a Nevada corporation, and its wholly-owned subsidiaries.
In this Annual Report on Form 10-K (“the Report”), we may make certain forward-looking statements, including statements regarding our plans, strategies, objectives, expectations, intentions and resources that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We do not undertake to update, revise or correct any of the forward-looking information. The following discussion should also be read in conjunction with the audited consolidated financial statements and the notes thereto.
The statements contained in this Annual Report on Form 10-K that are not historical fact are forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995), within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The 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,” “expects,” “may,” “will,” “should,” “intend,” “plan,” “could,”“believes”, “expects”, “may”, “will”, “should”, “intend”, “plan”, “could”, “is likely,”likely”, or “anticipates,”“anticipates”, or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. The Company wishesWe wish to caution the reader that these forward-looking statements that are not historical facts are only predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. While sometimes presented with numerical specificity, these projections and other forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which, although considered reasonable by the Company,us, may not be realized. Because of the number and range of assumptions underlying the Company’sour projections and forward-looking statements, many of which are subject to significant uncertainties and contingencies that are beyond the reasonable control of the Company,us, some of the assumptions inevitably will not materialize, and unanticipated events and circumstances may occur subsequent to the date of this report. These forward-looking statements are based on current expectations and the Company assumeswe assume no obligation to update this information. Therefore, theour actual experience of the Company and the results achieved during the period covered by any particular projections or forward-looking statements may differ substantially from those projected. Consequently, the inclusion of projections and other forward-looking statements should not be regarded as a representation by the Companyus or any other person that these estimates and projections will be realized, and actual results may vary materially. There can be no assurance that any of these expectations will be realized or that any of the forward-looking statements contained herein will prove to be accurate.
PART I
History
Deep Down, Inc. is a Nevada corporation engaged in the oilfield services industry. As used herein, “Deep Down”, “Company”, “we”, “our” and “us” may refer to Deep Down, Inc. and/or its subsidiaries. Deep Down, Inc. (OTCBB:DPDW), a publicly traded Nevada corporation, originatedwas incorporated on December 14, 2006, through a reverse merger with MediquipMediQuip Holdings, Inc. (“Mediquip”MediQuip”), a publicly tradedpublicly-traded Nevada corporation. Deep Down, Inc., the operating company, was originally a Delaware corporation founded in 1997, but had been acquired in a series of transactions on November 21, 2006, by Subsea Acquisition Corporation (“Subsea”).
On June 29, 2006, Subsea, a Texas corporation, was formed by three shareholders withDeep Down is the intent to acquire offshore energy service providers. On November 21, 2006, Subsea acquired allparent company of the common stock of Strategic Offshore Services Corporation (“SOS”), a Texas corporation, for 3,000 shares of Subsea’s Series F preferred stock and 1,000 shares of Series G preferred stock from two common shareholders (who were also shareholders of Subsea). Since the entities were under common control, and SOS did not constitute a business, the Company was charged compensation expense to shareholders for the fair value of both series of preferred stock totaling $3.3 million.
Additionally, on November 21, 2006, Subsea acquiredfollowing wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation founded in 1997. Under the terms of this transaction, all of (“Deep Down Delaware”); ElectroWave USA, Inc.’s shareholders transferred ownership of all of Deep Down Inc.’s common stock to Subsea in exchange for 5,000 shares of Subsea’s Series D preferred stock and 5,000 shares of Subsea’s Series E preferred stock resulting in Deep Down Inc. becoming, a wholly-owned subsidiary of Subsea. On the same day, Subsea then merged with Deep Down,Nevada corporation (“ElectroWave”), since its acquisition April 2, 2007; Mako Technologies, LLC, a Nevada limited liability company (“Mako”), since its acquisition effective December 1, 2007; Flotation Technologies, Inc., with the surviving company operating as Deep Down, Inc. This transaction was accounted for as a purchase, with Subsea being the accounting acquirer based on a change in voting control.
On December 14, 2006, after divestingMaine corporation (“Flotation”), since its Westmeria Healthcare Limited subsidiary, MediQuip acquired all 9,999,999 outstanding shares of Deep Down common stock and all 14,000 outstanding shares of Deep Down preferred stock in exchange for 75,000,000 shares of common stock and 14,000 shares of preferred stock of MediQuip. The shares of preferred stock of MediQuip were issued with the same designations, rights and privileges as the Deep Down preferred stock existing immediately prior to such transaction. As a result of the acquisition the shareholders of Deep Down obtained ownership of a majority of the outstanding voting stock of MediQuip. MediQuip changed its name to Deep Down, Inc. as part of the transaction,effective May 1, 2008 and Deep Down Inc. continued asInternational Holdings, LLC, a Nevada corporation following consummationlimited-liability company (“DDIH”), since its formation in February 2009. As discussed below, effective December 31, 2010, we engaged in a transaction in which all of the acquisition. The merger was accountedoperating assets and liabilities of Flotation were contributed, along with other contributions we made, to a joint venture entity named Cuming Flotation Technologies, LLC (“CFT”), in return for as a reverse merger whereby Deep Down was the accounting acquirer resulting20% common unit ownership interest in a recapitalization of Deep Down’s equity.CFT.
On April 2, 2007, Deep Downwe acquired substantially all of the assets of ElectroWave USA, Inc., a Texas corporation for a total purchase price of $0.2 million. Deep Downcorporation. We formed a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada corporation, to complete the acquisition. Located in Channelview, Texas, ElectroWave offers design, assembly, installationThis division has been inactive since 2009 and commissioning of electronic monitoring and control systems for the energy, military, and commercial business markets. This was not a "significant" acquisition; therefore,currently has no pro forma results are included for this acquisition in this Form 10-K.material assets or operations.
EffectiveOn December 1, 2007, Deep Downwe acquired all of the common stock of Mako Technologies, Inc. for a total purchase price of $11.3 million including transaction fees. Deep DownWe formed a wholly-owned subsidiary, Mako Technologies, LLC (“Mako”) to complete the acquisition. Located in Morgan City, Louisiana, Mako serves the offshore petroleum and marine industries with technical support services, and equipment vital to offshore petroleum production, through rentalsthe provision of itshighly qualified technicians, remotely operated vehiclesvehicle (“ROV”), services, topside and subsea equipment and support systems used in diving operations, maintenance and repair operations, and offshore construction and environmental and marine surveys.construction.
On June 5, 2008, Deep Downwe completed the acquisition of Flotation Technologies, Inc. (“Flotation”), for a total purchase price of $23.9 million. Deep Down also purchased related technology from an entity affiliated with the selling shareholders. Deep DownFlotation. We effectively dated the acquisition for accounting purposes as of May 1, 2008 and consummated the closing on June 6, 2008. Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers from its facilities in Biddeford, Maine.
In February 2009, we formed Deep Down International Holdings, LLC, a Nevada limited liabilitylimited-liability company and wholly ownedwholly-owned subsidiary of the Company, for the purpose of holding securities for foreign companies organized or acquired by Deep Down. Deep Down International Holdings, LLCthe Company. DDIH currently has no material assets or operations.
As noted above, effective December 31, 2010, we engaged in a joint venture transaction in which all of Flotation's operating assets and liabilities (except for one intercompany corporate overhead payable) were contributed, along with other contributions we made, to CFT in return for a 20% common unit ownership interest in CFT (the "JV"). For a more detailed explanation of this transaction, please see “Part II, Item 8. Financial Statements and Supplementary Data” Note 4 to the consolidated financial statements, “Investment in Joint Venture.”
Importantly, this transaction impacts the presentation of our financial condition and results of operations because it means that the operations of Flotation will no longer be included in such presentation for periods beginning January 1, 2011, except on the basis of our 20% common unit ownership interest in CFT. However, the operations of Flotation will continue to be fully included in our presentation of historical information for periods ended December 31, 2010 and prior (since the acquisition of Flotation in 2008).
Our current operations areinclude the result of thesignificant acquisitions of Deep Down ElectroWave, MakoDelaware and Flotation.Mako. In addition to our strategy of continuing to grow and strengthen our operations, including by expanding our services and products in accordance with 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 deepwater exploration, development and production of oil and gas reserves and other maritime operations.
Business Overview
We provide services to the offshore energy industry to support deepwater and ultra-deepwater exploration, development and production of oil and gas and other maritime operations. We are primarily a service company, and 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 deep water equipment,deepwater and ultra-deepwater, surface equipment and offshore rig equipment thatsolutions which are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. We also manufacture monitoring and control systems used by offshore energy and other maritime operations. Our products are often initially developed in direct response to customer requests for solutions to critical problems in the field. We also 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 and services designed to provide safer, more cost-effective solutionsour clients in a quicker timeframe for our clients.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, timelycost-effectiveness, timeliness of delivery and operational timesavingefficiency features of these products. Since our formation, we have introduced many new products that continue to broaden the market we currently served by us.serve.
We market our productsservices and servicesproducts primarily through our offices in Houston, Texas, Biddeford, Maine and Morgan City, Louisana.Louisiana. Our sales representatives travel worldwide to the major international energy and maritime markets. We generally manufacture and fabricate our products at our facilities, although we also work with third parties who provide manufacturing and fabrication support through their own facilities in the Houston, Texas metroplex.
Segments
For the fiscal years ended December 31, 2008 and 2007, the operations of Deep Down’s subsidiaries have been aggregated into a single reporting segment under the provisions of SFAS 131 “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). We determined that the operating segments of Delaware, ElectroWave, Mako and Flotation (as of their respective acquisition dates) may be aggregated into a single reporting segment because aggregation is consistent with the objective and basic principles of paragraph 17 of SFAS 131. While the operating segments have different product lines, they are very similar with regards See Note 1 to the five criteriaconsolidated financial statements, "Description of Business and Summary of Significant Accounting Policies," included in this Report for aggregation. They are all service-based operations revolving around our personnel’s expertise in the deep water industry, and any equipment is producedinformation related to a customer specified design and engineered using Deep Down personnel’s expertise, with installation as part of our service revenue to the customer. Additionally, the segments have similar customers and distribution methods, and their economic characteristics were similar with regard to their gross margin percentages for the fiscal years ended December 31, 2008 and 2007.segment reporting.
Services and Products
Services. We provide a wide variety of project engineering and management services, including the design, installation and retrieval of subsea equipment and systems, connection and termination operations, well commissioningwell-commissioning services, as well as construction support and ROV equipment rentals.operations support. We pride ourselves on theour ability to collaborate with the engineering departmentsfunctions of oil and gas operators, installation contractors and subsea equipment manufacturers to finddetermine the quickest,fastest, safest, and most cost-effective solutions to address all mannerthe full spectrum of complex issues which arise in the subsea world.our industry. We also provide various products in connection with the use of our installation, retrieval, storage and management services.
Offshore Project Management. Our installation management team specializes in deepwater subsea developments. We are often contracted by our customers to assist with the preparation and evaluation of subsea development bids and requests for quotes. Our experience comes from working with installation contractors, oil and gas operators, controls suppliers, umbilical manufacturers and other subsea equipment manufacturers, who often hire us to help ensure that a project progresses smoothly, on time and on budget.
Project Engineering. 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 customer 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 most 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.
Installation Support and Management. Our installation management services are centered on the utilization of standardized hardware, proven, well-tested installation techniques, and an experienced, consistent team that has proven to be safe and skilled in all aspects of the installation process. We pride ourselves on supporting installation contractors through our installation management and engineering services, installation aids and equipment, and our offshore installation support services, including spooling operations, offshore testing, and flying lead installation support. Many installation contractors find it beneficial to utilize our services to help reduce on-board personnel since our specialized technicians can perform multiple tasks. We have designed and fabricated many different installation tools and equipment over the years. We have been involved in the design of the following equipment to help make installations run as smoothly as possible: steel flying leads, steel flying lead deployment systems, umbilical hardware and termination systems, umbilical bell mouths, lay chutes, rapid deployment cartridges, horizontal drive units, mud mats, flying lead installation and parking frames, umbilical termination assembly stab & hinge over systems, and numerous other pieces of offshore equipment. Our team has 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 (“PLETs”) and manifolds. In addition, we provide an extensive array of installation aids, including steel flying lead installation systems, a 5-ton Caterpillar® tensioner, a 10-foot radius lay chute with work platform, many varieties of buoyancy, clump weights, 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, a 200-ton and 400-ton carousel, UTA running and parking deployment frames, termination shelters, pipe straightners, ROV hooks and shackles, intervention tooling, stackable SeaStax® tanks, baskets, and boxes, and ballgrab rental rigging.
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.
Pull-In Operations. We are involved in the pull-in operations for most of the major umbilical projects in the Gulf of Mexico. Our familiarity with offshore systems is important, and our pull-ins run smoothly because the same engineers who plan the pull-in operations are also involved in supervising the offshore operations. Our offshore servicemen comprise the topside umbilical support team and are familiar with the umbilical termination hardware. These same servicemen are often involved in terminating the umbilicals at the manufacturers’ yard several weeks prior to the installation. Everything is thoroughly tested prior to installation, including winches at the rental contractor’s yard and after set-up on the platform. Load cells are tested onshore, and the same load cells are used to test the system offshore. This eliminates variables and validates the condition of the pull-in system. We then perform pull-ins under more controlled conditions with increased confidence, resulting in safer operations.
Terminations. Deep Down and members of its team have been involved in umbilical terminations since 1988. The Company’sOur team was involved with the designs for the armored thermo plastic umbilicals at 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 have also pioneered the concept of the compliant Moray® section that enables a traditional helically wound umbilical to be used for direct well step outs, or long field flying leads. Our management believes we are the only company that can terminate umbilicals provided by any manufacturer with the same termination system.
Testing 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 (“EFAT”) and System Integration Testing (“SIT”), relating 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 the safest 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 clients. 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 believe we have one of the best filling, flushing and testing teams in the business. Deep Down employs a variety of different pumping systems to meet industry needs and offers maximum flexibility. Our philosophy is to flush through the maximum number of lines at the highest flow rate possible to maximize efficiency. We have assembled a comprehensive list of offshore pumping units and an assortment of chemical pumping skids. Our equipment can be used to pump all of the standard offshore water-based chemicals as well as all offshore commissioning fluids such as Methanol and diesel. The Company hasWe have been involved in the design, procurement, testing, installation, and operation of the testing equipment. Deep Down’s 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.
System Integration Testing. We have led the offshore industry move into the digital age with our use of digital transducers to provide much greater levels of accuracy compared to information gathered from conventional chart recorders. We have a wide variety of digital pressure transducers, flow meters, and temperature gauges. We have two wire data systems (4 port and one 16 port) as well as 25 individual digital pressure and temperature recorders that are often employed for installation monitoring activities. In addition to these units, the Companywe also hashave three desks set up with data systems that are capable of tracking from 4 to 15 individual sensors simultaneously. These capabilities, in combination with subsea handling equipment, experienced personnel, and a fully-equipped facility, render Deep Down ideal for managing SIT operations.
Commissioning. We have been involved in most of the topside connections and commissioning (the removal of inert fluids used during the umbilicals’ transportation and installation) projects in the Gulf of Mexico since its formation in 1997. Our commissioning team is often identified early in the project and participates in all aspects of planning and risk assessment for the project. Due to the limited time associated with project commissioning, it is extremely important to perform detailed planning and engineering prior to arrival at the offshore production platform location to reduce any possible shut in or down time. Our engineers and technicians 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. 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%100 percent glycol, paraffin inhibitors, and alcohol.
Storage Management. Our facility in Channelview covers more than 50,000 square feet of internal high quality warehousing capacity and 300,000 square feet of external storage and is strategically located in Houston's Ship Channel area. Our warehouse is designed to provide clients 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 client needs. Among other capabilities, we are capable of providing long-term specialized contract warehousing; long and short-term storage; modern materials handling equipment; undercover loading areas; quality security systems; integrated inventory management; packing and repacking; computerized stock controls; and labeling.
Marine Technical Support Services
We serve the growing offshore petroleum and marine industries with technical support services and products vital to offshore petroleum production. Our offerings in this area are primarily through the provision of ROV services which include the provision of skilled ROV operators/technicians and ROV equipment, as well as topside and subsea equipment, and support systems used in diving operations, maintenance and repair operations, and offshore construction.
ROV and ROV Tooling Services. We provide the latest ROV tooling technology as part of our ROV services. Our ROV tooling services are constantly growing, with the addition of tools as they are requested by our customers. 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 platform inspection (Level I, II and III, jack-up and template), platform installation and abandonment, search and recovery, salvage, subsea intervention (hot stab operations, torque tool, well, pipeline commissioning, and stack landings), telecommunication cable inspections (existing and as built), anchor handling (mooring and anchor chain monitoring), ROV consulting and project management, ROV pilots and technicians, and underwater cinematography. We provide an extensive line of ROV intervention tooling, ROV clamps and ROV-friendly hooks and shackles that are state-of-the-art in design. In the past few years, we began providing maintenance and fleet management services to other ROV owners as an outsourced support function to their ROV fleet.
Offshore Construction Equipment Rental. We employ a permanent staff of highly qualified technicians and mechanics to maintain and refurbish our equipment in-between rentals. We carry a wide array of equipment to service the diving industry, including water blasting equipment, breathing air dive compressors, hot water units with feed pumps, man rider winches, hydraulic tools and hose reels, underwater video units, sonar units, magnetic gradiometers, dive radios, lift bags, volume tanks, decompression chambers, and hot water pressure washers.
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, test and market subsea equipment, surface equipment and offshore rig equipment that are 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”). We have significant involvement in umbilical and steel flying lead installations in the Gulf of Mexico and throughout the world. A few of our major product lines are highlighted below.
Flying Leads. We have developed a method to pull individual steel tubes, hoses, or electrical cables to create a loose steel tube flying lead or short umbilical. We can manufacture steel flying leads up to 10,000 feet in length with any J-plate desired, with or without electrical cables included. We have built flying leads with up to 14 tubes. Additional electrical lines and fiber optic cables can be added to produce any combination required for the transportation of various fluids, chemicals or data. The flying leads are then fitted with our terminations and Morays® that are attached to the multiple quick connection plate, and finished off with our elastomeric bend limiters. The non-helix wound design allows for our flying leads to be very installation friendly with minimal-bending stiffness. A Moray® is the termination head on the flying lead and connects the tubing assembly to the junction plate. A compliant Moray® consists of a 20-foot flexible flying lead with an electro-hydraulic Moray® that is connected to a full-sized umbilical with the installation tension being applied through an armor pot and slings extending by the compliant section.
Umbilical Hardware. Our operational team has been involved in more umbilical installations than probably any other team in the industry. Our blend of experiences with drilling contractors, umbilical manufacturers, subsea engineers and installation contractors has been effective in positioning us to act on behalf of oil and gas operators to ensure key hardware installation is performed in the most efficient and safe manner. This breadth of experiences gives us a unique perspective when fabricating and designing terminations for umbilical manufacturers. 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 topsides terminations with our unique threaded welded fittings, the compliant umbilical splice, and the bend stiffener latcher. Our umbilical hardware has enabled our clients to use installation friendly techniques for deploying hardware on the ocean floor.
Bend Limiters. We offer both electrometricpolymer and steel bend limiters. Steel bend limiters are typically utilized for steel tube umbilicals and have been designed with a simple and reliable hinged attachment system which significantly decreases installation time. ElectrometricPolymer bend limiters are typically provided for small diameter umbilicals or flying leads, as well as for their compliant umbilical section, which turnsturn a traditional umbilical into a ROV-friendly, installable flying lead. Due to our ability to design and manufacture bend limiters in-house, delivery time is greatly reduced.
Compliant Splice®. We have created Compliant Splice® is a uniquepatented method of converting spare umbilicals into actual production umbilicals by splicing spare umbilicals together to produce any length required. This methodology is achieved through our Compliant Splice, which is a patent-pending termination system that eliminates the burdens of dealing with umbilical splices during installation. This designinstallation and is capable of housing both electrical and fiber optic Fiber Termination Assemblies while still allowing for the splice to be spooled up onto a reel or carousel. This allows oil and gas operators to save significant costs through utilization of existing capital investments in spare umbilicals, which reduces field development costs and delivery time. An optional mud mat is used to assist in carrying the splice over the chute and functions to keep the splice out of the mud for easy inspection.
SeaStax®. SeaStax® embodies our concept for offshore storage and space management to help optimize available deck space on offshore installation vessels, drilling rigs and production platforms. The key philosophy behind SeaStax® is to take common offshore items and store them in a standard-sized container to allow for the storage system to be stackable and interchangeable in subsurface conditions. The current system utilizes newly-designed 550 gallon tote tanks, baskets, and tool boxes that are all inter-changeable and stackable. Using common dimensions and designs allows a variety of different items to all be commonly stored and stacked, to minimize required storage area. The stacking philosophy can be applied to other custom applications if required. In order to maximize accessibility and to reduce maintenance, a variety of options are available such as galvanizing, ladders, and drip pans.
Installation Aids. To help our clients and to meet our own internal needs, we have developed an extensive array of installation aids, including steel flying lead installation systems, a 5-ton Caterpillar® tensioner, a 10-foot radius lay chute with work platform, many varieties of buoyancy, clump weights, 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, a 200-ton carousel, UTA running and parking deployment frames, termination shelters, pipe straightners, ROV hooks and shackles, stackable SeaStax® tanks, baskets, and boxes, and ballgrab rental rigging.
Services and Products from Acquisitions
Through our acquisitions of Flotation, Mako and ElectroWave, we have further increased our service and product offerings. Several of such increased offerings are described below.
FlotationBuoyancy Products
Flotation engineers, designsWe engineer, design and manufacturesmanufacture deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers. Flotation’sOur product offerings include distributed buoyancy for flexible pipes and umbilicals, drilling riser buoyancebuoyancy modules, CoreTecTM drilling riser buoyancy modules, ROVitsTM buoyancy, Hydro-FloatTM mooring buoys, StablemoorTM low-drag ADCP deployment solution, Quick-Loc™ cable floats, HardballTM umbilical floats, Flotec™ cable and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of any size and depth rating.
The majority of Flotation’sour buoyancy product offerings are made with FlotecTM syntactic foam, a product composed of hollow glass microballoons, combined with an epoxy resin and a catalyst.system. These microballoons or microspheres(also known as “microspheres”) are very small, 20-120 microns in diameter, and provide buoyancy. The epoxy system provides the buoyancystrength to syntactic foam.the system. The microballoons give syntactic foam itsresult is a light weight composite with low thermal conductivity and resistance to compressive stress that far exceeds other types of foams. The microballoons comefoam comes in different densities and strengths which are required for greater depth applications. In some applications, the liquid syntactic foam resulting from the combination of ingredients is poured into high-density polyethylene shells that form the flotation device and encase and protect the syntactic foam from damage. Some of our products are produced with proprietary, high-strength macrospheres.
BecauseAs of historic purchaser dissatisfaction with Flotation’s principal competitor, Flotation was asked by oil companiesDecember 31, 2010, the operations relating to provide buoyancy products were contributed to the oil and gas exploration and production sector. The most significant step for Flotation to take in order to get into the oil business was to secure an ISO 9001:2000 registration for its manufacturing operation. Receipt of those certificates allowed oil and gas clients to place their first orders with Flotation Technologies.
Flotation’s drilling riser product is marketed under the name CoreTec™. Flotation also manufactures polyurethane products, including bend restrictors, impact protection, drill riser auxiliary clamps and other custom-designed products, including some buoyancy products with macrospheres. While the overwhelming majority of Flotation‘s revenue comes from buoyancy products for the petroleum production sector, Flotation also serves the oceanographic and military markets.
Mako
Located in Morgan City, Louisiana, Mako serves the growing offshore petroleum and marine industries with technical support services and products vital to offshore petroleum production. Mako’s offerings are primarily, through rentals of its remotely operated vehicles ("ROV"), topside and subsea equipment, and support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.
Diving and Offshore Constuction Equipment Rental. We employ a permanent staff of highly qualified technicians and mechanics to maintain and refurbish Mako's equipment in between rentals. We carry a wide array of equipment to service the diving industry, including water blasting equipment, breathing air dive compressors, hot water units with feed pumps, man rider winches, hydraulic tools and hose reels, underwater video units, sonar units, magnetic gradiometers, dive radios, lift bags, volume tanks, decompression chambers, hot water pressure washers, and saturation systems.
ROV Equipment Rental. We provide the latest ROV tooling technologyCFT as part of Mako’s rental fleet. Mako's ROV tooling rental fleet is constantly growing, with the addition of tools as they are requested by our customers. We have, asJV transaction, and for periods beginning after that date will not be a direct part of Mako’s rental inventory, a 2,000-foot depth-rated inspection / light work class remotely-operated vehicle (ROV) complete with a control vanour financial condition and launch / recovery system. We also have, as partresults of Mako’s inventory, a 300-meter depth-rated Seaeye Falcon and a 1,500-meter depth rated Seaeye Lynx observation class ROV. Our services include platform inspection (Level I, II and III, jack-up and template), platform installation and abandonment, surveys (environmental, pipeline existing and as built, oceanographic, nuclear and hydroelectric), search and recovery, salvage, subsea intervention (hot stab operations, torque tool, well, pipeline commissioning, and stack landings), telecommunication cable inspections (existing and as built), research (fisheries, scientific and marine archeology), anchor handling (mooring and anchor chain monitoring), ROV consulting and project management, ROV pilots and technicians, and underwater cinematography. We provide an extensive lineexcept on the basis of ROV tools, ROV clamps and ROV-friendly hooks and shackles that are state-of-the-artour minority ownership interest in design.
Marine Surveys. Mako provides the offshore industry with a responsive marine survey service. Mako’s surveyors have extensive experience in the marine industry, and provide a reliable and timely service, encompassing on-and-off hire surveys, damage surveys, engine surveys, loading / securing of cargo (warranty), trip and tow, suitability surveys, valuation surveys, hull audio gauging, owner representatives, and regulatory vessel compliance.CFT.
ElectroWaveMarine Products
We offer products and services in the fields of electronic monitoring and control systems for the energy, military, and commercial business sectors. We design, manufacture, install, and commission integrated Programmable Logic Controller (“PLC”) and Supervisory Control and Data Acquisition (“SCADA”) based instrumentation and control systems, including ballast control and monitoring, drilling instrumentation, vessel management systems, marine advisory systems, machinery plant control and monitoring systems, and closed circuit television systems. We can take projects from conceptual/system design through installation, commissioning, and support. Our understanding of system requirements and our ability to quickly understand our customer’s needs allows us to produce quality products and services on time and on budget.
We have supplied equipment on drilling production rigs operating throughout the world, including Abu Dhabi, Angola, Australia, Azerbaijan, Brazil, Congo, Dubai, Egypt, Equatorial Guinea, India, Indonesia, Kuwait, Mexico, Nigeria, Norway, Russia, the United Kingdom, United States, Vietnam, and other areas. ElectroWave isWe are also a supplier of integrated marine systems for ships with design, manufacture, and delivery of machinery plant control and monitoring systems and/or alarm monitoring systems for 3 Molinari Class Staten Island ferries, a United States Coast Guard ice breaker, one of the world’s largest hopper dredges, and other vessels.
Below are some of ElectroWave’s major services:
Drillers Display System. We have two proprietary drillers display systems. One of the proprietary systems was provided by one of our customers and is installed only on that customer’s rigs. The other proprietary drillers display system was developed internally and is installed in rigs worldwide. Drillers display systems allow the driller to keep an eye on all the important parameters required for monitoring activity. Viewing of mud pits, trip pits, flow rates, weight on bit, hook load, and other activities are available to the driller at a glance. Logging software provides data analysis at a whole new level, bringing more efficient drilling operations and increased production from each working rig. Our two largest customers for ElectroWave’s drillers display systems are Transocean Offshore and Diamond Offshore Drilling.
Machinery Plant Control System. The Machinery Plant Control and Monitoring Systems (MPCMS) allow the operators of a vessel to reduce manning requirements by integrating all of the machinery controls and monitoring systems into one. The MPCMS can reduce the number of crew on one vessel by more than 50%, allowing the vessel owner to save personnel expenses or allocate personnel to more critical areas. ElectroWave's largest MPCMS system consists of over 5,000 points, consisting of hard wired sensors, contacts, and data over industrial protocols such as Ethernet, Modbus, and Profibus. We have integrated systems such as fire, flooding, ballast, fueling, bridge, propulsion, engines, HVAC, deck machinery, air systems, emergency generators, lighting, and more, into one system. An entire vessel can now almost be operated from one station by a very minimal crew. Our MPCMS is currently in use on the United States Coast Guard Ice Breaker Mackinaw.
Ballast Console. ElectroWave designs replacement ballast control consoles for a number of customers. The consoles they are replacing have fallen out of service and are typically only partially functioning. ElectroWave first sends out a technician to perform a "site survey" during which our technician will take copious notes about the existing installation, all of the wiring, and any manuals that exist for the system. Our team then brings this information back to our facility where we design replacement consoles that fit exactly where the old console was, reducing hot work and re-wiring. After designing a new console, drawings are sent to the rig managers, electricians, and company electricians for verification. After drawings are verified, the console is released for production. Upon receiving the console at our factory, our electricians (some of which are ex-rig electricians) wire the console to match the old system wiring. After through testing at our factory, the console is shipped to the customer where it is installed by our field service personnel. The new console is wired to operate exactly like the old system to reduce re-training of ballast control officers and rig hands. After the console is commissioned, our technicians will provide any support and training necessary before leaving the site. We have installed ballast control systems that are full touch screen capable, operating over 80 valves and more than 30 tanks.
CCTV System. ElectroWave has tackled some very difficult Closed-circuit Television (“CCTV”) security and monitoring requirements. Post-911, the New York Department of Transportation (NYDOT) wanted cameras to watch every available compartment of their three new ferries. ElectroWave stepped up to the challenge and provided NYDOT one of the most sophisticated CCTV systems available on passenger transportation ferries. A system of cameras, coupled with digital video recording, allow post-event tracing and security on one of the most-used transportation devices in New York. CCTV is more than just security, many (if not all) oil rigs have CCTV systems installed to keep an eye on the safety of those working on the rig. Cameras watch unmanned spaces, machinery spaces, and potential hazard zones for trouble. This helps to keep the manning requirement on the rigs to a minimum while allowing for a safer working environment. ElectroWave typically provides Pelco camera systems, but is capable of integrating existing camera systems into new CCTV installations. ElectroWave has also developed hardware and software in-house to allow the use of Pan/Tilt/Zoom (“P/T/Z”) cameras from hazardous locations where PTZ keyboards cannot be installed.
Manufacturing
Our manufacturing facilities are in Channelview, Texas, a suburb of Houston, where we conducthouse a broad variety of processes, including machining, fabrication, inspection, assembly and testing. Our Manufactured Systems Division isWe are devoted to the design, manufacturing, testing, and commissioning of heavy equipment used in both on- and offshore operations in a variety of markets and industries.
Our manufacturing plant is ISO 9001 and American Petroleum Institute certified. We maintain our high standards of product quality through the use of quality assurance specialists who work with product manufacturing personnel throughout the manufacturing process and inspect and document equipment as it is processed through the Company'sour manufacturing facility. We have the capability to manufacture various products from each of our product lines at our major manufacturing facility and believe that this localized manufacturing capability is essential in order to compete with our major competitors. We maintain valuable relationships with several other companies that own additional fabrication facilities in and around Houston, Texas. These other companies provide excellent subcontract manufacturing support on an as-needed basis. Our manufacturing process includes heat treatment, machining, fabrication, inspection, assembly and testing.
We have designed, developed,During fiscal years 2010 and assembled our own continuous liquid syntactic foam production machine. This machine allows2009, we also had manufacturing facilities for Flotation in Biddeford, Maine, but these facilities were contributed along with Flotation’s other assets and liabilities to produce the large volume of foam required to make the 7-14 foot long drilling pipe flotation risers that appear to be in high demand for offshore drilling in very deep waters such as those in Brazil. These drill pipe risers will operate effectively in water depths of up to 4,000 meters (13,000 feet). Flotation has foam that is capable of operating in water depths of up to 7,000 meters (23,000 feet). Flotation’s drilling riser buoyancy design is unique in the industry, and a patent application has been filed.CFT effective December 31, 2010.
Customers
Demand for our deep waterdeepwater and ultra-deepwater services, surface equipment and offshore rig equipment is substantially dependent on the condition of the oil and gas industry to invest in substantial 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, 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 OPEC. 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, the military 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 their 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 productsservices and servicesproducts throughout the world directly through our sales personnel in our Houston, Texas Biddeford, Maine and Morgan City, Louisiana offices.offices (prior to December 31, 2010 we also had a sales presence in Biddeford, Maine). We periodically advertise in trade and technical publications of 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.complete, though we have accepted several longer-term projects, including one that has exceeded a year completion. Our customers select our products and services based on the quality, reliability and reputation of the product or service, price, timely delivery and advance technology. For large drilling and 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.
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 include well pressures of up to 15,000 psi, mixed flows of oil and gas under high pressure that may also be highly corrosive, and water depths in excess of 5,000 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 its products.
We have an established track record of introducing new products and product enhancements. Our product development work is conducted at our facilities in Channelview, Texas, and in the field.field (and prior to December 31, 2010, in Biddeford, Maine). 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, the ability to provide quality service 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. We compete principally with Dynacon, FMC, Halliburton Product Pipeline Services, Kvaerner, Norson, Ocean Works, Oceaneering, VFL, and Halliburton Product Pipeline Services on our umbilical services; Dynacon, Ocean Works and Odem on our Launch and Recovery Systems; and Entech, Technip, Manatec and Pegasus on our installation management services.
Flotation’sUntil the contribution of Flotation to CFT on December 31, 2010, our principal competitors in the polyurethane area arewere Trelleborg AB, Balmoral Group, Dunlaw Engineering Ltd., ABCO Industries Limited, and Whitefield Plastics Corporation. Flotation’sOur principal competitor in the syntactic foam is Trelleborg AB. CRP Groupmarket was acquired by Trelleborg AB in January 2006 and now operates worldwide as Trelleborg Offshore, with North American operations under the name Trelleborg Offshore, Inc. Other competitors include Cummingincluded Cuming Corp., located in Massachusetts; Matrix Composites & Engineering Ltd., located in Australia; Balmoral Group, located in Scotland; Syntech Materials, Inc., located in Virginia; and Marine Subsea Group, located in Norway.
Employees
WeAt March 31, 2011, we had 169 employees as of March 13, 2009.approximately 75 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, 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 strict 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.
Patents, Trademarks and Copyrights
The Company currently holds one patent covering riser tensioner sensor assembly. An additional five patents have been applied for and are in process. Trademarked names of the Company include DRILSYS TM, ELECTROWAVE TM, MUDSYS TM , AQUASOX TM , MORAY TM and SEASTAX TM , QUICK-LOC®, FLOTEC®, and PROTEUS™.
We also obtained all the rights to the following inventions, including all provisional applications in connection with the acquisition of Flotation:
· | Drilling Riser Buoyancy Produced with Plastic Shell (inventors Timothy H. Cook, Fred Maguire and David Capotosto); |
· | Drilling Riser Auxiliary Claim with Integral Mux Clamp (inventors Timothy H. Cook, Fred Maguire and David Capotosto); |
· | Clam for Holding Distributed Buoyancy Modules (inventors David Capotosto and William Stewart); and |
· | Hinged Distributed Buoyancy Module (inventors Timothy H. Cook and David Capotosto). |
This item is not applicable for smaller reporting companies.
On August 27, 2008, Deep Down received a letter from the SEC whereby the SEC requested additional information related to issues disclosed in our Form 10-KSB for the year ended December 31, 2007, filed April 1, 2008, regarding the following topics: corporate history, segment disclosures, critical accounting policies, non-GAAP presentation of financial information, predecessor financial statements and the Mako purchase disclosures. We responded to the SEC in a comment response letter dated October 7, 2008 filed as correspondence with the SEC with the information requested on all topics.
On December 4, 2008, Deep Down received a response letter from the SEC whereby the SEC requested additional information related to our response letter dated October 7, 2008. The SEC comments in the December 4 letter requested further clarification to our responses regarding the following topics: corporate history, segment disclosures, predecessor financial statements and the Mako purchase disclosures. We responded to the SEC in a comment response letter dated January 28, 2009 filed as correspondence with the SEC with the information requested on all topics.
On February 26, 2009, Deep Down received a response letter from the SEC stating that they require that we amend the Form 10-KSB for December 31, 2007 to present supplemental audited predecessor financial statements for Deep Down, Inc. for the period January 1, 2006 through November 20, 2006, in accordance with Rule 310(a) of Regulation S-B. There were no further questions regarding the other issues in our response dated January 28, 2009. We are working to complete the predecessor financial statements along with the additional disclosure items and footnotes that would be necessary to explain the predecessor statements and to appropriately disclose the predecessor operating results for Deep Down, Inc. for the noted accounting period. We anticipate completing the noted financial statements and required audit procedures shortly after this Form 10-K is filed. We replied to the SEC with this same information on March 11, 2009.
Our principal corporate offices were relocated to 8827 W. Sam Houston Parkway N., Suite 100, Houston, TX 77040 on February 21, 2009. The 89-month lease term began on that date and includes 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) beginning on the sixth month of the lease term. Monthly lease cost rangescosts range from $12,177 to $14,391 plus CAM charges, due to a rent escalation clause over the term of the 89-month lease.
Our operating facilities for Deep Down and ElectroWaveDelaware continue to be located at 15473 East Freeway, Channelview, Texas 77530. We leasepurchased the Channelview property from the lessor in May 2009, which consists of approximately 8 acres of land that houses 60,000 square feet of manufacturing space and 7,000 square feet of office space. We lease all buildings, structures, fixtures and other improvements from JUMA, LLC, a related party. See Item 13 “Certain“Certain Relationships and Related Transactions, and Director Independence” included in this report. The base rateReport for information regarding the related nature of $15,000 per month is payable to JUMA, LLC through August 31, 2013, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.former lessor.
Mako leases its property and buildings from Sutton Industries at a base rate of $7,300 per month. Mako is located at 125 Mako Lane, Morgan City, LA 70380. The 5-year lease term commenced on June 1, 2006, and includes an additional 5-year renewal option at the end of the initial term.
In connection with the purchase of Flotation, Deep Down acquired thePrior to December 31, 2010, we also had operating facilities and administrative offices located at 20 Morin Street, Biddeford, Maine 0400504005. We had originally acquired the facility in May 2008 for a fair market value of $3.3 million. Themillion, and the facility consistsconsisted of 3.61 acres of land, including a 46,925 square-foot light industrial manufacturing facility and administrative offices. Additionally, in October 2008, Flotation entered into a 60-month lease for 18,000 square feet of warehouse space, which was increased to 21,900 square feet in April 2009, within a 107,000 square foot warehouse located at 26 Morin Street, Biddeford, Maine and purchased a three-quarter acre parcel, which are both adjacent to Flotation’s operating facility. Both the owned and leased real property in Biddeford, Maine was contributed to CFT effective as of December 31, 2010. See Note 4 "Investment in Joint Venture" to the consolidated financial statements included in this Report.
Our operating facilities in Channelview, Texas are subject to the liens of our lender, Whitney National Bank, under our credit agreement. We believe that our current space is suitable, adequate and of sufficient capacity to support our current operations.
We are from time to timePeriodically, we may be involved in legal proceedings arising in the normal course of business. As of the date of this Annual Report, on Form 10-K, we are currently not involved in any pending, material legal proceedings except as noted below.proceedings.
Deep Down is currentlyAs disclosed in arbitrationour Form 8-K filed on November 12, 2010, we received a Notice of Federal Tax Lien from the Internal Revenue Service (“IRS”) in an approximate amount of $573,000 for nonpayment of certain taxes. This claim related primarily to 2007 and 2008 tax returns that were filed when the Company changed its tax year. We paid approximately $592,000 in December 2010, resolved the issue with the former stockholdersIRS and the lien was removed effective December 7, 2010. As of Flotation Technologies, Inc. regardingDecember 31, 2010, we have recorded a receivable from the proper calculationIRS of approximately $592,000, which is included as a component of accounts receivable on the “Cash Price Adjustment” pursuant to the Stock Purchase Agreement by and between Deep Down, Flotation Technologies, Inc. and its stockholders dated April 17, 2008.accompanying consolidated balance sheet.
In connection with the private placement of our common stock in June 2008 (the “Private Placement”), Deep Down entered into a registration rights agreement with the purchasers in the Private Placement (the “Registration Rights Agreement”) pursuant to which the purchasers have certain demand registration rights. Deep Down filed a Registration Statement on Form S-1 on July 21, 2008. Pursuant to the Registration Rights Agreement, Deep Down was obligated to have the Registration Statement declared effective by September 3, 2008 (the “Required Effective Date”), or the Company would be required to pay damages to the purchasers in the Private Placement for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective. Deep Down has evaluated this obligation under the Registration Rights Agreement for liability treatment under FASB Statement No. 5, “Accounting for Contingencies” (“SFAS 5”) and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights meet the definition of a liability under the authoritative guidance and has reserved $1.2 million in potential damages under the terms of the Private Placement for the 90-day period September 4 to December 4, 2008, when we obtained a legal opinion allowing the removal of the related stock’s restrictive legends.
There were no matters submitted to a vote of our security holders during the period covered by this Annual Report on Form 10-K.
PART II
Market for Common Stock
Our common stock trades publicly on the OTC Bulletin Board ("OTCBB") under the symbol “DPDW.” The OTCBB is a regulated quotation service that displays real-time quotes, last-sale prices and volume information in over-the-counter equity securities. The OTCBB securities are traded by a community of market makers that enter quotes and trade reports. This market is extremely limited and any prices quoted may not be a reliable indication of the value of our common stock.
Prior to the reverse merger with MediQuip on December 14, 2006, no public market in our common stock existed. Beginning December 14, 2006, our common stock was quoted on the OTC Bulletin Board.OTCBB. These quotes represent inter-dealer quotations, without adjustment for retail mark-up, markdown or commission and may not represent actual transactions. The following table sets, for the periods indicated, the high and low sales prices for our common stock as reported by the OTC Bulletin Board.OTCBB.
| | | High | | | Low | |
| Fiscal Year 2008: | | | | | | |
| December 31, 2008 | | $ | 0.62 | | | $ | 0.11 | |
| September 30, 2008 | | $ | 0.95 | | | $ | 0.44 | |
| June 30, 2008 | | $ | 1.27 | | | $ | 0.68 | |
| March 31, 2008 | | $ | 1.24 | | | $ | 0.35 | |
| Fiscal Year 2007: | | | | | | |
| December 31, 2007 | | $ | 2.35 | | | $ | 0.76 | |
| September 30, 2007 | | $ | 0.94 | | | $ | 0.51 | |
| June 30, 2007 | | $ | 0.78 | | | $ | 0.27 | |
| March 31, 2007 | | $ | 0.42 | | | $ | 0.16 | |
| | | High | | | Low | |
| Fiscal Year 2010: | | | | | | |
| December 31, 2010 | | $ | 0.10 | | | $ | 0.05 | |
| September 30, 2010 | | $ | 0.07 | | | $ | 0.04 | |
| June 30, 2010 | | $ | 0.17 | | | $ | 0.05 | |
| March 31, 2010 | | $ | 0.15 | | | $ | 0.11 | |
| Fiscal Year 2009: | | | | | | |
| December 31, 2009 | | $ | 0.28 | | | $ | 0.11 | |
| September 30, 2009 | | $ | 0.16 | | | $ | 0.10 | |
| June 30, 2009 | | $ | 0.17 | | | $ | 0.10 | |
| March 31, 2009 | | $ | 0.19 | | | $ | 0.08 | |
Holders
As of March 13, 2009,31, 2011, there were 1,081 holdersapproximately 1,050 stockholders of record of our common stock. All common stock and we believe there were 1,081 beneficial owners.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 use. Under the terms of our credit agreement with Whitney National Bank, we are restricted from paying cash dividends on our common stock, unless no default under the credit agreement exists at the time of or would arise after giving effect to any such distribution. We intend to retain operating capital for the growth of the company operations.
Equity Compensation Plan Information
The following table sets forth the outstanding equity instruments as of December 31, 2008:2010:
| | Number of securities to be issued upon exercise of outstanding options, | | Weighted-average exercise price of outstanding options, | | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected | |
| Plan Category | warrants and rights | | warrants and rights | | in first column) | | Number of securities to be issued upon exercise of outstanding options, warrants and rights | | Weighted-average exercise price of outstanding options, warrants and rights | | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in first column) |
| Equity compensation plans approved by securityholders | 8,066,667 (1) | | $0.96 | | 17,336,000 (1) | | 16,141,667 (1) | | $0.13 | | 11,468,000(1) |
| | | | | | | |
| Equity compensation plans not approved by securityholders | 638,812 (2) | | $0.78 | | N/A | | 638,812 (2) | | $0.78 | | |
| | | | | | | |
| TOTAL | 8,705,479 | | $0.95 | | 17,336,000 | | 16,780,479 | | $0.15 | | 11,468,000 |
____________
(1) Represents 8,066,667approximately 31,100,000 shares of common stock that may be issued pursuant to optionsequity awards granted as of December 31, 2008 and approximately 17,336,000 additional available for future grant2010, less 3,500,000 outstanding shares of restricted stock granted under the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). and approximately 11,468,000 additional shares of common stock available for future grant under the Plan. Shares available for grant include 1,200,000is net of 3,500,000 restricted shares that were granted under the Plan to executives and employees on February 14, 2008 which vest on February 14,in 2009 and 2010 provided such respective recipient remains employed with the Company on such date.(see additional discussion of terms and vesting under Executive Compensation). These restricted shares are included in the shares outstanding as of December 31, 2008. ��2010. Under the Plan, the total number of shares subject to grants and awards is 15%15 percent of issued and outstanding shares of common stock. Effective in March 2010, we cancelled 2,000,000 outstanding options held by two executives which were scheduled to vest on February 14, 2011, and did not reissue any replacement options, thus increasing the number of securities available for future issuance. We recorded the remaining unamortized share-based compensation in March 2010 when the shares were cancelled. The Plan was approved by security holders of our predecessor MediQuip Holdings, Inc.
(2) Represents 638,812438,812 shares of common stock underlying warrants, approved by the Company’s Board of Directors, including 320,000 warrants granted to a consultantin 2007 as part of our prior $6.5 million borrowing facility, entered into on August 6, 2007, plus an additional 118,812 warrants granted to a consultant as part of the additional $6.0 million advanced under the amendment to that same borrowing facility effective December 31, 2007, plus an additional 200,000 warrants issued on June 5,in 2008 in connection with the purchase of Flotation.Flotation during fiscal 2008. See Note 119 "Warrants" to our consolidated financial statements included in this reportReport with regard to material terms of such warrants.
Recent Sales of Unregistered Securities
NoneWe have previously disclosed in our quarterly and current reports our sales of equity that were not registered under the Securities Act. In particular for this purpose, please see our Current Report on Form 8-K filed on January 5, 2011.
This item is not applicable for smaller reporting companies.
HistoryThe 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 financial statements appearing elsewhere in this Form 10-K. 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.
Deep Down, Inc.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.
Revision of 2009 Consolidated Financial Statements
As discussed in our Form 10Q/A for the quarter ended September 30, 2010, filed with the SEC on March 8, 2011, in conjunction with an internal review meeting of Flotation, our management reviewed the status of one of our long-term fixed price contracts (the “Contract”) that we entered into in November 2008 which is scheduled to be completed in the third quarter of 2011. As a publicly traded Nevadaresult of this review, our management identified errors in the percentage-of-completion accounting model for revenue recognition pertaining to this Contract. We considered the effect of the error to be immaterial to the consolidated financial statements for the year ended December 31, 2009. The audited consolidated balance sheet and statements of operations, cash flows and stockholders’ equity for the year ended December 31, 2009 included in this Annual Report on Form 10-K (the “Report”) have been adjusted to correct the immaterial effects of the error.
The 2009 consolidated balance sheet reflects the increase of $639 to the amounts of billings in excess of costs and estimated earnings on uncompleted contracts and accumulated deficit. On the consolidated statement of operations, revenues and gross profit for the year ended December 31, 2009 were reduced by $639, which resulted in a corresponding $639 increase to operating loss, loss before income taxes and net loss. On the consolidated statement of cash flows, the revision increased net loss by $639 which was offset to billings in excess of costs and estimated earnings on uncompleted contracts, for a net impact to cash flows provided by operations of $0. On the consolidated statement of stockholders’ equity, the revision increased accumulated deficit by $639. See additional discussion in Note 2 "Revision of 2009 Financial Statements" to the consolidated financial statements included in this Report.
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. In connection with our JV, we install buoyancy modules on risers for deepwater drilling; we manufacture collars used with the riser buoyancy and we provide buoyancy repair and maintenance.
Equity Investment in Joint Venture
On December 31, 2010, the Company and its wholly-owned subsidiary Flotation, entered into a Contribution Agreement by and among the Company, Flotation, Cuming Flotation Technologies, LLC, a Delaware limited liability company (“CFT”), and Flotation Investor, LLC, a Delaware limited liability company (“Holdings”), pursuant to which Flotation contributed all of its operating assets and liabilities (except for one intercompany corporate overhead payable) to CFT in exchange for common units of CFT. Pursuant to the Contribution Agreement, we contributed to CFT $1,400 in cash and all of our rights and obligations under that certain Stock Purchase Agreement, dated May 3, 2010, as amended (the “Cuming SPA”), by and among the Company, Cuming Corporation, a Massachusetts corporation originated on December 14, 2006, through a reverse merger(“Cuming”), and the stockholders of Cuming, in exchange for common units of CFT. Concurrently with Mediquip, a publicly traded Nevada corporation. Deep Down, Inc.,the closing of the transactions described above, CFT contributed the operating company, was originallyassets and liabilities it acquired from Flotation to Flotation Tech, LLC, a Delaware corporation founded in 1997, but had been acquired in a serieslimited liability company and wholly-owned subsidiary of transactions on November 21, 2006, by Subsea.CFT.
On June 29, 2006, Subsea,December 31, 2010, we entered into a Texas corporation, was formedContract Assignment and Amendment Agreement by three shareholdersand among the Company, CFT and Cuming, pursuant to which we assigned all of our rights and obligations under the Cuming SPA to CFT. Concurrent with our entry into such Contract Assignment and Amendment Agreement, we entered into a Securities Purchase Agreement, by and among the intentCompany and Holdings (the “Securities Purchase Agreement”), pursuant to acquire offshore energy service providers. On November 21, 2006, Subsea acquired all thewhich we sold and issued to Holdings 20,000 shares of our common stock for an aggregate purchase price of SOS, a Texas corporation,$1,400. The Securities Purchase Agreement provides Holdings with registration rights for 3,000such 20,000 shares of Subsea’s Series F preferred stock and 1,000 shares of Series G preferred stock from two common shareholders (who were also shareholders of Subsea). Sinceonly in the entities were under common control, and SOS did not constitute a business, the Company charged compensation expenseevent we fail to shareholders for the fair value of both series of preferred stock totaling $3.3 million.maintain current public filings.
Additionally,
In connection with the consummation of the foregoing described transaction, on November 21, 2006, Subsea acquiredDecember 31, 2010, the Company and Flotation entered into an Amended and Restated Limited Liability Company Agreement (the “JV LLC Agreement”) of CFT by and among us, Flotation and Holdings, each as a member of the CFT, to provide for the respective rights and obligations of the members of CFT. We and Flotation collectively hold 20% of the common units of CFT. Holdings holds 80% of the common units and 100% of the preferred units, which are entitled to a preferred return until the holder thereof receives a full return of its initial capital contribution. The preferred units have no voting rights. Pursuant to the terms of the JV LLC Agreement, we and Flotation collectively have the right to appoint one director to CFT’s board of directors and Holdings has the right to appoint the other 4 directors. The JV LLC Agreement provides that, without the prior approval of Deep Down Inc.and Flotation, certain actions cannot be taken by CFT, including: increasing the number of members of CFT’s board of directors; amending the JV LLC Agreement or the certificate of formation of CFT in a manner that disproportionately adversely affects Deep Down or Flotation; engaging in activities other than the business of CFT; declaring or paying dividends or distributions not in accordance with the JV LLC Agreement; repurchasing or redeeming CFT units; causing a material change in the nature of CFT’s business; engaging in activity that disproportionately affects Deep Down or Flotation as holders of units of CFT; liquidating, dissolving or effecting a recapitalization or reorganization of CFT; prior to November 2, 2012, authorizing or issuing any equity securities or other securities with equity features or convertible into equity securities except with regard to incentive plans for management; making loans, advancements, guarantees or investments except under certain circumstances; granting an exclusive license in all or substantially all of the intellectual property rights of CFT; amending any provision of, or entering into a resolution of any dispute with the parties under the Cuming SPA; entering into a transaction with an officer, director or other person who is an affiliate of CFT; incurring any funded indebtedness other than for the purpose of retiring CFT’s indebtedness to Holdings until such time as such indebtedness is fully repaid; or agreeing or committing or causing any subsidiary to agree to or commit to any of the above.
Concurrent with the closing of the joint venture transaction on December 31, 2010, we entered into a Management Services Agreement to be effective as of January 1, 2011, with CFT, pursuant to which we provide CFT the services of certain officers and management personnel. We have amended this Management Services Agreement effective as March 1, 2011 to, among other things, alter the minimum monthly fee we are paid by CFT (due partly to a change in the staffing levels for services and personnel we provide to CFT).
See additional discussion in Note 4 “Investment in Joint Venture” to the consolidated financial statements included in this Report.
Industry and Executive Outlook
Effective May 30, 2010, the United States Department of the Interior, (the “DOI”) ordered a moratorium on all deepwater drilling on the Outer Continental Shelf in response to the April 20, 2010, Deepwater Horizon incident (the “GOM Incident”). Although this moratorium was lifted by the DOI on October 12, 2010, the impact of the GOM Incident on our operations and severity of the industry downturn cannot be predicted with certainty. The timing of market recovery will depend upon several additional factors outside of our control, including the securing of permits, among other required approvals, necessary prior to commencement of deepwater operations in the GOM. Recently, several of our customers have received drilling permits. We expect our operations in the GOM will start improving sometime during the last half of 2011.
Financial markets, which are critical to the funding of the major offshore and deepwater projects, also continued to show some signs of stabilization and recovery and we continue to see an increase in our multi-national bidding activity. Our operations continue to benefit from increased demand for our products and services primarily in Brazil and West Africa.
The deepwater and ultra-deepwater industry remains one of the best frontiers for adding large hydrocarbon reserves with high production flow rates. We are well positioned to supply services and products required to support safe offshore and deepwater projects of our customers. We anticipate demand for our deepwater and ultra-deepwater services and products will continue to grow and we will continue to focus on this sector of the industry worldwide.
For fiscal year 2011, our focus remains on successful execution of our projects, obtaining new project awards and effective cash management.
Results of Operations
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Revenues | | $ | 42,471 | | | $ | 28,810 | | | $ | 13,661 | | | | 47.4 | % |
Revenues
Revenues increased $13,661, or 47.4 percent, to $42,471 for the year ended December 31, 2010 from $28,810 for the previous year. The increase in revenues was due primarily to generally higher demand for our services and products, especially in the GOM and West Africa, leading to higher utilization of our personnel, equipment and ROVs, increased equipment and tooling rentals, greater output of engineered subsea projects (including installation support services) and increased manufacture of products for deepwater and ultra-deepwater projects.
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Cost of sales | | $ | 28,886 | | | $ | 19,888 | | | $ | 8,998 | | | | 45.2% | |
| Gross Profit | | $ | 13,585 | | | $ | 8,922 | | | $ | 4,663 | | | | 52.3% | |
| Gross Profit % | | | 32.0% | | | | 31.0% | | | | | | | | 1.0% | |
Gross profit increased $4,663 to $13,585 for the year ended December 31, 2010, an increase of 52.3 percent over the same period of the prior year, reflecting an overall increase in the gross profit margin to 32 percent from 31 percent. The increases in gross profit and gross profit margin were due to the increased revenues described above and to the larger percentage of service rather than product revenue during the same period last year.
We record depreciation expense related to revenue-generating fixed assets as cost of sales, which totaled $2,327 and $1,615 for the years ended December 31, 2010 and 2009, respectively. The increase in 2010 resulted from the purchases of ROVs and other capital expenditures to increase capacity in 2010 and late in fiscal year 2009.
Selling, general and administrative expenses
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Selling, general & administrative | | $ | 13,963 | | | $ | 14,371 | | | $ | (408 | ) | | | (2.8)% | |
| Selling, general & administrative as a % of revenues | | | 32.9% | | | | 49.9% | | | | | | | | (17.0)% | |
Selling, general and administrative expenses (“SG&A”), as a percent of revenue, decreased 17.0% from the previous fiscal year. SG&A decreased $408 from the previous year, even though revenues for the same period increased by 47.4%. Now that we have completed the JV transaction, we will continue our cost containment program. During the year ended December 31, 2009, we reversed an accrual of $586 for registration penalty expense that was accrued during fiscal 2008. The effect of this accrual reversal in 2009 indicates our SG&A actually declined by $994, which is a significant reduction in SG&A as a result of our cost containment program.
Depreciation and amortization expense (excluded from Cost of sales)
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Depreciation | | $ | 329 | | | $ | 343 | | | $ | (14 | ) | | | (4.1)% | |
| Amortization | | | 1,402 | | | | 6,195 | | | | (4,793 | ) | | | (77.4)% | |
| Depreciation and amortization | | $ | 1,731 | | | $ | 6,538 | | | $ | (4,807 | ) | | | (73.5)% | |
Depreciation and amortization expense consists primarily of depreciation of our fixed assets that are not related to revenue generation, plus amortization of intangible assets, including our customer lists, technology and trademarks. Depreciation and amortization expense, excluded from “Cost of sales” in the accompanying statements of operations, was $1,731 and $6,538 for the years ended December 31, 2010 and 2009, respectively.
Amortization of intangible assets for the year ended December 31, 2010 was $1,402 compared to $6,195 for the year ended 2009. Included in amortization for 2009 was an impairment charge to certain long-lived intangible assets totaling $4,616, due partially to a change in the estimated useful life of some technology intangible assets from twenty-five years to ten years which reduced the fair value measurement of the asset. See further discussion regarding the specific assumptions and test results in Note 6 "Intangible Assets and Goodwill" to the consolidated financial statements included in this Report.
Goodwill impairment
During the year ended December 31, 2010, we recognized an impairment to goodwill in the amount of $4,513 related to the Flotation and Mako reporting units. As of December 31, 2009, we recognized an impairment to goodwill in the amount of $5,537 related to the Deep Down Delaware corporation foundedand Mako reporting units. See further discussion of the related analysis in 1997.Note 6 "Intangible Assets and Goodwill" to the consolidated financial statements included in this Report.
Net interest expense
Net interest expense for the year ended December 31, 2010 was $510 compared to $356 for the same prior year period. Net interest expense for the years ended December 31, 2010 and 2009 was generated by our outstanding bank debt, capital leases and our outstanding subordinated debenture.
Loss on contribution of net assets of wholly-owned subsidiary
Effective December 31, 2010, we engaged in a joint venture transaction in which all of Flotation’s operating assets and liabilities (except for one intercompany corporate overhead payable) were contributed, along with other contributions we made, to CFT in return for a 20% common unit ownership interest in CFT. A gain or loss is recognized on the difference between the determined fair value of our investment in CFT and the book value of the net assets contributed. Because the fair value of CFT’s net assets (common equity) was determined to be $17,000, our 20% investment was valued at $3,400. When this amount was compared to the combined book value of Flotation’s net assets of $12,119 plus cash we contributed of $1,400, a loss on contribution in the amount of $10,119 was generated. Based on the financial forecasts of CFT, we believe that the expected equity earnings from our 20% investment in CFT in future years will exceed the loss on contribution of Flotation.
Equity in net loss of joint venture
The transaction with CFT closed on December 31, 2010. The loss of CFT for the year ended December 31, 2010 was comprised of acquisition and legal costs, which were partially offset by the recognition of a bargain purchase gain. There was no operating activity recorded in 2010. We recorded our 20% equity-method portion of CFT’s net loss in the amount of $254 for the year ended December 31, 2010.
Adjusted EBITDA
Our management evaluates our performance based on a non-GAAP measure, Adjusted EBITDA, which consists of earnings (net income or loss) available to common shareholders before cumulative effect of accounting change, net interest expense, income taxes, non-cash stock compensation expense, non-cash impairments, depreciation and amortization, other non-cash items and one-time charges. 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 U.S. 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 U.S. GAAP. The amounts included in the Adjusted EBITDA calculation, however, are derived from amounts included in the accompanying consolidated statements of operations data.
We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it is widely used by investors in our industry to measure a company’s operating performance without regard to items such as income taxes, net interest expense, depreciation and amortization, non-cash impairment, non-cash stock compensation expense, non-cash impairments, other non-cash items and one-time charges 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) and asset base (primarily depreciation and amortization) and actions that do not affect liquidity (stock compensation expense, goodwill impairment and loss on contribution of assets of a wholly-owned subsidiary) from our operating results; and it helps investors identify items that are within our operational control. Depreciation and amortization charges, while a component of operating income, are fixed at the time of the asset purchase or acquisition in accordance with the depreciable lives of the related asset and as such are not a directly controllable period operating charge.
The following is a reconciliation of net loss to Adjusted EBITDA for the years ended December 31, 2010 and 2009:
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Net loss | | $ | (17,415 | ) | | $ | (16,781 | ) | | $ | (634 | ) | | | (3.8 | )% |
| Add back interest expense, net of interest income | | | 510 | | | | 356 | | | | 154 | | | | 43.3 | % |
| Add back depreciation and amortization | | | 4,058 | | | | 8,154 | | | | (4,096 | ) | | | (50.2 | )% |
| Add back income tax expense (benefit) | | | 175 | | | | (1,026 | ) | | | 1,201 | | | | 117.1 | % |
| Add back loss on contribution of net assets of wholly-owned subsidiary | | | 10,119 | | | | - | | | | 10,119 | | | | 100.0 | % |
| Add back share-based compensation | | | 727 | | | | 836 | | | | (109 | ) | | | (13.0 | )% |
| Add back goodwill impairment | | | 4,513 | | | | 5,537 | | | | (1,024 | ) | | | (18.5 | )% |
| Adjusted EBITDA | | $ | 2,687 | | | $ | (2,924 | ) | | $ | 5,611 | | | | 191.9 | % |
Adjusted EBITDA was $2,687 for the year ended December 31, 2010 compared to $(2,924) for the previous year. The $5,611 improvement was primarily driven by improved operations and reduced costs, particularly in the second half of the year.
Capital Resources and Liquidity
Overview
As a deepwater service provider, our revenues, profitability, cash flows, and future rate of growth are substantially dependent on the condition of the global oil and gas industry generally, 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 delay 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 our fiscal years ended December 31, 2010 and 2009, we have supplemented the financing of our capital needs through a combination of debt and equity financings. Most significant in this regard has been our debt facility we have maintained with Whitney National Bank (“Whitney”). Our loans outstanding under the Amended and Restated Credit Agreement with Whitney (the “Restated Credit Agreement”) become due on April 15, 2012. We will need to raise additional debt or equity capital or renegotiate the existing debt prior to such date. We are currently in discussions with several lenders who have expressed interest in refinancing our debt. Our plan is to refinance the outstanding indebtedness under the Restated Credit Agreement or seek terms with Whitney that will provide an extension of such Restated Credit Agreement along with additional liquidity. However, we cannot provide any assurance that any financing will be available to us on acceptable terms or at all. If we are unable to raise additional capital or renegotiate our existing debt, this would have a material adverse impact on our business or would raise substantial doubt about our ability to continue as a going concern. In addition to the foregoing, as of December 31, 2010, we were not in compliance with the financial covenants under the Restated Credit Agreement. On March 25, 2011 we obtained a waiver for these covenants as of December 31, 2010.
Although the factors described above create uncertainty, if our planned financial results are achieved we believe that we will have adequate liquidity to meet our future operating requirements, and we believe we will be able to raise additional capital or renegotiate our existing debt.
The following are summaries regarding our primary sources of capital financing for our fiscal year ended December 31, 2010.
Whitney Credit Agreement
We originally entered into a credit agreement with Whitney in November 2008. The credit agreement originally provided a commitment to lend to us the lesser of $2,000 or 80 percent of eligible receivables. All of this commitment was also available for Whitney to issue letters of credit (“L/C”) for our benefit. In December 2008, we entered into an amendment of the credit agreement that provided for us to receive a term loan in the principal amount of $1,150. Then, in May 2009, we entered into another amendment to the credit agreement providing for us to receive another term loan in the principal amount of $2,100. We used the proceeds from the December 2008 term loan to purchase a piece of equipment (a remotely operated vehicle) and we used the proceeds of the May 2009 term loan to purchase real property in Channelview, Texas. There was $850 outstanding under the revolving credit line available on December 31, 2009. We also used the credit agreement to have Whitney issue an irrevocable transferable standby L/C in the ordinary course of business, with an annual commission rate of 2.4 percent for $1,107 during the year ended December 31, 2009 (which such L/C related to a large contract we expect to have completed during 2011). The Restated Credit Agreement does not obligate Whitney to issue new L/Cs. However on September 1, 2010, Whitney did renew the aforementioned L/C under the same terms for a period of one year to expire on August 31, 2011. We paid the annual commission in advance, and the L/C will remain in effect until it expires.
On April 14, 2011, we entered into a Second Amendment to the Restated Credit Agreement with Whitney, pursuant to which Whitney extended the maturity dates of the respective term loans and the letter of credit facility under the Restated Credit Agreement to April 15, 2012.
Under the original credit agreement with Whitney, we were obligated to repay the December 2008 term loan on the basis of monthly installments of $35, with the initial payment on February 1, 2009 and a final payment on January 2, 2012. Outstanding amounts of principal of the December 2008 term loan accrue interest at a rate of 6.5 percent per annum. Under the terms of the Restated Credit Agreement, the monthly installment payments and interest rate of the December 2008 term loan remain the same. As of December 31, 2010, the outstanding principal amount of the December 2008 term loan was $443.
Under the original credit agreement with Whitney, we were obligated to repay the May 2009 term loan on the basis of monthly installments of $18, with the initial payment on June 1, 2009 and a final payment on May 1, 2024. Outstanding amounts of principal of the May 2009 term loan accrue interest at a rate of 6.5 percent per annum. Under the terms of the Restated Credit Agreement, the monthly installment payments and interest rate of the May 2009 term loan remain the same, and the final balloon payment of $1,834 is now due on April 15, 2012. As of December 31, 2010, the outstanding principal amount of the May 2009 term loan was $1,944.
Upon execution of the Restated Credit Agreement in April 2010, our indebtedness in the amount of $850 outstanding under the revolving credit line of the credit agreement was converted to a term loan. This term loan requires us to make monthly installments in the amount of $40 plus the amount of accrued and unpaid interest beginning on May 1, 2010 with a final payment on February 1, 2012. Outstanding amounts of principal of the April 2010 term loan accrue interest at a rate of 6.5 percent per annum. As of December 31, 2010, the outstanding principal amount of the April 2010 term loan was $530.
Whitney possesses a lien on all of our assets to secure the outstanding indebtedness under the Restated Credit Agreement. Furthermore, each of our subsidiaries has guaranteed our obligations under the Restated Credit Agreement, and as such, our obligations in connection with the Restated Credit Agreement are generally secured by a first priority lien on all of our subsidiaries’ assets. With regard to the Channelview Property purchased with the proceeds of the May 2009 term loan, we also entered into a Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing creating a lien on such property.
On December 31, 2010, we entered into a First Amendment to Amended and Restated Credit Agreement with Whitney, pursuant to which Whitney provided its consent concerning our contribution of Flotation’s assets to CFT and our issuance of shares to Holdings and using the proceeds thereof for a further cash contribution to CFT. This amendment allowed the Company to complete the acquisition of Cuming Corporation and form the JV, which we contributed all of the assets, liabilities and bank debt of the Flotation subsidiary to the JV for our 20% ownership in the JV. However, as a result of this transaction occurring on December 31, 2010, we are required to expense all acquisition costs and write down the value of the contributed assets in order to establish a fair value of our investment in the JV. These expenses and write down caused us to be not in compliance with certain financial covenants under the Restated Credit Agreement. On March 25, 2011 we obtained a waiver for these covenants as of December 31, 2010.
Under the Restated Credit Agreement, as amended and restated, beginning with the quarter ended June 30, 2010, and for each quarter thereafter, we have been obligated to comply with the following financial covenants: (i) total debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) of not greater than 3.0 to 1.0 (“Leverage Ratio”), consolidated EBITDA to consolidated net interest expense and principal payments on the total debt greater than 1.5 to 1.0 (“Fixed Charge Coverage Ratio”), and consolidated net worth after deducting other assets as are properly classified as “Intangible Assets”, plus 50 percent of net income, after provision for taxes (“Tangible Net Worth”) in excess of $15,000. The calculation of EBITDA, with regards to the Leverage Ratio and Fixed Charge Coverage Ratio, allows us to deduct certain non-cash items, specifically asset impairment charges as of December 31, 2009 and going forward. As of both September 30, 2010 and December 31, 2010, we were not in compliance with the Leverage Ratio and the Fixed Charge Coverage Ratio and, as noted above, such circumstance entitles Whitney at its option to accelerate and immediately require all amounts outstanding under the Restated Credit Agreement to become immediately due. Under the Restated Credit Agreement, we continue to have obligations for other covenants, including limitations on issuance of common stock, liens, transactions with affiliates, additional indebtedness and permitted investments, among others.
The Restated Credit Agreement removed a provision from the prior credit agreement with Whitney that permitted us to obtain additional indebtedness from a third party in the event Whitney declined to increase its commitment of indebtedness to us. As such, we expect to have to refinance the indebtedness outstanding under the Restated Credit Agreement at any such time as we seek to obtain new financing from a third party.
During fiscal 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds from TD Bank, N.A. in the principal amount of $2,160 (the “TD Bank Loan”). Under the terms of the TD Bank Loan, we were obligated to make payments in monthly installments of $15, with an initial payment on March 13, 2009 and a final payment of the unpaid principal and accrued interest in February 2029. The interest rate on the TD Bank Loan was 5.75 percent.
The TD Bank Loan was secured by Flotation’s operating premises in Biddeford, Maine under a mortgage and security agreement and a collateral assignment of leases and rents. The TD Bank loan required us to enter into a debt subordination agreement that subordinated any debt Flotation owed to Deep Down, Inc.’s shareholders transferred ownershipother than accounts payable between them arising in the ordinary course of business. Additionally, the TD Bank Loan required a “negative pledge” that prohibited Flotation and Deep Down from granting security interests in Flotation’s personal property, other than such security interests granted in respect of our credit agreement with Whitney, as appropriate.
Under the TD Bank Loan, we were required to meet certain covenants and restrictions. The financial covenants were reportable annually beginning with the year ended December 31, 2009, and were specific to the Flotation subsidiary financials. At December 31, 2009, we were not in compliance with the financial covenants, and on April 15, 2010, we obtained a waiver for these covenants as of December 31, 2009.
In connection with Flotation’s contribution of all of Deep Down Inc.’sits assets to CFT on December 31, 2010, CFT assumed the obligations of Flotation under the TD Bank Loan and we were released from the obligations under such loan.
Other Debt
We have a subordinated debenture with a principal amount of $500 which originated from the exchange of preferred stock in a prior year. The debenture has a fixed interest rate of 6.0 percent per annum, which is required to be paid annually beginning March 31, 2009 through maturity on March 31, 2011, when the unpaid principal balance is due.
Equity Financings
Between April 25 and April 30, 2010, we sold 5,150 shares of our common stock in a private placement to Subsea in exchange for 5,000 sharesaccredited investors at a per share price of Subsea’s Series D preferred stock and 5,000 shares of Subsea’s Series E preferred stock$0.10 resulting in Deep Down Inc. becoming a wholly-owned subsidiarytotal proceeds of Subsea. On the same day, Subsea then merged with Deep Down, Inc., with the surviving company operating as Deep Down, Inc. This transaction was accounted$501, net of $14 applied to an outstanding vendor invoice for as a purchase, with Subsea being the acquirer based on a change in voting control.services provided, which we have used for working capital purposes.
On December 14, 2006, after divesting its Westmeria Healthcare Limited subsidiary, MediQuip acquired all 9,999,999 outstanding31, 2010, we sold 20,000 shares of Deep Downour common stock and all 14,000 outstanding shares of Deep Down preferred stock in exchange for 75,000,000 shares of common stock and 14,000 shares of preferred stock of MediQuip. The shares of preferred stock of MediQuip were issued with the same designations, rights and privileges as the Deep Down preferred stock existing immediately prior to such transaction. As a result of the acquisition, the shareholders of Deep Down obtained ownership of a majority of the outstanding voting stock of MediQuip. MediQuip changed its name to Deep Down, Inc. as part of the transaction, and Deep Down, Inc. continued as a Nevada corporation following consummation of the acquisition. The transaction was accounted for as a reverse merger, whereby Deep Down was considered to be the accounting acquirer resulting in a recapitalization of Deep Down’s equity.
On April 2, 2007, Deep Down acquired substantially all of the assets of ElectroWave USA, Inc., a Texas corporationprivate placement to Holdings for a totalan aggregate purchase price of $0.2 million. Deep Down formed$1,400. We then contributed these proceeds to CFT in return for common units of CFT. For a wholly-owned subsidiary, ElectroWave,description of the joint venture transaction of which this sale and contribution were a Nevada corporation,part, see “Part II, Item 8. Financial Statements and Supplemental Data” Note 4 "Investment in Joint Venture" to complete the acquisition. Locatedconsolidated financial statements.
Cash Flows
For the year ended December 31, 2010, cash used in Channelview, Texas, ElectroWave offers design, assembly, installation and commissioningoperating activities was $4,043 as compared to cash provided by operating activities of electronic monitoring and control systems$2,532 for the energy, military,prior year. Our working capital balances vary due to delivery terms and commercial business markets. This was not a "significant" acquisition; therefore, no pro forma results arepayments on key contracts, costs and estimated earnings in excess of billings on uncompleted contracts, and outstanding receivables and payables. For the year ended December 31, 2009, we recorded depreciation and amortization of $8,154, which included for this acquisition in this Form 10-K.$4,616 additional amortization due to the impairment of two long-lived intangible assets. The net intangible assets and other operating assets and liabilities of Flotation were contributed to CFT effective December 31, 2010, as discussed above.
EffectiveFor the year ended December 1, 2007, Deep Down acquired all31, 2010, cash provided by investing activities was $5,946 compared to cash used in investing activities of $6,611 for the prior year. During the year ended December 31, 2010, we used $2,634 to purchase property and equipment and $278 for capitalized software. Additionally, we contributed $1,400 to the joint venture with CFT, which was generated by the sale of 20,000 shares of our common stock at $0.07 per common share, and contributed the net assets and liabilities of Mako Technologies, Inc. forFlotation to CFT, which resulted in a totalloss of $10,119. For the year ended December 31, 2009, we used $6,117 to purchase price of $11.3 million including transaction fees. Deep Down formed a wholly-owned subsidiary, Mako, to complete the acquisition. Located in Morgan City, Louisiana, Mako serves the offshore petroleum and marine industries with technical support services,property and equipment vitalrelated to offshore petroleum production, through rentalsplant improvements and the purchase of its ROV, topsideROVs, plus $614 for capitalized software.
For the year ended December 31, 2010, cash provided by financing activities was $915 which represented net proceeds from the sale of stock of $1,901, offset by $961 in principal payments on long term debt and subsea equipment$25 value of stock canceled for payroll taxes related to employee restricted stock vestings. During the year ended December 31, 2009, cash provided by financing activities was $2,496 which consisted of borrowings of $3,000 and support systems used in diving operations, maintenance and repair operations, offshore construction and environmental and marine surveys.principle payments of $504.
On June 5, 2008, Deep Down completed the acquisition of Flotation, for a total purchase price of $23.9 million. Deep Down also purchased related technology from an entity affiliated with the selling shareholders. Deep Down effectively dated the acquisition for accounting purposes as of May 1, 2008 and consummated the closing on June 6, 2008. Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers from its facilities in Biddeford, Maine.22
In February 2009, we formed Deep Down International Holdings, LLC, a Nevada limited liability company and wholly owned subsidiary of the Company, for the purpose of holding securities for foreign companies organized or acquired by Deep Down. Deep Down International Holdings, LLC currently has no material assets or operations.
Our current operations are the result of the acquisitions of Deep Down, ElectroWave, Mako and Flotation. In addition to our strategy of continuing to grow and strengthen our operations, including by expanding our services and products in accordance with 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 offshore deepwater exploration, development and production of oil and gas reserves and other maritime operations.
Critical Accounting Policies
The accompanying discussion and analysis of our financial condition and results of operations is based uponon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United StatesStates. The preparation of America. See Note 1 “Naturethese financial statements in accordance with U.S. 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 Businessbillings on uncompleted contracts, inventory, impairments of long-lived assets, including intangible assets, impairments of goodwill, income taxes including the valuation allowance for deferred tax assets, billings in excess of costs and Summaryestimated 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 Significant Accounting Policies”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.
We believe the following accounting policies are critical to our business operations and the understanding of our operations and include the more significant judgments and estimates used in the preparation of our consolidated financial statements. The consolidated financial statements includedinclude the accounts of Deep Down, Inc. and its wholly-owned subsidiaries.
All intercompany transactions and balances have been eliminated in this report for additional details. The following discussion addresses our most critical accounting policies, which are those that require significant judgment and useconsolidation.
Collectability of assumptions.
Accounts Receivable
Trade accountsAccounts receivable are recorded atreduced by an allowance for amounts that may become uncollectible in the invoiced amount and do not bear interest. Thefuture. Estimates are used in determining our allowance for doubtful accounts and are based on trade receivables is our best estimatehistorical level of write-offs and judgments management makes about the probable amountcreditworthiness of significant customers based on ongoing credit evaluations. Further, we monitor current economic trends that might impact the level of credit losses in the future. Since we cannot predict with certainty future changes in the financial stability of our existingcustomers, actual future losses from uncollectible accounts receivables. A considerable amountmay differ from our estimates. Additional allowances may be required if the economy or the financial condition of judgment is requiredour customers deteriorates. If we determined that a smaller or larger allowance was appropriate, we would record a credit or a charge to selling, general and administrative expense in assessing the realization of receivables. Relevant assessment factors include the credit worthiness of the customers and prior collection history. Account balances are charged off against the allowance after all reasonable means are exhausted and the potential for recovery is considered remote. The allowance requirements are based on the most current facts available and are re-evaluated and adjusted onperiod in which we made such a regular basis and as additional information is received. We do not expect to have any off-balance sheet credit exposure related to our customers.determination.
Consolidation
The accompanying audited financial statements include the results of Deep Down and all of its wholly-owned subsidiaries, including Deep Down Delaware since its inception on June 29, 2006, ElectroWave since its acquisition on April 2, 2007, Mako since its acquisition on December 1, 2007 and Flotation since its acquisition on May 1, 2008. All significant intercompany balances and transactions have been eliminated.
Long-Lived AssetsRevenue Recognition
We evaluate long-lived assets for impairment whenever changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts exceed the fair values of the assets. Assets to be disposed are reported at the lower of carrying values or fair values, less costs of disposal. We found no significant adjustments during our review of fixed assets.
Stock-Based Compensation
We account for stock-based compensation issued to employees and non-employees as required by SFAS No. 123(R) “Share-based Payment”. Under these provisions, we record expense ratably over the requisite service period based on the fair value of the awards determined at the grant date utilizing the Black-Scholes pricing model for options and warrants. We first granted stock options in April 2007, and thus do not have extensive history upon which to evaluate our estimates. For the year ended 2008, we estimated forfeitures to be 0%. We expect to increase our forfeiture estimate in future periods as we accumulate our history with regard to forfeitures.
Key assumptions used in the Black-Scholes model for both stock options and warrant valuations include (1) expected volatility (2) expected term (3) discount rate and (4) expected dividend yield. Since we do not have a sufficient trading history to determine the volatility of our own stock, 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, Deep Down continues to use the simplified method related to employee option grants as allowed by Staff Accounting Bulletin ("SAB") 110, Share-Based Payment.
The fair value of each stock option or warrant grant is estimated on the date of the grant using the Black-Scholes model and is based on the following key assumptions for the year ended December 31, 2008:
Dividend yield | | 0% |
Risk free interest rate | | 2.52% - 2.84% |
Expected life of options | 2-3 years |
Expected volatility | | 51.7% - 61.3% |
Revenue Recognition
We generally recognize revenue once the following four criterioncriterions 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 and determinable and (iv) collectability is reasonably assured. For certain fabrication projects, revenue is recognized upon shipment or when customer-specific contract elements (“milestone(s)”) are met. Fabrication and sale of equipment billings are contingent upon satisfaction of a significant condition of sale milestone, including but not limited to, factory acceptance testing and customer approval, and recognized upon transfer of title to the customer. Service revenue is recognized as the service is provided.
provided, and “time and material” 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. From time to time, we enter into large fixed price contracts which we determine that recognizing revenues for these types of contracts is appropriate using the percentage-of-completion method, under Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”), which compares the percentage of costs incurred to date to the estimated total costs for the contract. This method is preferredappropriate because management considers total costs the best available measure of progress.
Total costs include all direct material and labor costs plus all indirect costs related to contract performance, such as supplies, equipment repairs, employee travel and supervisor time. Selling, general and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts (if any) are made in the period in which such losses are determined. 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.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 items are shipped to the customer.
In accordance with industry practice, assetsAssets 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.year, though such long-term contracts include contractual milestone billings as discussed above.
All intercompany revenue balances and transactions were eliminated in consolidation.
Long-Lived Assets
Long-lived assets include property, plant and equipment and long-lived intangible assets. Our intangible assets generally consist of assets acquired in the purchases of the Mako and Flotation subsidiaries and are comprised of customer lists, non-compete covenants with key employees and trademarks related to Mako’s ROVs and to Flotation’s branding, processes, materials and technology. We amortize intangible assets over their useful lives ranging from six to twenty-five years on a straight-line basis. We make judgments and estimates in conjunction with the carrying value of these assets, including amounts to be capitalized, depreciation and amortization methods, useful lives and the valuation of acquired long-lived intangible assets.
We test for the impairment of long-lived assets upon the occurrence of a triggering event. We base our evaluation on impairment indicators such as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements and other external market conditions or factors that may be present. If these impairment indicators are present or other factors exist that indicate the carrying amount of an asset may not be recoverable, we determine whether an impairment has occurred through the use of an undiscounted cash flows analysis of the asset at the lowest level for which identifiable cash flows exist. The undiscounted cash flow analysis consists of estimating the future cash flows that are directly associated with and expected to arise from the use and eventual disposition of the asset over its remaining useful life. These cash flows are inherently subjective and require significant estimates based upon historical experience and future expectations reflected in our budgets and internal projections. If the undiscounted cash flows do not exceed the carrying value of the long-lived asset, an impairment has occurred, and we recognize a loss for the difference between the carrying amount and the estimated fair value of the asset. The fair value of the asset is measured using quoted market prices or, in the absence of quoted market prices, is based on an estimate of discounted cash flows. Cash flows are generally discounted at an interest rate commensurate with our weighted average cost of capital for a similar asset.
We assessed the conditions and concluded, as of December 31, 2009, that a triggering event had occurred that required an impairment analysis of long-lived intangible assets (see further discussion below related to Goodwill annual testing). For the year ended December 31, 2009, we recorded impairment charges totaling $4,616 to several long-lived intangible assets, which total impairment charges were recorded on the statement of operations as amortization expense. There was no impairment of long-lived assets for the year ended December 31, 2010. Unanticipated changes in revenue, gross margin, or long-term growth factor could result in a material impact on the estimated fair values of our long-lived assets which could result in long-lived asset impairments in future periods. See further discussion in Note 6 "Intangible Assets and Intangible Assets Goodwill" to the consolidated financial statements included in this Report. Additionally, the net intangible assets of Flotation were contributed to CFT effective December 31, 2010, as discussed above.
Goodwill
Goodwill represents the cost in excess of the fair value of net assets acquired in business combinations. SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), prescribes the process for impairment testing of goodwill on an annual basis or more often if a triggering event occurs. Goodwill is not amortized, and there were no indicators of impairment at December 31, 2008.
We evaluatedevaluate the carrying value of goodwill during the fourth quarter of each yearannually on December 31 and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include a significant adverse change in legal factors or in business or the business climate or unanticipated competition. When evaluating whether
The test for goodwill impairment is impaired, wea two-step approach. The first step is to compare the estimated fair value of any reporting units within the business to its carrying amount, including goodwill. TheCompany that have goodwill with the recorded net book value (including the goodwill) of the reporting unit. If the estimated fair value of the reporting unit is higher than the recorded net book value, no impairment is deemed to exist and no further testing is required. If, however, the estimated usingfair value of the income or discounted cash flows method. Ifreporting unit is below the recorded net book value, then a second step must be performed to determine the goodwill impairment required, if any. In this second step, the estimated fair value from the first step is used as the purchase price in a hypothetical acquisition of the reporting unit. Purchase business combination accounting rules are followed to determine a hypothetical purchase price allocation to the reporting unit’s assets and liabilities. The residual amount of goodwill that results from this hypothetical purchase price allocation is compared to the carrying value of goodwill for the reporting unit, and the carrying value is written down to the hypothetical amount, if lower.
At December 31, 2010 and 2009, respectively, our management completed the annual impairment test of goodwill. There was no indication of impairment for the business exceedsyear ended December 31, 2010. Management’s calculations indicated as of December 31, 2009, due to a number of factors, including the global economic environment, increased costs of capital and the decrease in our market capitalization, that the calculations for the reporting units of Deep Down Delaware, Mako and Flotation each indicated their respective net book value exceeded its fair value thenand, accordingly, goodwill for each unit was considered to be potentially impaired. We used the amountestimated fair value of each reporting unit from the first step as the purchase price in a hypothetical acquisition of the respective reporting unit. See Note 6 "Intangible Assets and Goodwill" to the consolidated financial statements for a discussion of testing inputs and assumptions. We recognized a goodwill impairment loss must be measured. Theof $3,056 for Deep Down Delaware, $2,481 for Mako and $0 for Flotation for the year ended December 31, 2009. Remaining goodwill by reporting unit was $4,472, $2,874 and $2,083 for the Deep Down Delaware, Mako and Flotation reporting units, respectively, as of December 31, 2009.
Additionally, we assessed market conditions and concluded, as of September 30, 2010, that a triggering event had occurred that required an impairment loss would be calculated by comparinganalysis of goodwill for each reporting unit. Management’s calculations indicated, due to a number of factors, including the global economic environment, increased costs of capital and the decrease in our market capitalization, that the calculations for the reporting units of Mako and Flotation each indicated their respective net book value exceeded its fair value and, accordingly, we estimated the implied fair value of the goodwill for each reporting unit’s goodwill to its carrying amount.
Our intangible assets consistunit. The calculation for Deep Down Delaware did not indicate any impairment of assets acquiredgoodwill. We used the estimated fair value of each reporting unit from the first step as the purchase price in the purchasesa hypothetical acquisition of the respective reporting unit. We recognized a goodwill impairment of $2,430 for Mako and $2,083 for Flotation subsidiaries and is comprisedreporting units as of customer lists, non-compete covenants with key employees and trademarks related to Mako’s ROVs and to Flotation’s processes, materials and technology. We amortize the intangible assets over their useful lives ranging from three to forty years on a straight-line basis.
Income Taxes
We have adopted the provisions of SFAS No. 109, “Accounting for Income Taxes" which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been includednine months ended September 30, 2010. The impairment was recorded in operating expenses in the consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. If a tax position is more likely than not to be sustained upon examination, then an enterprise would be required to recognize in its financial statements the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. We have determined that there was no FIN 48 tax liability at December 31, 2008.
Executive Overview
2008 has been a very difficult year economically and on Wall Street, however it has been a very good year for Deep Down in continuing our dramatic growth operationally. We are continuing to mature and develop into an elite deepwater offshore energy service provider. We acquired Flotation in May 2008, which significantly expanded our operations in the buoyancy products and services area. We announced a major contract of $11.0 million for our riser buoyancy products and services which will be used in a deepwater project off the coast of Brazil. We also expanded our fleet of ROVs in Louisiana by five ROVs during the year.
In June 2008, we completed a Private Placement sale of stock which allowed us to acquire Flotation, as well as retire the very expensive Prospect Capital Corporation (“Prospect”) debt of over $12.0 million. The sale of this stock required the Company to file a registration statement with the Securities and Exchange Commission in order to register the shares. The registration statement has taken much longer and is significantly more costly than expected, however, the acquisition of Flotation has allowed us to become an essential service company to the offshore deepwater energy industry, which is the best market place, and we are expanding rapidly with new technology during a major down turn in the industry.
Deep Down’s balance sheet is very strong with healthy liquidity ratios. During the year, we incurred a significant number of one-time cash expenses along with a significant number of non-cash expenses. Deep Down expensed over $2.9 million in amortization of debt discounts and deferred financing costs and costs related to the extinguishment of the $12.0 million Prospect debt. Our bad debt expense increased by $1.4 million as a result of substantially increasing our reserves as well as expensing a receivable for a large customer in Louisiana that filed for bankruptcy during the year. Our general and administrative expenses are up by almost $1.2 million for professional fees in connection with the acquisition of Flotation and the registration statement. General and administrative expense is also increased by $1.2 million in accrual of penalty fees associated with not having the registration statement declared effective by the SEC. These one-time expenses total over $6.7 million. We look forward to 2009 when most of these expenses will not be a part of our operations.
Recent developments
On March 5, 2009, the Company’s wholly owned subsidiary, Flotation, obtained loan proceeds in the principal amount of approximately $1.8 million pursuant to a loan agreement Flotation and the Company entered into with TD Bank, N.A. (“TD Bank”) as of February 13, 2009. This loan agreement provides a further commitment to Flotation for advancement of principal in the amount of $0.3 million. Loans under the loan agreement are generally secured by Flotation’s operational premises in Biddeford, Maine under a mortgage and security agreement and a collateral assignment of leases and rents. In connection with the loan agreement, TD Bank required that the Company enter into a debt subordination agreement that subordinated any debt Flotation owes to the Company other than accounts payable between them arising in the ordinary course of business. Furthermore, as part of the loan agreement, TD Bank required a “negative pledge” that prohibits Flotation and the Company from granting security interests in Flotation’s personal property, other than such security interests granted in respect of the Company’s primary facility for borrowed money (as currently held with Whitney National Bank (“Whitney Bank”)). The Company is obligated to repay proceeds funded on March 5, 2009 based on a schedule of monthly installments of approximately $13,000, with an initial payment on March 13, 2009 and a final payment of all remaining outstanding and unpaid principal and accrued interest in February 2016. However, upon advancement of additional principal amounts available under the loan agreement, TD Bank will recalculate the monthly installments to an amount that will fully amortize the then outstanding principal balance over a 20-year amortization schedule.
In connection with such loan for Flotation, the Company entered into a second amendment of its existing credit facility with Whitney Bank to permit such loan and the security and other arrangements relating to Flotation’s loan agreement. The terms of the second amendment also included a guarantor’s consent and agreement, to be signed by each of the Company’s subsidiaries as guarantors of the obligations of the Company under such existing credit facility, that Whitney required as a condition to the effectiveness of the second amendment. Additionally, Whitney Bank required that Deep Down International Holdings, LLC, a Nevada limited liability company and wholly owned subsidiary of the Company formed in February 2009, enter into joinder agreements for the guaranty and security agreement arrangements generally required of the Company’s subsidiaries under the existing credit facility. Deep Down International Holdings, LLC currently has no material assets or 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 financial statements appearing elsewhere in this Form 10-K. 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.
Results of Operations
Revenues
| | | 2008 | | | 2007 | | | Change | | | % | |
| Revenues | | $ | 35,769,705 | | | $ | 19,389,730 | | | $ | 16,379,975 | | | | 84.5% | |
Revenues increased by approximately $16.4 million, or 84.5% to $35.8 million for the year ended December 31, 2008 from approximately $19.4 million for2010. This non-cash charge did not impact our liquidity position, debt covenants or cash flows.
Determining the previous year. This increasefair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions, among others. Unanticipated changes in revenue, was primarily attributable to strong demandgross margin, long-term growth factor or discount rate could result in a material impact on the estimated fair values of our reporting units, which could result in additional goodwill impairments in future periods.
Share-based Compensation
We record share-based payment awards exchanged for ouremployee services at fair value on the date of grant and equipment from our customersexpense the awards in the oilconsolidated statements of operations over the requisite employee service period. Share-based compensation expense includes an estimate for forfeitures and gas industry andis generally recognized over the impactexpected term of the inclusion of our acquisitions of Mako and Flotation, which accounted for $17.3 million of the increase. The remainder of the change in revenue is due to not repeating some large construction projects that we billed in fiscal 2007, since they had low gross margins and did not meet our criteria for continuing orders.
Cost of sales
| | | 2008 | | | 2007 | | | Change | | | % | |
| Cost of sales | | $ | 21,686,033 | | | $ | 13,306,086 | | | $ | 8,379,947 | | | | 63.0% | |
| Gross Margin | | $ | 14,083,672 | | | $ | 6,083,644 | | | $ | 8,000,028 | | | | 131.5% | |
| Gross Margin % | | | 39% | | | | 31% | | | | 49% | | | | | |
Gross profit was $14.1 million for the year endedaward on a straight-line basis. At December 31, 2008 compared to $6.1 million for the previous year, reflecting an overall improvement in gross profit margin from 31% to 39%. Gross margins were positively impacted by the inclusion2010, we had two types of our acquisitions of Flotation and Mako, which had slightly better margins than the rest of the Company operations.
Selling, general and administrative expenses
Selling, general and administrative expenses (“SG&A”) included rent, utilities, general office expenses, insurance, personnel and other costs necessary to conduct business operations. SG&A for the year ended December 31, 2008 was $14.3 million compared to $4.3 million for the same period last year for an increase of $10.0 million. The acquisitions of Mako and Flotation represented $3.8 million of the increase. Bad debt increased by $1.4 million due to the write off of certain accounts, one of which filed for bankruptcy protection. Personnel and related costs (not included in the Mako and Flotation amount) increased by $2.3 million due to expansion of our businesses requiring more personnel and the related requirements to administer a public company and comply with reporting requirements. Additionally, we paid approximately $2.0 million more than the prior year in professional, accounting and legal fees to support our various initiatives during fiscal 2008 relating to the filing of a registration statement and to support the referenced acquisitions. Stock-based compensation related toshare-based employee compensation: stock options and restricted stock was approximately $0.6 millionstock.
Key assumptions used in the current fiscal year comparedBlack-Scholes model for stock option valuations include (1) expected volatility (2) expected term (3) discount rate and (4) expected dividend yield. Since we do not have a sufficient trading history to approximately $0.2 milliondetermine the volatility of our own stock, 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.
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 comparable prior year period.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 enacted 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. Our effective tax rates for 2010 and 2009 were (1.0) percent, and 5.98 percent, respectively.
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 pretax 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.
Depreciation
We record an estimated tax liability or tax benefit for income and amortizationother 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.
| | | 2008 | | | 2007 | | | Change | | | % | |
| Depreciation | | $ | 1,314,138 | | | $ | 398,611 | | | $ | 915,527 | | | | 229.7% | |
| Amortization | | | 1,048,968 | | | | 28,353 | | | | 1,020,615 | | | | 3599.7% | |
| Depreciation and amortization | | $ | 2,363,106 | | | $ | 426,964 | | | $ | 1,936,142 | | | | 453.5% | |
DepreciationOur 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 amortization expensewhen our deferred tax assets are no longer fully reserved, we will begin to provide for taxes at the year ended December 31, 2008 was $2.4 million compared to $0.4 million for the year ended 2007 due mainlyfull statutory rate. In addition, we are subject to the acquisitionsexamination of Makoour income tax returns by the Internal Revenue Service and Flotation, though Flotation has only eight monthsother tax authorities. We regularly assess the likelihood of depreciation expense since it was acquired May 1, 2008. Fixed assets acquired inadverse outcomes resulting from these examinations to determine the Mako and Flotation subsidiaries totaled $7.9 million. A totaladequacy of $1.1 million of the depreciation expense is recorded as cost of sales related to revenue-producing assets, compared to $0.3 millionour provision for the previous year. In addition, amortization of intangible assets for the year ended December 31, 2008 was $1.0 million compared to approximately $28,000 for the year ended 2007. For the year ended December 31, 2008 we recorded eight months of amortization for Flotation intangible assets plus a full year of Mako intangible assets, whereas only one month of Mako amortization was included for 2007.income taxes.
We depreciate our assets using the straight-line method over the estimated useful lives of the respective assets. Buildings are depreciated between 10 and 36 years, and leasehold improvements are amortized over the shorter of the assets' useful lives or lease terms. We depreciate equipment from two to seven years, computers and electronics from two to four years, and furniture and fixtures from two to seven years. Deep Down’s intangible assets consist of $19.2 million in specifically identified intangible assets acquired in the purchase of the Flotation and Mako subsidiaries, including customer relationships, non-compete covenants, trademarks and various technology rights. We are amortizing the intangible assets over their estimated useful lives on the straight-line basis between three and forty years.Recent Accounting Pronouncements
Interest expense
Interest expense for the year ended December 31, 2008 was $3.5 million compared to $2.4 million for the prior year. In connection with the early payoff of our credit agreement with ProspectRecent Accounting Pronouncements are included in June 2008, we accelerated the remaining deferred financing costs totaling $0.7 million and recorded this charge to interest expense. Additionally, $1.5 million in debt discounts were accelerated and recorded as interest expense. We paid cash interest related to such credit agreement totaling $0.9 million for the year ended December 31, 2008 compared to $0.5 million in the prior year. During the year ended December 31, 2008, we recognized $0.1 million of interest related to accretion on the redemption of Series E Preferred Stock. For the prior year, $1.6 million of the total interest related to accretion on the redemption of Series G and Series E Preferred Stock.
Gain/(loss) on debt extinguishment
In connection with the early payoff of our credit agreement with Prospect in June 2008, early termination fees of approximately $0.4 million were recognized as a loss on early extinguishment of debt. During the year ended December, 31, 2007, we executed a Securities Redemption Agreement with our former chief financial officer to redeem 4,000 shares of Series E exchangeable preferred stock at a discounted price of $500 per share for a total of $2.0 million. The discount of $500 per share from the face value of $1,000 was accounted for as a substantial modification of debt, thereby generating a gain on extinguishment of debt of $2.0 million.
Net Income (loss)
Net loss was $4.3 million for the year ended December 31, 2008 as compared to net income of approximately $1.0 million for the prior year. This is due primarily to the costs incurred with private placement of stock and the related registration statement penalty costs of $1.2 million, the costs associated with the acquisition of Flotation, and a $1.4 million increase to bad debt expense to increase reserves and write off a large receivable from a customer in Louisiana that filed for bankruptcy.
EBITDA
Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP financial measure. We use EBITDA as an unaudited supplemental financial measure to assess the financial performance of our assets without regard to financing methods, capital structures, taxes or historical cost basis; our liquidity and operating performance over time in relation to other companies that own similar assets and that we believe calculate EBITDA in a similar manner; and the ability of our assets to generate cash sufficient for us to pay potential interest costs. We also understand that such data are used by investors to assess our performance. However, the term EBITDA is not defined under generally accepted accounting principles and EBITDA is not a measure of operating income, operating performance or liquidity presented in accordance with generally accepted accounting principles. When assessing our operating performance or liquidity, investors should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with generally accepted accounting principles.
EBITDA decreased by approximately $3.7 million to $0.4 million for the year ended December 31, 2008 from approximately $4.1 million for the previous year. This decrease includes one-time charges of $1.4 million for increased bad debt expense, and in connection with the acquisition of Flotation and the registration statement, approximately $1.2 million in professional fees plus $1.2 million in accrued penalties associated with the delay in the approval of the registration statement.
The following is a reconciliation of net income (loss) to EBITDA for the years ended December 31, 2008 and 2007:
| | | 2008 | | | 2007 | | | Change | | | % | |
| Net income (loss) | | $ | (4,322,893 | ) | | $ | 952,509 | | | $ | (5,275,402 | ) | | | -553.8% | |
| Add back interest expense | | | 3,511,177 | | | | 2,430,149 | | | | 1,081,028 | | | | 44.5% | |
| Deduct interest income | | | (110,504 | ) | | | (92,664 | ) | | | (17,840 | ) | | | 19.3% | |
| Add back depreciation and amortization | | | 2,363,106 | | | | 426,964 | | | | 1,936,142 | | | | 453.5% | |
| Add back tax expense (benefit) | | | (1,042,372 | ) | | | 369,673 | | | | (1,412,045 | ) | | | -382.0% | |
| EBITDA | | $ | 398,514 | | | $ | 4,086,631 | | | $ | (3,688,117 | ) | | | (90.2)% | |
Capital Resources and Liquidity
We believe that the liquidity we derived from the Private Placement and cash flows attributable to our operations is sufficient to fund our capital expenditures, debt maturities and other business needs. We generated our liquidity and capital resources primarily through operations and available capital markets. At December 31, 2008, long-term debt was $2.1 million, of which $0.4 million was current.
Notwithstanding the foregoing, on November 11, 2008, we entered into a $2.0 million revolving credit agreement (the “Revolver”) with Whitney Bank as lender. On December 18, 2008, we amended the Revolver and added an additional $1.2 million to the credit agreement as a term loan. We expect that such financing will sufficiently support our working capital needs. At December 31, 2008, we have not drawn any amounts available under the Revolver. The $1.2 million term loan was used to pay 75% of the new Super Mohawk 21 ROV which was delivered in January 2009. See“Part II, Item 8. Financial Statements” Note 71 to the consolidated financial statements, included in this report.
Our credit agreement with Whitney Bank provides for letters“Summary of credit, which we executed an irrevocable transferrable standby letter of credit with a customer for $1.1 million on February 10, 2009. The letter of credit was executed as a guarantee of performance by Deep Down and its subsidiaries on a long-term contract, allows partial and multiple drawings, and expires August 31, 2009 with an automatic one-year extension period unless cancelled 90 days in advance of the expiration date.
On March 5, 2009, Flotation, obtained loan proceeds in the principal amount of approximately $1.8 million pursuant to a loan agreement Flotation and the Company entered into with TD Bank as of February 13, 2009. This loan agreement provides a further commitment to Flotation for advancement of principal in the amount of $0.3 million. In connection with the loan agreement, TD Bank required that the Company enter into a debt subordination agreement that subordinated any debt Flotation owes to the Company other than accounts payable between them arising in the ordinary course of business. Furthermore, as part of the loan agreement TD Bank required a “negative pledge” that prohibits Flotation and the Company from granting security interests in Flotation’s personal property, other than such security interests granted in respect of the Company’s primary facility for borrowed money (as currently held with Whitney Bank). See Note 15 to the consolidated financial statements included in this report for further information on this loan agreement.
In connection with such loan for Flotation, the Company entered into a second amendment of its existing credit facility with Whitney Bank. The terms of the second amendment included a guarantor’s consent and agreement, to be signed by each of the Company’s subsidiaries as guarantors of the obligations of the Company under such existing credit facility, that Whitney Bank required as a condition to the effectiveness of the second amendment. Additionally, Whitney Bank required that Deep Down International Holdings, LLC enter into joinder agreements for the guaranty and security agreement arrangements generally required of the Company’s subsidiaries under the existing credit facility.
As of December 31, 2008, our cash and cash equivalents were $2.6 million, which includes restricted cash of $0.1 million. Cash and cash equivalents were $2.6 million including restricted cash of $0.4 million as of December 31, 2007. Management believes that we have adequate capital resources when combined with our cash position and cash flow from operations to meet current operating requirements for the 12 months ending December 31, 2009.
On June 5, 2008, we sold 57,142,857 shares of Deep Down’s common stock in the Private Placement at a price of $0.70 per share, for a total purchase price of $40.0 million and net proceeds to us of approximately $37.1 million. We used $22.1 million of the net proceeds to fund the cash portion of the Flotation purchase, and used approximately $12.5 million to repay outstanding debt, interest and early termination fees on June 12, 2008. We retained the balance from the Private Placement to be used for working capital purposes. In connection with the Registration Rights Agreement associated with the Private Placement and under guidance of SFAS 5, we have reserved $1.2 million in potential damages for the 90-day period September 4 to December 4, 2008. See Item 3. Legal Proceedings included in this report with regard to the Registration Rights Agreement.
On January 4, 2008, in accordance with the terms of the purchase of Mako, the original shareholders of Mako received the first cash installment of $2.9 million, and on April 11, 2008 they received the final cash installment of $1.2 million pursuant to the securities redemption and shareholder payable agreement.
Cash Flow from Operating Activities
For the year ended December 31, 2008, cash used in operating activities was $0.2 million as compared to $3.0 million for the prior year. Our working capital balances vary due to delivery terms and payments on key contracts, costs and estimated earnings in excess of billings on uncompleted contracts, and outstanding receivables and payables. We used some of the operating cash flow to reduce accounts payable and accrued liabilities by $0.3 million compared to an increase of $1.0 million in 2007. Billings in excess of costs on uncompleted contracts increased by $2.1 million for 2008 mostly related to a large job that will be completed during 2009. Additionally, we recorded the following non-cash charges during 2008: amortization of deferred financing costs and debt discount related to the extinguishment of long-term debt totaling $2.6 million, share-based compensation of $0.6 million, bad debt expense of $1.5 million and depreciation and amortization of $2.4 million. In fiscal 2007, we had a gain on extinguishment of debt of $2.0 million related to the redemption of preferred stock at a discount, recognition of a sales type lease receivable of $0.9 million, an increase of finished goods of $0.5 million, depreciation and amortization of $0.4 million and amortization of deferred financing costs, debt discounts and accretion on preferred stock totaling $1.8 million.
Cash Flow from Investing Activities
For the year ended December 31, 2008, cash used in investing activities was $31.0 million as compared to $1.4 million for the prior year. The majority of the 2008 activity related to the cash paid to Flotation shareholders totaling $22.1 million offset by cash acquired of $0.2 million, which was funded by the net proceeds of the Private Placement as discussed above. Additionally, in accordance with the terms of the purchase of Mako, we made the cash payments to the original Mako shareholders in the amount of $4.2 million plus some adjustments to purchase price expenses. The restricted cash balance of $0.37 million as of December 31, 2007 was released in connection with the payoff of the Credit Agreement, offset by the increase in restricted cash of $0.1 million required under a letter of credit entered into during fiscal year 2008. We used $4.8 million for equipment purchases for the year ended December 31, 2008 as compared to $0.8 million for the prior year period.
Cash Flow from Financing Activities
For the year ended December 31, 2008, cash provided by financing activities was $31.5 million compared to $6.6 million for the prior year period. During the year ended December 31, 2008, we completed the foregoing described Private Placement for net proceeds of $37.1 million. In June 2008, we paid approximately $12.5 million to Prospect to pay the balance due under its Credit Agreement and related interest and early termination fees. In January 2008, in accordance with the terms of the purchase of Mako, we paid $0.9 million of notes payable plus accrued interest of $2,664, and received proceeds from Prospect totaling $5.6 million. During the third quarter of 2008, we received the balance due under the sales lease receivable, bringing the annual receipts to $0.6 million.
For the year ended December 31, 2007, net cash provided from financing activities was $6.6 million. This was primarily due to long-term debt issuances totaling $6.2 million, which was offset by payments on long term debt of $2.8 million. Additionally, we received proceeds from the issuance of common stock net of expenses of $4.0 million.
Significant Accounting Policies.”
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 is material to investors.
Inflation and Seasonality
We do not believe that our operations are significantly impacted by inflation. Our business is not seasonal in nature.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value under generally accepted accounting procedures and expands disclosures on fair value measurements. This statement applies under previously established valuation pronouncements and does not require the changing of any fair value measurements, though it may cause some valuation procedures to change. Under SFAS No. 157, fair value is established by the price that would be received to sell the item or the amount to be paid to transfer the liability of the asset as opposed to the price to be paid for the asset or received to transfer the liability. Further, it defines fair value as a market specific valuation as opposed to an entity specific valuation, though the statement does recognize that there may be instances when the low amount of market activity for a particular item or liability may challenge an entity’s ability to establish a market amount. In the instances that the item is restricted, this pronouncement states that the owner of the asset or liability should take into consideration what effects the restriction would have if viewed from the perspective of the buyer or assumer of the liability. This statement is effective for all assets valued in financial statements for fiscal years beginning after November 15, 2007. Deep Down adopted SFAS 157 for financial assets and liabilities in 2008 with no material impact to the consolidated financial statements but with additional required consolidated financial statement footnote disclosures. We do not anticipate the application of SFAS 157 to nonfinancial assets and nonfinancial liabilities will have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”) and No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 141(R) and SFAS No. 160 are products of a joint project between the FASB and the International Accounting Standards Board. The revised standards continue the movement toward the greater use of fair values in financial reporting. SFAS No. 141(R) will significantly change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. These changes include the expensing of acquisition related costs and restructuring costs when incurred, the recognition of all assets, liabilities and noncontrolling interests at fair value during a step-acquisition, and the recognition of contingent consideration as of the acquisition date if it is more likely than not to be incurred. SFAS No. 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 141(R) and SFAS No. 160 are effective for both public and private companies for fiscal years beginning on or after December 15, 2008 (January 1, 2009 for companies with calendar year-ends). SFAS No. 141(R) will be applied prospectively. SFAS No. 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS No. 160 shall be applied prospectively. Early adoption is prohibited for both standards. We will apply the requirements of SFAS No. 141(R) to all business combinations after January 1, 2009; SFAS No. 160 will have no impact on our consolidated financial statements as we have no minority interests.
In December 2007, the SEC staff issued Staff Accounting Bulletin (“SAB”) 110, Share-Based Payment, which amends SAB 107, Share-Based Payment, to permit public companies, under certain circumstances, to use the simplified method in SAB 107 for employee option grants after December 31, 2007. Use of the simplified method after December 2007 is permitted only for companies whose historical data about their employees’ exercise behavior does not provide a reasonable basis for estimating the expected term of the options. Deep Down did not have stock options outstanding until 2007, and thus does not have adequate historical data to determine expected option lives. Therefore, we will continue to use the simplified method as allowed under the provision of SAB 110.
In June 2008, EITF 07-5, “Determining whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock” was issued. This standard triggers liability accounting on all options and warrants exercisable at strike prices denominated in any currency other than the Company’s functional currency or where instruments’ exercise prices is reset under certain future events. This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application is not permitted. We are currently evaluating the impact that EITF 07-5 will have on our consolidated financial position or result of operations.
In June 2008, FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5 (“EITF No. 08-4”)”. The objective of EITF No.08-4 is to provide transition guidance for conforming changes made to EITF No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, that result from EITF No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments”, and SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008. Early application is permitted. Management is currently evaluating the impact of adoption of EITF No. 08-4.
ItemITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This item is not applicable for smaller reporting companies.
The financial statements and schedules are included herewith commencing on page F-1.
Reports of Independent Registered Public Accounting Firm Firms | F-2 |
| |
| Consolidated Balance Sheets | F-5
F-4 |
| |
| Consolidated Statements of Operations | F-6
F-5 |
| |
| Consolidated Statements of Changes in Stockholders’ Equity | F-7
F-6 |
| |
| Consolidated Statements of Cash Flows | F-8F-7 |
| |
| Notes to Consolidated Financial Statements | F-10F-8 |
None.
ItemITEM 9A.CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
. We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officerChief Executive Officer and principal financial officer,Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, our principal executive officerChief Executive Officer and principal financial officerChief Financial Officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective due to the material weaknesses described below to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officerChief Executive Officer and principal financial officer,Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. This determination was in response to the SEC comment letter received February 26, 2009, in which the SEC stated that they require that we present the audited predecessor financial statements for Deep Down, Inc. for the period January 1, 2006 through November 20, 2006, in accordance with Rule 310(a) of Regulation S-B. Management will remediate this as soon as practicable by supplementing the amounts reported in Form 10-KSB for December 31, 2007 with the predecessor audited financial information for Deep Down from January 1, 2006 to November 20, 2006. See Item 1B. Unresolved Staff Comments, included in this report on Form 10-K for further information on the SEC response.
Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
Management’s Report on Internal Control Over Financial Reporting.
Our managementManagement is responsible for the fair presentation of the consolidated financial statements of Deep Down, Inc. Management is also responsible for establishing and maintaining adequatea system of internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
(i)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(ii)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of our management assessedand directors; and
(iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2008. In making this assessment, our management usedbased on the criteria set forthframework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Commission. Based on this evaluation, our management concluded our internal control over financial reporting was not effective as of December 31, 2010.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company'sour annual or interim financial statements will not be prevented or detected on a timely basis. We have identified the following material weaknesses.weaknesses as of December 31, 2010:
| 1. | As of December 31, 2008, we did not maintain effective controls over the control environment. Specifically, we have not formally adopted a written code of business conduct and ethics that governs the Company’s employees, officers and directors. Further, the Board of Directors does not currently have any independent members and no director qualifies as an audit committee financial expert as defined in Item 407(d)(5)(ii) of Regulation S-B. We did not maintain the following controls: sufficient policies and procedures over the administration of an accounting and fraud risk policy, sufficient documentation on the review and follow-up on the remediation of deficiencies, and a sufficient segregation of duties to decrease the risk of inappropriate accounting. Since these entity level programs have a pervasive effect across the organization, management has determined that these circumstances constitute a material weakness. |
| | |
| 2. | Management has determinedWe did not maintain effective monitoring controls. Specifically, we did not have sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training who could execute appropriate monitoring and review controls, particularly in situations where transactions were complex or non-routine. This material weakness contributed to the additional material weaknesses discussed below.We did not have adequate controls to provide reasonable assurance that revenue was recorded in accordance with GAAP. Specifically, we did not have appropriately designed or effectively operating management review controls performed by individuals with appropriate technical expertise to ensure that the accounting for contracts under the percentage-of-completion method was appropriate. This material weakness resulted in material errors that caused a restatement of our interim financial statements for the fiscal periods ended March 31, 2010, June 30, 2010, and September 30, 2010. We did not have an adequate internal control designed to prevent or detect and correct erroneous information in our project cost accounting application. This material weakness resulted in material errors that caused a restatement of our interim financial statements for the fiscal periods ended March 31, 2010, June 30, 2010, and September 30, 2010. As a result of the material weaknesses described above, we concluded that we did not maintain effective controls over the accuracy of revenue recognition. Specifically, there was not sufficient review, supervision, and monitoring in regards to projects accounted for under the percentage-of-completion method. |
Because of these material weaknesses, management has concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2008,2010 based on the criteria established in "Internal Control-Integrated Framework" issued by the COSO.Framework.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC.
Changes in Internal Control Over Financial Reporting. Management has implemented the following changes to our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the fiscal quarter ended December 31, 2010 which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting:
· | During the fourth quarter of fiscal 2010 and into 2011, Management has increased review of the processes related to the recognition of revenue accounted for under the percentage-of-completion methodology, including the timely review of cost estimates at completion for all material percentage-of-completion contracts. Effective with the Restatement and during the fourth quarter of fiscal 2010, Management corrected the errors identified in the labor and burden rates applied to the project costs used in the percentage-of-completion accounting model. |
· | As discussed elsewhere in this Form 10-K, the Flotation subsidiary was contributed to CFT effective December 31, 2010. We retain a 20% equity ownership interest in the joint venture. |
Management’s remediation plans. In our efforts to continuously improve our internal controls, management has taken steps to enhance the following controls and procedures subsequent to December 31, 20082010 as part of our remediation efforts in addressing the material weaknesses above:
· | During the quarter ended March 31, 2011, management strengthened management review controls surrounding revenue recognition to provide reasonable assurance that revenue was recorded in accordance with GAAP, including review by operating and finance management of all estimates to complete for percentage-of-completion contracts. |
· | Management also plans to complete and distribute an Accounting Policy and Procedures manual. |
· | Management is inThough the processoperations of implementing a new system-wide accounting andFlotation were contributed to CFT effective December, 31, 2010, we plan to monitor improvements to the JV’s internal controls deemed necessary by the JV’s management, software programparticularly those related to address the revenue recognition and gross margin analysis of projects accounted for under the percentage-of-completion method.recognition. |
· | Management has prepared an Employee Handbook and Code of Conduct and plans to circulate these documents throughout the organization and obtain signed acknowledgements from employees. |
· | Management plans to document its accounting policies and procedures to increase consistency among divisions. |
· | Management has increased documentation around certain authorization and review controls. |
This annual report includes an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.
ItemITEM 9B.OTHER INFORMATION
None.
PART III
Item 10. | DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT |
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth the names, ages and positions of all of our directors and executive officers.
| Name | | Age | | Position Held With The CompanyDeep Down |
RobertRonald E. Chamberlain, Jr.Smith(2) | | 50 | | Chairman of the Board, Chief Acquisitions Officer and Director |
Ronald E. Smith* | | 5052 | | President, Chief Executive Officer and Director |
Eugene L. Butler (1) | | 6769 | | Executive Chairman and Chief Financial Officer and Director |
Mary L. Budrunas*Budrunas(2) | | 5759 | | Vice-President,Vice President, Corporate Secretary and Director |
Bradley M. ParroMichael J. Newbury | | 5143 | | Vice-PresidentVice President Operations and Business Development |
| Mark R. Hollinger | | 53 | | Director |
_________________________
*(1) Mr. Butler was appointed our Executive Chairman of the Board effective September 1, 2009. Effective April 29, 2010, in connection with Gay Mayeux’s appointment as Chief Financial Officer, the Board accepted the resignation of Mr. Butler as Chief Financial Officer. We continued to employ Mr. Butler as Executive Chairman of the Board under the Employment Agreement dated January 1, 2010. Mr. Butler was then was reappointed as Chief Financial Officer upon Ms. Mayeux’s departure, effective January 24, 2011.
(2) Ronald E. Smith and Mary L. Budrunas are married to each other.
Robert E. Chamberlain, Jr., ChairmanBiographical 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 Board, Chief Acquisitions Officer,time of this filing, in light of our business and Director. Mr. Chamberlain has served as Chairman and Director of the Company since December 2006. Mr. Chamberlain has a B.S. in Chemical Engineering and a B.S. in Biomedical Engineering from Northwestern University's Technological Institute and an MBA from Northwestern University's Kellogg Graduate School of Management. Mr. Chamberlain served as Vice President with Solomon Brothers Inc. (1986 to 1992), where his responsibilities included mergers, acquisitions, leveraged buyouts, merchant banking, divestitures, corporate finance, capital raises, restructurings and new product development in both the private and public markets. From 1992 through 1995, Mr. Chamberlain served as Vice President for Laidlaw Securities and Dickinson & Co. where he was responsible for generating public and private equity transactions. Since 1995, Mr. Chamberlain has assisted small emerging growth companies gain access to the capital markets and develop well articulated strategic objectives through consulting companies he controlled. Previously, Mr. Chamberlain served as Chairman, CEO, CFO and Director of a publicly-traded energy company involved in the development of oil and gas opportunities, primarily in the Barnett Shale of Texas.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 of the Company 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 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 and Director.Officer. Mr. Butler has served as Chief Financial Officer and Director with Deep Down since June 2007.2007, and was appointed Executive Chairman of the Board effective September 1, 2009. Mr. Butler was Managing Director of CapSources, Inc., an investment banking firm specializing in mergers, acquisitions and restructurings, from 2002 until 2007. Prior to this, he has served in various capacities as a director, president, chief executive officer, chief financial officer and chief operating officer for Weatherford International, Inc., a $2 billionmulti-billion 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 also serves on the Board of Powell Industries, Inc. (Nasdaq: POWL) since 1991, where he is the Chairman of the Audit Committee and on the Governance Committee. Mr. Butler is a Certified Public Accountant.
In addition to his extensive knowledge of us, 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, and has served as our Vice-President, Corporate Secretary and Director of the Company since December 2006. Ms. Budrunas is responsible for the Company’sour 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.
Bradley M. Parro, Vice President. Mr. Parro has served as Vice President since May 2008. Prior to this, he wasMs. Budrunas is qualified for service on the Managing Director for Continental Shelf Associates where he was responsible for business development for that company’s Houston, Texas office. From 1998 through 2004, he served in various executive capacities, including chief financial officer, chief operating officer and chief executive officer of PetroCom, LLC, a $30 million wireless communications company serving the offshoreBoard based on her extensive oil and gas industry. He alsoindustry experience. Such expertise provides valuable insight to the Board.
Michael J. Newbury, Vice President Operations and Business Development. Mr. Newbury joined Deep Down in March 2009 in the role of Corporate Business Development Manager, bringing more than 19 years of international experience and relationships in offshore business development, sales and marketing, and subsea service project support. Mr. Newbury’s initial role at Deep Down was the improvement in our marketing, sales and commercial aspects, additionally to oversee large project opportunities and to strengthen our contractual functions. In February 2010, Mr. Newbury was promoted to Vice President Business Development and was tasked with the additional responsibilities of corporate operations and interfacing with all of our business units. Prior to joining us, Mr. Newbury held various positions with increasing authority and responsibility with such companies as Subsea 7 from 2002 to 2009, a $2 billion multi-national service and equipment corporation serving the positionworldwide energy market, General Manager, North and Central America – i-Tech Division, Commercial Manager, North and Central America – ROV, Survey & DGPS, Business Development Manager, North America; Halliburton Subsea (US) 1999 – 2002, Senior Manager – Business Development, Operations Project Manager – ROV and Marine; Subsea International (US) 1997 – 1999, Safety, Quality and Environmental Group Manager & Human Resources & Payroll Manager, and Subsea Offshore Limited (Great Yarmouth and Aberdeen UK) 1990-1997, General Manager, HSEQ Global Manager, Quality Assurance Global Manager, Quality Assurance Engineer. Mr. Newbury has worked in most major oil producing regions of chief financial officer for oilfield service providers Ceanic Corporationthe world, including the Gulf of Mexico, Central America, North Sea, Asia, and Perry Tritech, Inc. His experience includes mergersAustralia. Mr. Newbury’s main areas of focus over the past eight years have been in offshore business development, tendering, and acquisitions, corporate restructuring, equity and sub-debt placement, strategic planning and execution and executive financial and operational management.contract negotiation. Mr. Parro hasNewbury graduated in 1990 with a Bachelor of Science degree in finance from the University of Illinois at Champaign-Urbana and a Master of Business Administration degree from Loyola University of Chicago.Management.
Mark R. Hollinger, Director. Mr. Hollinger joined the Board as an independent director effective April 12, 2010, and was appointed Chairman of the Audit Committee of the Board of Directors. Mr. Hollinger is currently President of MacDermid Offshore Solutions at MacDermid, Inc. (“MacDermid”), which provides specialty fluids used for the hydraulic controls of valves in the offshore drilling and production systems; a position he has held since September 2007. Prior to MacDermid, Mr. Hollinger served as President of Merix Corporation from May 1999 to January 2007 and Chief Executive Officer from September 1999 to January 2007. During the past five years, Mr. Hollinger served on the board of directors of Merix Corporation and Simple Tech, as well as several non-profit board of directors. Mr. Hollinger holds an MBA in Finance from The Ohio State University.
Mr. Hollinger is qualified for service on the Board based on his experience and expertise in management, plus his knowledge of the international energy market and business strategy, and is a financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K. Also, Mr. Hollinger’s past and current service on the Boards of other public companies brings a depth of experience and perspective to our Board.
Corporate Governance
The Company promotesWe promote accountability for adherence to honest and ethical conduct; endeavorswe endeavor to provide full, fair, accurate, timely and understandable disclosure in reports and documents that the Company fileswe file with the SEC and in other public communications made by the Companyus and strivesstrive to be compliant with applicable governmental laws, rules and regulations. The Company has not formallyWe have adopted a written codeDirectors Code of businessBusiness Conduct to promote honest and ethical conduct and ethics that governscompliance with applicable laws, rules, regulations and standards on the part of our board of directors. This code addresses several matters, including conflicts of interest, corporate opportunities, confidentiality, fair dealing, protection and proper use of Company assets, compliance with laws, rules and regulations (including insider trading laws), and encouraging the reporting of any illegal or unethical behavior. We have also adopted Financial Officer’s Code of Business Conduct to promote honest and ethical conduct, proper disclosure of financial information in the Company’s employees,periodic reports, and compliance with applicable laws, rules, and regulations by the Company’s officers and directors asmanagement personnel, including the Company is not requiredCompany’s chief executive officer, chief financial officer and controller. The policies established by this code are aimed at preventing wrongdoing and at promoting honest and ethical conduct, including ethical handling of actual and apparent conflicts of interest, the full, fair, accurate, timely and understandable disclosure in public communications, compliance with applicable laws, rules and regulations, and accountability for adherence to do so.the code through prompt internal reporting of violations of the code.
InUntil the addition of Mr. Hollinger to our Board, in lieu of an Audit Committee, the Company’sour Board of Directors iswas 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'sour financial statements and other services provided by the Company’sour independent public accountants. We created an Audit Committee in April 2010 who will perform these functions. The Board of Directors reviews the Company'sour internal accounting controls, practices and policies. Our Board of Directors has determined that no directorMr. Hollinger, Chairman of the Audit Committee, qualifies as an independent audit committee financial expert as defined in Item 407(d) (5) (ii) of Regulation S-K.
Changes to the Procedures for Stockholder’s Nomination of Directors
By action approved by the Company’s stockholders during fiscal year 2008 and under provisions of amendments to the Company’s Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008, the Company established the following rules for stockholder nominations for directors to serve on the Company’s Board of Directors:
· | In order to make a nomination, a stockholder must give notice of such nomination to the Secretary of the Company in writing, delivered or mailed by first class United States mail, postage prepaid, not less than 30 days or more than 60 days prior to the meeting at which directors are to be elected; provided, however, that if the Company gives less than 40-days’ notice of such meeting of stockholders, such written notice shall be delivered or mailed to the Secretary of the Company no later than the close of the tenth day following the day on which notice of the meeting was mailed to the stockholders. |
· | Each notice given by a stockholder with respect to any nomination of directors shall set forth (1) the name, age, business address and, if known, residence address of each nominee proposed in the notice, (2) the principal occupation or employment of each such nominee, and (3) the number of shares of stock of the Company which are beneficially owned by each such nominee. |
· | The stockholder making any such nomination shall promptly provide any other information reasonably requested by the Company. |
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company’sour officers and directors, and persons who own more than ten percent of a registered class of the Company’sour 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 the Companyus with copies of all Section 16(a) forms they file.
Based solely upon a review of the copies of such forms furnished to the Companyus or written representations that no Forms 5 were required, the Company believesof our officers and directors, we believe that all Section 16(a) filing requirements were filed on a timely basis, except that Mr. Newbury and Mr. Hollinger were each not met during fiscal year 2008. There weretimely in the filing of one Form 3, Mr. Hollinger was not timely in the filing of two Form 4 filings due on April 1, 2008, required by Mary4s and Ms. Budrunas and Ron Smith for conversionswas not timely in the filing of Series D Preferred Stock into common stock on March 28, 2008, representing 16,627,005 and 6,652,871 shares of common stock, respectively. Theseone Form 4 filings have not been completed. Additionally, there were two Form 3 filings that were filed late during the year ended December 31, 2008. The first was required by Bradley M. Parro, to report the issuance of 350,000 stock options granted on May 1, 2008. The second was required by Jacob Marcell, to report the issuance of 7,032,781 shares of common stock granted on January 22, 2008. A total of three Form 4 filings were filed late for the reporting of issuance of 1,000,000 stock options and 350,000 shares of restricted common stock to each of Ron Smith, Robert Chamberlain and Eugene Butler. These Form 4 filings were due on February 19, 2008 and filed on February 28, 2008.5.
The following table sets forth information concerning the total compensation earned in the years ended December 31, 20082010 and 20072009 by our Chief Executive Officer and our twothree highest compensated executive officers other than our CEO, which included one executive who resigned in January 2011 (collectively, our “Named Executive Officers” or “NEOs”).
Summary Compensation Table
Name and Principal Position | Year | | Salary ($) | | | Bonus ($) | | | Stock Awards ($) (1) | | | Option Awards ($) (1) | | | All Other Compensation ($) (2) | | | Total | |
| | | | | | | | | | | | | | | | | | | | |
| Ronald E. Smith | 2008 | | $ | 250,000 | | | $ | 175,000 | | | $ | 64,313 | | | $ | 14,172 | | | $ | 12,000 | | | $ | 515,485 | |
| President, Chief Executive Officer and Director | 2007 | | $ | 250,000 | | | $ | 19,231 | | | $ | - | | | $ | - | | | $ | - | | | $ | 269,231 | |
| Robert E. Chamberlain, Jr. | 2008 | | $ | 225,000 | | | $ | 175,000 | | | $ | 64,313 | | | $ | 14,172 | | | $ | 32,440 | | | $ | 510,925 | |
| Chairman of the Board, Chief Acquisitions Officer and Director | 2007 | | $ | 180,000 | | | $ | - | | | $ | - | | | $ | - | | | $ | 20,265 | | | $ | 200,265 | |
| Eugene L. Butler | 2008 | | $ | 225,000 | | | $ | 175,000 | | | $ | 64,313 | | | $ | 220,272 | | | $ | 28,204 | | | $ | 712,789 | |
| Chief Financial Officer and Director | 2007 | | $ | 105,000 | | | $ | - | | | $ | - | | | $ | 120,225 | | | $ | 14,568 | | | $ | 239,793 | |
| Name and Principal Position | Year | | Salary ($) | | | Bonus ($) (6) | | | Stock Awards ($) (1) | | | Option Awards ($) (1) | | | All Other Compensation ($) (2) | | | Total | |
| Ronald E. Smith | 2010 | | $ | 362,250 | | | $ | - | | | $ | - | | | $ | - | | | $ | 18,000 | | | $ | 380,250 | |
| President and Chief Executive Officer | 2009 | | $ | 345,000 | | | $ | - | | | $ | 93,000 | | | $ | - | | | $ | 12,000 | | | $ | 450,000 | |
| Eugene L. Butler | 2010 | | $ | 325,500 | | | $ | - | | | $ | - | | | $ | - | | | $ | 46,817 | | | $ | 372,317 | |
| Executive Chairman and Chief Financial Officer (3) | 2009 | | $ | 310,000 | | | $ | - | | | $ | 93,000 | | | $ | 771,600 | | | $ | 24,348 | | | $ | 1,198,948 | |
| Gay Stanley Mayeux | 2010 | | $ | 163,462 | | | $ | - | | | $ | 87,500 | | | $ | 61,600 | | | $ | 12,000 | | | $ | 324,562 | |
| Vice President and Chief Financial Officer (4) | 2009 | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Michael J. Newbury | 2010 | | $ | 190,000 | | | $ | - | | | $ | - | | | $ | 18,150 | | | $ | 12,000 | | | $ | 220,150 | |
Vice President of Operations and Business Development (5) | 2009 | | $ | 109,615 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 109,615 | |
(1)Included in the “Stock Awards” and “Option Awards” columns are quantifiedthe aggregate grant date fair values of restricted stock awards and option awards made in 2010 and 2009. The grant date fair values of the table according to the amount included in 2008 and 2007 share-based compensation expense for the equity awards granted to each NEO through the end of 2008 as determinedwere computed in accordance with SFAS 123(R). No stock awards orFASB ASC Topic 718. A total of 2,000,000 option awards grantedwhich were originally issued on February 14, 2008 were cancelled in March 2010 and not reissued (such cancellation has no impact on compensation, since we are required to NEOs were forfeited during 2008 and 2007.expense the remaining unamortized stock based compensation at the time of cancellation). For a discussion of the assumptions and methodologies used to value the stock and option awards reported in the table above, see Note 10 “Stock-Based8 “Share-Based Compensation” to our consolidated financial statements included in this report.Report. All options are for the purchase of our common stock. Stock awards are grants of restricted stock representing time-vesting shares.
(2) The amounts in the “All Other Compensation” column for 20082010 were attributed to the following:
| · | Mr. Smith: Amounts included for the year ended 20082010 consisted of a vehicle allowance ($1,500 per month). |
| · | Mr. Butler: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,500 per month), payroll tax reimbursement of $13,517 and healthcare premium reimbursement of $13,800. |
| Ms. Mayeux: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,500 per month) for the eight months of her employment. |
| Mr. Newbury: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,000 per month). |
· | Mr. Chamberlain: Amounts included for the year ended 2008 consisted of a vehicle allowance ($1,000 per month) and $20,440 for reimbursement for federal and state payroll withholdings customarily withheld for an employee. |
· | Mr. Butler: Amounts included for the year ended 2008 consisted of a vehicle allowance ($1,000 per month) and $16,204 for reimbursement for federal and state payroll withholdings customarily withheld for an employee. |
(3) Mr. Butler was appointed Executive Chairman of the Board effective September 1, 2009. Effective April 29, 2010, in connection with Ms. Mayeux’s appointment as Chief Financial Officer, the Board accepted the resignation of Mr. Butler as Chief Financial Officer. We continued to employ Mr. Butler as Executive Chairman of the Board under the Employment Agreement dated January 1, 2010. Mr. Butler was then was reappointed as Chief Financial Officer upon Ms. Mayeux’s departure, effective January 24, 2011.
(4) Ms. Mayeux was hired as Chief Financial Officer effective April 29, 2010, and resigned effective January 24, 2011.
(5) Mr. Newbury was hired by Deep Down effective March 30, 2009 as Manager of Business Development and was promoted to Vice President of Operations and Business Development effective February 17, 2010.
(6) There were no bonuses awarded in 2010 or 2009 due to our current cost containment efforts.
Narrative Disclosure to Summary Compensation Table
All of the compensation described in the foregoing table, other than those amounts shown in the “Bonus”, “Stock Awards” and “Option Awards” columns, was paid to the NEOs pursuant to agreements with Deep Down.
Mr. Smith has an employment agreement to serve as our President and Chief Executive Officer.Officer, which provided initially for annual cash compensation of $345,000, and a monthly vehicle allowance of $1,000. Effective January 1, 2010, Mr. Smith’s employment agreement provides for an annual base salary of $250,000, whichcash compensation was increased to $345,000 effective January 1, 2009, plus$362,250, and a monthly vehicle allowance of $1,000 per month.$1,500. The term of Mr. Smith’s employment agreement is through August 6, 2010,January 1, 2013, and is subject to further automatic renewals for annual periods up to an additional two years.
For the year ended December 31, 2009, Mr. Chamberlain serves as our Chairman of the Board and Chief Acquisitions Officer pursuant toButler had a consulting agreement we have with Strategic Capital Services, Inc. (“Strategic”). Thebetween Deep Down and Eugene L. Butler & Associates to serve as our Chief Financial Officer. Mr. Butler’s consulting agreement with Strategic provides that we pay Mr. Chamberlain anprovided for annual base salarycash compensation of $180,000, which was increased to $225,000$310,000 effective as of January 1, 2008 and to $310,000 effective as of January 1, 2009. Additionally, Mr. Chamberlain receives2009; also a monthly vehicle allowance of $1,000 per month and reimbursement for federal and state payroll withholdings customarily withheld for an employee which are included in the “All Other Compensation” column. TheEffective January 1, 2010, Mr. Butler’s consulting agreement with Strategicwas replaced by an employment agreement. The employment agreement provides for Mr. Chamberlain’s services has an initialButler to receive cash compensation of $325,500 and a monthly vehicle allowance of $1,500. The term of Mr. Butler’s employment agreement is through August 6, 2010,January 1, 2013, and is subject to further automatic renewals for annual periods up to an additional two years.
Effective May 31, 2007, we hired Mr. ButlerMs. Mayeux had an employment agreement to serve as our Vice President and Chief Financial Officer, andwhich provided for hisannual cash compensation under an employment agreement. This employment agreement provided that Mr. Butler receive an annual base salary of $180,000.$250,000, and a monthly vehicle allowance of $1,500. The agreement also provided that he receive an aggregateterm of options to purchase 3,000,000 shares of our common stock. These options will vest over three years, with substantially one-third vesting on the first, second and third anniversary of the date of grant. The per share exercise price of $0.515 for such options was determined by the closing market price of the common stock on the date of grant. Effective August 6, 2007, Mr. Butler’sMs. Mayeux’s employment agreement was replaced by a consulting agreement between Deep Down and Eugene L. Butler & Associates. We increased compensation payable to Mr. Butler to $225,000 effective as ofthrough January 1, 20082013; Ms. Mayeux resigned from the Company effective January 24, 2011.
Mr. Newbury has an employment agreement to serve as our Vice President Operations and to $310,000 effective asBusiness Development, which provides for annual cash compensation of January 1, 2009. Additionally, Mr. Butler receives$190,000, and a monthly vehicle allowance of $1,000 per month and reimbursement for federal and state payroll withholdings customarily withheld for an employee, which are included in the “All Other Compensation” column.$1,000. The consultingterm of Mr. Newbury’s employment agreement for Mr. Butler’s services has an initial termis through August 6, 2010,February 17, 2012, and is subject to automatic renewals for annual periods up to an additional two years.unless cancelled by either party upon 90 days notice.
The amounts included in the “Bonus” column of the foregoing table represent specific cash bonuses paid to the NEOs. In June 2008, Messrs. Smith, Chamberlain and Butler were each awarded and paid a cash performance bonus in the amount of $100,000. Additionally, Deep Down awarded Messrs. Smith, Chamberlain and Butler with cash performance bonuses of $75,000 relating to fiscal year 2008 (the amounts were paid in January 2009). The amount included in the 2007 “Bonus” column of $19,168 for Mr. Smith represents offshore bonuses that are paid by the Company in respect of time the Company requires of its employees to spend offshore.
The amounts included for 20082010 in the “Stock Awards” and the “Option Awards” columnscolumn above reflect awards to purchasereflects a grant of 1,000,000 shares of our common stock and grants of 350,000 restricted shares of our common stock provided to each of Messrs. Smith, Chamberlain and ButlerMs. Mayeux on February 14, 2008. In each case,May 25, 2010 under the awards and grants were made under our 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan. The options vest over three years and have an exercise price of $1.50. Each of the grantsgrant of restricted shares of our common stock iswas scheduled to vest in its entirety on February 14, 2010,over three years ratably beginning one year from grant date, provided that the officer continues to be employed with Deep Down through the vesting date. All these shares were cancelled and returned to the Company upon resignation of Ms. Mayeux on January 24, 2011.
The amounts included for 2009 in the “Stock Awards” column above reflect grants of 750,000 restricted shares of our common stock provided to each of Messrs. Smith, and Butler on March 23, 2009 under the Plan. Each of the grants of restricted shares of our common stock vested in its entirety on March 23, 2011.
The amounts included for Ms. Mayeux for 2010 in the “Option Awards” column above reflect awards to purchase 1,000,000 shares of our common stock granted to Ms. Mayeux on April 29, 2010 under the Plan. The options were scheduled to vest over three years ratably beginning one year from grant date, and had an exercise price of $0.105. These options were cancelled and returned to the Company upon the resignation of Ms. Mayeux on January 24, 2011.
The amounts included for Mr. Newbury for 2010 in the “Option Awards” column above reflect awards to purchase 250,000 shares of our common stock granted to Mr. Newbury on February 19, 2010 under the Plan. The options are scheduled to vest over three years ratably beginning one year from grant date, and have an exercise price of $0.122.
The amounts included for Mr. Butler for 2009 in the “Option Awards” column above reflect awards to purchase 2,000,000 and 10,000,000 shares of our common stock granted to Mr. Butler on March 23, 2009 and September 1, 2009, respectively, under the Plan. The options vest over three years ratably beginning one year from grant date, and have an exercise price of $0.124 and $0.10, respectively.
Outstanding Equity Awards at December 31, 20082010
The following tables present information regarding the outstanding equity awards held by each of the NEOs as of December 31, 2008.2010. Mr. Smith had no outstanding option awards on that date.
Option Awards
| | Option Grant | | Number of Securities Underlying Unexercised Options | | | Number of Securities Underlying Unexercised Options | | | Option Exercise Price | | Option Expiration | |
| Name | Date | | Exercisable (#) | | | Unexercisable (#) | | | ($/Sh) | | Date | | | | Number of Securities Underlying Unexercised Options Exercisable | | Number of Securities Underlying Unexercised Options Unexercisable (#) | | Option Exercise Price ($/Sh) | | |
| Ronald E. Smith | 2/14/2008 | | - | | | | 1,000,000 | (1) | | | 1.50 | | 2/14/2013 | |
| Robert W. Chamberlain | 2/14/2008 | | - | | | | 1,000,000 | (1) | | | 1.50 | | 2/14/2013 | |
| Eugene L. Butler | 2/14/2008 | | - | | | | 1,000,000 | (1) | | | 1.50 | | 2/14/2013 | | 9/1/2009 | | 3,333,333 | | 6,666,667 (1) | | 0.10 | | 9/1/2014 |
| | 5/31/2007 | | 1,000,000 | (2) | | | 2,000,000 | (2) | | | 0.52 | | 8/31/2010 | | 3/23/2009 | | 666,667 | | 1,333,333 (2) | | 0.12 | | 3/23/2014 |
| Gay Stanley Mayeux | | | 4/29/2010 | | - | | 1,000,000 (3) | | 0.11 | | 4/29/2015 |
| Michael J. Newbury | | | 2/19/2010 | | - | | 250,000 (4) | | 0.12 | | 2/19/2015 |
| (1) | These options will vest over three years, with substantially one-third vesting on the first, second and third anniversary of the date of grant, provided that the officer continues to be employed with Deep Down through each vesting date. |
(2) | The remaining unvested portion of this option award is scheduled to vest in equal installments on May 31, 2009September 1, 2011 and May 31, 2010,September 1, 2012, provided that Mr. Butler continues to be employed with Deep Down through eachthose vesting dates. |
| (2) | A total of 666,667 options that were unexercisable at December 31, 2010 vested on March 23, 2011. The remaining 666,666 unvested options are scheduled to vest on March 23, 2012, provided that Mr. Butler continues to be employed with Deep Down through that vesting date. |
| (3) | These unvested options were cancelled in connection with Ms. Mayeux’s resignation effective January 24, 2011. |
| (4) | A total of 83,334 options vested on February 19, 2011. The unvested portions of this option award are scheduled to vest in equal installments on February 19, 2012 and February 19, 2013, provided that Mr. Newbury continues to be employed with Deep Down through those vesting dates. |
Stock Awards
| | | | | | | Award | | Number of Shares or Units of Stock That Have Not Vested | | Market Value of Shares or Units of Stock that Have Not Vested |
| Name | | | | | | Grant Date | | (#) (2) | | ($) (1) |
| Ronald E. Smith | | | | | | 2/14/2008 | | 350,000 | | 56,000 |
| Robert W. Chamberlain | | | | | | 2/14/2008 | | 350,000 | | 56,000 |
| Eugene L. Butler | | | | | | 2/14/2008 | | 350,000 | | 56,000 |
| Name | | | | Number of Shares or Units of Stock That Have Not Vested (#) | | Market Value of Shares or Units of Stock that Have Not Vested ($)(1) | | Number of Shares or Units of Stock That Vested (#) | | Market Value of Shares or Units of Stock that Have Vested ($)(1) |
| Ronald E. Smith | | 3/23/2009 | | 750,000 | (2) | $60,000 | | - | | - |
| | | 2/14/2008 | | | | | | 350,000 (3) | | $28,000 |
| Eugene L. Butler | | 3/23/2009 | | 750,000 | (2) | $60,000 | | - | | - |
| | | 2/14/2008 | | | | | | 350,000 (3) | | $28,000 |
| Gay Stanley Mayeux | | 5/25/2010 | | 1,000,000 | (4) | $80,000 | | - | | - |
| (1) | The market value is calculated by multiplying the number of shares by the closing price of our common stock of $ 0.160.08 on December 31, 2008.2010. |
| (2) | This restricted stock award is scheduled to vestvested in its entirety on March 23, 2011. |
| (3) | This restricted stock award was granted on February 14, 2008, and vested in its entirety on February 14, 2010, provided that the officer continues to be employed2010. |
| (4) | This unvested restricted stock award was cancelled in connection with Deep Down through the vesting date.Ms. Mayeux’s resignation effective January 24, 2011. |
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. Ms. Mayeux’ employment agreement contained the same provisions, however her agreement was terminated in connection with her departure in January 2011.
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 is 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 is 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; provided further that if no previous annual bonus has been paid to the Executive, then the lump sum cash payment 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 (as defined in the Employment Agreement), then each and every share option, restricted share award and other equity-based award that is outstanding and held by the Executive shall immediate vest and become exercisable.
Each of the Executives have 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 customer or potential customers, solicit the employment or services of any person employed by or a consultant us on the date of termination or with 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 Committee Report
We do not have a separate compensation committee. Accordingly, to the extent that decisions are made regarding the compensation policies pursuant to which our named executive officers are compensated, they are made by our Board.
In light of the foregoing, the Board has reviewed and discussed with management the Compensation Discussion and Analysis set forth above and determined that it be included in this annual report for the year ended December 31, 2010.
Submitted by:
Ronald E. Smith
Mary L. Budrunas
Eugene L. Butler
Mark R. Hollinger
Notwithstanding anything to the contrary set forth in any previous filings under the Securities Act, as amended, or the Exchange Act, as amended, that incorporate future filings, including this annual report, in whole or in part, the foregoing Compensation Committee Report shall not be incorporated by reference into any such filings.
Option Exercises and Stock Vested During the Year Ended December 31, 20082010
There were no options exercised by NEOs during the year ended December 31, 2008.2010. All of the restricted stock issued on February 14, 2008 becomesbecame fully vested on February 14, 2010. Additionally, 666,667 option granted to Mr. Butler on March 23, 2009 vested on March 23, 2010. All of the restricted stock issued on May 25, 2010 was cancelled in connection with the resignation of the executive effective January 24, 2011.
Compensation of Directors
The following table provides certain information with respect to the 2010 compensation of our directors who served in such capacity during the year. The 2010 compensation of those directors who are also our named executive officers is disclosed in the Summary Compensation Table above. We refer to our directors who are neither employed by us nor by our principal stockholders as outside directors. Compensation for our outside directors consists of equity and cash as described below. Our outside director as of the Company are all also executive officersdate of the Company and as directors do not receive any additional compensation for their performance of services as directors. The Company may agree to provide compensation to directors in the future.this statement is Mark R. Hollinger.
| Name | | Fees Earned or Paid in Cash ($) | | | Stock Awards ($) (1) | | | Option Awards ($) (1) | | | All Other Compensation ($) | | | Total | |
Eugene L. Butler (2) | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Ronald E. Smith (2) | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Mary L. Budrunas (2) | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Mark R. Hollinger | | $ | 32,500 | | | $ | 87,500 | | | $ | 50,800 | | | $ | - | | | $ | 170,800 | |
| (1) | Included in the “Stock Awards” and “Option Awards” columns are the aggregate grant date fair values of restricted stock awards and option awards made to our outside director in 2010. The grant date fair values of the awards were 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 8 “Share-Based Compensation” to our consolidated financial statements included in this Report. All options are for the purchase of our common stock. Stock awards are grants of restricted stock representing time-vesting shares. In May 2010, we granted 1,000,000 restricted shares, par value $0.001 per share for a total of $1,000, to Mr. Hollinger. The shares were valued at $0.0875 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 $87,500 over the three-year requisite service period. Additionally, in May 2010, we granted option awards to purchase 1,000,000 shares of our common stock to Mr. Hollinger. The options are scheduled to vest over three years ratably beginning one year from grant date, and have an exercise price of $0.09. |
| Each of our directors who also serve as our executive officers do not receive any additional compensation for their performance of services as directors. We may agree to provide compensation to these directors in the future. |
Equity Compensation
Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
We have not formalized equity compensation for outside directors.
Cash Compensation
We pay our outside directors an annual retainer of $12,000, plus meeting fees of $2,000 per meeting of the Board of Directors attended in person and $1,000 per meeting attended by telephone or other electronic means. All directors are also entitled to reimbursement of expenses. Outside directors serving in specified committee positions also receive the following additional annual retainers:
| Chairman of the Audit Committee | | $ | 10,000 | |
| Chairman of the Compensation Committee | | $ | 10,000 | |
| Chairman of the Governance Committee | | $ | 5,000 | |
Each committee member receives $1,000 for each meeting of a committee of the Board of Directors attended in person or by telephone or other electronic means.
Our outside director fees are payable in cash or, at the election of each director, which is made on an annual basis, in shares of stock determined by the current market price of the stock at the time of each payment.
Determining Director Compensation
The Board of Directors makes all decisions regarding the compensation of the Board of Directors. The Chief Executive Officer makes periodic recommendations regarding director compensation based on his subjective judgment and review of available survey data, and the Board of Directors may exercise its discretion in modifying or approving any adjustments or awards to the directors.
Compensation Policy Related to Risk Management
We do not believe that there are any risks arising from our compensation policies and practices for our employees that are reasonably likely to have a material adverse effect on us.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information, as of March 13, 2009,April 15, 2011, concerning the beneficial ownership of shares of Common Stock of the CompanyDeep Down by (i) each person known by the Companyus to beneficially own more than 5%5 percent of the outstanding shares of the Company’sour common stock; (ii) each Director; (iii) the Company’sour “Named Executive Officers” (as determined under Item 402(m) of Regulation S-K); and (iv) all directors and executive officers of the CompanyDeep Down as a group. To theour knowledge, of the Company, 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. In addition, unlessUnless otherwise indicated, all persons namedthe address for each of the individuals listed below can be reached atis c/o Deep Down, Inc., 8827 W. Sam Houston Pkwy N., Suite 100, Houston, Texas 77040.
| | Shares of Common Stock Beneficially Owned (1) | | Percent of Common Stock Outstanding |
| Ronald E. Smith (2) | | 44,963,209 | | 25.3% |
| Mary L. Budrunas (2) | | 44,963,209 | | 25.3% |
| Robert E. Chamberlain, Jr.(3) | | 25,691,708 | | 14.5% |
| Eugene L. Butler (4) | | 1,683,333 | | * |
| All directors and officers as a group (4 persons) | 72,338,250 (5) | | 40.3% |
| | | | | |
| * - Less than 1% | | | | |
| Name of Beneficial Owner (1) | | Shares of Common Stock Beneficially Owned | | Percent of Common Stock Outstanding |
| | | | | | |
| Directors and Executive Officers: | | | | |
| Ronald E. Smith (2) | | 45,337,301 | | | 22.0% |
| Mary L. Budrunas (2) | | 45,337,301 | | | 22.0% |
| Eugene L. Butler (4) | | 5,674,092 | | | 2.7% |
| Michael J. Newbury (5) | | 83,334 | | | * |
| Mark R. Hollinger (6) | | 1,166,666 | | | * |
| All directors and officers as a group (5 persons) | 52,261,393 | (7) | | 24.7% |
| | | | | | |
| 5% Shareholders: | | | | | |
| Flotation Investor, LLC | | 20,000,000 | | | 9.7% |
| 767 Fifth Avenue, 17th Floor | | | | | |
| New York, New York 10153 | | | | | |
| Robert E. Chamberlain, Jr. (3) | | 19,750,975 | | | 9.6% |
| 2909 N. Island Drive | | | | | |
| Seabrook, Texas 77586 | | | | | |
| | | | | | |
| * Less than 1% | | | | | |
| (1) | A person is deemed to be the beneficial owner of securities that can be acquired within 60 days from the date set forth above through the exercise of any option, warrant or right. Shares of common stock subject to options, warrants or rights that are currently exercisable or exercisable within 60 days are deemed outstanding for computing the percentage of the person holding such options, warrants or rights, but are not deemed outstanding for computing the percentage of any other person. The amounts and percentages are based upon 177,350,630206,399,155 shares of common stock outstanding as of MarchApril 13, 2009.2011. |
| (2) | Mr. Smith and Ms. Budrunas are husband and wife. Shares include 26,216,87126,724,296 shares owned directly by Mr. Smith and 18,413,00518,613,005 shares owned directly by Ms. Budrunas. SharesSuch shares also include 350,000 shares of restricted stock issued to Mr. Smith on February 14, 2008 which become fully vested on the second anniversary of the grant, February 14, 2010, plus 333,333 shares of Deep Down’s common stock that Mr. Smith has the right to acquire by exercise of stock options which vested on February 14, 2009.2010, and 750,000 shares of restricted stock issued to Mr. Smith on March 23, 2009 which vested on March 23, 2011. |
| (3) | Shares include 350,000 shares of restricted stock issued to Mr. Chamberlain on February 14, 2008, and 750,000 shares of restricted stock issued to Mr. Chamberlain on March 23, 2009 which becomewere fully vested on the second anniversary of the grant, February 14, 2010,September 1, 2009 in connection with Mr. Chamberlain’s Severance and Separation Agreement, plus 333,333750,000 shares of Deep Down’s commonrestricted stock thatissued to Mr. Chamberlain has the right to acquire by exercise of stock optionson September 1, 2009 which vested on, February 14, 2009.September 1, 2010, in connection with such Severance and Separation Agreement. |
| (4) | Shares include 350,000 shares of restricted stock issued to Mr. Butler on February 14, 2008 which become fully vested on the second anniversary of the grant, February 14, 2010 and 750,000 shares of restricted stock issued to Mr. Butler on March 23, 2009 which vested on March 23, 2011, plus 333,333 and 1,000,0004,666,667 shares of Deep Down’s common stock that Mr. Butler has the right to acquire by exercise of stock options which vested onduring 2010 and 2011. |
| (5) | Includes 83,334 shares of Deep Down’s common stock that Mr. Newbury has the right to acquire by exercise of stock options which vested February 14, 2009 and11, 2011. |
| (6) | Includes 500,000 shares of restricted stock purchased by Mr. Hollinger in April 2010 as part of a private placement, plus 333,333 shares of Deep Down’s common stock that Mr. Hollinger has the right to acquire by exercise of stock options which vestedvest on May 31, 2008, respectively.2011, and 333,333 shares of restricted stock issued to Mr. Hollinger on May 31, 2011 which will vest on May 31, 2011. |
(5) (7) | Shares include 1,999,9995,416,667 shares of Deep Down’s common stock that executive officers and directors have the right to acquire by exercise of stock options.options or restricted stock that are vested within 60 days of April 15, 2011. |
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, and Related Stockholder Matters and Issuer Purchases of Equity Securities” in Part II of this report.
Review and Approval of Related Person Transactions
We leaseOur board of directors and management recognize that related person transactions present a heightened risk of conflicts of interest, and therefore we review all buildings, structures, fixturesrelationships 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.
Ronald E. Smith, President, CEO and Director of Deep Down and Eugene Butler, Executive Chairman, CFO and Director of Deep Down, were investors in Ship and Sail, Inc. (“Ship and Sail”), a former vendor of Deep Down. During the year ended December 31, 2010, we made payments of $10,000 to Ship and Sail, and we expensed the prepaid balance of $38,000 as of December 31, 2009 during the first quarter of 2010. The payments and expense to Ship and Sail related to services provided by that entity for the support of the development of marine technology which is currently being marketed. Ship and Sail discontinued operations in mid-2010, thus there is no longer a related party relationship. As disclosed in the 2009 Form 10-K, we made a deposit for a boat in the amount of $100,000 which was written off in connection with the discontinued operations of Ship and Sail.
In January 2010, we loaned South Texas Yacht Services, a vendor of Deep Down, $100,000. The owner of South Texas Yacht Services was in a business alliance with Ship and Sail. The note receivable, included in other improvementsassets on the consolidated balance sheet, bears interest at our Channelview,a rate of 5.5 percent per annum and monthly principal and interest payments in the amount of $2,000 commenced in April 2010. The final principal and interest payment is due March 24, 2015. As of March 31, 2011, the payments on this note were current. Additionally, as of September 30, 2010, South Texas location fromYacht Services is no longer a related party as they are no longer in a business alliance with Ship and Sail.
Additionally, during the year ended December 31, 2010, we recorded expenses to JUMA, LLC, a company owned by Ronald E. Smith, CEO and a directorhis wife Mary L. Budrunas, Corporate Secretary and Director of Deep Down, in the amount of $35,000; there is no balance due as of December 31, 2010. Payments related to the monthly rental of a boat owned by JUMA, in connection with the development of marine technology as discussed above. The board of directors approved the arrangement between JUMA and Mary L. Budrunas,Deep Down with a vice president and a directortermination date of Deep Down. The base rate of $15,000 per month is payableDecember 31, 2010. No future payments are anticipated to JUMA, LLC through August 31, 2013, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.JUMA.
On March 28, 2008, Deep Down redeemed 4,500 sharesUntil the addition of Series D preferred stock owned by Ronald Smith and Mary Budrunas. The Series D preferred shares were redeemed for 23,279,876 shares of common stock.
None of the Company’s Directors are independent. Under the NASDAQ® standards for “independence”,Mr. Hollinger to our Board in April 2010, none of our Directors was independent. We feel additional independent directors would qualifywill add strength and perspective to our Board of Directors and will increase our internal control process as discussed above, thus we are actively working towards adding additional independent generally or with respectmembers to any specific independence requirements for any committee member. However, as the Company is not traded on the NASDAQ®, the Company is not required to comply with NASDAQ® independence requirements at this time. At such time, if ever, as the Company is traded on NASDAQ® or any alternative exchange, which requires director independence, the Company plans to take steps at that time to comply with such independence requirements.our Board.
We retained KPMG, LLP (“KPMG”) as our principal accountant in 2010. We had no relationship with KPMG prior to their retention as our principal accountant. The following table sets forth the aggregate fees paid to Malone & Bailey, PC KPMG for audit services rendered in connection with the Company'sour consolidated financial statements and reports for the yearsyear ended December 31, 2008 and 2007, respectively,2010, and for other services rendered during those yearsthat year on behalf of Deep Down and its subsidiaries:subsidiaries, and fees billed to us by PricewaterhouseCoopers LLP for audit and other services during 2009:
| | December 31, 2008 | December 31, 2007 | | December 31, 2010 | | | December 31, 2009 | |
| (i) Audit Fees | $ 503,714 | $ 205,967 | | $ | 821,700 | | | $ | 502,023 | |
| (ii) Audit Related Fees | 86,634 | 165,931 | | | - | | | | - | |
| (iii) Tax Fees | 49,130 | 16,260 | | | 118,307 | | | | 5,250 | |
| (iv) All Other Fees | - | - | | | - | | | | - | |
Audit Fees: Consists of fees billed for professional services rendered for the audit of Deep Down’s consolidated financial statements, the review of interim condensed consolidated financial statements included in quarterly reports, registration statements and other offering documentation, services that are normally provided by Malone & Bailey, PC 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." These services include auditing work on proposed transactions, including the audit of Mako Technologies, Inc., and Flotation Technologies, Inc., attest services that are not required by statute or regulation, and consultations concerning financial accounting and reporting standards.
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 Audit Committee of the Board of Directors pre-approves all audit and permissible non-audit services provided by Malone & Bailey, PC.KPMG. These services may include audit services, audit-related services, tax services and other services. The Audit Committee of 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
ItemITEM 15. Exhibits, EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial Statement SchedulesStatements and Schedules. See the consolidated financial statements and related footnotes commencing on page F-1 of this report.
(a) | Financial Statements and Schedules. See the consolidated financial statements and related schedules commencing on page F-1 of this report. |
Exhibit Number | | Description of Exhibit |
| 2.1 | | Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc. (incorporated by reference from Exhibit 2.1 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.1 | | Articles of Incorporation of Deep Down, Inc. (conformed to include the amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008)2008 (incorporated by reference from Exhibit A to our Schedule 14C filed on August 15, 2008). |
| 3.2 | | Amended and Restated ByLawsBy Laws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008). |
| 3.3 | | Form of Certificate of Designations of Series D Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.4 | | Form of Certificate of Designations of Series E Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.5 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.5 | | Form of Certificate of Designations of Series F Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.6 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.6 | | Form of Certificate of Designations of Series G Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.7 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 4.1 | | Common Stock Purchase Warrant for 320,000 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated August 6, 2007 (incorporated herein by reference from Exhibit 4.2 to our Form 10-KSB filed with the Commission on April 1, 2008). |
| 4.2 | | Common Stock Purchase Warrant for 118,812 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated January 4, 2008 (incorporated herein by reference from Exhibit 4.3 to our Form 10-KSB filed with the Commission on April 1, 2008). |
| 4.3 | | Common Stock Purchase Warrant for 200,000 shares of common stock of Deep Down, Inc. issued to Subsea, LLC dated June 6, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 8-K/A (Amendment No. 2) filed with the Commission on June 9, 2008). |
| 4.4 | | Registration Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect Capital Corporation (incorporated herein by reference from Exhibit 4.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 4.5 | Private Placement Memorandum
| Securities Purchase Agreement, dated May 16, 2008December 31, 2010, by and among Deep Down, Inc. and Flotation Investor, LLC (incorporated herein by reference from Exhibit 20.110.3 to our Form 8-K/A (Amendment No. 2)8-K filed with the Commission on June 9, 2008)January 5, 2011). |
| 4.6 | Amended and Restated Supplement No. 1 to Private Placement Memorandum, dated June 2, 2008 (incorporated herein by reference from Exhibit 4.6 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008).
|
4.7 | Purchase Agreement, dated June 2, 2008, among Deep Down, Inc., and the Purchasers named therein (incorporated herein by reference from Exhibit 10.1 to our Form 8-K/A (Amendment No. 2) filed with the Commission on June 9, 2008)
|
4.8 | 6% Subordinated Debenture of Deep Down, Inc. dated March 31, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 10-Q filed with the Commission on May 16, 2008) |
4.9† | Stock Option, Stock Warrant and Stock Award Plan (incorporated herein by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008).
|
| 10.1 | | Amended and Restated Credit Agreement, datedentered into as of November 11, 2008, amongApril 14, 2010, between Deep Down, Inc., as borrower, and Whitney National Bank, as lender, (incorporated herein by reference from Exhibit 10.1 to our Form 10-Q filed with the Commission on November 14, 2008). |
10.2 | First Amendment to Credit Agreement entered into as of December 18, 2008, among Deep Down, Inc. as borrower and Whitney National Bank, including the Guarantor’s Consent and Agreement as signed on behalf of ElectrowaveElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down Inc.International Holdings, LLC (incorporated herein by reference from Exhibit 10.110.31 to our Form 8-K10-K filed with the Commission on December 19, 2008)April 15, 2010). |
10.3*10.2 | Second
| First Amendment to Amended and Restated Credit Agreement, entered into as of February 13, 2009,dated December 31, 2010, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectrowaveElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down Inc.International Holdings, LLC (incorporated herein by reference from Exhibit 10.4 to our Form 8-K filed with the Commission on January 5, 2011). |
10.410.3 | | Guaranty, dated as of November 11, 2008, by ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.2 to our Form 10-Q filed with the Commission on November 14, 2008). |
10.5*10.4 | | Joinder to Guaranty, dated as of February 13, 2009, by Deep Down International Holdings, LLC.LLC (incorporated herein by reference from Exhibit 10.5 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
10.610.5 | | Security Agreement, dated as of November 11, 2008, among Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed with the Commission on November 14, 2008). |
10.7*10.6 | | Joinder to Security Agreement, dated as of February 13, 2009, by Deep Down International Holdings, LLC.LLC (incorporated herein by reference from Exhibit 10.7 to our Form 10-K filed with the Commission on March 16, 2009). |
10.810.7 | Second
| First Amendment to Security Agreement, dated as of February 13, 2009,December 18, 2008, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 8-K filed with the Commission on December 19, 2008). |
10.910.8 | Term Note, dated December 18, 2008,
| Second Amendment to Security Agreement, executed as of May 29, 2009, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and paid to order toDeep Down, Inc., for the benefit of Whitney National Bank (incorporated hereinby reference from Exhibit 10.4 to our Form 8-K filed on June 2, 2009). |
| 10.9 | | Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing, executed as of May 29, 2009, by Deep Down, Inc., as grantor, in favor of Gary M. Olander, as trustee, for the benefit of Whitney National Bank, as beneficiary (incorporated by reference from Exhibit 10.2 to our Form 8-K filed with the Commission on December 19, 2008)June 2, 2009). |
10.10†10.10 | Consulting
| Ratification of Guaranty, Security Agreement, and Intercreditor Agreement, dated as of August 6, 2007, betweenApril 14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and Strategic Capital Services,ElectroWave USA, Inc. regarding the services of Robert Chamberlain, Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc., a Delaware corporation, each a guarantor, and Whitney National Bank, a national banking association, as lender (incorporated herein by reference from Exhibit 10.110.36 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2011). |
10.11†10.11 | Employment Agreement,
| First Modification to Deed of Trust, dated as of August 6, 2007, betweenApril 14, 2010, executed by Deep Down, Inc. and Ronald E. Smith, as grantor, for the benefit of Whitney National Bank, as lender (incorporated herein by reference from Exhibit 10.210.37 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010). |
10.12†10.12 | Consulting Agreement,
| First Modification to Assignment of Leases and Rents, dated effective as of August 6, 2007, betweenApril 14, 2010, executed by Deep Down, Inc., as assignor, and Eugene L. Butler & Associates regarding the services of Eugene L. ButlerWhitney National Bank, as assignee (incorporated herein by reference from Exhibit 10.310.38 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010). |
| 10.13 | Agreement and Plan of Merger among
| ROV Term Note, dated April 14, 2010, executed by Deep Down, Inc., Mako Technologies, LLC, Mako Technologies, Inc. and paid to the shareholdersorder of Mako Technologies, Inc. dated December 17, 2007Whitney National Bank (incorporated herein by reference from Exhibit 2.110.32 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010). |
| 10.14 | Agreement and Plan of Reorganization among
| RE Term Note, dated April 14, 2010, executed by Deep Down, Inc., ElectroWave (USA), Inc., a Nevada corporation, ElectroWave (USA) Inc., a Texas corporation, Pinemont IV, Martin L. Kershman and Ronald W. Nancepaid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.1010.33 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
10.15 | Lease Agreement, dated September 1, 2006, between Deep Down, Inc., a Delaware corporation, as tenant, and JUMA, L.L.C. (incorporated herein by reference from Exhibit 10.4 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010).
|
10.1610.15 | Lease Amendment and Extension Agreement,
| RLOC Term Note, dated as of May 1, 2008, betweenApril 14, 2010, executed by Deep Down, Inc. a Delaware corporation, and JUMA, L.L.C.paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.810.34 to our Form 10-Q10-K filed with the Commission on AugustApril 15, 2008)2010). |
10.1710.16 | Lease Agreement
| LC Note, dated June 1, 2006, between Mako Technologies,April 14, 2010, executed by Deep Down, Inc., as Lessee and Sutton Industries, as Lessorpaid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.1210.35 to our Form 10-KSB/A10-K filed with the Commission on May 1, 2008)April 15, 2010). |
10.18*10.17 | | Office Building Lease, dated November 24, 2008, between Deep Down, Inc. and A-K-S-L 49 Beltway 8, L.P. |
10.19 | Stock Purchase Agreement, dated April 17, 2008, among Deep Down, Inc., Flotation Technologies, Inc. and the selling stockholders named therein (incorporated herein by reference from Exhibit 10.110.18 to our Form 8-K10-K filed with the Commission on April 21, 2008)March 16, 2009).
|
10.20†10.18† | Employment | Severance and Separation Agreement, with David A. Capotosto, dated June 5, 2008September 1, 2009, by and between Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr. (“Consultant”) and Deep Down, Inc. (incorporated herein by reference from Exhibit 10.1210.3 to our Form S-1 Registration Statement (file no. 333-152435)10-Q filed with the Commission on July 21, 2008)November 16, 2009). |
10.21† | Employment Agreement with Bradley M. Parro, dated May 1, 2008 (incorporated herein by reference from Exhibit 10.13 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008).
|
10.22*10.19 | | Loan Agreement entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.22 to our Form 10-K filed with the Commission on March 16, 2009). |
10.23*10.20 | | Mortgage and Security Agreement, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.23 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
10.24*10.21 | | Collateral Assignment of Leases and Rents, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.24 to our Form 10-K filed with the Commission on March 16, 2009). |
10.25*10.22 | | Commercial Note, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.25 to our Form 10-K filed with the Commission on March 16, 2009). |
10.26*10.23 | | Debt Subordination Agreement, entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.26 to our Form 10-K filed with the Commission on March 16, 2009). |
10.27*10.24 | Environmental Indemnity
| Purchase and Sale Agreement, entereddated May 22, 2009, by and between Deep Down, Inc. and JUMA Properties, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on June 2, 2009). |
| 10.25† | | Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 15, 2010). |
| 10.26† | | Amended and Restated Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 15, 2010). |
| 10.27† | | Employment Agreement, dated effective as of February 17, 2010, between Deep Down, Inc. and Michael J. Newbury (incorporated by reference from Exhibit 10.30 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.28† | | Employment Agreement, dated effective as of April 29 2010, between Deep Down, Inc. and Gay Stanley Mayeux (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010). |
| 10.29† | | Stock Option, Stock Warrant and Stock Award Plan (incorporated by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008). |
| 10.30 | | Stock Purchase Agreement, dated May 3, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010). |
| 10.31 | | Amendment No. 1 to Stock Purchase Agreement, dated July 13, 2009 in favor2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on July 14, 2010). |
| 10.32 | | Amendment No. 2 to Stock Purchase Agreement, dated October 4, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on October 4, 2010). |
| 10.33 | | Amendment No. 3 to Stock Purchase Agreement, dated effective as of TDOctober 31, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on November 8, 2010). |
| 10.34 | | Agreement and Amendment No. 4 to Stock Purchase Agreement, dated effective as of November 30, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on December 9, 2010). |
| 10.35 | | Waiver Agreement, dated April 28, 2010, by and between Whitney National Bank, N.A.as lender, and Deep Down, Inc., as borrower (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on May 5, 2010). |
| 10.36 | | Contribution Agreement, dated December 31, 2010, by and among Deep Down, Inc., Flotation Technologies, Inc., Cuming Flotation Technologies, LLC and Flotation Investor, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 5, 2011). |
| 10.37 | | Contract Assignment and Amendment Agreement, dated December 31, 2010, by and among Deep Down, Inc., Cuming Flotation Technologies, LLC and Cuming Corporation (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 5, 2011). |
| 10.38 | | Amended and Restated Limited Liability Company Agreement of Cuming Flotation Technologies, LLC, dated December 31, 2010 (incorporated by reference from Exhibit 10.5 to our Form 8-K filed January 5, 2011). |
| 10.39 | | Management Services Agreement, dated effective as of January 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.6 to our Form 8-K filed January 5, 2011). |
| 10.40 | | First Amendment to Management Services Agreement, dated effective as of March 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed March 8, 2011). |
| 10.41* | | Waiver, dated March 25, 2011, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower. |
| 10.42* | | Second Amendment to Amended and Restated Credit Agreement, dated April 14, 2011, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC. |
| Exhibit Number | | Description of Exhibit |
| 14.1 | | Directors Code of Business Conduct (incorporated herein by reference from Exhibit 14.1 to our Form 10-K filed with the Commission on April 15, 2010). |
21.1*14.2 | Subsidiary list
| Financial Officer’s Code of Business Conduct (incorporated herein by reference from Exhibit 14.2 to our Form 10-K filed with the Commission on April 15, 2010). |
| 16.1 | | Letter, dated July 14, 2009, from Malone & Bailey, PC to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed on July 14, 2009). |
| 16.2 | | Letter, dated June 30, 2010, from PricewaterhouseCoopers LLP to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed July 7, 2010). |
| 21.1* | | Subsidiary list. |
| 24.1* | | Power of Attorney (set forth immediately following the registrant’s signatures to this report). |
| 31.1* | | Rule 13a-14(a)/15d-14(a) Certification of the President and Chief Executive Officer of Deep Down, Inc. |
| 31.2* | | Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep Down, Inc. |
| 32.1* | | Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc. |
| 32.2* | | Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc. |
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DEEP DOWN, INC.
DEEP DOWN, INC. (Registrant) | | |
| | |
| | |
| /s/ RONALD E. SMITH | | |
Ronald E. Smith President and Chief Executive Officer Dated: April 15, 2011 | | |
| | |
| | |
| /s/ EUGENE L. BUTLER | | |
Eugene L. Butler Chief Financial Officer Dated: April 15, 2011 | | |
/s/ RONALD E. SMITH
President and Chief Executive Officer
Dated: March 16, 2009
/s/ EUGENE L. BUTLER
Eugene L. ButlerChief Financial Officer
Dated: March 16, 2009
POWER OF ATTORNEY
KNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints RONALD E. SMITH and EUGENE L. BUTLER, and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and re-substitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person hereby ratifying and confirming all that said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
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 dates indicated.
Signatures | | Title | | Date |
| | | | |
| /s/ RONALD E. SMITH | | President, Chief Executive Officer and Director | March 16, 2009 | April 15, 2011 |
| Ronald E. Smith | | (Principal Executive Officer) | | |
| | | | | |
| | | | |
| /s/ EUGENE L. BUTLER | | Executive Chairman and Chief Financial Officer and Director | March 16, 2009 | April 15, 2011 |
| Eugene L. Butler | | (Principal Financial Officer and Principal Accounting Officer) | |
| | | |
| | | | |
/s/ ROBERT E. CHAMBERLAIN, JR. | | Chairman, Chief Acquisitions Officer and Director | March 16, 2009 |
Robert E. Chamberlain, Jr. | Accounting Officer) | | |
| | | | |
| | | | |
| /s/ MARY L. BUDRUNAS | | Vice-President, Corporate Secretary and Director | March 16, 2009 | April 15, 2011 |
| Mary L. Budrunas | | | | |
| | | | |
| | | | |
| /s/ MARK R. HOLLINGER | | Director | | April 15, 2011 |
| Mark R. Hollinger | | | | |
EXHIBIT INDEX
Exhibit Number | | Description of Exhibit |
| 2.1 | | Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc. (incorporated by reference from Exhibit 2.1 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.1 | | Articles of Incorporation of Deep Down, Inc. (conformed to include the amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008)2008 (incorporated by reference from Exhibit A to our Schedule 14C filed on August 15, 2008). |
| 3.2 | | Amended and Restated ByLawsBy Laws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008). |
| 3.3 | | Form of Certificate of Designations of Series D Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.4 | | Form of Certificate of Designations of Series E Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.5 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.5 | | Form of Certificate of Designations of Series F Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.6 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.6 | | Form of Certificate of Designations of Series G Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.7 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 4.1 | | Common Stock Purchase Warrant for 320,000 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated August 6, 2007 (incorporated herein by reference from Exhibit 4.2 to our Form 10-KSB filed with the Commission on April 1, 2008). |
| 4.2 | | Common Stock Purchase Warrant for 118,812 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated January 4, 2008 (incorporated herein by reference from Exhibit 4.3 to our Form 10-KSB filed with the Commission on April 1, 2008). |
| 4.3 | | Common Stock Purchase Warrant for 200,000 shares of common stock of Deep Down, Inc. issued to Subsea, LLC dated June 6, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 8-K/A (Amendment No. 2) filed with the Commission on June 9, 2008). |
| 4.4 | | Registration Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect Capital Corporation (incorporated herein by reference from Exhibit 4.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 4.5 | Private Placement Memorandum
| Securities Purchase Agreement, dated May 16, 2008December 31, 2010, by and among Deep Down, Inc. and Flotation Investor, LLC (incorporated herein by reference from Exhibit 20.110.3 to our Form 8-K/A (Amendment No. 2)8-K filed with the Commission on June 9, 2008)January 5, 2011). |
| 4.6 | Amended and Restated Supplement No. 1 to Private Placement Memorandum, dated June 2, 2008 (incorporated herein by reference from Exhibit 4.6 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008).
|
4.7 | Purchase Agreement, dated June 2, 2008, among Deep Down, Inc., and the Purchasers named therein (incorporated herein by reference from Exhibit 10.1 to our Form 8-K/A (Amendment No. 2) filed with the Commission on June 9, 2008)
|
4.8 | 6% Subordinated Debenture of Deep Down, Inc. dated March 31, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 10-Q filed with the Commission on May 16, 2008) |
4.9† | Stock Option, Stock Warrant and Stock Award Plan (incorporated herein by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008).
|
| 10.1 | | Amended and Restated Credit Agreement, datedentered into as of November 11, 2008, amongApril 14, 2010, between Deep Down, Inc., as borrower, and Whitney National Bank, as lender, (incorporated herein by reference from Exhibit 10.1 to our Form 10-Q filed with the Commission on November 14, 2008). |
10.2 | First Amendment to Credit Agreement entered into as of December 18, 2008, among Deep Down, Inc. as borrower and Whitney National Bank, including the Guarantor’s Consent and Agreement as signed on behalf of ElectrowaveElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down Inc.International Holdings, LLC (incorporated herein by reference from Exhibit 10.110.31 to our Form 8-K10-K filed with the Commission on December 19, 2008)April 15, 2010). |
10.3*10.2 | Second
| First Amendment to Amended and Restated Credit Agreement, entered into as of February 13, 2009,dated December 31, 2010, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectrowaveElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down Inc.International Holdings, LLC (incorporated herein by reference from Exhibit 10.4 to our Form 8-K filed with the Commission on January 5, 2011). |
10.410.3 | | Guaranty, dated as of November 11, 2008, by ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.2 to our Form 10-Q filed with the Commission on November 14, 2008). |
10.5*10.4 | | Joinder to Guaranty, dated as of February 13, 2009, by Deep Down International Holdings, LLC.LLC (incorporated herein by reference from Exhibit 10.5 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
10.610.5 | | Security Agreement, dated as of November 11, 2008, among Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed with the Commission on November 14, 2008). |
10.7*10.6 | | Joinder to Security Agreement, dated as of February 13, 2009, by Deep Down International Holdings, LLC.LLC (incorporated herein by reference from Exhibit 10.7 to our Form 10-K filed with the Commission on March 16, 2009). |
10.810.7 | Second
| First Amendment to Security Agreement, dated as of February 13, 2009,December 18, 2008, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 8-K filed with the Commission on December 19, 2008). |
10.910.8 | Term Note, dated December 18, 2008,
| Second Amendment to Security Agreement, executed as of May 29, 2009, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and paid to order toDeep Down, Inc., for the benefit of Whitney National Bank (incorporated hereinby reference from Exhibit 10.4 to our Form 8-K filed on June 2, 2009). |
| 10.9 | | Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing, executed as of May 29, 2009, by Deep Down, Inc., as grantor, in favor of Gary M. Olander, as trustee, for the benefit of Whitney National Bank, as beneficiary (incorporated by reference from Exhibit 10.2 to our Form 8-K filed with the Commission on December 19, 2008)June 2, 2009). |
10.10†10.10 | Consulting
| Ratification of Guaranty, Security Agreement, and Intercreditor Agreement, dated as of August 6, 2007, betweenApril 14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and Strategic Capital Services,ElectroWave USA, Inc. regarding the services of Robert Chamberlain, Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc., a Delaware corporation, each a guarantor, and Whitney National Bank, a national banking association, as lender (incorporated herein by reference from Exhibit 10.110.36 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2011). |
10.11†10.11 | Employment Agreement,
| First Modification to Deed of Trust, dated as of August 6, 2007, betweenApril 14, 2010, executed by Deep Down, Inc. and Ronald E. Smith, as grantor, for the benefit of Whitney National Bank, as lender (incorporated herein by reference from Exhibit 10.210.37 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010). |
10.12†10.12 | Consulting Agreement,
| First Modification to Assignment of Leases and Rents, dated effective as of August 6, 2007, betweenApril 14, 2010, executed by Deep Down, Inc., as assignor, and Eugene L. Butler & Associates regarding the services of Eugene L. ButlerWhitney National Bank, as assignee (incorporated herein by reference from Exhibit 10.310.38 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010). |
| 10.13 | Agreement and Plan of Merger among
| ROV Term Note, dated April 14, 2010, executed by Deep Down, Inc., Mako Technologies, LLC, Mako Technologies, Inc. and paid to the shareholdersorder of Mako Technologies, Inc. dated December 17, 2007Whitney National Bank (incorporated herein by reference from Exhibit 2.110.32 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010). |
| 10.14 | Agreement and Plan of Reorganization among
| RE Term Note, dated April 14, 2010, executed by Deep Down, Inc., ElectroWave (USA), Inc., a Nevada corporation, ElectroWave (USA) Inc., a Texas corporation, Pinemont IV, Martin L. Kershman and Ronald W. Nancepaid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.1010.33 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
10.15 | Lease Agreement, dated September 1, 2006, between Deep Down, Inc., a Delaware corporation, as tenant, and JUMA, L.L.C. (incorporated herein by reference from Exhibit 10.4 to our Form 10-KSB10-K filed with the Commission on April 1, 2008)15, 2010).
|
10.1610.15 | Lease Amendment and Extension Agreement,
| RLOC Term Note, dated as of May 1, 2008, betweenApril 14, 2010, executed by Deep Down, Inc. a Delaware corporation, and JUMA, L.L.C.paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.810.34 to our Form 10-Q10-K filed with the Commission on AugustApril 15, 2008)2010). |
10.1710.16 | Lease Agreement
| LC Note, dated June 1, 2006, between Mako Technologies,April 14, 2010, executed by Deep Down, Inc., as Lessee and Sutton Industries, as Lessorpaid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.1210.35 to our Form 10-KSB/A10-K filed with the Commission on May 1, 2008)April 15, 2010). |
10.18*10.17 | | Office Building Lease, dated November 24, 2008, between Deep Down, Inc. and A-K-S-L 49 Beltway 8, L.P. |
10.19 | Stock Purchase Agreement, dated April 17, 2008, among Deep Down, Inc., Flotation Technologies, Inc. and the selling stockholders named therein (incorporated herein by reference from Exhibit 10.110.18 to our Form 8-K10-K filed with the Commission on April 21, 2008)March 16, 2009).
|
10.20†10.18† | Employment | Severance and Separation Agreement, with David A. Capotosto, dated June 5, 2008September 1, 2009, by and between Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr. (“Consultant”) and Deep Down, Inc. (incorporated herein by reference from Exhibit 10.1210.3 to our Form S-1 Registration Statement (file no. 333-152435)10-Q filed with the Commission on July 21, 2008)November 16, 2009). |
10.21† | Employment Agreement with Bradley M. Parro, dated May 1, 2008 (incorporated herein by reference from Exhibit 10.13 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008).
|
10.22*10.19 | | Loan Agreement entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.22 to our Form 10-K filed with the Commission on March 16, 2009). |
10.23*10.20 | | Mortgage and Security Agreement, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.23 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
10.24*10.21 | | Collateral Assignment of Leases and Rents, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.24 to our Form 10-K filed with the Commission on March 16, 2009). |
10.25*10.22 | | Commercial Note, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.25 to our Form 10-K filed with the Commission on March 16, 2009). |
10.26*10.23 | | Debt Subordination Agreement, entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.26 to our Form 10-K filed with the Commission on March 16, 2009). |
10.27*10.24 | Environmental Indemnity
| Purchase and Sale Agreement, entereddated May 22, 2009, by and between Deep Down, Inc. and JUMA Properties, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on June 2, 2009). |
| 10.25† | | Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 15, 2010). |
| 10.26† | | Amended and Restated Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 15, 2010). |
| 10.27† | | Employment Agreement, dated effective as of February 13, 2009 in favor of TD Bank, N.A.17, 2010, between Deep Down, Inc. and Michael J. Newbury (incorporated by reference from Exhibit 10.30 to our Form 10-K filed with the Commission on April 15, 2010). |
21.1*10.28† | Subsidiary list
| Employment Agreement, dated effective as of April 29 2010, between Deep Down, Inc. and Gay Stanley Mayeux (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010). |
| 10.29† | | Stock Option, Stock Warrant and Stock Award Plan (incorporated by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008). |
| 10.30 | | Stock Purchase Agreement, dated May 3, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010). |
| 10.31 | | Amendment No. 1 to Stock Purchase Agreement, dated July 13, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on July 14, 2010). |
| 10.32 | | Amendment No. 2 to Stock Purchase Agreement, dated October 4, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on October 4, 2010). |
| 10.33 | | Amendment No. 3 to Stock Purchase Agreement, dated effective as of October 31, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on November 8, 2010). |
| 10.34 | | Agreement and Amendment No. 4 to Stock Purchase Agreement, dated effective as of November 30, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on December 9, 2010). |
| 10.35 | | Waiver Agreement, dated April 28, 2010, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on May 5, 2010). |
| 10.36 | | Contribution Agreement, dated December 31, 2010, by and among Deep Down, Inc., Flotation Technologies, Inc., Cuming Flotation Technologies, LLC and Flotation Investor, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 5, 2011). |
| 10.37 | | Contract Assignment and Amendment Agreement, dated December 31, 2010, by and among Deep Down, Inc., Cuming Flotation Technologies, LLC and Cuming Corporation (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 5, 2011). |
| 10.38 | | Amended and Restated Limited Liability Company Agreement of Cuming Flotation Technologies, LLC, dated December 31, 2010 (incorporated by reference from Exhibit 10.5 to our Form 8-K filed January 5, 2011). |
| 10.39 | | Management Services Agreement, dated effective as of January 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.6 to our Form 8-K filed January 5, 2011). |
| 10.40 | | First Amendment to Management Services Agreement, dated effective as of March 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed March 8, 2011). |
| 10.41* | | Waiver, dated March 25, 2011, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower. |
| 10.42* | | Second Amendment to Amended and Restated Credit Agreement, dated April 14, 2011, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC. |
| Exhibit Number | | Description of Exhibit |
| 14.1 | | Directors Code of Business Conduct (incorporated herein by reference from Exhibit 14.1 to our Form 10-K filed with the Commission on April 15, 2010). |
| 14.2 | | Financial Officer’s Code of Business Conduct (incorporated herein by reference from Exhibit 14.2 to our Form 10-K filed with the Commission on April 15, 2010). |
| 16.1 | | Letter, dated July 14, 2009, from Malone & Bailey, PC to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed on July 14, 2009). |
| 16.2 | | Letter, dated June 30, 2010, from PricewaterhouseCoopers LLP to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed July 7, 2010). |
| 21.1* | | Subsidiary list. |
| 24.1* | | Power of Attorney (set forth immediately following the registrant’s signatures to this report). |
| 31.1* | | Rule 13a-14(a)/15d-14(a) Certification of the President and Chief Executive Officer of Deep Down, Inc. |
| 31.2* | | Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep Down, Inc. |
| 32.1* | | Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc. |
| 32.2* | | Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc. |
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting FirmFirms | F-2 |
| | |
| Consolidated Balance Sheets | F-5F-4 |
| | |
| Consolidated Statements of Operations | F-6F-5 |
| | |
| Consolidated Statements of Changes in Stockholders’ Equity | F-7F-6 |
| | |
| Consolidated Statements of Cash Flows | F-8F-7 |
| | |
| Notes to the Consolidated Financial Statements | F-10F-8 |
Independent Auditors’ Report
The Board of Directors
Deep Down, Inc.:
We have audited the accompanying consolidated balance sheet of Deep Down, Inc. and subsidiaries as of December 31, 2010, and the related consolidated statement of operations, statement of changes in stockholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Deep Down, Inc. and subsidiaries as of December 31, 2010, and the results of their operations and their cash flows for the year then ended in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
April 15, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Deep Down, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheetssheet of Deep Down, Inc. (the "Company")and its subsidiaries as of December 31, 2008 and 20072009, and the related consolidated statementsstatement of operations, changes in stockholders'shareholders' equity and cash flows for the yearsyear ended December 31, 2008 and 2007.2009. These consolidated financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.audit.
We conducted our auditsaudit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the auditsaudit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 provideaudit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company, as ofDeep Down, Inc. and their subsidiaries at December 31, 2008 and 2007,2009, and the results of itstheir operations and itstheir cash flows for the yearsyear ended December 31, 2008 and 20072009 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 12, 2009, expressed an adverse opinion.
/s/ MALONE & BAILEY, PC
www.malone-bailey.comPRICEWATERHOUSE COOPERS LLP
Houston, Texas
March 12, 2009
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
ToApril 15, 2010, except for the Board of Directors and Shareholders of Deep Down, Inc., Houston, Texas
We have audited Deep Down, Inc.’s (“the Company”) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizationseffects of the Treadway Commission (the COSO criteria). Deep Down, Inc.’s managementmatter discussed in Note 2, as to which the date is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.April 15, 2011
Management excluded from its assessment of the effectiveness of the Company’s disclosure controls and procedures and internal control over financial reporting, the disclosure controls and procedures and internal controls of the Flotation business. Management was unable to assess the effectiveness of the disclosure controls and procedures and internal control over financial reporting of the Flotation businesses because of the integration of the business. Management expects to update its assessment of the effectiveness of the disclosure controls and procedures and internal control over financial reporting to include the Flotation businesses as soon as practicable. The business accounts for approximately 32% of the consolidated revenue of Deep Down, and approximately 43% of consolidated assets.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management’s assessment:
· | Management has determined that the Company did not maintain an effective entity level control environment. Specifically: |
o | The Company has not yet implemented all the necessary policies and procedures to ensure that they have an effective control environment based on criteria established in the COSO framework. Specifically, the Company needs to fully implement controls to help prevent or detect the circumvention of controls by employees or management. The Company also needs to perform a formal risk profile and analysis of the Company. |
o | The Company did not maintain sufficient policies and procedures over the administration of an accounting and fraud risk policy. |
o | The Company did not maintain sufficient documentation on the review and follow up on the remediation of deficiencies. |
o | The Company did not maintain a sufficient segregation of duties to decrease the risk of inappropriate accounting. |
· | Management has determined that the Company did not maintain effective controls over the accuracy of revenue recognition. Specifically, there was not sufficient review, supervision, and monitoring in regards to projects accounted for under the percentage-of-completion method. |
These material weaknesses were considered in determining the nature, timing and extent of audit tests applied in our auditDEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
| (In thousands, except par value amounts) | | December 31, 2010 | | | December 31, 2009 | |
| ASSETS | | | | | | |
| Current assets: | | | | | | |
| Cash and cash equivalents | | $ | 3,730 | | | $ | 912 | |
| Accounts receivable, net of allowance of $245 and $304, respectively | | | 5,518 | | | | 7,662 | |
| Inventory | | | 223 | | | | 896 | |
| Costs and estimated earnings in excess of billings on uncompleted contracts | | | - | | | | 267 | |
| Prepaid expenses and other current assets | | | 267 | | | | 225 | |
| Total current assets | | | 9,738 | | | | 9,962 | |
| Property, plant and equipment, net | | | 11,676 | | | | 20,011 | |
| Investment in joint venture | | | 3,146 | | | | - | |
| Intangibles, net | | | 2,908 | | | | 12,342 | |
| Goodwill | | | 4,916 | | | | 9,429 | |
| Other assets | | | 1,240 | | | | 960 | |
| Total assets | | $ | 33,624 | | | $ | 52,704 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 5,719 | | | $ | 2,865 | |
| Billings in excess of costs and estimated earnings on uncompleted contracts | | | 446 | | | | 4,984 | |
| Deferred revenues | | | 315 | | | | 89 | |
| Current portion of long-term debt | | | 1,609 | | | | 1,497 | |
| Total current liabilities | | | 8,089 | | | | 9,435 | |
| Long-term debt, net | | | 2,443 | | | | 5,379 | |
| Total liabilities | | | 10,532 | | | | 14,814 | |
| | | | | | | | | |
| Commitments and contingencies (Note 13) | | | | | | | | |
| | | | | | | | | |
| Stockholders' equity: | | | | | | | | |
Common stock, $0.001 par value, 490,000 shares authorized, 207,399 and 180,451 shares, respectively, issued and outstanding | | | 207 | | | | 180 | |
| Additional paid-in capital | | | 63,751 | | | | 61,161 | |
| Accumulated deficit | | | (40,866 | ) | | | (23,451 | ) |
| Total stockholders' equity | | | 23,092 | | | | 37,890 | |
| Total liabilities and stockholders' equity | | $ | 33,624 | | | $ | 52,704 | |
The accompanying notes are an integral part of the fiscal year 2008 consolidated financial statements and this report does not affect our report dated March 12, 2009 on those financial statements.
In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, Deep Down, Inc. has not maintained effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Deep Down, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years ended December 31, 2008 and 2007 and our report dated March 12, 2009 expressed an unqualified opinion thereon.
/s/ Malone & Bailey, PC
www.malone-bailey.com
Houston, Texas
March 12, 2009
|
Consolidated Balance Sheets
|
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | December 31, 2008 | | | December 31, 2007 | |
| ASSETS | | | | | | |
| Cash and cash equivalents | | $ | 2,495,464 | | | $ | 2,206,220 | |
| Restricted cash | | | 135,855 | | | | 375,000 | |
| Accounts receivable, net | | | 10,772,097 | | | | 7,190,466 | |
| Prepaid expenses and other current assets | | | 633,868 | | | | 720,886 | |
| Inventory | | | 1,224,170 | | | | 502,253 | |
| Costs and estimated earnings in excess of billings on uncompleted contracts | | | 707,737 | | | | - | |
| Work in progress | | | 137,940 | | | | 749,455 | |
| Deferred tax asset | | | 216,900 | | | | 75,810 | |
| Receivable from Prospect, net | | | - | | | | 2,687,333 | |
| Total current assets | | | 16,324,031 | | | | 14,507,423 | |
| Property and equipment, net | | | 13,799,196 | | | | 5,368,961 | |
| Other assets, net | | | 457,836 | | | | 1,211,514 | |
| Intangibles, net | | | 18,090,680 | | | | 4,369,647 | |
| Goodwill | | | 15,024,300 | | | | 10,594,144 | |
| Total assets | | $ | 63,696,043 | | | $ | 36,051,689 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 4,318,394 | | | $ | 3,569,826 | |
| Billings in excess of costs and estimated earnings on uncompleted contracts | | | 2,315,043 | | | | 188,030 | |
| Payable to Mako shareholders | | | - | | | | 3,205,667 | |
| Current portion of long-term debt | | | 382,912 | | | | 995,177 | |
| Total current liabilities | | | 7,016,349 | | | | 7,958,700 | |
| Long-term debt, net of accumulated discount of $0 and $1,703,258 respectively | | | 1,718,475 | | | | 10,698,818 | |
| Deferred tax liabilities | | | 1,125,945 | | | | - | |
| Series E redeemable exchangeable preferred stock, par value $0.01, face value and liquidation | | | | | | | | |
preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate shares of all series of preferred stock, -0- and 500 issued and outstanding, respectively | | | - | | | | 386,411 | |
| Total liabilities | | | 9,860,769 | | | | 19,043,929 | |
| Temporary equity: | | | | | | | | |
| Series D redeemable convertible preferred stock, $0.01 par value, face value and liquidation | | | | | | | | |
preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate
shares of all series of preferred stock, -0- and 5,000 issued and outstanding, respectively | | | - | | | | 4,419,244 | |
| Total temporary equity | | | - | | | | 4,419,244 | |
| Stockholders' equity: | | | | | | | | |
| Common stock, $0.001 par value, 490,000,000 shares authorized, 177,350,630 | | | | | | | | |
| and 85,976,532 shares issued and outstanding, respectively | | | 177,351 | | | | 85,977 | |
| Additional paid-in capital | | | 60,328,124 | | | | 14,849,847 | |
| Accumulated deficit | | | (6,670,201 | ) | | | (2,347,308 | ) |
| Total stockholders' equity | | | 53,835,274 | | | | 12,588,516 | |
| Total liabilities and stockholders' equity | | $ | 63,696,043 | | | $ | 36,051,689 | |
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
See| | | | |
| (In thousands, except per share amounts) | | 2010 | | | 2009 | |
| | | | | | | |
| Revenues | | $ | 42,471 | | | $ | 28,810 | |
| Cost of sales: | | | | | | | | |
| Cost of sales | | | 26,559 | | | | 18,272 | |
| Depreciation expense | | | 2,327 | | | | 1,616 | |
| Total cost of sales | | | 28,886 | | | | 19,888 | |
| Gross profit | | | 13,585 | | | | 8,922 | |
| Operating expenses: | | | | | | | | |
| Selling, general and administrative | | | 13,964 | | | | 14,371 | |
| Depreciation and amortization | | | 1,731 | | | | 6,538 | |
| Goodwill impairment | | | 4,513 | | | | 5,537 | |
| Total operating expenses | | | 20,208 | | | | 26,446 | |
| Operating loss | | | (6,623 | ) | | | (17,524 | ) |
| Other income (expense): | | | | | | | | |
| Interest expense, net | | | (510 | ) | | | (356 | ) |
| Loss on contribution of net assets of wholly-owned subsidiary | | | (10,119 | ) | | | - | |
| Equity in net loss of joint venture | | | (254 | ) | | | - | |
| Other income, net | | | 266 | | | | 73 | |
| Total other expense | | | (10,617 | ) | | | (283 | ) |
| Loss before income taxes | | | (17,240 | ) | | | (17,807 | ) |
| Income tax (expense) benefit | | | (175 | ) | | | 1,026 | |
| Net loss | | $ | (17,415 | ) | | $ | (16,781 | ) |
| | | | | | | | | |
| Net loss per share, basic and diluted | | $ | (0.09 | ) | | $ | (0.09 | ) |
Weighted-average common shares outstanding, basic and diluted | | | 193,147 | | | | 179,430 | |
The accompanying notes toare an integral part of the consolidated financial statements.
Deep Down, Inc. | |
| |
For the Years Ended December 31, 2008 and 2007 | |
| | | For the Twelve Months Ended | |
| | | December 31, | |
| | | 2008 | | | 2007 | |
| | | | | | | |
| Revenues | | $ | 35,769,705 | | | $ | 19,389,730 | |
| Cost of sales | | | 21,686,033 | | | | 13,306,086 | |
| Gross profit | | | 14,083,672 | | | | 6,083,644 | |
| Operating expenses: | | | | | | | | |
| Selling, general & administrative | | | 14,290,440 | | | | 4,284,553 | |
| Depreciation and amortization | | | 1,285,079 | | | | 141,247 | |
| Total operating expenses | | | 15,575,519 | | | | 4,425,800 | |
| Operating income (loss) | | | (1,491,847 | ) | | | 1,657,844 | |
| Other income (expense): | | | | | | | | |
| Gain (loss) on debt extinguishment | | | (446,412 | ) | | | 2,000,000 | |
| Interest income | | | 110,504 | | | | 92,664 | |
| Interest expense | | | (3,511,177 | ) | | | (2,430,149 | ) |
| Other (expense) income | | | (26,333 | ) | | | 1,823 | |
| Total other expense | | | (3,873,418 | ) | | | (335,662 | ) |
| Income (loss) before income taxes | | | (5,365,265 | ) | | | 1,322,182 | |
| Benefit from (provision for) income taxes | | | 1,042,372 | | | | (369,673 | ) |
| Net income (loss) | | $ | (4,322,893 | ) | | $ | 952,509 | |
| Earnings (loss) per share: | | | | | | | | |
| Basic | | $ | (0.03 | ) | | $ | 0.01 | |
| Weighted-average common shares outstanding | | | 142,906,616 | | | | 73,917,190 | |
| Diluted | | $ | (0.03 | ) | | $ | 0.01 | |
| Weighted-average common shares outstanding | | | 142,906,616 | | | | 104,349,455 | |
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
See| | | Common Stock | | | | | | Accumulated | | | | |
| (In thousands) | | Shares (#) | | | Amount ($) | | | Capital | | | Deficit | | | Total | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Balance at December 31, 2008 | | | 177,351 | | | $ | 177 | | | $ | 60,328 | | | $ | (6,670 | ) | | $ | 53,835 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (16,781 | ) | | | (16,781 | ) |
| Restricted stock issued for service | | | 3,100 | | | | 3 | | | | (3 | ) | | | - | | | | - | |
| Share-based compensation | | | - | | | | - | | | | 836 | | | | - | | | | 836 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2009 | | | 180,451 | | | $ | 180 | | | $ | 61,161 | | | $ | (23,451 | ) | | $ | 37,890 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (17,415 | ) | | | (17,415 | ) |
| Issuance of common stock pursuant to a | | | | | | | | | | | | | | | | | | | | |
| private placement | | | 5,150 | | | | 5 | | | | 510 | | | | - | | | | 515 | |
| Issuance of restricted stock | | | 1,798 | | | | 2 | | | | (27 | ) | | | - | | | | (25 | ) |
| Stock issued | | | 20,000 | | | | 20 | | | | 1,380 | | | | - | | | | 1,400 | |
| Share-based compensation | | | - | | | | - | | | | 727 | | | | - | | | | 727 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2010 | | | 207,399 | | | $ | 207 | | | $ | 63,751 | | | $ | (40,866 | ) | | $ | 23,092 | |
The accompanying notes toare an integral part of the consolidated financial statements.
Deep Down, Inc. |
|
For the Years Ended December 31, 2008 and 2007 |
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
| | | | | | | | | | | | | | | Additional | | | | | | | |
| | | Common Stock | | | Series C Preferred Stock | | | Paid-in | | | Accumulated | | | | |
| | | Shares (#) | | | Amount ($) | | | Shares (#) | | | Amount ($) | | | Capital | | | Deficit | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2006 | | | 82,870,177 | | | $ | 82,870 | | | | 22,000 | | | $ | 22 | | | $ | (82,792 | ) | | $ | (3,299,817 | ) | | $ | (3,299,717 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | - | | | | - | | | | 952,509 | | | | 952,509 | |
| Shares repurchased | | | (25,000,000 | ) | | | (25,000 | ) | | | | | | | | | | | (225,000 | ) | | | | | | | (250,000 | ) |
| Redemption of Series E Preferred Stock | | | 3,463,592 | | | | 3,464 | | | | | | | | | | | | 3,840,314 | | | | | | | | 3,843,778 | |
| Redemption of Series C Preferred Stock | | | 4,400,000 | | | | 4,400 | | | | (22,000 | ) | | | (22 | ) | | | (4,378 | ) | | | | | | | - | |
| Stock issued for debt payment | | | 543,689 | | | | 544 | | | | | | | | | | | | 559,456 | | | | | | | | 560,000 | |
| Stock issued for acquisition of a business | | | 6,574,074 | | | | 6,574 | | | | | | | | | | | | 4,989,723 | | | | | | | | 4,996,297 | |
| Private Placement offering | | | 13,125,000 | | | | 13,125 | | | | | | | | | | | | 3,946,875 | | | | | | | | 3,960,000 | |
| Stock based compensation | | | - | | | | - | | | | | | | | | | | | 187,394 | | | | | | | | 187,394 | |
| Warrants issued to lender | | | | | | | | | | | | | | | | | | | 1,479,189 | | | | | | | | 1,479,189 | |
| Warrants issued to third party for deferred financing costs | | | | | | | | | | | | | | | | | | | 159,066 | | | | | | | | 159,066 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2007 | | | 85,976,532 | | | $ | 85,977 | | | | - | | | | - | | | $ | 14,849,847 | | | $ | (2,347,308 | ) | | $ | 12,588,516 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | - | | | | - | | | | (4,322,893 | ) | | | (4,322,893 | ) |
| Exchange of Series D preferred stock | | | 25,866,518 | | | | 25,867 | | | | | | | | | | | | 4,393,377 | | | | | | | | 4,419,244 | |
| Stock issued for acquisition of Mako | | | 2,802,969 | | | | 2,803 | | | | | | | | | | | | 1,959,275 | | | | | | | | 1,962,078 | |
| Stock issued for acquisition of Flotation | | | 1,714,286 | | | | 1,714 | | | | | | | | | | | | 1,421,143 | | | | | | | | 1,422,857 | |
| Warrants issued for acquisition of Flotation | | | | | | | - | | | | | | | | | | | | 121,793 | | | | | | | | 121,793 | |
| Restricted stock issued for service | | | 1,200,000 | | | | 1,200 | | | | | | | | | | | | (1,200 | ) | | | | | | | - | |
| Stock issued in private placement, net of $2,940,331 fees | | | 57,142,857 | | | | 57,143 | | | | | | | | | | | | 37,002,527 | | | | | | | | 37,059,670 | |
| Cashless exercise of stock options | | | 29,339 | | | | 29 | | | | | | | | | | | | (29 | ) | | | | | | | - | |
| Stock issued for exercise of warrants | | | 2,618,129 | | | | 2,618 | | | | | | | | | | | | (2,618 | ) | | | | | | | - | |
| Stock based compensation | | | - | | | | - | | | | | | | | | | | | 584,009 | | | | | | | | 584,009 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2008 | | | 177,350,630 | | | $ | 177,351 | | | | - | | | | - | | | $ | 60,328,124 | | | $ | (6,670,201 | ) | | $ | 53,835,274 | |
| | | | |
| (In thousands) | | 2010 | | | 2009 | |
| Cash flows from operating activities: | | | | | | |
| Net loss | | $ | (17,415 | ) | | $ | (16,781 | ) |
| Adjustments to reconcile net loss to net cash provided by operating activities: | | | | | |
| Impairment of goodwill | | | 4,513 | | | | 5,537 | |
| Equity in loss of joint venture | | | 254 | | | | - | |
| Share-based compensation | | | 727 | | | | 836 | |
| Stock issued for services | | | 14 | | | | - | |
| Bad debt expense | | | 72 | | | | 192 | |
| Depreciation and amortization | | | 4,058 | | | | 8,154 | |
| (Gain) loss on disposal of property, plant and equipment | | | (190 | ) | | | 78 | |
| Deferred income taxes, net | | | - | | | | (909 | ) |
| Changes in assets and liabilities: | | | | | | | | |
| Accounts receivable | | | 1,669 | | | | 2,918 | |
| Inventory | | | 79 | | | | 466 | |
| Costs and estimated earnings in excess of billings on uncompleted contracts | | | 267 | | | | 441 | |
| Prepaid expenses and other current assets | | | 233 | | | | 409 | |
| Other assets | | | 189 | | | | (113 | ) |
| Accounts payable and accrued liabilities | | | 2,827 | | | | (1,454 | ) |
| Deferred revenues | | | 227 | | | | 80 | |
| Billings in excess of costs and estimated earnings on uncompleted contracts | | | (1,567 | ) | | | 2,678 | |
| Net cash (used in) provided by operating activities | | | (4,043 | ) | | | 2,532 | |
| | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | |
| Purchases of property, plant and equipment | | | (2,634 | ) | | | (6,117 | ) |
| Proceeds from sale of property, plant and equipment | | | 251 | | | | 148 | |
| Investment in cost method securities | | | (25 | ) | | | (200 | ) |
| Cash paid for equity investment in joint venture | | | (1,400 | ) | | | - | |
| Contribution of net assets of wholly-owned subsidiary | | | 10,119 | | | | - | |
| Proceeds from final settlement of acquisition of Flotation | | | - | | | | 58 | |
| Cash paid for capitalized software | | | (278 | ) | | | (614 | ) |
| Proceeds from note receivable | | | (87 | ) | | | (22 | ) |
| Change in restricted cash | | | - | | | | 136 | |
| Net cash provided by (used in) investing activities | | | 5,946 | | | | (6,611 | ) |
| | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | |
| Proceeds from sale of common stock | | | 1,901 | | | | - | |
| Stock cancelled for payroll taxes | | | (25 | ) | | | - | |
| Borrowings of long-term debt | | | - | | | | 3,000 | |
| Repayments of long-term debt | | | (961 | ) | | | (504 | ) |
| Net cash provided by financing activities | | | 915 | | | | 2,496 | |
| Change in cash and equivalents | | | 2,818 | | | | (1,583 | ) |
| Cash and cash equivalents, beginning of period | | | 912 | | | | 2,495 | |
| Cash and cash equivalents, end of period | | $ | 3,730 | | | $ | 912 | |
| | | | | | | | | |
| Supplemental schedule of noncash operating, investing and financing activities: | | | | | |
| Cash paid for interest | | $ | 519 | | | $ | 373 | |
| Prepaid insurance purchased with debt | | $ | 305 | | | $ | - | |
| Fixed assets purchased with debt | | $ | - | | | $ | 2,100 | |
| Fixed assets purchased with capital lease | | $ | 253 | | | $ | 92 | |
| Fixed assets transferred to other assets | | $ | 100 | | | $ | - | |
| Restricted stock issued for service | | $ | 2 | | | $ | 3 | |
SeeThe accompanying notes toare an integral part of the consolidated financial statements.
Deep Down, Inc. | |
| |
For the Years Ended December 31, 2008 and 2007 | |
| | | 2008 | | | 2007 | |
| Cash flows from operating activities: | | | | | | |
| | | | | | | |
| Net income (loss) | | $ | (4,322,893 | ) | | $ | 952,509 | |
| Adjustments to reconcile net income to net cash used in operating activities: | | | | | | | | |
| Gain on extinguishment of debt | | | - | | | | (2,000,000 | ) |
| Interest income | | | (54,975 | ) | | | - | |
| Non-cash amortization of debt discount | | | 1,816,847 | | | | 1,780,922 | |
| Non-cash amortization of deferred financing costs | | | 762,700 | | | | 54,016 | |
| Share-based compensation | | | 584,009 | | | | 187,394 | |
| Bad debt expense | | | 1,507,494 | | | | 108,398 | |
| Depreciation and amortization | | | 2,363,106 | | | | 426,964 | |
| Loss on disposal of equipment | | | 228,352 | | | | 24,336 | |
| Deferred taxes payable | | | (855,708 | ) | | | - | |
| Changes in assets and liabilities: | | | | | | | | |
| Lease receivable | | | - | | | | (863,000 | ) |
| Accounts receivable | | | (3,087,260 | ) | | | (4,388,146 | ) |
| Prepaid expenses and other current assets | | | (493,100 | ) | | | (54,310 | ) |
| Inventory | | | (1,224,170 | ) | | | - | |
| Finished goods | | | - | | | | (502,253 | ) |
| Costs and estimated earnings in excess of billings on uncompleted contracts | | | 1,482,698 | | | | - | |
| Work in progress | | | (707,737 | ) | | | 246,278 | |
| Accounts payable and accrued liabilities | | | (328,788 | ) | | | 1,022,726 | |
| Billings in excess of costs and estimated earnings on uncompleted contracts | | | 2,127,013 | | | | (1,970 | ) |
| Net cash used in operating activities | | $ | (202,412 | ) | | $ | (3,006,136 | ) |
| Cash flows used in investing activities: | | | | | | | | |
| Cash paid for acquisition of Flotation, net of cash acquired of $235,040 | | | (22,161,864 | ) | | | - | |
| Cash paid for acquisition of Mako, net of cash acquired of $280,841 | | | (4,236,634 | ) | | | 280,841 | |
| Cash deficit acquired in ElectroWave acquisition | | | - | | | | (18,974 | ) |
| Cash paid for third party debt | | | - | | | | (432,475 | ) |
| Cash received from sale of ElectroWave receivables | | | - | | | | 261,068 | |
| Cash paid for final acquisition costs | | | - | | | | (242,924 | ) |
| Purchases of equipment | | | (4,803,795 | ) | | | (830,965 | ) |
| Restricted cash | | | 239,145 | | | | (375,000 | ) |
| Net cash used in investing activities | | $ | (30,963,148 | ) | | $ | (1,358,429 | ) |
| Cash flows from financing activities: | | | | | | | | |
| Payment for cancellation of common stock | | | - | | | | (250,000 | ) |
| Redemption of preferred stock | | | - | | | | (250,000 | ) |
| Proceeds from sale of common stock, net of expenses | | | 37,059,670 | | | | 3,960,000 | |
| Proceeds from sales-type lease | | | 587,000 | | | | 276,000 | |
| Borrowings on debt - related party | | | - | | | | 150,000 | |
| Payments on debt - related party | | | - | | | | (150,000 | ) |
| Borrowings on long-term debt | | | 6,769,087 | | | | 6,204,779 | |
| Increase in deferred financing fees | | | - | | | | (442,198 | ) |
| Creation of debt discount due to lender's fees | | | - | | | | (180,000 | ) |
| Payments of long-term debt | | | (12,960,953 | ) | | | (2,760,258 | ) |
| Net cash provided by financing activities | | $ | 31,454,804 | | | $ | 6,558,323 | |
| Change in cash and equivalents | | | 289,244 | | | | 2,193,758 | |
| Cash and cash equivalents, beginning of period | | | 2,206,220 | | | | 12,462 | |
| Cash and cash equivalents, end of period | | $ | 2,495,464 | | | $ | 2,206,220 | |
See accompanying notes to consolidated financial statements.
Deep Down, Inc. |
Consolidated Statements of Cash Flows |
For the Years Ended December 31, 2008 and 2007 |
| | | 2008 | | | 2007 | |
| Supplemental schedule of noncash investing and financing activities: | | | | | | |
| Warrants issued for acquisition of Flotation | | $ | 121,793 | | | $ | - | |
| Stock issued for acquisition of Flotation | | $ | 1,422,857 | | | $ | - | |
| Stock issued for acquisition of Mako | | $ | 1,962,078 | | | $ | 4,996,297 | |
| Receivable from lender - Prospect Capital Corporation | | $ | - | | | $ | 5,604,000 | |
| Payable to Mako Shareholders | | $ | - | | | $ | (2,916,667 | ) |
| Non-cash increases to Mako Goodwill | | $ | (371,728 | ) | | $ | - | |
| Deferred tax adjustment to Mako Goodwill | | $ | (1,840,563 | ) | | $ | - | |
| Correction of common stock par value to paid in capital | | $ | - | | | $ | 114,750 | |
| Fixed assets purchased with capital lease | | $ | - | | | $ | 525,000 | |
| Fixed assets transferred from Inventory | | $ | 502,253 | | | $ | 110,181 | |
| Exchange of Series D preferred stock | | $ | 4,419,244 | | | $ | - | |
| Exchange of Series E preferred stock | | $ | - | | | $ | 3,366,778 | |
| Redemption of Series E preferred stock | | $ | - | | | $ | 4,935,463 | |
| Common stock issued for notes payable | | $ | - | | | $ | 560,000 | |
| Exchange of Series E preferred stock for subordinated debenture | | $ | 500,000 | | | $ | - | |
| Common shares issued as restricted stock | | $ | 1,200 | | | $ | - | |
| Creation of debt discount due to warrants issued to lender | | $ | - | | | $ | 1,479,189 | |
| Creation of deferred financing fee due to warrants issued to third party | | $ | - | | | $ | 159,066 | |
| Supplemental Disclosures: | | | | | | | | |
| Cash paid for interest | | $ | 909,027 | | | $ | 594,667 | |
| Cash paid for pre-payment penalties | | $ | 446,413 | | | $ | - | |
| Cash paid for taxes | | $ | 332,009 | | | $ | 114,970 | |
See accompanying notes to consolidated financial statements.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
NatureDescription of Business
Deep Down, Inc., a Nevada corporationand its wholly-owned subsidiaries (“Deep Down”), is“we”, “us” or the parent“Company”) is an oilfield services company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), since its acquisition effective April 2, 2007, Mako Technologies, LLC, a Nevada limited liability company (“Mako”), since its acquisition effective December 1, 2007,serving the worldwide offshore exploration and Flotation Technologies, Inc., a Maine corporation (“Flotation”), since its acquisition effective May 1, 2008.
Deep Down Delaware providesproduction industry. Our services and technological solutions include distribution system installation management,support and engineering services, umbilical terminations, loose-tube steel flying leads, flotation and drill riser buoyancy, Remote Operated Vehicles (“ROVs”) and toolings. 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 storage management services fortechnologies, used between the subsea controls, umbilicalsplatform and offshore pipeline industries. Deep Down Delaware also fabricates component parts for subsea distribution systems and assemblies.the wellhead.
ElectroWave offers productsAs described below in Note 4 “Investment in Joint Venture���, effective December 31, 2010, we engaged in a transaction in which all of the operating assets and servicesliabilities of our wholly-owned subsidiary, Flotation Technologies, Inc. ("Flotation"), were contributed, along with other contributions we made, to a joint venture entity named Cuming Flotation Technologies, LLC (“CFT”), in the fields of electronic monitoring and control systemsreturn for the energy, military, marine and commercial business sectors.a 20% common unit ownership interest in CFT.
Mako servesIn the growingnotes to the consolidated financial statements, all dollar and share amounts are in thousands of dollars and shares, unless otherwise indicated.
Liquidity
As a deepwater service provider, our revenues, profitability, cash flows, and future rate of growth are substantially dependent on the condition of the global oil and gas industry generally, and our customers’ ability to invest capital for offshore petroleumexploration, drilling and marine industriesproduction 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 delay in payments by significant customers or delays in completion of our contracts for any reason. While our objective is to enter into contracts with technical support servicesour 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 products vitalthe uncertainties noted above create risks that we may not achieve our planned earnings or cash flow from operations, which may require us to offshore petroleum production, through rentals of its remotely operated vehicles (“ROV”), topside and subsea equipment and diving support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.raise additional debt or equity capital. There can be no assurance that we could raise additional capital.
Flotation engineers, designsDuring our fiscal years ended December 31, 2010 and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam2009, we have supplemented the financing of our capital needs through a combination of debt and polyurethane elastomers. Flotation’s product offerings include distributed buoyancyequity financings. Most significant in this regard has been our debt facility we have maintained with Whitney National Bank (“Whitney”). Our loans outstanding under the Amended and Restated Credit Agreement with Whitney (the “Restated Credit Agreement”) become due on April 15, 2012. We will need to raise additional debt or equity capital or renegotiate the existing debt prior to such date. We are currently in discussions with several lenders who have expressed interest in refinancing our debt. Our plan is to refinance the outstanding indebtedness under the Restated Credit Agreement or seek terms with Whitney that will provide an extension of such Restated Credit Agreement along with additional liquidity. However, we cannot provide any assurance that any financing will be available to us on acceptable terms or at all. If we are unable to raise additional capital or renegotiate our existing debt, this would have a material adverse impact on our business or would raise substantial doubt about our ability to continue as a going concern. In addition to the foregoing, as of December 31, 2010, we were not in compliance with the financial covenants under the Restated Credit Agreement. On March 25, 2011 we obtained a waiver for flexible pipesthese covenants as of December 31, 2010.
Although the factors described above create uncertainty, if our planned financial results are achieved we believe that we will have adequate liquidity to meet our future operating requirements, and umbilicals, drilling riser buoyance modules, CoreTecTM drilling riser buoyancy modules, ROVitsTM buoyancy, Hydro-Float mooring buoys, StablemoorTM low-drag ADCP deployment solution, Quick-Loc™ cable floats, HardballTM umbilical floats, Flotec™ cablewe believe we will be able to raise additional capital or renegotiate our existing debt.
Notes to Consolidated Financial Statements for the Years ended December 31, 2010 and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of any size and depth rating.2009
(Amounts in thousands except per share amounts)
Summary of Significant Accounting Policies
Principles of consolidation:consolidation
The consolidated financial statements include the accounts of Deep Down and its wholly-owned subsidiaries for the years ended December 31, 20082010 and 2007.
2009. All significant inter-companyintercompany transactions and balances have been eliminated in consolidation.eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Segments
For the fiscal years ended December 31, 2010 and 2009, our operating segments, Deep Down Delaware, Mako and Flotation have been aggregated into a single reporting segment. Effective December 31, 2010 we contributed all of Flotation’s operating assets and liabilities to CFT. While the operating segments have different product lines; they are very similar. They are all service-based operations revolving around our personnel’s expertise in the deepwater and ultra-deepwater industry, and any equipment is produced to a customer specified design and engineered using Deep Down personnel’s expertise, with installation and project management as part of our service revenue to the customer. Additionally, the segments have similar customers and distribution methods, and their economic characteristics are similar with regard to their gross margin percentages. Our operations are located in the United States, though we occasionally make sales to multi-national customers.
Other comprehensive income
Deep Down has no items that comprise other comprehensive income for the years ended December 31, 2010 and 2009.
Reclassifications
Prior period information presented in these financial statements includes reclassifications which were made to conform to the current period presentation. Specifically, depreciation expense included in cost of sales has been presented as a separate line in the consolidated statements of operations. Additionally, deferred revenues have been split out from billings in excess of costs and estimated earnings on uncompleted contracts on the face of the balance sheets. These reclassifications had no effect on our previously reported gross profit, net income (loss)loss or stockholders'stockholders’ equity. For example, Deep Down reclassified a portion of total depreciation expense, $1,078,027 and $285,717, into Cost of sales from Operating expenses for the years ended December 31, 2008 and 2007, respectively. The remainder of depreciation expense for each respective year is reported in the Operating expenses section of the Statements of Operations.
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
Cash and Cash Equivalents and Restricted Cash
Deep Down considersWe consider all highly liquid investments with maturities from date of purchase of three months or less to be cash equivalents. Cash and equivalents consist of cash on deposit with foreign and domestic banks and, at times, may exceed federally insured limits.
Per the terms of its secured credit agreement with Prospect Capital Corporation, Deep Down was required to keep cash on hand equal to the previous six months interest payment on the debt arising under such credit agreement. At December 31, 2007, this amount approximated $375,000 which is reflected on the balance sheet as restricted cash. When the credit agreement was paid in June 2008, this amount was released from all restrictions.
At December 31, 2008, Deep Down haswe had restricted cash of $135,855$136 related to a letter of credit for a vendor. See further details at Note 14 Commitmentsvendor, which was released due to completion of the project during 2009.
Notes to Consolidated Financial Statements for the Years ended December 31, 2010 and Contingencies.2009
(Amounts in thousands except per share amounts)
Fair Value of Financial Instruments
The estimatedFair 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 Deep Down’sobservable 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 is as follows at December 31, 2008:consist primarily of cash equivalents, trade receivables and payables and debt instruments. The carrying values of cash, accounts receivable, accounts payable and notes payable approximate their fair values due to the short-term maturity of these instruments.
· | Cash and equivalents, accounts receivable and accounts payable - the carrying amounts approximated fair value due to the short-term maturity of these instruments. |
· | Long-term debt - the carrying value of Deep Down’s debt instruments closely approximates the fair value due to the recent date of the debt and that the line of credit portion has a LIBOR-based rate. |
For discussion of assets and liabilities measured at fair value on a non-recurring basis, see Note 6 "Intangibles Assets and Goodwill."
Accounts Receivable
Deep Down providesWe provide an allowance for doubtful accounts on trade receivables based on historical collection experience, the level of past due accounts and a specific review of each customer’s trade receivable balance with respect to their ability to make payments and expectations of future conditions that could impact the collectability of accounts receivable. When specific accounts are determined to be uncollectable, they are expensed as bad debt expense in that period. At December 31, 20082010 and 2007, Deep Down2009, we estimated itsthe allowance for doubtful accounts to be $574,975$245 and $139,787,$304, respectively. Bad debt expense totaled $1,507,494$72 and $110,569$192 for the years ended December 31, 20082010 and 2007,2009, respectively.
Concentration of Credit Risk
Deep Down maintains cash balances at several banks. Accounts at the institution are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. Deep Down had approximately $932,000 of uninsured cash balances at December 31, 2008.
As of December 31, 2008, four2010, five of Deep Down’sour customers accounted for 20%, 11%, 9%19 percent, 18 percent, 16 percent, 12 percent and 4%8 percent of total accounts receivable, respectively. For the year ended December 31, 2008, Deep Down’s five largest2009, four of our customers accounted for 20%, 7%, 7%, 4%22 percent, 9 percent, 8 percent and 3% of total revenues, respectively.
As of December 31, 2007, four of Deep Down’s customers accounted for 11%, 9%, 7% and 7%5 percent of total accounts receivable, respectively. For the year ended December 31, 2007, Deep Down’s four2010, our five largest customers accounted for 7%, 7%, 6%24 percent, 11 percent, 9 percent, 9 percent and 6%7 percent of total revenues, respectively.
For the year ended December 31, 2009, our five largest customers accounted for 12 percent, 10 percent, 8 percent, 6 percent and 5 percent of total revenues, respectively.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Inventory and Work in Progress
Inventory is stated at lower of cost (first-in, first out) or net realizable value.
| | | December 31, 2008 | | | December 31, 2007 | |
| Raw materials | | $ | 789,815 | | | $ | - | |
| Finished goods | | | 145,928 | | | | 502,253 | |
| Work in progress | | | 288,427 | | | | - | |
| Total Inventory | | $ | 1,224,170 | | | $ | 502,253 | |
| | | December 31, 2010 | | | December 31, 2009 | |
| | | | | | | |
| Raw materials | | $ | 167 | | | $ | 765 | |
| Work in progress | | | 56 | | | | 84 | |
| Finished goods | | | - | | | | 47 | |
| Total inventory | | $ | 223 | | | $ | 896 | |
Work
A portion of work in progress at December 31, 2008 and 2007 not presented in inventory above, represents costs that have been incurred for time and materials that are not appropriate to be billed to customers at such date, according to the contractual terms. Some of our billings are contingent upon satisfaction of a significant condition of sale (“milestone”), including but not limited to, FAT and customer approval. Amounts at December 31, 2008 and 2007 were $137,940 and $749,455, respectively.
Property and EquipmentLong-Lived Assets
Property, Plant and Equipment Property, plant and equipment are stated at cost, net of accumulated depreciation. Depreciation and amortization isare computed using the straight-line method over the estimated useful lives of the respective assets. Buildings are depreciated between 10seven and 36thirty-six years, and leasehold improvements are amortized over the shorter of the assets' useful lives or lease terms. Equipment lives range from two to sevenfifteen years, computers and electronicoffice equipment lives are generally from two to fourthree years, and furniture and fixtures are two to seveneight years. Replacements and betterments are capitalized, while maintenance and repairs are expensed as incurred. It is Deep Down’sour policy to include depreciation expense on assets acquired under capital leases with depreciation expense on owned assets. Additionally, we record depreciation expense related to revenue-generating assets as Cost of Sales on the accompanying statements of operations.
Other Assets We capitalize certain internal and external costs related to the acquisition and development of internal use software during the application development stages of projects. Such costs consist primarily of custom-developed and packaged software and the direct labor costs of internally-developed software and are included with Other Assets on the accompanying balance sheets. Capitalized costs are amortized using the straight-line method over the estimated lives of the software, which range from three to five years. The costs capitalized in the application development stage include the costs of design, coding, installation of hardware and testing. We capitalize costs incurred during the development phase of the project as permitted. Costs incurred during the preliminary project or the post-implementation/operation stages of the project are expensed as incurred.
Additionally, we recorded an investment in a nonmarketable equity security, in which we own less than 20 percent, at cost during the years ended December 31, 2010 and 2009 in the amount of $225. We review this investment on a regular basis to determine if there has been a decline in market value.
Long-lived intangible assets. Our intangible assets generally consist of assets acquired in the purchases of the Mako and Flotation subsidiaries and are comprised of customer lists, non-compete covenants with key employees and trademarks related to Mako’s ROVs and to Flotation’s branding, processes, materials and technology. We amortize intangible assets over their useful lives ranging from six to twenty-five years on a straight-line basis. We make judgments and estimates in conjunction with the carrying value of these assets, including amounts to be capitalized, depreciation and amortization methods, useful lives and the valuation of acquired long-lived intangible assets. All the intangible assets of Flotation were contributed to CFT effective December 31, 2010, see additional discussion at Note 4, “Investment in Joint Venture.”
We test for the impairment of long-lived assets upon the occurrence of a triggering event. We base our evaluation on impairment indicators such as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements and other external market conditions or factors that may be present. If these impairment indicators are present or other factors exist that indicate the carrying amount of an asset may not be recoverable, we determine whether an impairment has occurred through the use of an undiscounted cash flows analysis of the asset at the lowest level for which identifiable cash flows exist. The undiscounted cash flow analysis consists of estimating the future cash flows that are directly associated with and expected to arise from the use and eventual disposition of the asset over its remaining useful life. These cash flows are inherently subjective and require significant estimates based upon historical experience and future expectations reflected in our budgets and internal projections. If the undiscounted cash flows do not exceed the carrying value of the long-lived asset, an impairment has occurred, and we recognize a loss for the difference between the carrying amount and the estimated fair value of the asset. The fair value of the asset is measured using quoted market prices or, in the absence of quoted market prices, is based on an estimate of discounted cash flows. Cash flows are generally discounted at an interest rate commensurate with our weighted average cost of capital for a similar asset.
Notes to Consolidated Financial Statements for the Years ended December 31, 2010 and 2009
(Amounts in thousands except per share amounts)
There was no impairment of long-lived assets for the year ended December 31, 2010. We assessed the market conditions and have concluded, as of December 31, 2009, that a triggering event had occurred that required an impairment analysis of long-lived intangible assets. For the year ended December 31, 2009, we recorded impairment charges totaling $4,616 to several long-lived intangible assets, which total impairment charges were recorded on the statement of operations as amortization expense. See further discussion in Note 6 "Intangible Assets and Goodwill" regarding the testing and conclusions.
Goodwill and Intangible Assets
Goodwill represents the cost in excess of the fair value of net assets acquired in business combinations. SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), prescribes the process for impairment testing of goodwill on an annual basis or more often if a triggering event occurs. Goodwill is not amortized, and there were no indicators of impairment at December 31, 2008.
Deep Down evaluatesWe evaluate the carrying value of goodwill during the fourth quarter of each yearannually on December 31 and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include a significant adverse change in legal factors or in business or the business climate or unanticipated competition. When evaluating whetherFor purposes of our annual impairment test, our reporting units are the same as our operating segments discussed above.
The test for goodwill impairment is impaired, Deep Down comparesa two-step approach. The first step is to compare the estimated fair value of any reporting units within the business to its carrying amount, including goodwill. TheCompany that have goodwill with the recorded net book value (including the goodwill) of the reporting unit. If the estimated fair value of the reporting unit is estimated using an income, or discounted cash flow approach.higher than the recorded net book value, no impairment is deemed to exist and no further testing is required. If, however, the carrying amount of the business exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the impliedestimated fair value of the reporting unit is below the recorded net book value, then a second step must be performed to determine the goodwill to its carrying amount.
Deep Down’s intangible assets, net of accumulated amortization consist of $18.1 million in specifically identified intangible assets acquired inimpairment required, if any. In this second step, the estimated fair value from the first step is used as the purchase price in a hypothetical acquisition of the Flotationreporting unit. Purchase business combination accounting rules are followed to determine a hypothetical purchase price allocation to the reporting unit’s assets and Mako subsidiaries, including customer relationships, non-compete covenants, trademarks and various technology rights. We are amortizingliabilities. The residual amount of goodwill that results from this hypothetical purchase price allocation is compared to the intangible assets over their estimated useful lives on the straight line basis between three and forty years.
Long-Lived Assets
SFAS No. 144, "Accountingcarrying value of goodwill for the Impairment or Disposal of Long-Lived Assets," requires that Deep Down periodically reviewreporting unit, and the carrying amounts of its property and equipment and its finite-lived intangible assetsvalue is written down to determine whether current events or circumstances indicate that such carrying amounts may not be recoverable. The carryingthe hypothetical amount, of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If it is determined that an impairment loss has occurred, the loss is measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value.
lower.
Notes to Consolidated Financial Statements forEquity Method Investments
Equity method investments in joint ventures are reported as investments in joint venture in the Years endedconsolidated balance sheets, and our share of earnings or losses is included in the statement of operations and reported as equity in net income or loss of joint venture in the consolidated statements of operations. At December 31, 2008 and 2007
2010, our accumulated deficit included $254 related to the undistributed equity in net loss of joint venture.
Lease Obligations
Deep Down leasesWe lease land, buildings, vehicles and buildingscertain equipment under noncancelablenon-cancellable operating leases. Deep Down leases its Channelview, Texas, operating location for Delaware and ElectroWave from an entity owned by the CEO and his wife, a Vice President and Director, in addition to several vehicles, modular office buildings and office equipment which are also recorded as operating leases and are expensed. Additionally, beginning inSince February 2009, Deep Down leases its officewe lease our corporate headquarters in Houston, Texas, under a noncancellablenon-cancellable operating lease. Mako leases office, warehouse and operating space in Morgan City, Louisana,Louisiana, under a noncancellable operating lease. Flotation entered into a noncancellablenon-cancellable operating lease, for warehouse facilitiesand Flotation leases their manufacturing and warehousing locations in Biddeford, Maine under non-cancellable operating leases; this lease obligation was contributed to CFT effective December 31, 2010 as discussed in October 2008. Deep DownNote 4 “Investment in Joint Venture.” We also leases a 100-ton mobile gantry cranelease certain office and other operating equipment under a capital lease, which isleases; the related assets are included with Property, Plant and Equipment on the consolidated balance sheet.sheets.
At the inception of a lease, Deep Down evaluateswe evaluate each 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.
Deep Down accounts for tenant incentives received from its landlords in connection with certainRevenue Recognition
We recognize revenue once the following four criterions are met: (i) persuasive evidence of its operating leases as a deferred rent liability within lease obligations and amortizes such amounts over the relevant lease term. For leases that contain rent escalations, Deep Down records the total rent payable during the lease term, as determined above, on a straight-line basis over the terman arrangement exists, (ii) delivery of the lease (including any “rent abatement” period beginning upon possessionequipment has occurred or services have been rendered, (iii) the price of the premises),equipment or service is fixed and records the difference between the minimum rents paiddeterminable and the straight-line rent as a lease obligation.
Revenue Recognition
Deep Down’s contract revenue(iv) collectability is made up of customized product and service revenue. Revenue from fabrication and sale of equipment is recognized upon transfer of title to the customer which is upon shipment or when customer-specific acceptance requirements are met.reasonably assured. Service revenue is recognized as the service is provided. Rental revenue is recognized pro-rata over the rental period basedprovided, and “time and material” contracts are billed on dailya bi-weekly or monthly rates. Shippingbasis as costs are incurred. Customer billings for shipping and handling charges paid by Deep Down are included in cost of goods sold.revenue.
From time to time, Deep Down enterswe enter into large fixed price contracts which Deep Down determineswe determine that recognizing revenues for these types of contracts wereis appropriate using the percentage-of-completion method, under Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”), measured bywhich compares the percentage of costs incurred-to-dateincurred to date to the estimated total costs for the contract. This method is preferredappropriate because management considers the total cost to becosts the best available measure of progress onprogress.
Notes to Consolidated Financial Statements for the contracts. Years ended December 31, 2010 and 2009
(Amounts in thousands except per share amounts)
Contract
Total costs include all direct material and labor costs and thoseplus all indirect costs related to contract performance, such as supplies, equipment repairs, employee travel and supervisor time. Selling, general and administrative costs are expensedcharged to expense as incurred. Provisions for estimated losses on uncompleted contracts (if any) are accruedmade in the same period as the estimated loss isin which such losses are determined. 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. ChangeUnapproved change orders are accounted for in revenue and cost when it is probable that the costs will be recovered.recovered through a change in the contract price. In such circumstances where recovery is considered probable but the revenues cannot be reliably estimated, costs attributable to change orders are deferred pending re-negotiationdetermination of contract terms.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 subsequently invoiced upon satisfactioncompletion of contractual requirements or “milestones”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 substantiallyvirtually all of the anticipated costs have been incurred and the items have beenare shipped to the customer.
In accordance with industry practice, assetsAssets 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.year, though such long-term contracts include contractual milestone billings as discussed above.
All intercompany revenue balances and transactions were eliminated in consolidation.
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. Our effective tax rates for 2010 and 2009 were (1.0) percent, and 5.98 percent, respectively.
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 pretax 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.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
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.
Income Taxes
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 accordance with SFAS No. 109, Accounting for Income Taxes,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 is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.taxes.
During 2008, Deep Down adopted the Financial Accounting Standards Board’s (“FASB”) Financial Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. FIN 48 changes the accounting for uncertainty in income taxes by creating a new framework for how companies should recognize, measure, present, and disclose uncertain tax positions in their financial statements. Under FIN 48, Deep Down may recognize the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. FIN 48 also provides guidance on the reversal of previously recognized tax positions, balance sheet classifications, accounting for interest and penalties associated with tax positions, and income tax disclosures. See Note 12, “Income Taxes” for additional information, including the effects of adoption on Deep Down’s consolidated financial statements.
Stock-BasedShare-based Compensation
Deep Down accountsWe record share-based payment awards exchanged for stock-based compensation issued to employees and non-employees as required by SFAS No. 123(R) “Share-based Payment” (“SFAS No. 123(R)”). Under these provisions, Deep Down records an expense basedemployee services at fair value on the fair valuedate 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 awards utilizingaward on a straight-line basis. At December 31, 2010, we had two types of share-based employee compensation: stock options and restricted stock.
Key assumptions used in the Black-Scholes pricing model for optionsstock option valuations include (1) expected volatility (2) expected term (3) discount rate and warrants.(4) expected dividend yield. Since we do not have a sufficient trading history to determine the volatility of our own stock, 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, Deep Down continueswe continue to use the simplified method related to employee option grants as allowed by Staff Accounting Bulletin ("SAB") 110, Share-Based Payment.grants.
SFAS No. 123(R) prohibits recognitionThe fair value of a deferred tax asset for an excess tax benefit that has not been realized. The Company will recognize a benefit from stock-based compensation in equity if an incremental tax benefiteach stock option grant is realized by followingestimated on the ordering provisionsdate of the tax law.grant using the Black-Scholes model and is based on the following key assumptions for the years ended December 31, 2010 and 2009:
Earnings | | December 31, 2010 | | December 31, 2009 |
| Dividend yield | 0% | | 0% |
| Risk free interest rate | 2.08% - 2.49% | | 1.69% - 2.33% |
| Expected life of options | 3.5 years | | 3 years |
| Expected volatility | 94.7% - 97.4% | | 88.5% - 92.8% |
Earnings/(Loss) per Common Share
SFAS No. 128, Earnings (Loss) Per Share (“EPS”) requires earnings (loss) per share to be calculated and reported as both basic EPS and diluted EPS. Basic EPS is calculated by dividing net income income/(loss) by the weighted average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net incomeincome/(loss) by the weighted average number of common shares and dilutive common stock equivalents (convertible notes and interest on the notes, stock(stock awards and stock options) outstanding during the period. Dilutive EPS reflects the potential dilution that could occur if options and warrants to purchase common stock were exercised for shares of common stock. The following is a reconciliation of the number of shares (denominator) used in the basic and diluted EPS computations:
| | | For the Twelve Months Ended | | | Year Ended | |
| | | December 31, | | | December 31, | |
| | | 2008 | | | 2007 | | | 2010 | | | 2009 | |
| Numerator: | | | | | | | | | | | | |
| Net income (loss) | | $ | (4,322,893 | ) | | $ | 952,509 | | | $ | (17,415 | ) | | $ | (16,781 | ) |
| | | | | | | | | | | | | | | | | |
| Denominator: | | | | | | | | | | | | | | | | |
| Weighted average shares outstanding | | 142,906,616 | | | 73,917,190 | | |
Weighted average number of common shares outstanding | | | | 193,147 | | | | 179,430 | |
| Effect of dilutive securities | | | - | | | | 30,432,265 | | | | - | | | | - | |
| Denominator for diluted earnings per share | | | 142,906,616 | | | | 104,349,455 | | | | 193,147 | | | | 179,430 | |
| | | | | | | | | | | | | | | | | |
| Basic earnings per share | | $ | (0.03 | ) | | $ | 0.01 | | |
| | | | | | | | | | |
| Diluted earnings per share | | $ | (0.03 | ) | | $ | 0.01 | | |
Net loss per common share outstanding, basic and diluted | | | $ | (0.09 | ) | | $ | (0.09 | ) |
| Diluted net loss per common share | | | $ | (0.09 | ) | | $ | (0.09 | ) |
PotentiallyThere were no potentially dilutive securities representing 501,615 shares of common stock for the yearyears ended December 31, 20082010 and 2009 which were excluded from the computation of diluted earnings per share for this year because their effect would have been anti-dilutive.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
Dividends
Deep Down has no formal dividend policy or obligations. Under the terms of a $2 million borrowing facility from Whitney National Bank signed on November 11, 2008, we are restricted from paying cash dividends on our common stock, though the terms do allow that we may from time to time make cash distributions to our shareholders if no default exists prior to or after giving effect to any such distribution. Deep Down intends to retain operating capital for the growth of the company operations.
Advertising costs:(Amounts in thousands except per share amounts)
Advertising and promotion costs, which totaled $412,202 and $114,209 during the year ended December 31, 2008 and 2007, respectively, are expensed as incurred.
Segment information
For the fiscal year ended December 31, 2008, the operations of Deep Down’s subsidiaries have been aggregated into a single reporting segment under the provisions of SFAS 131 “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). We determined that the operating segments of Delaware, ElectroWave, Mako and Flotation may be aggregated into a single reporting segment because aggregation is consistent with the objective and basic principles of paragraph 17 of SFAS 131. While the operating segments have different product lines, they are very similar with regards to the five criteria for aggregation. They are all service-based operations revolving around our personnel’s expertise in the deep water industry, and any equipment is produced to a customer specified design and engineered using Deep Down personnel’s expertise, with installation as part of our service revenue to the customer. Additionally, the segments have similar customers and distribution methods, and their economic characteristics were similar with regard to their gross margin percentages for the fiscal year ended December 31, 2008.
RecentRecently Issued Accounting PronouncementsStandards
In September 2006,January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). This update provides amendments to Subtopic 820-10 and requires new disclosures for 1) significant transfers in and out of Level 1 and Level 2 and the reasons for such transfers and 2) activity in Level 3 fair value measurements to show separate information about purchases, sales, issuances and settlements. In addition, this update amends Subtopic 820-10 to clarify existing disclosures around the disaggregation level of fair value measurements and disclosures for the valuation techniques and inputs utilized (for Level 2 and Level 3 fair value measurements). The provisions in ASU 2010-06 are applicable to interim and annual reporting periods beginning subsequent to December 15, 2009, with the exception of Level 3 disclosures of purchases, sales, issuances and settlements, which will be required in reporting periods beginning after December 15, 2010. The adoption of ASU 2010-06 did not impact our operating results, financial position or cash flows.
In April 2010, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value under generally accepted accounting procedures and expands disclosures on fair value measurements. This statement applies under previously established valuation pronouncements and does not require the changing of any fair value measurements, though it may cause some valuation procedures to change. Under SFAS No. 157, fair value is established by the price that would be received to sell the item or the amount to be paid to transfer the liability of the asset as opposed to the price to be paidguidance for the asset or receivedmilestone method of revenue recognition. This guidance allows entities to transfermake a policy election to use the liability. Further, it defines fair value asmilestone method of revenue recognition and provides guidance on defining a market specific valuation as opposedmilestone and the criteria that should be met for applying the milestone method. The scope of this guidance is limited to an entity specific valuation, thoughtransactions involving milestones relating to research and development deliverables. The guidance includes enhanced disclosure requirements about each arrangement, individual milestones and related contingent consideration, information about substantive milestones and factors considered in the statement does recognize that there may be instances when the low amount of market activity for a particular item or liability may challenge an entity’s ability to establish a market amount. In the instances that the item is restricted, this pronouncement states that the owner of the asset or liability should take into consideration what affects the restriction would have if viewed from the perspective of the buyer or assumer of the liability.determination. This statementguidance is effective for all assets valuedprospectively to milestones achieved in financial statements for fiscal years, and interim periods within those years, beginning after NovemberJune 15, 2007. Deep Down adopted SFAS 157 for2010. Early application and retrospective application are permitted. We have evaluated this new guidance and have determined that it will not currently have a significant impact on the determination or reporting of our financial assets and liabilities in 2008 with no material impact to the consolidated financial statements but with additional required consolidated financial statement footnote disclosures. Deep Down doesresults.
Management believes that other recently issued accounting standards, which are not anticipate the application of SFAS 157 to nonfinancial assets and nonfinancial liabilitiesyet effective, will not have a material impact on itsour consolidated financial statements.statements upon adoption.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”) and No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 141(R) and SFAS No. 160 are products of a joint project between the FASB and the International Accounting Standards Board. The revised standards continue the movement toward the greater use of fair values in financial reporting. SFAS No. 141(R) will significantly change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. These changes include the expensing of acquisition related costs and restructuring costs when incurred, the recognition of all assets, liabilities and noncontrolling interests at fair value during a step-acquisition, and the recognition of contingent consideration as of the acquisition date if it is more likely than not to be incurred. SFAS No. 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 141(R) and SFAS No. 160 are effective for both public and private companies for fiscal years beginning on or after December 15, 2008 (January 1, 2009 for companies with calendar year-ends). SFAS No. 141(R) will be applied prospectively. SFAS No. 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS No. 160 shall be applied prospectively. Early adoption is prohibited for both standards. Deep Down will apply the requirements of SFAS No. 141(R) to all business combinations after January 1, 2009. SFAS No. 160 will have no impact on Deep Down’s financial statements as the Company has no minority interests.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Note 2: Revision of 2009 Consolidated Financial Statements
In December 2007,As discussed in our Form 10Q/A for the quarter ended September 30, 2010, filed with the SEC staff issued SAB 110, Share-Based Payment,on March 8, 2011, in conjunction with an internal review meeting of Flotation, our management reviewed the status of one of our long-term fixed price contracts (the “Contract”) that we entered into in November 2008 which amends SAB 107, Share-Based Payment,is scheduled to permit public companies, under certain circumstances,be completed in the third quarter of 2011. As a result of this review, our management identified errors in the percentage-of-completion accounting model for revenue recognition pertaining to usethis Contract. We considered the simplified method in SAB 107effect of the error to be immaterial to the consolidated financial statements as of and for employee option grants afterthe year ended December 31, 2007. Use2009. The audited consolidated balance sheet and statements of operations, cash flows and stockholders’ equity for the year ended December 31, 2009 included in this Form 10-K have been adjusted to correct the immaterial effects of the simplified method after December 2007 is permitted only for companies whose historical data about their employees’ exercise behavior does not provide a reasonable basis for estimating the expected term of the options. Deep Down did not have stock options outstanding until 2007, thus does not have adequate historical data to determine option lives. Therefore, Deep Down will continue to use the simplified method as allowed under the provision of SAB 110.error.
In June 2008, EITF 07-5, “Determining whether an Instrument (or Embedded Feature) is indexedThe 2009 consolidated balance sheet reflects the increase of $639 to an Entity’s Own Stock”the amounts of billings in excess of costs and estimated earnings on uncompleted contracts and accumulated deficit. On the consolidated statement of operations, revenues and gross profit for the year ended December 31, 2009 were reduced by $639, which resulted in a corresponding $639 increase to operating loss, loss before income taxes and net loss. On the consolidated statement of cash flows, the revision increased net loss by $639 which was issued. This standard triggers liability accountingoffset to billings in excess of costs and estimated earnings on all options and warrants exercisable at strike prices denominated in any currency other thanuncompleted contracts, for a net impact to cash flows provided by operations of $0. On the Company’s functional currency. This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application is not permitted. Deep Down is currently evaluatingconsolidated statement of stockholders’ equity, the impact that EITF 07-5 will have on its consolidated financial position or result of operations.revision increased accumulated deficit by $639.
In June 2008, FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5 (“EITF No. 08-4”)”. The objective of EITF No.08-4 is to provide transition guidance for conforming changes made to EITF No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, that result from EITF No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments”, and SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008. Early application is permitted. Management is currently evaluating the impact of adoption of EITF No. 08-4.
Note 2:3: Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts and Deferred Revenue
The components of costs and estimated earnings in excess of billings on uncompleted contracts are summarized below:
| | | December 31, 2008 | | | December 31, 2007 | |
| Costs incurred on uncompleted contracts | | $ | 2,114,714 | | | $ | - | |
| Estimated earnings | | | 4,969,444 | | | | - | |
| | | | 7,084,158 | | | | - | |
| Less: Billings to date | | | 8,691,464 | | | | 188,030 | |
| | | $ | (1,607,306 | ) | | $ | (188,030 | ) |
| Included in the accompanying consolidated balance sheets under the following captions: | | | | | | | | |
| Costs and estimated earnings in excess of billings on uncompleted contracts | | | 707,737 | | | | - | |
| Billings in excess of costs and estimated earnings on uncompleted contracts | | | (2,315,043 | ) | | | (188,030 | ) |
| | | $ | (1,607,306 | ) | | $ | (188,030 | ) |
| | | December 31, 2010 | | | December 31, 2009 | |
| Costs incurred on uncompleted contracts | | $ | 319 | | | $ | 3,319 | |
| Estimated earnings on uncompleted contracts | | | 151 | | | | 2,304 | |
| | | | 470 | | | | 5,623 | |
| Less: Billings to date on uncompleted contracts | | | (916 | ) | | | (10,340 | ) |
| | | $ | (446 | ) | | $ | (4,717 | ) |
| | | | | | | | | |
Included in the accompanying consolidated balance sheets under the following captions: | | | | | | | | |
Costs and estimated earnings in excess of billings on uncompleted contracts | | $ | - | | | $ | 267 | |
Billings in excess of costs and estimated earnings on uncompleted contracts | | | (446 | ) | | | (4,984 | ) |
| | | $ | (446 | ) | | $ | (4,717 | ) |
The
At December 31, 2009, the asset balance of $707,737 at December 31, 2008 is$267 was related to a large contracttwo contracts that waswere completed during December 2008 except for the final documentation. This retention amount isfiscal 2010. The balances in accordance with applicable provisions of engineering and construction contracts and became due upon completion of contractual requirements in January 2009. Deep Down has recognized approximately 90% of the related revenue based on the percentage-of-completion method. The billings in excess of costs and estimated earnings on uncompleted contracts of $2,315,043 at December 31, 2008 consists mainly2010 and December 31, 2009, were $446 and $4,984, respectively, and consisted of significant milestone billings, primarily related to a large fabrication project, plus several smaller contracts. In connection with the contribution of net assets and liabilities of Flotation to CFT, $2,972 in billings in excess of costs and estimated earnings on uncompleted contracts was contributed at December 31, 2010. See further discussion in Note 4 “Investment in Joint Venture.”
As discussed in Note 2, “Revision of 2009 Consolidated Financial Statements”, the December 31, 2009 balances reflect the correction of an immaterial error that resulted in an increase of $639 to the amounts of billings in excess of costs and estimated earnings on uncompleted contracts, which is comprised of a depositdecrease in costs incurred on a large job that will be completeduncompleted contracts of $731, offset by an increase in estimated earnings on uncompleted contracts of $92.
At December 31, 2010 and 2009, we reported deferred revenue liability balances of $315 and $89, respectively. These balances represented prepayments or deposits on time and material and rental projects for which work has not yet been performed. We expect to recognize the deferred revenue at December 31, 2010 during fiscal year 2009.2011.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Note 4: Investment in Joint Venture
On December 31, 2010, the Company and its wholly-owned subsidiary Flotation, entered into a Contribution Agreement by and among the Company, Flotation, Cuming Flotation Technologies, LLC, a Delaware limited liability company (“CFT”), and Flotation Investor, LLC, a Delaware operating limited liability company (“Holdings”), pursuant to which Flotation contributed all of its assets and liabilities (except for one intercompany corporate overhead payable) to CFT in exchange for common units of CFT. Pursuant to the Contribution Agreement, we contributed to CFT $1,400 in cash and all of our rights and obligations under that certain Stock Purchase Agreement, dated May 3, 2010, as amended (the “Cuming SPA”), by and among the Company, Cuming Corporation, a Massachusetts corporation (“Cuming”), and the stockholders of Cuming, in exchange for common units of CFT. Concurrently with the closing of the transactions described above, CFT contributed the assets and liabilities it acquired from Flotation to Flotation Tech, LLC, a Delaware limited liability company and wholly-owned subsidiary of CFT.
Note 3: Acquisitions
On December 31, 2010, we entered into a Contract Assignment and Amendment Agreement by and among the Company, CFT and Cuming, pursuant to which we assigned all of our rights and obligations under the Cuming SPA to CFT. Concurrent with our entry into such Contract Assignment and Amendment Agreement, we entered into a Securities Purchase Agreement, by and among the Company and Holdings (the “Securities Purchase Agreement”), pursuant to which we sold and issued to Holdings 20,000 shares of Mako Technologies, Inc.our common stock for an aggregate purchase price of $1,400. The Securities Purchase Agreement provides Holdings with registration rights for such 20,000 shares only in the event we fail to maintain current public filings.
EffectiveIn connection with the consummation of the foregoing described transaction, on December 1, 2007, Deep Down purchased31, 2010, the Company and Flotation entered into an Amended and Restated Limited Liability Company Agreement (the “JV LLC Agreement”) of CFT by and among us, Flotation and Holdings, each as a member of the CFT, to provide for the respective rights and obligations of the members of CFT. We and Flotation collectively hold 20% of the common units of CFT. Holdings holds 80% of the common units and 100% of the common stockpreferred units, which are entitled to a preferred return until the holder thereof receives a full return of Mako Technologies, Inc. for $11,307,000.its initial capital contribution. The preferred units have no voting rights. Pursuant to the agreementterms of the JV LLC Agreement, we and planFlotation collectively have the right to appoint one director to CFT’s board of merger, two installments were paiddirectors and Holdings has the right to appoint the Mako shareholders.other 4 directors. The first installment of $2,916,667 in cash and 6,574,074 restricted shares of common stockJV LLC Agreement provides that, without the prior approval of Deep Down valued at $0.76 per share ($4,996,297), were paid on January 4, 2008. The second installmentand Flotation, certain actions cannot be taken by CFT, including: increasing the number of 2,802,969 restricted sharesmembers of common stockCFT’s board of directors; amending the JV LLC Agreement or the certificate of formation of CFT in a manner that disproportionately adversely affects Deep Down valued at $0.70 per share ($1,962,090), was issued on March 28, 2008. The final cash paymentor Flotation; engaging in activities other than the business of $1,243,571 which was paid on April 11, 2008, was included in the “Payable to Mako shareholders” on the historical consolidated balance sheets at December 31, 2007. The total purchase price of $11,307,000 included $188,369 of transaction expenses.
The first payment to the shareholders of Mako was reflected on the accompanying consolidated balance sheet as of December 31, 2007 due to the certainty of payment and the intention of all the parties to complete this payment prior to fiscal year end. The second payment of $3,205,667 was reflected as a payable to shareholders due to the timing of payments in the subsequent fiscal year. The financing with Prospect was also reflected as of December 31, 2007 since the funds were generally used to pay the shareholders of Mako. The net proceeds from Prospect of $5,604,000 are offset by the first cash payment to shareholders of Mako of $2,916,667 resulting in a balance of $2,687,333 reflected as “Receivable from Prospect,” on the consolidated balance sheet at December 31, 2007.
The acquisition of Mako was accounted for using the purchase method of accountingCFT; declaring or paying dividends or distributions not in accordance with SFAS 141, “Business Combinations” (“SFAS 141”) sincethe JV LLC Agreement; repurchasing or redeeming CFT units; causing a material change in the nature of CFT’s business; engaging in activity that disproportionately affects Deep Down acquiredor Flotation as holders of units of CFT; liquidating, dissolving or effecting a recapitalization or reorganization of CFT; prior to November 2, 2012, authorizing or issuing any equity securities or other securities with equity features or convertible into equity securities except with regard to incentive plans for management; making loans, advancements, guarantees or investments except under certain circumstances; granting an exclusive license in all or substantially all of the assets, certain liabilities, employees, and businessintellectual property rights of Mako.
The following table summarizesCFT; amending any provision of, or entering into a resolution of any dispute with the estimated fair valuesparties under the Cuming SPA; entering into a transaction with an officer, director or other person who is an affiliate of CFT; incurring any funded indebtedness other than for the purpose of retiring CFT’s indebtedness to Holdings until such time as such indebtedness is fully repaid; or agreeing or committing or causing any subsidiary to agree to or commit to any of the assets acquired and liabilities assumed at the date of acquisition:above.
| Purchase of Mako: | | | |
| Cash and cash equivalents | | $ | 280,841 | |
| Accounts receivable | | | 1,411,420 | |
| Construction in progress | | | 279,590 | |
| Prepaid expenses | | | 179,583 | |
| Property, plant and equipment, net | | | 2,994,382 | |
| Intangibles | | | 4,371,000 | |
| Goodwill | | | 5,354,840 | |
| Total assets acquired | | $ | 14,871,656 | |
| | | | | |
| Accounts payable and accrued expenses | | | 904,709 | |
| Deferred tax liability | | | 1,840,563 | |
| Long term debt | | | 819,384 | |
| Total liabilities assumed | | $ | 3,564,656 | |
| Net assets acquired | | $ | 11,307,000 | |
Upon finalization of final tax returns, Deep Down determined that $1,840,563Concurrent with the closing of the purchase price wasjoint venture transaction on December 31, 2010, we entered into a Management Services Agreement to be allocatedeffective as of January 1, 2011, with CFT, pursuant to which we provide CFT the services of certain officers and management personnel. We have amended this Management Services Agreement effective as March 1, 2011 to, among other things, alter the minimum monthly fee we are paid by CFT (due partly to a deferred tax liability due to the differencechange in the tax balance sheetstaffing levels for services and book balance sheet relatedpersonnel we provide to the intangible and fixed assets.CFT).
The allocation of the purchase price has been finalized upon the receipt of management’s review of final amounts and final tax returns.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Below is a summary of the net assets contributed to CFT as of December 31, 2010:
| | | December 31, 2010 | |
| Cash and cash equivalents | | $ | 1 | |
| Accounts receivable | | | 403 | |
| Inventory | | | 594 | |
| Prepaid expenses and other current assets | | | 25 | |
| Property, plant and equipment, net | | | 8,405 | |
| Intangibles, net | | | 8,035 | |
| Other assets | | | 23 | |
| Total assets contributed | | $ | 17,486 | |
| | | | | |
| Accounts payable and accrued expenses | | | 277 | |
| Billings in excess of costs on uncompleted contracts | | | 2,972 | |
| Deferred revenue | | | 1 | |
| Long term debt | | | 2,117 | |
| Total liabilities contributed | | $ | 5,367 | |
| Net assets contributed | | $ | 12,119 | |
Below is an unaudited condensed consolidated balance sheet of CFT as of December 31, 2010:
| | | December 31, 2010 | |
| Current assets | | $ | 53,784 | |
| Property, plant & equipment | | | 17,896 | |
| Intangible assets | | | 14,719 | |
| Other assets | | | 60 | |
| Total assets | | $ | 86,459 | |
| | | | | |
| Current liabilities | | $ | 59,962 | |
| Long-term debt | | | 2,019 | |
| Preferred units - Holdings | | | 8,750 | |
| Common units - Holdings | | | 13,600 | |
| Common units - DDI/Flotation | | | 3,400 | |
| Accumulated deficit | | | (1,272 | ) |
| Total liabilities and equity | | $ | 86,459 | |
PurchaseThe fair value of Flotation Technologies, Inc.
On June 5, 2008, Deep Down completed the acquisitionour investment in CFT as of Flotation, pursuantDecember 31, 2010 is equal to the Stock Purchase Agreement entered into on April 17, 2008. Deep Down purchased Flotation from three individual shareholder members$3,400 value assigned to our common units of the same family and purchased related technology from an entity affiliated with the selling shareholders. Deep Down assumed effective control and dated the acquisition for accounting purposes on May 1, 2008. As such, the consolidated statement of operations include the operating results of Flotation from May 1, 2008 to December 31, 2008.CFT.
The acquisition of Flotation has been accounted for using the purchase method of accounting in accordance with SFAS 141 since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Flotation.
The purchase price of Flotation was $23,941,554 and consisted of $22,100,000 cash and 1,714,286 shares of common stock valued at $0.83 per common share plus transaction costs of $296,904. In addition, warrants to purchase 200,000 shares of common stock at $0.70 per share were issued to an entity affiliated with the selling shareholders for the acquisition of the related technology. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. Deep Down valued the warrants at $121,793 based on the Black-Scholes option pricing model. The purchase price may be adjusted upward or downward, dependant on certain working capital targets. Both parties are in preliminary negotiations concerning this adjustment and as of the current date, there has been no agreement as to the adjustment.
Deep Down sold 57,142,857 shares to accredited investors on June 5, 2008, for approximately $37,000,000 in net proceeds, at a price of $0.70 per share. Deep Down used $22,100,000 in proceeds from this private placement to fund the cash requirement of the Flotation acquisition.
Deep Down also issued 600,000 incentive common stock purchase options to employees of Flotation for their continued services with an exercise price of $1.15 per share. The employee options vest one-third of the original amount each year and may be exercised in whole or in part after vesting. Deep Down valued the options at $264,335 based on the Black-Scholes option pricing model, and will recognize the related compensation cost ratably over the requisite service period and not in the purchase price of the transaction.
The table below reflects the composition of the purchase price as noted above:
| Summary of purchase price: | | | | |
| Cash | | $ | 22,100,000 | |
| Certain transaction costs | | | 296,904 | |
| Fair market value of common stock | | | 1,422,857 | |
| Fair market value of warrants issued | | | 121,793 | |
| Total purchase price | | $ | 23,941,554 | |
The purchase price of $23,941,554 was in exchange for all of the outstanding capital stock of Flotation. The acquisition price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values with the excess being recorded in goodwill. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition on May 1, 2008:
| Summary of net assets acquired: | | | |
| Cash and cash equivalents | | $ | 235,040 | |
| Accounts receivable | | | 2,105,519 | |
| Construction in progress | | | 871,183 | |
| Prepaid expenses | | | 15,904 | |
| Property, plant and equipment, net | | | 4,907,752 | |
| Intangibles | | | 14,797,000 | |
| Goodwill | | | 2,141,469 | |
| Total assets acquired | | $ | 25,073,867 | |
| | | | | |
| Accounts payable and accrued liabilities | | | 1,132,313 | |
| Total liabilities assumed | | $ | 1,132,313 | |
| Net assets acquired | | $ | 23,941,554 | |
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
Deep Down obtained an independent valuation of the assets and liabilities as of the purchase date of May 1, 2008. Based on the independent valuation, the fair value of the property, plant and equipment was increased by approximately $1,258,000 and will be depreciated over estimated useful lives of 3 to 40 years using the straight-line method.
Deep Down has estimated the fair value of Flotation’s identifiable intangible assets as follows:
| | | Estimated Fair Value | | Useful Life |
| Trademarks | | $ 2,039,000 | | 40 |
| Technology | | 11,209,000 | | 25 |
| Non-compete covenant | | 879,000 | | 3 |
| Customer relationship | | 670,000 | | 25 |
| | | $ 14,797,000 | | |
The table below reflects the assumptions used for warrant and option grants related to Flotation during the year ended December 31, 2008:
Dividend yield | | 0% |
Risk free interest rate | | 2.52% - 2.84% |
Expected life of options | 2-3 years |
Expected volatility | | 51.7% - 61.3% |
The allocation of the purchase price was based on preliminary unaudited estimates. Estimates and assumptions are subject to change upon the receipt of management’s review of audited final amounts and final tax returns. This final evaluation of net assets acquired will be offset by a corresponding change in goodwill and is expected to be complete within one year of the purchase date.
Unaudited pro forma condensed combined financial statements
The unaudited pro forma combined condensed financial statements are presented for informational purposes only and are not necessarily indicative of the results of operations that actually would have been achieved had each acquisition been consummated as of that time, nor are they intended to be a projection of future results.
The unaudited condensed combined pro forma results were as follows:
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
| |
| For the Year Ended December 31, 2008 | |
| | | | | | | | | | | | | | | | |
| | | Historical | | | | | | | | | | |
| | | | | | Four Months | | | | | | | | | Combined | |
| | | | | | April 30, | | | Flotation | | | | | | Condensed | |
| | | | | | 2008 | | | Pro Forma | | | | | | Pro Forma | |
| | | Deep Down | | | Flotation | | | Entries | | | | | | Results | |
| | | | | | | | | | | | | | | | |
| Revenues | | $ | 35,769,705 | | | $ | 5,941,472 | | | $ | - | | | | | | $ | 41,711,177 | |
| Cost of sales | | | 21,686,033 | | | | 4,005,179 | | | | - | | | | | | | 25,691,212 | |
| Gross profit | | | 14,083,672 | | | | 1,936,293 | | | | - | | | | | | | 16,019,965 | |
| | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 15,575,519 | | | | 968,179 | | | | 302,416 | | | (d/e) | | | | 16,846,114 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | | (1,491,847 | ) | | | 968,114 | | | | (302,416 | ) | | | | | | | (826,149 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total other expense | | | (3,873,418 | ) | | | (57,335 | ) | | | - | | | | | | | | (3,930,753 | ) |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | | (5,365,265 | ) | | | 910,779 | | | | (302,416 | ) | | | | | | | (4,756,902 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Benefit from (provision for) income taxes | | | 1,042,372 | | | | - | | | | (225,094 | ) | | (f) | | | | 817,278 | |
| Net income (loss) | | $ | (4,322,893 | ) | | $ | 910,779 | | | $ | (527,510 | ) | | | | | | $ | (3,939,624 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | | $ | (0.03 | ) | | | | | | | | | | | | | | $ | (0.02 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | | 142,906,616 | | | | | | | | | | | | | | | | 168,682,522 | |
| | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | | $ | (0.03 | ) | | | | | | | | | | | | | | $ | (0.02 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | | 142,906,616 | | | | | | | | | | | | | | | | 168,682,522 | |
| | | | | | | | | | | | | | | | | | | | | |
| See accompanying notes to unaudited pro forma combined condensed financial statements. | |
| | | December 31, 2010 | |
| Book value of Flotation net assets | | $ | 12,119 | |
| Cash contribution by Deep Down to CFT | | | 1,400 | |
| Total book value of contributions to CFT | | | 13,519 | |
| Less: Fair value of Investment in CFT | | | (3,400 | ) |
| Loss on contribution of Flotation | | | (10,119 | ) |
The historical resultscomponents of Deep Down for the year endedour Investment in joint venture as of December 31, 2008 contain eight months of results for Flotation operations since its acquisition was effective May 1, 2008, thus the four months ending April 30, 20082010 are presented as pro forma. The weighted-average shares of stock used in computing basic and diluted per share amounts give effect to the 2,802,969 Mako shares issued on March 28, 2008 and the total of 58,857,143 common shares of Deep Down issued in June 2008, of which such amount 57,142,857 were issued in connection with the Private Placement and 1,714,286 were issued to Flotation’s prior shareholders, as if all these shares were issued January 1, 2008. Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.follows:
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
| | | December 31, 2010 | |
| Contribution to CFT | | $ | 3,400 | |
| Equity in net loss of CFT for the year ended December 31, 2010 | | | (254 | ) |
| Investment in joint venture | | $ | 3,146 | |
|
| For the Year Ended December 31, 2007 |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Historical | | | | | | | | | | | | | | |
| | | | | | Mako | | | | | | | | | | | | | | | | | |
| | | Deep Down | | | Eleven | | | Flotation | | | | | | | | | | | | | Combined | |
| | | Year Ended | | | Months Ended | | | Year Ended | | | Mako | | | | Flotation | | | | | | Condensed | |
| | | December 31, | | | November 30, | | | December 31, | | | Pro Forma | | | | Pro Forma | | | | | | Pro Forma | |
| | | 2007 | | | 2007 | | | 2007 | | | Entries | | | | Entries | | | | | | Results | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Revenues | | $ | 19,389,730 | | | $ | 5,494,388 | | | $ | 13,410,002 | | | $ | - | | | | $ | - | | | | | | $ | 38,294,120 | |
| Cost of sales | | | 13,306,086 | | | | 2,298,597 | | | | 8,117,600 | | | | - | | | | | - | | | | | | | 23,722,283 | |
| Gross profit | | | 6,083,644 | | | | 3,195,791 | | | | 5,292,402 | | | | - | | | | | - | | | | | | | 14,571,837 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 4,425,800 | | | | 2,455,728 | | | | 2,001,047 | | | | 448,679 | | (a) | | | 907,247 | | | (d/e) | | | | 10,238,501 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | | 1,657,844 | | | | 740,063 | | | | 3,291,355 | | | | (448,679 | ) | | | | (907,247 | ) | | | | | | | 4,333,336 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | | (335,662 | ) | | | (65,702 | ) | | | 766,477 | | | | (1,059,573 | ) | (b) | | | - | | | | | | | | (694,460 | ) |
| Income (loss) from continuing operations | | | 1,322,182 | | | | 674,361 | | | | 4,057,832 | | | | (1,508,252 | ) | | | | (907,247 | ) | | | | | | | 3,638,876 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Benefit from (provision for) income taxes | | | (369,673 | ) | | | (319,432 | ) | | | - | | | | 558,053 | | | | | (1,165,716 | ) | | (f) | | | | (1,296,768 | ) |
| Net income (loss) | | $ | 952,509 | | | $ | 354,929 | | | $ | 4,057,832 | | | $ | (950,199 | ) | | | $ | (2,072,963 | ) | | | | | | $ | 2,342,108 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings per share | | $ | 0.01 | | | | | | | | | | | | | | | | | | | | | | | | $ | 0.02 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shares used in computing basic per share amounts | | | 73,917,190 | | | | | | | | | | | | | | | | | | | | (c/g) | | | | 142,133,381 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings per share | | $ | 0.01 | | | | | | | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shares used in computing diluted per share amounts | | | 104,349,455 | | | | | | | | | | | | | | | | | | | | (c/g) | | | | 172,565,646 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| See accompanying notes to unaudited pro forma combined condensed financial statements. | |
The Unaudited Pro Forma Combined Condensed Statements includeDue to the following pro forma assumptions and entries for Mako (net of estimated taxes at Deep Down’s estimated combinedabove-described transaction, effective rate of 37%):
(a) | Amortization of the intangible assets at a rate of $40,789 per month for the eleven months ended November 30, 2007. One month is included in the historical Deep Down total for the year ended December 31, 2007. |
(b) | Represents cash interest plus amortization of deferred financing costs and debt discounts for the Credit Agreement. Interest was payable at 15.5% on the outstanding principal, and the related fees were amortized using the effective interest method over the four-year life of the loan. |
(c) | A total of 9,377,043 shares were issued for the total transaction. These pro forma amounts give effect as if shares were issued January 1, 2007. |
The Unaudited Pro Forma Combined Condensed Statements include the following pro forma assumptions and entries for Flotation:
(d) | Recognition of stock based compensation from employee stock options issued in connection with the acquisition of Flotation. Deep Down estimated $7,343 per month for the respective time periods. |
(e) | Amortization of the intangible assets at a rate of $68,261 per month based on the remaining useful lives in the table above. |
(f) | Represents estimated income tax accruals for the historical income plus all pro forma adjustments for the respective periods at Deep Down’s estimated combined effective rate of 37%. Flotation was an S-Corp, and as such did not accrue income taxes in its historical financial statements. |
(g) | A total of 58,857,143 common shares of Deep Down were issued; 57,142,857 in connection with the Private Placement, and 1,714,286 to Flotation shareholders. These pro forma amounts give effect as if shares were issued January 1, 2007. |
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 20072010 we will no longer aggregate the contributed operations of Flotation as an operating segment for fiscal periods beginning after such date.
Note 4:5: Property, Plant and Equipment
Property, plant and equipment consisted of the following as of December 31, 20082010 and 2007:2009:
| | | December 31, 2010 | | | December 31, 2009 | | | | |
| Land | | $ | 1,492 | | | $ | 1,954 | | | | - | |
| Buildings and improvements | | | 1,540 | | | | 5,458 | | | 7 - 36 years | |
| Leasehold improvements | | | 221 | | | | 313 | | | 2 - 5 years | |
| Equipment | | | 9,709 | | | | 13,773 | | | 2 - 15 years | |
| Furniture, computers and office equipment | | | 930 | | | | 1,154 | | | 2 - 8 years | |
| Construction in progress | | | 1,605 | | | | 954 | | | | - | |
| Total property, plant and equipment | | | 15,497 | | | | 23,606 | | | | | |
| Less: Accumulated depreciation | | | (3,821 | ) | | | (3,595 | ) | | | | |
| Property, plant and equipment, net | | $ | 11,676 | | | $ | 20,011 | | | | | |
Included in property and equipment are assets under capital lease of $870 and $648 at December 31, 2010 and 2009, respectively, with related accumulated depreciation of $332 and $230 at December 31, 2010 and 2009, respectively.
| | | December 31, 2008 | | | December 31, 2007 | | | Useful Life | |
| Land | | $ | 461,955 | | | $ | - | | | | - | |
| Building | | | 3,201,301 | | | | 195,305 | | | 7 - 36 years | |
| Leasehold improvements | | | 344,485 | | | | 75,149 | | | 2 - 5 years | |
| Furniture and fixtures | | | 160,443 | | | | 63,777 | | | 2 - 7 years | |
| Vehicles and trailers | | | 120,847 | | | | 112,161 | | | 3 - 5 years | |
| Equipment | | | 3,897,475 | | | | 1,809,474 | | | 2 - 10 years | |
| Rental Equipment | | | 4,694,681 | | | | 3,144,559 | | | 7 - 10 years | |
| Computer and office equipment | | | 473,518 | | | | 194,693 | | | 2 - 5 years | |
| Construction in progress | | | 2,130,068 | | | | 196,157 | | | | | |
| Total | | | 15,484,773 | | | | 5,791,275 | | | | | |
| Less: Accumulated depreciation | | | (1,685,577 | ) | | | (422,314 | ) | | | | |
| Property and equipment, net | | $ | 13,799,196 | | | $ | 5,368,961 | | | | | |
Depreciation expense, excluded from “Cost of sales” in the accompanying statements of operations, was $329 and $343 for the years ended December 31, 20082010 and 2007 was $1,314,138 and $398,611,2009, respectively. Deep Down recorded $1,078,027 and $285,717, respectively,Depreciation expense, included in “Cost of the total depreciation as Cost of Sales onsales” in the accompanying statements of operations. Accumulated depreciation on equipment under capital lease is $137,500operations, was $2,327 and $62,500 at December 31, 2008 and 2007, respectively.
During$1,616 for the yearyears ended December 31, 2008, we leased additional2010 and 2009, respectively. Net property, from JUMA, LLC, a related party,plant and incurred $342,430 in leasehold improvements. See additional discussionequipment totaling $8,405 was contributed to CFT by Flotation effective December 31, 2010 as discussed in Note 13 regarding the nature of the related party.
In connection with the purchase of Flotation, Deep Down acquired land along with a building and improvements with a fair market value of approximately $3,300,000. This 3.61 acre site4 “Investment in Maine houses a 46,925 square foot light industrial manufacturing facility.
On June 30, 2008, Deep Down transferred equipment with a cost basis of $502,253 from inventory to its rental equipment fleet.Joint Venture.”
At December 31, 2008,2010 and 2009, construction in progress represents assets that are not ready for service or are in the construction stage. The balance includes approximately $1,509,000 for a new ROV which was completed in January 2009. Deep DownWe will begin depreciating these assets once they are put into use.placed in service. The 2009 balance included approximately $954 for equipment in progress that was placed in service in 2010.
Note 5: Other Assets
Other assets consisted of the following as of December 31, 2008 and 2007:
| | | December 31, 2008 | | | December 31, 2007 | |
| Patents | | $ | 174,434 | | | $ | 5,172 | |
| Capitalized R&D | | | 270,097 | | | | 270,097 | |
| Deferred financing costs, net of amortization of $0 and $54,560 | | | - | | | | 762,700 | |
| Lease receivable, long term | | | | | | | 173,000 | |
| Other | | | 13,305 | | | | 545 | |
| Total other assets | | $ | 457,836 | | | $ | 1,211,514 | |
See further discussion of the deferred financing costs in Note 7 under the heading Secured Credit Agreement.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
On May 29, 2009, we consummated a purchase transaction with JUMA Properties, LLC (“JUMA”), a company owned by Ronald E. Smith, President, CEO and Director of Deep Down, and wife Mary L. Budrunas, Corporate Secretary and Director of Deep Down. Pursuant to a Purchase and Sale Agreement dated May 22, 2009, we acquired certain property and improvements located in Channelview, Texas, where certain of our operations are currently located (the “Channelview Property”). The Channelview Property consists of 8.203 acres and was purchased for $2,600. The transaction was conducted on an arms-length basis, with the purchase price being determined primarily on the basis of an independent appraisal, and in accordance with normal terms and conditions. Prior to May 29, 2009, we leased the Channelview Property from JUMA at a base rate of $15 per month. In connection with the purchase of the Channelview Property, the lease between us and JUMA was terminated. We incurred no early termination penalties from JUMA in connection with this termination.
Note 6: Intangible Assets and Goodwill
Goodwill
Goodwill represents the excess of the cost over the net tangible and identifiable intangible assets of acquired businesses.
The change in the carrying value of goodwill during the years ended December 31, 2010 and 2009 is set forth below:
| Carrying amount as of December 31, 2008 | | $ | 15,024 | |
| Adjustments to previously reporting purchase price | | | (58 | ) |
| Goodwill impairment | | | (5,537 | ) |
| Carrying amount as of December 31, 2009 | | $ | 9,429 | |
| Goodwill impairment | | | (4,513 | ) |
| Carrying amount as of December 31, 2010 | | $ | 4,916 | |
The decreases in 2010 and 2009, respectively, were primarily due to the non-cash impairment charge as discussed below, plus an adjustment to reduce the purchase price of Flotation by $58 as of December 31, 2009, net of legal fees, due to the resolution of a dispute concerning the working capital adjustment for the purchase price calculation.
Because quoted market prices for our individual reporting units are not available, management must apply judgment in determining the estimated fair value of our reporting units for purposes of performing the annual goodwill impairment test. Management uses all available information to make these fair value determinations, including the discounting of reporting units’ projected cash flow, publicly traded company multiples and recent merger and acquisition transaction values as a multiple of earnings. A key component of these fair value determinations is an assessment of the fair value using discounted cash flows and other market-related valuation models in relation to our market capitalization.
The accounting principles regarding goodwill acknowledge that the observed market prices of individual trades of a company’s stock (and thus its computed market capitalization) may not be representative of the fair value of the entity as a whole. Substantial value may arise from the ability to take advantage of synergies and other benefits that flow from control over another entity. Consequently, measuring the fair value of a collection of assets and liabilities that operate together in a controlled entity is different from measuring the fair value of that entity’s individual common stock. In most industries, including Deep Down’s, an acquiring entity typically is willing to pay more for equity securities that give it a controlling interest than an investor would pay for a number of equity securities representing less than a controlling interest. Therefore, the above fair value calculations using discounted cash flows and other market-related valuation models are compared to market capitalization plus a control premium.
Notes to Consolidated Financial Statements for the Years ended December 31, 2010 and 2009
(Amounts in thousands except per share amounts)
At December 31, 2010 and 2009, our management completed the annual impairment test of goodwill. There was no impairment indicated at December 31, 2010. Management’s calculations indicated as of December 31, 2009, due to a number of factors, including the global economic environment, increased costs of capital and the decrease in our market capitalization, that the calculations for the reporting units of Deep Down Delaware, Mako and Flotation each indicated their respective net book value exceeded its fair value and, accordingly, we estimated the implied fair value of the goodwill for each reporting unit. We used the estimated fair value of each reporting unit from the first step as the purchase price in a hypothetical acquisition of the respective reporting unit. We recognized a goodwill impairment of $3,056 for Deep Down Delaware, $2,481 for Mako and $0 for Flotation reporting units for the year ended December 31, 2009. After adjusting the Flotation carrying value of intangible assets to fair value, there was no goodwill impairment for that reporting unit. See detailed discussion of intangible asset below. The impairment was recorded in operating expenses in the consolidated statement of operations for the year ended December 31, 2009. This non-cash charge did not impact our liquidity position, debt covenants or cash flows.
We estimated the fair value of the reporting units using discounted cash flows and earnings multiples of comparable publicly traded companies. The key discounted cash flow assumptions used to determine the fair value of our reporting units included: a) cash flow periods of six years with a four percent estimated annual growth rate, b) terminal values based on the terminal cash flow growth rate and the capitalization rate (weighted average cost of capital – terminal growth rate) and c) a weighted average cost of capital of 20.8 percent. The remaining goodwill by reporting unit was $4,472, $2,874 and $2,083 for the Delaware, Mako and Flotation reporting units, respectively, as of December 31, 2009. As a result of the adjustments discussed above, approximately $7,346 of our goodwill was recorded at fair value as of December 31, 2009, based upon Level 3 inputs.
Additionally, we assessed the market conditions and concluded, as of September 30, 2010, that a triggering event had occurred that required an impairment analysis of goodwill for each reporting unit. Management’s calculations indicated, due to a number of factors, including the global economic environment, increased costs of capital and the decrease in our market capitalization, that the calculations for the reporting units of Mako and Flotation each indicated their respective net book value exceeded its fair value and, accordingly, we estimated the implied fair value of the goodwill for each reporting unit. The calculation for Deep Down Delaware did not indicate any impairment of goodwill. We used the estimated fair value of each reporting unit from the first step as the purchase price in a hypothetical acquisition of the respective reporting unit. We recognized a goodwill impairment of $2,430 for Mako and $2,083 for Flotation reporting units for the nine months ended September 30, 2010. The impairment was recorded in operating expenses in the consolidated statement of operations for the year ended December 31, 2010. This non-cash charge did not impact our liquidity position, debt covenants or cash flows.
We estimated the fair value of the reporting units using discounted cash flows and earnings multiples of comparable publicly traded companies. The key discounted cash flow assumptions used to determine the fair value of our reporting units included: a) cash flow periods of six years with various annual revenue growth rates as estimated by management, b) terminal values based on the terminal cash flow growth rate and the capitalization rate (weighted average cost of capital – terminal growth rate) and c) a weighted average cost of capital of 26.2 percent and 27.9 percent for Flotation and Mako, respectively. The remaining goodwill by reporting unit was $4,472, $444 and $0 for the Delaware, Mako and Flotation reporting units, respectively, as of September 30, 2010.
Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions, among others. Unanticipated changes in revenue, gross margin, long-term growth factor or discount rate could result in a material impact on the estimated fair values of our reporting units which could result in additional goodwill impairment in future periods.
Notes to Consolidated Financial Statements for the Years ended December 31, 2010 and 2009
(Amounts in thousands except per share amounts)
Intangible Assets
Identifiable intangible assets acquired in business combinations are recorded based upon fair market value at the date of acquisition. Amounts allocated to intangible assets are amortized on a straight-line basis over their estimated useful lives. Deep Down is in the process of finalizing the valuations of certain intangible assets related to the Flotation acquisition; consequently, the initial allocations of the respective purchase price amounts are preliminary and subject to change for a period of one year following the acquisition, although management believes amounts are materially accurate as of December 31, 2008. Estimated intangible asset values, net of recognized amortization expense include the following:
| | | | December 31, 2010 | | | December 31, 2009 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| Customer relationship | 6 Years | | $ | 2,845 | | | $ | (1,092 | ) | | $ | 1,753 | | | $ | 3,515 | | | $ | (786 | ) | | $ | 2,729 | |
| Non-compete covenant | 5 Years | | | 455 | | | | (415 | ) | | | 40 | | | | 1,334 | | | | (893 | ) | | | 441 | |
| Trademarks and other | 17-25 Years | | | 1,247 | | | | (132 | ) | | | 1,115 | | | | 3,286 | | | | (174 | ) | | | 3,112 | |
| Technology | | | | - | | | | - | | | | - | | | | 11,209 | | | | (5,149 | ) | | | 6,060 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | | $ | 4,547 | | | $ | (1,639 | ) | | $ | 2,908 | | | $ | 19,344 | | | $ | (7,002 | ) | | $ | 12,342 | |
There was no triggering event or impairment to intangible assets at December 31, 2010. We previously assessed the market conditions and concluded, as of September 30, 2010, that a triggering event had occurred that required an impairment analysis of long-lived intangible assets. For the nine months ended September 30, 2010, the analysis determined that there was no impairment of long-lived assets as of September 30, 2010. Fair values for technology and customer relationships were based upon an excess earnings methodology. Fair value for non-compete agreements was based on the expected differential cash flow of the reporting unit between “with non-compete agreements” and “without” non-compete agreements scenarios.
| | | | December 31, 2008 | | | December 31, 2007 | |
| | Estimated | | Gross Carrying | | | Accumulated | | | Net Carrying | | | Gross Carrying | | | Accumulated | | | Net Carrying | |
| | Useful Life | | Value | | | Amortization | | | Amount | | | Value | | | Amortization | | | Amount | |
| | | | | | | | | | | | | | | | | | | | |
| Customer relationship | 8-25 Years | | $ | 3,515,000 | | | $ | (403,131 | ) | | $ | 3,111,869 | | | $ | 2,869,000 | | | $ | (11,157 | ) | | $ | 2,857,843 | |
| Non-Compete Covenant | 3-5 Years | | | 1,334,000 | | | | (293,916 | ) | | | 1,040,084 | | | | 458,000 | | | | (7,633 | ) | | | 450,367 | |
| Trademarks | 25-40 Years | | | 3,110,000 | | | | (80,393 | ) | | | 3,029,607 | | | | 1,071,000 | | | | (9,563 | ) | | | 1,061,437 | |
| Technology | 25 Years | | | 11,209,000 | | | | (299,880 | ) | | | 10,909,120 | | | | - | | | | - | | | | - | |
| Total | | | $ | 19,168,000 | | | $ | (1,077,320 | ) | | $ | 18,090,680 | | | $ | 4,398,000 | | | $ | (28,353 | ) | | $ | 4,369,647 | |
For the year ended December 31, 2009, we recorded impairment charges totaling $4,616 to the following long-lived intangible assets: $4,401 reduction in the carrying value of the technology intangibles primarily due to a change in the estimated useful life from twenty-five years to ten years based on recent technology developments in the buoyancy industry, which shorter life lessened the projected cash flows generated by this asset, and $215 reduction in the non-compete covenants. As a result, approximately $6,110 of long-lived intangible assets were recorded at fair value based upon Level 3 inputs at December 31, 2009. We recorded the adjustment as amortization expense on the statement of operations. Additionally, we reduced the estimated useful lives of the following intangible assets based upon current market trends and estimated future cash flows: customer lists from a range of eight to twenty-five years to a range of six to fourteen years, and technology from twenty-five to ten years. The estimated amortization expense below reflects the adjusted carrying values and useful lives.
As of December 31, 2010, net intangible assets of Flotation totaling $8,035 were contributed to CFT as discussed in Note 4 “Investment in Joint Venture.”
Estimated amortization expense for each of the five subsequent fiscal years is expected to be:
| Years ended December 31,: | | | |
| 2009 | | $ | 1,308,588 | |
| 2010 | | | 1,308,588 | |
| 2011 | | | 1,113,243 | |
| 2012 | | | 1,008,017 | |
| 2013 | | | 924,588 | |
| Thereafter | | | 12,427,656 | |
| | | $ | 18,090,680 | |
| Years ended December 31,: | | | | |
| 2011 | | $ | 414 | |
| 2012 | | | 414 | |
| 2013 | | | 414 | |
| 2014 | | | 414 | |
| 2015 | | | 404 | |
| Thereafter | | | 848 | |
| | | $ | 2,908 | |
The following table presents goodwill as of the dates indicated, as well as changes in the account during the period shown:
| | | Amount | |
| Carrying amount as of December 31, 2007 | | $ | 10,594,144 | |
| Goodwill acquired during the year | | | 4,430,156 | |
| Carrying amount as of December 31, 2008 | | $ | 15,024,300 | |
The increases to goodwill include the adjustment to the Mako purchase price due to the finalization of tax returns as discussed in Note 3 above. Deep Down determined that approximately $1,840,000 of the purchase price was to be allocated to a deferred tax liability due to the difference in the tax balance sheet and book balance sheet related to the intangible and fixed assets.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Note 7: Long-Term Debt
At December 31, 20082010 and 20072009 long-term debt consisted of the following:
| | | December 31, 2008 | | | December 31, 2007 | |
| | | | | | | |
| Bank term loan | | $ | 1,150,000 | | | $ | - | |
| Secured credit agreement | | | - | | | | 12,000,000 | |
| Debt discount, net of amortization of $0 and $135,931 respectively | | | - | | | | (1,703,258 | ) |
| Other bank loans | | | 15,087 | | | | 916,044 | |
| Total secured credit agreements and bank debt | | | 1,165,087 | | | | 11,212,786 | |
| 6% Subordinated Debenture | | | 500,000 | | | | - | |
| Capital lease obligation | | | 436,300 | | | | 481,209 | |
| Total long-term debt | | | 2,101,387 | | | | 11,693,995 | |
| Current portion of long-term debt | | | (382,912 | ) | | | (995,177 | ) |
| Long-term debt, net of current portion | | $ | 1,718,475 | | | $ | 10,698,818 | |
| | | December 31, 2010 | | | December 31, 2009 | |
| Secured credit agreement - Whitney Bank | | $ | 2,917 | | | $ | 3,694 | |
| Secured credit agreement - TD Bank | | | - | | | | 2,125 | |
| Other bank loans | | | - | | | | 63 | |
| Total bank debt | | | 2,917 | | | | 5,882 | |
| 6% Subordinated debenture | | | 500 | | | | 500 | |
| Capital lease obligations | | | 635 | | | | 494 | |
| Total debt | | | 4,052 | | | | 6,876 | |
| Less: Current portion of long-term debt | | | (1,609 | ) | | | (1,497 | ) |
| Long-term debt, net of current portion | | $ | 2,443 | | | $ | 5,379 | |
Whitney Credit Agreement
Revolving Credit Line and Term Loan
On November 11, 2008, Deep DownWe originally entered into a new Credit Agreement (the “Revolver”)credit agreement with Whitney National Bank (“Whitney Bank”) as lender.in November 2008. The Revolver providescredit agreement originally provided a commitment to lend to Deep Down ofus the lesser of $2,000,000 and 80%$2,000 or 80 percent of eligible receivables (generally defined as current due accounts receivables in which the lender has a first priority security interest).receivables. All of thethis commitment under the Revolver iswas also available in commitments for the lenderWhitney to issue letters of credit (“L/C”) for the benefit of Deep Down. Outstanding amounts under the Revolver generally will bear interest at rates based on the British Bankers Association LIBOR Rate for dollar deposits with a term of one month plus an applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep Down. Accrued interest under the Revolver is payable monthly. Unused portions of the commitment generally accrue a commitment fee of 0.25% to 0.50% based on the leverage ratio of Deep Down and such fee is due and payable by Deep Down quarterly. The Revolver has a termination date of November 11, 2010. Atour benefit. In December 31, 2008, Deep Down has not drawn on any amounts available under the Revolver.
On December 18, 2008, Deep Downwe then entered into an amendment of the credit agreement that provided for us to receive a term loan in the principal amount of $1,150. Then, in May 2009, we entered into another amendment to the Revolver, (the “Term Loan”) withcredit agreement providing for us to receive another term loan in the principal amount of $2,100. We used the proceeds from the December 2008 term loan to purchase a piece of equipment (a remotely operated vehicle) and we used the proceeds of the May 2009 term loan to purchase real property in Channelview, Texas. There was $850 outstanding under the revolving credit line available on December 31, 2009. We also used the credit agreement to have Whitney Bank and receivedissue an advanceirrevocable transferable standby L/C in the ordinary course of $1,150,000 on that date. The Term Loan provides for a 3-year term loanbusiness, with an annual interestcommission rate of 6.5%,2.4 percent for $1,107 during the year ended December 31, 2009 (which such L/C related to a large contract we expect to have completed during 2011). The Restated Credit Agreement does not obligate Whitney to issue new L/Cs. However on September 1, 2010, Whitney did renew the aforementioned L/C under the same terms for a period of one year to expire on August 31, 2011. We paid the annual commission in advance, and the L/C will remain in effect until it expires.
On April 14, 2011, we entered into a Second Amendment to the Restated Credit Agreement with Whitney, pursuant to which Whitney extended the maturity dates of the respective term loans and the letter of credit facility under the Restated Credit Agreement to April 15, 2012.
Under the original credit agreement with Whitney, we were obligated to repay the December 2008 term loan on the basis of monthly principal and interest payments paid in arrearsinstallments of $35,246 per month beginning$35, with the initial payment on February 1, 2009 withand a maturityfinal payment on January 2, 2012. Outstanding amounts of December 18, 2011 (unless accelerated by default under termsprincipal of the Revolver). Funds were used towards the purchase price of a new Super Mohawk 21 ROV for use in Deep Down's operations, which was delivered in January 2009. This Term Loan replaces the provision in the Revolver for a five-yearDecember 2008 term loan and is subject to the terms and conditionsaccrue interest at a rate of the Revolver.
Each of Deep Down’s subsidiaries has guaranteed the obligations of Deep Down under the Revolver and as such, Deep Down’s obligations in connection with the Revolver are secured by a first priority lien generally on all of their non real property assets. The terms of the Revolver and the related loan documents subject Deep Down to several covenants, including requirements to: provide security generally on all of Deep Down's non real property assets, cause Deep Down’s subsidiaries to provide guarantees, provide certain financial information to the lender, give inspection rights to the lender, and apply insurance and eminent domain proceeds to repayment of amounts outstanding under the Revolver. Furthermore,6.5 percent per annum. Under the terms of the Revolver impose restrictionsRestated Credit Agreement, the monthly installment payments and interest rate of the December 2008 term loan remain the same. As of December 31, 2010, the outstanding principal amount of the December 2008 term loan was $443.
Under the original credit agreement with Whitney, we were obligated to repay the May 2009 term loan on the abilitybasis of Deep Downmonthly installments of $18, with the initial payment on June 1, 2009 and its subsidiariesa final payment on May 1, 2024. Outstanding amounts of principal of the May 2009 term loan accrue interest at a rate of 6.5 percent per annum. Under the terms of the Restated Credit Agreement, the monthly installment payments and interest rate of the May 2009 term loan remain the same, and the final balloon payment of $1,834 is now due on April 15, 2012. As of December 31, 2010, the outstanding principal amount of the May 2009 term loan was $1,944.
Upon execution of the Restated Credit Agreement in April 2010, our indebtedness in the amount of $850 outstanding under the revolving credit line of the credit agreement was converted to incur further indebtedness or liens,a term loan. This term loan requires us to make investments in other businesses, to pay dividends, to engage in mergers, acquisitions or dispositions or other lines of businesses, to enter into transactions with their affiliates, to prepay other indebtedness or to make any change in their respective fiscal year or method of accounting (other than changes as required by generally accepted accounting principlesmonthly installments in the U.S.).amount of $40 plus the amount of accrued and unpaid interest beginning on May 1, 2010 with a final payment due February 1, 2012. Outstanding amounts of principal of the April 2010 term loan accrue interest at a rate of 6.5 percent per annum. As of December 31, 2010, the outstanding principal amount of the April 2010 term loan was $530.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Whitney possesses a lien on all of our assets to secure the outstanding indebtedness under the Restated Credit Agreement. Furthermore, each of our subsidiaries has guaranteed our obligations under the Restated Credit Agreement, and as such, our obligations in connection with the Restated Credit Agreement are generally secured by a first priority lien on all of our subsidiaries’ assets. With regard to the Channelview Property purchased with the proceeds of the May 2009 term loan, we also entered into a Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing, creating a lien on such property.
On December 31, 2010, we entered into a First Amendment to Amended and Restated Credit Agreement with Whitney, pursuant to which Whitney provided its consent concerning our contribution of Flotation’s assets to CFT and our issuance of shares to Holdings and using the proceeds thereof for a further cash contribution to CFT. This amendment allowed the Company to complete the acquisition of Cuming Corporation and form the JV, which we contributed all of the assets, liabilities and bank debt of the Flotation subsidiary to the JV for our 20% ownership in the JV. However, as a result of this transaction occurring on December 31, 2010, we are required to expense all acquisition costs and write down the value of the contributed assets in order to establish a fair value of our investment in the JV. These expenses and write down caused us to be not in compliance with certain financial covenants under the Restated Credit Agreement. On March 25, 2011 we obtained a waiver for these covenants as of December 31, 2010.
Under the Revolver, Deep Down is required to meet certain covenantsRestated Credit Agreement, as amended and restrictions. The financial covenants are reportable each quarter,restated, beginning with the quarter ending March 31, 2009. Financial covenants include maintainingended June 30, 2010, and for each quarter thereafter, we have been obligated to comply with the following financial covenants: (i) total debt to consolidated EBITDA below 2.5earnings before interest, taxes, depreciation and amortization (“EBITDA”) of not greater than 3.0 to 1,1.0 (“Leverage Ratio”), consolidated EBITDA to consolidated net interest expense and principal payments on the total debt greater than 1.5 to 1,1.0 (“Fixed Charge Coverage Ratio”), and tangibleconsolidated net worth after deducting other assets as are properly classified as “Intangible Assets”, plus 50 percent of net income, after provision for taxes (“Tangible Net Worth”) in excess of $20,000,000$15,000. The calculation of EBITDA, with regards to the Leverage Ratio and Fixed Charge Coverage Ratio, allows us to deduct certain non-cash items, specifically asset impairment charges as each term is definedof December 31, 2009 and going forward. As of both September 30, 2010 and December 31, 2010, we were not in compliance with the Leverage Ratio and the Fixed Charge Coverage Ratio and, as noted above, such circumstance entitles Whitney at its option to accelerate and immediately require all amounts outstanding under the Restated Credit Agreement. OtherAgreement to become immediately due. Under the Restated Credit Agreement, we continue to have obligations for other covenants, includeincluding limitations on issuance of common stock, liens, transactions with affiliates, additional indebtedness and permitted investments, among others.
Secured Credit Agreement
On August 6, 2007, Deep Down entered into a $6,500,000 secured credit agreement, (the “Credit Agreement”) with Prospect Capital Corporation (“Prospect”) and received an advance of $6,000,000 on that date. The Credit Agreement provided for a 4-year term, an annual interest rate of 15.5%, with the ability to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and principal payments of $75,000 per quarter beginning September 30, 2008, with the remaining balance outstanding due August 6, 2011. Interest payments were payable monthly, in arrears, on each month-end commencing on August 31, 2007.
On December 21, 2007, Deep Down entered into an amendment to the Credit Agreement (the “Amendment”) to provide the funding for the cash portion of the purchase of Mako. The total commitment available under the Amendment was increased to $13,000,000. Amounts borrowed were $6,000,000 on the increased line for a total of $12,000,000 outstanding. Quarterly principal payments increased to $250,000 beginning September 30, 2008.
Terms of the Credit Agreement also included a detachable warrant to purchase up to 4,960,585 shares of common stock at an exercise price of $0.507 per share. The warrant had a five-year term and became exercisable on the earlier of the two-year anniversary of the original financing, or upon payment in full of the outstanding balance. The relative fair value of the warrant was estimated to be $1,479,189 based on the Black Scholes pricing model and was recorded as a discount to the note. The assumptions used in the model included (1) expected volatility of 52.7%, (2) expected term of 3.5 years, (3) discount rate of 5% and (4) zero expected dividends.
Additionally, in connection with the initial advance in August 2007 and the additional advance under the Amendment, Deep Down pre-paid $180,000, respectively, in points to the lender which were each treated as discounts to the note.
The discounts associatedRestated Credit Agreement removed a provision from the prior credit agreement with Whitney that permitted us to obtain additional indebtedness from a third party in the valueevent Whitney declined to increase its commitment of indebtedness to us. As such, we expect to have to refinance the indebtedness outstanding under the Restated Credit Agreement at any such time as we seek to obtain new financing from a third party.
TD Bank Loan Agreement
During fiscal 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds from TD Bank, N.A. in the principal amount of $2,160 (the “TD Bank Loan”). Under the terms of the warrantsTD Bank Loan, we were obligated to make payments in monthly installments of $15, with an initial payment on March 13, 2009 and the cash-based expenses were amortized into interest expense over the lifea final payment of the Credit Agreement using the effectiveunpaid principal and accrued interest in February 2029. The interest rate method. A total of $1,703,258 and $135,931 of debt discount was amortized into interest expense for the years ended December 31, 2008 and 2007, respectively. The fiscal year 2008 amount included acceleration of the remaining balance due to early payoff of the debt as discussed below.
Deep Down capitalized a total of $555,314 in deferred financing costs related to the original amounts borrowed under the Credit Agreement. Of this amount, $442,194 was paid in cash to various third parties related to the financing, and the remainder of $113,120 represents the Black Scholes valuation of warrants issued to one of these third party vendors. The warrant is a detachable warrant to purchase up to 320,000 shares of common stock at an exercise price of $0.75 per share. The warrant has a five-year term and becomes exercisable on the earlier of the two-year anniversary of the original financing, or upon payment in full of the outstanding balance. The assumptions used in the Black Scholes model included (1) expected volatility of 52.7%, (2) expected term of 3.5 years, (3) discount rate of 5% and (4) zero expected dividends.
In connection with the second advance under the Credit Agreement on January 4, 2008, Deep Down capitalized an additional $261,946 in deferred financing costs. Of this amount, $216,000TD Bank Loan was paid in cash to various third parties related to the financing, and the remainder of $45,946 represents the Black-Scholes valuation of warrants issued to one of these third party vendors. The detachable warrant was granted to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share. The warrant had a five-year term and is immediately exercisable. The fair value of the warrant was estimated to be $45,946 based on the Black Scholes pricing model, using the following assumptions: (1) expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate of 3.2% and (4) zero expected dividends. 5.75 percent.
The deferred financing costs associatedTD Bank Loan was secured by Flotation’s operating premises in Biddeford, Maine under a mortgage and security agreement and a collateral assignment of leases and rents. The TD Bank loan required us to enter into a debt subordination agreement that subordinated any debt Flotation owed to Deep Down, other than accounts payable between them arising in the ordinary course of business. Additionally, the TD Bank Loan required a “negative pledge” that prohibited Flotation and Deep Down from granting security interests in Flotation’s personal property, other than such security interests granted in respect of our credit agreement with the value of the warrants and the cash-based expenses were amortized into interest expense over the life of the Credit Agreement using the effective interest rate method. A total of $762,700 and $54,560 of deferred financing cost was amortized into interest expense for the years ended December 31, 2008 and 2007, respectively. The fiscal year 2008 amount included acceleration due to early payoff of the debtWhitney, as discussed below.appropriate.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Cash interest paid for the years ended December 31, 2008 and 2007 was $821,500 and $377,167, respectively. Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through June 2008 when the debt was paid in full, see details below. Under the Credit Agreement, Deep Down wasTD Bank Loan, we were required to meet certain covenants and restrictionsrestrictions. The financial covenants were reportable annually beginning with the year ended December 31, 2009, and were specific to the Flotation subsidiary financials. At December 31, 2009, we were not in compliance with the financial covenants, and on April 15, 2010, we obtained a waiver for these covenants as well as maintain a debt service reserve account. As of December 31, 2007, $375,000 was classified as “Restricted cash” on the accompanying consolidated balance sheets.
On June 12, 2008, Deep Down paid $12,492,912 to Prospect to pay off the balance outstanding under the Credit Agreement and related interest and early termination fees. In connection with the early payoff, Deep Down accelerated the remaining deferred financing costs totaling $661,149 and recorded this charge as interest expense. Additionally, $1,490,955 in debt discounts were accelerated and recorded as interest expense. Early termination fees of $446,412 were recognized as a loss on early extinguishment of debt. Since the warrants issued in connection with the original Credit Agreement and the Amendment dated January 4, 2008 were detachable, there was no change to these equity instruments. On July 3, 2008, Prospect exercised their outstanding 4,960,585 warrants in a cashless exercise for a total of 2,618,129 shares of Deep Down common stock.
Other Bank Loans2009.
In connection with Flotation’s contribution of all of its assets to CFT on December 2008, Deep Down entered into an auto loan with 36 monthly payments31, 2010, CFT assumed the obligations of $454, including interest at 5.5%, beginning January 22, 2009 through December 22, 2011. The loan is collateralized byFlotation under the vehicle purchased.TD Bank Loan and we were released from the obligations under such loan.
Other Debt
In January 2008, in accordanceWe have a subordinated debenture with the terms of the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664. These notes were payable to various banks, with interest rates between 7.85% and 8.3% and were collateralized by Mako assets and life insurance policy.
Exchange of Series E Redeemable Exchangeable Preferred Stock to 6% Subordinated Debenture
On March 31, 2008, 500 shares of the Series E Redeemable Exchangeable Preferred Stock were exchanged into a 6% Subordinated Debenture (the “Debenture”) in an outstanding principal amount of $500,000.$500 which originated from the exchange of preferred stock in a prior year. The Debenturedebenture has a fixed interest rate of 6% interest6.0 percent per annum, which is required to be paid annually onbeginning March 31st31, 2009 through maturity on March 31, 2011. See2011, when the additional discussion of the terms of the Series E preferred stock at unpaid principal balance is due.
Note 8. Interest expense on the Debenture of $22,603 has been recognized and recorded as an accrued liability for the year ended December 31, 2008.8: Share-Based Compensation
Capital lease
In February 2007, Deep Down purchased under a seller-financed capital lease, a 100-ton mobile gantry crane and related equipment. The equipment was delivered and placed into service in March 2007. In accordance with SFAS 13 “Accounting for Leases” as amended, the lease was capitalized and the lease obligation and related assets recognized on Deep Down’s consolidated balance sheet. The total value of the lease payments discounted at an 11.2% interest rate, or $525,000, was capitalized. The off-setting lease obligation is $436,300 at December 31, 2008. See Note 14 regarding the future minimum payments due on the capital lease.
Payment table
Aggregate principal maturities of long-term debt, excluding capital leases which are detailed in Note 14, were as follows for years ended December 31:
| Years ended December 31,: | | | |
| 2009 | | $ | 332,720 | |
| 2010 | | | 385,747 | |
| 2011 | | | 911,564 | |
| 2012 | | | 35,056 | |
| | | $ | 1,665,087 | |
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
Note 8: Preferred Stock
Series D Redeemable Convertible Preferred Stock Classified as Temporary Equity Instruments
During the first quarter of fiscal year 2008, the outstanding 5,000 shares of Series D redeemable convertible preferred stock (“Series D”) were converted into 25,866,518 shares of common stock. The Series D had a face value and liquidation preference of $1,000 per share, no dividend preference, and were convertible into shares of common stock determined by dividing the face amount by a conversion price of $0.1933. The Series D had been valued at inception at $4,419,244 based on the Black-Scholes fair value of the Series D.
Series E and G Classified as Liabilities
The Series E and G redeemable exchangeable preferred stock (“Series E” and “Series G”) had a face value and liquidation preference of $1,000 per share, no dividend preference, and were exchangeable at the holder’s option into 6% Subordinated Notes due three years from the date of the exchange. These shares carried voting rights equal to 690 votes per share. The Series E and G preferred stock were valued based on the discounted value of their expected future cash flows, using a discount rate of 20%. Deep Down evaluated the Series E and G preferred stock and classified them as debt instruments from the date of issuance due to the fact that they were exchangeable at the option of the holder thereof into Notes. The difference between the face value of the Series E and G preferred stock and the discounted book value recorded on the balance sheet, or original issue discount, was deemed to be non-cash interest expense from the date of issuance through the term of the Stock.
Deep Down was accreting this original issue discount using the effective interest rate method. Interest expense related to the accretion of the original issue discount totaled $113,589 and $1,644,990 for the years ended December 31, 2008 and 2007, respectively.
On March 31, 2008, 500 shares of the Series E preferred stock were exchanged into a 6% Subordinated Debenture in an outstanding principal amount of $500,000. The Series E had a face value and liquidation preference of $1,000 per share, no dividend preference, and were exchangeable at the holder’s option into a 6% debenture due three years from the date of the exchange. Upon exchange into the Debenture, Deep Down recorded $113,589 in interest expense for the accretion of the Series E up to face value. See additional discussion of the Subordinated Debenture in Note 7.
In February 2007, Deep Down redeemed 250 shares of Series E preferred stock held by its CEO at the face value of $1,000 per share for a total of $250,000. Deep Down accreted the remaining discount of $72,799 attributable to such shares on the date of redemption as interest expense.
In May 2007, Deep Down executed a Securities Redemption Agreement with the former CFO of Deep Down to redeem 4,000 shares of Series E preferred stock at a discounted price of $500 per share for a total of $2,000,000. The discount of $500 per share from the face value of $1,000 was accounted for as a substantial modification of debt, thereby generating a gain on extinguishment of debt which is reflected in other income. Deep Down accreted the remaining discount of $1,017,707 attributable to such shares on the date of redemption as interest expense.
On September 13, 2007, Deep Down redeemed 2,250 shares of Series E preferred stock owned by the CEO and director, and his wife, a Vice-President and director of Deep Down. The Series E preferred stock was redeemed for 2,250,000 shares of common stock at the closing price of $0.66 totaling $1,473,750. Since the shareholders are related parties, no accretion interest was recorded related to the redemption. The difference between the carrying value of the Series E shares of $1,685,463 and the common stock market value was recorded to Paid in Capital.
Additionally, in October 2007, Deep Down redeemed 1,250 shares of Series E preferred stock at the face value of $1,000 per share for a total of $1,250,000. The Series E preferred shares were redeemed for 1,213,592 shares of common stock at the closing price of $1.03. Deep Down accreted the remaining discount of $260,520 attributable to such shares on the date of redemption and recorded it as interest expense.
All Series G preferred shares were cancelled and exchanged during the first quarter of 2007. Accordingly, there is no future discount accretion relating to the Series G preferred shares. See “Series F and G Cancellation and Issuance of Additional Series E” below.
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
Series F and G Cancellation and Issuance of Additional Series E
On March 20, 2007, Deep Down finalized the terms of an agreement with a former non-employee director who surrendered 25,000,000 shares of common stock for $250,000 in cash. The market value of those shares was $7,250,000. Additionally, he surrendered 1,500 shares of Series F convertible preferred stock with a value of $1,325,773 and 500 shares of Series G exchangeable preferred stock with a value of $357,615 to Deep Down for cancellation in exchange for 1,250 shares of Series E exchangeable preferred stock valued at $945,563. The Series E Preferred Stock was valued based on the discounted value of its expected future cash flows, using a discount rate of 20%. The difference between the values of the preferred shares surrendered and the newly issued shares was $737,826 which is reflected in paid in capital on the accompanying consolidated balance sheet. In addition, he also kept 500 shares of Series E exchangeable preferred stock he previously owned and agreed to tender his resignation from the Board.
On March 20, 2007, Deep Down issued 2,000 shares of Series E exchangeable preferred stock to John C. Siedhoff, then Chief Financial Officer, and director, valued at $1,512,901 for the surrender of his ownership of 1,500 shares of Series F convertible preferred stock valued at $1,325,773 and 500 shares of Series G exchangeable preferred stock valued at $357,616, which were returned to the transfer agent for cancellation. The Series E Preferred Stock was valued based on the discounted value of its expected future cash flows, using a discount rate of 20%. The difference between the values of the surrendered shares and the newly issued shares was $170,489 which is reflected in paid in capital on the accompanying consolidated balance sheet. Deep Down has treated this as a modification ofWe have a share-based payment in accordance with the provisions of SFAS No. 123R, “Share-Based Payments”.
Series C Preferred Stock
The Series C shares had a face value and a liquidation preference of $12.50 per share, a cumulative dividend of 7% payable at the conversion date, and were convertible into shares of common stock determined by dividing the face amount by a conversion price of $0.0625. These shares carried no voting rights. All of the Series C shares were converted in the fourth quarter of fiscal year 2007 to 4,400,000 shares of Deep Down’s common stock.
Note 9: Common Stock
Private Placement, fiscal year 2008
On June 5, 2008, Deep Down sold 57,142,857 shares of its common stock in a private placement to accredited investors, for $40,000,000 at a per-share price of $0.70 (the “Private Placement”). After transaction costs, Deep Down had net proceeds of $37,059,670. Dahlman Rose & Company, LLC acted as exclusive placement agent for the equity financing.
Deep Down used $22,100,000 of the net proceeds to fund the cash portion of the Flotation purchase, and used $12,492,912 to repay outstanding debt, along with early termination fees, to Prospect on June 12, 2008. Deep Down retained the remaining net proceeds for working capital purposes.
Private Placements, fiscal year 2007
On March 20, 2007, Deep Down completed the sale of 10,000,000 shares of common stock in a private placement for $1,000,000. A total of 1,025,000 shares were purchased by the CEO and director, and his wife, a Vice-President and director of Deep Down. The shares are restricted securities as defined in Rule 144 of the Securities Act of 1933 and contain a restrictive legend, which restricts the ability of the holders to sell these shares for a period of no less than six months. Funds from such private placement sale were used to redeem certain outstanding exchangeable preferred stock and for working capital.
On October 12, 2007, Deep Down closed an agreement with Ironman Energy Capital, L.P. for a private placement of 3,125,000 shares of common stock at $0.96 per share, or $3,000,000 in the aggregate, pursuant to an agreement reached on October 2, 2007 when the closing price was $1.03 per share. In connection with this private placement, the Deep Down entered into registration rights agreement, under which, upon demand registration by the holder after December 31, 2008, Deep Down could be subject to liquidating damages in the amount of 1% of the proceeds for every 30 days a registration statement is not declared effective. Deep Down is currently evaluating the probability of incurring these liquidated damages as a contingent liability and not yet determined the potential impact on the financial statements.
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
Other stock issuances
On September 13, 2007, Deep Down redeemed 2,250 shares of Series E preferred stock owned by the Chief Executive Officer and director, and his wife, a Vice-President of Deep Down. The Series E preferred shares were redeemed for 2,250,000 shares of common stock at the closing price of $0.66.
During the year ended December 31, 2007, we executed a Securities Redemption Agreement with our former chief financial officer to redeem 4,000 shares of Series E exchangeable preferred stock at a discounted price of $500 per share for a total of $2,000,000. In October 2007, Deep Down made the final payment of $560,000 under the terms of this Securities Redemption Agreement by issuing 543,689 shares of common stock valued at the closing price of $1.03 on the same day.
Note 10: Stock-Based Compensation
Deep Down has a stock-based compensation plan, - the 2003“2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award PlanPlan” (the “Plan”). Deep Down accounts for stock-basedShare based compensation is recognized as provided under the applicable authoritative guidance which requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense under SFAS No. 123 (Revised 2004), “Share-based Payment,” (“SFAS No. 123(R)”). The exercise price ofover the options, as well asrequisite service period (generally the vesting period,period) in the financial statements based on their fair values. The impact of forfeitures that may occur prior to vesting is established by Deep Down’s Boardalso estimated and considered in the amount recognized. In addition, the realization of Directors.tax benefits in excess of amounts recognized for financial reporting purposes will be recognized as a financing activity. The options granted under the Plan have vesting periods that range from immediate vesting to vesting over five years, and the contract terms of the options granted are up to ten years. Under the Plan, the total number of options permitted is 15%15 percent of issued and outstanding common shares.
During the year ended December 31, 2008, Deep Down2010, we granted 4,200,0002,250 options and 1,200,0002,000 shares of restricted stock, and cancelled 875,000or forfeited 6,133 options subject to forfeitures under the Plan. Based on the shares of common stock outstanding at December 31, 2008,2010, there were approximately 17,336,00011,468 options available for grant under the Plan as of that date.
Restricted Stock
In December 2007, the SEC staff issued Staff Accounting Bulletin (“SAB”) 110, Share-Based Payment, which amends SAB 107, Share-Based Payment, to permit public companies, under certain circumstances, to use the simplified method in SAB 107 for employee option grants after December 31, 2007. Use of the simplified method after December 2007 is permitted only for companies whose historical data about their employees’ exercise behavior does not provide a reasonable basis for estimating the expected term of the options. Deep Down did not have stock options outstanding until fiscal year 2007, and has exercised a relatively small amount of shares, and thus does not have adequate historical data to determine option lives. Therefore, Deep Down will continue to use the simplified method as allowed under the provision of SAB 110.
Shares issued for Service
On February 14, 2008, Deep Down issued 1,200,000May 2010, we granted 1,000 restricted shares, par value $0.001 per share for a total of $1, to executives and employees on February 14, 2008 which vest on February 14, 2010, provided such respective recipient remains employed with Deep Down on such date.an executive. The shares were valued at $0.0875 per share and vest over three years in equal tranches on the grant date anniversary, with continued employment; we are amortizing the related share-based compensation of $87.5 over the three-year requisite service period. In January, 2011, this executive resigned from the Company, and all shares were forfeited.
In May 2010, we granted 1,000 restricted shares, par value $0.001 per share for a total of $1, to an outside director. The shares were valued at $0.0875 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 $87.5 over the three-year requisite service period.
On March 23, 2009, we granted 2,350 restricted shares, par value $0.001 per share for a total of $2, to executives and employees which vest on March 23, 2011, with continued employment. The shares had a fair value grant price of $0.42$0.12 per share based on the closing price of common stock on that date.March 20, 2009. The shares vest on the second anniversary of the grant date, and Deep Down iswe are amortizing the related stock-basedshare-based compensation of $504,000$291 over the 2 yeartwo-year requisite service period. For
On September 1, 2009, we granted 750 restricted shares, par value $0.001 per share for a total of $1, to an executive in connection with his Severance and Separation Agreement. The shares had a fair value grant price of $0.10 per share based on the closing price of common stock on September 1, 2009. The shares vest on the anniversary of the grant date, and we are amortizing the related share-based compensation of $75 over the one-year requisite service period.
In connection with the departure of two executives during the third quarter of 2009, we accelerated the vesting of 850 shares of restricted stock granted on March 23, 2009, and 350 shares granted in February 2008, and recognized the related share-based compensation of $106. During the year ended December 31, 2008, Deep Down2010 and 2009, we recognized a total of $220,500$182 and $464, respectively, in stock-basedshare-based compensation related to these issuedall outstanding shares of restricted stock; thestock. The unamortized portion of the estimated fair value of restricted stock is $283,500was $179 at December 31, 2008.2010.
Notes to Consolidated Financial Statements for the Years ended December 31, 2010 and 2009
(Amounts in thousands except per share amounts)
The following table summarizes Deep Down’sour restricted stock activity for the yearyears ended December 31, 2008.2009 and 2010. The aggregate intrinsic value is based upon the closing price of $0.16$0.08 of Deep Down’sour common stock on December 31, 2008.2010.
| | | Restricted Shares | | | Weighted- Average Fair Value Grant Price | | | Aggregate Intrinsic Value | |
| Outstanding at December 31, 2008 | | | 1,200 | | | $ | 0.42 | | | | |
| Vested | | | (1,200 | ) | | | 0.21 | | | | |
| Granted | | | 3,100 | | | | 0.12 | | | | |
| Outstanding at December 31, 2009 | | | 3,100 | | | $ | 0.20 | | | $ | 37 | |
| Vested | | | (1,600 | ) | | | 0.27 | | | | | |
| Granted | | | 2,000 | | | | 0.09 | | | | | |
| Outstanding at December 31, 2010 | | | 3,500 | | | $ | 0.23 | | | $ | - | |
Summary of Stock Options
| | | Restricted Shares | | | Weighted- Average Grant Price | | | Aggregate Intrinsic Value | |
| Outstanding at December 31, 2007 | | | - | | | | | | | |
| Grants | | | 1,200,000 | | | $ | 0.42 | | | | |
| Outstanding at December 31, 2008 | | | 1,200,000 | | | $ | 0.42 | | | $ | - | |
The following table summarizes our stock option activity for the years ended December 31, 2009 and 2010. The aggregate intrinsic value is based on the closing price of $0.08 on December 31, 2010.
| | | Shares Underlying Options | | | Weighted- Average Exercise Price | | | Weighted- Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value (In-The-Money) | |
| Outstanding at December 31, 2008 | | | 8,067 | | | $ | 0.96 | | | | 2.3 | | | $ | - | |
| Grants | | | 14,475 | | | | 0.11 | | | | | | | | | |
| Cancellations & Forfeitures | | | (2,517 | ) | | | 0.90 | | | | | | | | | |
| Outstanding at December 31, 2009 | | | 20,025 | | | $ | 0.35 | | | | 2.5 | | | $ | 323 | |
| Grants | | | 2,250 | | | | 0.10 | | | | | | | | | |
| Cancellations & Forfeitures | | | (6,133 | ) | | | 0.83 | | | | | | | | | |
| Outstanding at December 31, 2010 | | | 16,142 | | | $ | 0.13 | | | | 2.9 | | | $ | - | |
| Exerciseable at December 31, 2010 | | | 4,817 | | | $ | 0.17 | | | | 2.1 | | | $ | - | |
The following summarizes our outstanding options and their respective exercise prices at December 31, 2010:
| Exercise Price | | | Shares Underlying Options | |
| $0.09 - 0.49 | | | | 15,684 | |
| $0.50 - 0.69 | | | | 25 | |
| $0.70 - 0.99 | | | | 33 | |
| $1.00 - 1.15 | | | | 400 | |
| | | | 16,142 | |
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
Stock Option Activity During 2008
During the year ended December 31, 2008, Deep Down granted 4,200,000 options under the Plan as detailed below. On June 17, 2008, Deep Down effected a cashless exercise of 50,000 employee stock options for 29,339 net shares of common stock issued(Amounts in accordance with terms of the Plan.
During the year ended December 31, 2008, Deep Down granted an aggregate of 350,000 stock options to various employees with exercise prices between $0.71 and $0.88, reflecting the respective closing price on the applicable date of grant. The fair value of such options was $114,737 based on the Black-Scholes option pricing model. Additionally, Deep Down issued 600,000 stock options to employees of Flotation in connection with that acquisition.
On February 14, 2008, Deep Down issued an aggregate of 3,000,000 stock options to Ronald E. Smith, Robert E. Chamberlain, and Eugene L. Butler, with an exercise pricethousands except per share of $1.50, which was in excess of the day’s closing price of $0.42. The fair value of such options was $145,764 based on the Black-Scholes option pricing model.amounts)
Additionally, on January 22, 2008, Deep Down issued 250,000 stock options to an officer with an exercise price of $0.70, the closing price of Deep Down’s common stock on that date. These options have since been forfeited due to the officer’s departure in May 2008.
All of the options issued during 2008 have terms for vesting at the rate of one third of the total grant annually on the anniversary of their respective grant dates. Since Deep Down does not have a sufficient trading history to determine the volatility of its own stock, it based its estimates of volatility on a representative peer group consisting of companies in the same industry, with similar market capitalizations and similar stage of development.
Stock Options Granted During 2007
During the year ended December 31, 2007, Deep Down granted 5,500,000 options under the Plan. Deep Down issued an aggregate of 1,500,000 stock options to various consultants, of which 300,000 were issued with an exercise price of $0.30, $0.50, $0.75, $1.00, and $1.25, respectively. Additionally, Deep Down issued an aggregate of 1,000,000 stock options to various employees with an exercise price of $0.50 and 3,000,000 stock options to an officer and director with an exercise price of $0.515.
Summary of Stock Options
Deep Down is expensing all stock options on a straight line basis over the requisite expected service periods. The total stock-based compensation expense for stock options for the years ended December 31, 2008 and 2007, respectively, was $584,009 and $187,394, respectively. The unamortized portion of the estimated fair value of outstanding stock options is $718,912 at December 31, 2008.
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
The following table summarizes Deep Down’s stock option activity for the year ended December 31, 2008. The aggregate intrinsic value is based on the closing price of $0.16 on December 31, 2008.
| | | Shares Underlying Options | | | Weighted- Average Exercise Price | | | Weighted- Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value (In-The-Money) | |
| Outstanding at December 31, 2006 | | | - | | | $ | - | | | | | | | |
| Grants | | | 5,500,000 | | | $ | 0.58 | | | | | | | |
| Outstanding at December 31, 2007 | | | 5,500,000 | | | $ | 0.58 | | | | | | | |
| Grants | | | 4,200,000 | | | | 1.35 | | | | | | | |
| Exercises | | | (50,000 | ) | | | 0.50 | | | | | | | |
| Cancellations & Forfeitures | | | (1,583,333 | ) | | | 0.70 | | | | | | | |
| Outstanding at December 31, 2008 | | | 8,066,667 | | | $ | 0.96 | | | | 2.3 | | | $ | - | |
| Exerciseable at December 31, 2008 | | | 1,720,834 | | | $ | 0.57 | | | | 1.6 | | | $ | - | |
The following summarizes Deep Down’s outstanding options and their respective exercise prices at December 31, 2008:
Exercise Price | | | Shares
Underlying Options
| |
| $ 0.30 - 0.49 | | | | 100,000 | |
| $ 0.50 - 0.69 | | | | 3,716,667 | |
| $ 0.70 - 0.99 | | | | 450,000 | |
| $ 1.00 - 1.29 | | | | 800,000 | |
| $ 1.30 - 1.50 | | | | 3,000,000 | |
| | | | | 8,066,667 | |
The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes model and is based on the following key assumptions for the year ended December 31, 2008:2010:
| December 31, 2010 |
| Dividend yield | | 0% |
| Risk free interest rate | 2.64%2.08% - 2.84%2.49% |
| Expected life of options | 33.5 years |
| Expected volatility | 53.3%94.7% - 63.3%97.4% |
Note 11:9: Warrants
In connection with the purchase of Flotation, Deep DownWe have issued warrants related to purchase 200,000 common shares at $0.70 per share to an entity affiliated with the selling shareholdersvarious transactions in consideration for the acquisition of related technology. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. Deep Down valued the warrants at $121,793 based on the Black Scholes option pricing model and included this value in the purchase price allocation relating to Flotation.
On August 6, 2007, as part of the Credit Agreement with Prospect, described above in Note 7, Deep Down issued detachable warrants to purchase up to 4,960,585 shares of common stock with an exercise price of $0.51, forprevious years; a term of five years, with vesting occurring on the earlier of the second anniversary of the agreement or upon payment in full of the debt. On July 3, 2008, the holder of these warrants exercised the warrants for a total of 2,618,129 shares of Deep Down’s common stock in a cashless exercise.
Additionally, as part of the Credit Agreement with Prospect, described above in Note 7, Deep Down issued a detachable warrant to purchase up to 320,000 shares of common stock at an exercise price of $0.75, for a term of five years, with vesting occurring on the earlier of the second anniversary of the agreement or upon payment in full of the debt. In connection with the second advance under the Credit Agreement with Prospect, Deep Down granted a detachable warrant to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share. This warrant has a five-year term and is immediately exercisable.
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
A summary of warrant transactions follows. The aggregate intrinsic value is based on the closing price of $0.16$0.08 on December 31, 2008.2010.
| | | Shares Underlying Warrants | | | Weighted- Average Exercise Price | | | Weighted- Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value (In-The-Money) | |
| Outstanding at December 31, 2006 | | | - | | | $ | - | | | | | | | |
| Grants | | | 5,399,397 | | | | 0.53 | | | | | | | |
| Outstanding at December 31, 2007 | | | 5,399,397 | | | | 0.53 | | | | | | | |
| Grants | | | 200,000 | | | | 0.70 | | | | | | | |
| Exercised | | | (4,960,585 | ) | | | 0.51 | | | | | | | |
| Outstanding at December 31, 2008 | | | 638,812 | | | $ | 0.78 | | | | 4.0 | | | $ | - | |
| Exerciseable at December 31, 2008 | | | 438,812 | | | $ | 0.82 | | | | 4.0 | | | $ | - | |
| | | Shares Underlying Warrants | | | Weighted- Average Exercise Price | | | Weighted- Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value (In-The-Money) | |
Outstanding and exercisable at December 31, 2009 | | | 639 | | | $ | 0.78 | | | | 2.3 | | | $ | - | |
Outstanding and exercisable at December 31, 2010 | | | 639 | | | $ | 0.78 | | | | 1.3 | | | $ | - | |
The following summarizes Deep Down’sour outstanding warrants and their respective exercise prices at December 31, 2008:2010:
| Exercise Price | | | Shares Underlying Warrants | |
| $ 0.70 - 0.99 | | | | 520 | |
| $ 1.01 | | | | 119 | |
| | | | | 639 | |
Note 10: Common Stock
| Exercise Price | | Shares Underlying Warrants |
| $ 0.70 - 0.99 | | 520,000 |
| $ 1.01 | | 118,812 |
| | | 638,812 |
As discussed in Note 4 “Investment in Joint Venture”, on December 31, 2010, concurrent with our entry into the Contract Assignment and Amendment Agreement, we entered into the Securities Purchase Agreement, by and among the Company and Holdings, pursuant to which we sold and issued to Holdings 20,000 shares of our common stock for an aggregate purchase price of $1,400. We then contributed these proceeds to CFT in return for common units of CFT. The fair valueSecurities Purchase Agreement provides Holdings with registration rights for such 20,000 shares only in the event we fail to maintain current public filings.
Private Placement, Fiscal Year 2010
Between April 25 and April 30, 2010, we sold 5,150 shares of each warrant grant is estimated on the dateour common stock in a private placement to accredited investors at a per-share price of the grant using the Black-Scholes model and is based on the following key assumptions$0.10 resulting in total proceeds of $501, net of $14 applied to an outstanding vendor invoice for services provided, which we used for working capital purposes.
Notes to Consolidated Financial Statements for the yearsYears ended December 31, 20082010 and 2007:2009
(Amounts in thousands except per share amounts)
| | | December 31, 2008 | | December 31, 2007 |
| | 0% | | 0% |
| Risk free interest rate | 2.52% | | 3.18% - 5.0% |
| Expected life of options | 2 years | | 2.5 - 3.5 years |
| Expected volatility | 51.70% | | 52.7% - 61.3% |
Note 12:11: Income Taxes
The provision for income taxes on income from continuing operations is comprised of the following for the years ended December 31, 20082010 and 2007.2009. The provision for income taxes differs from the amount computed by applying the U.S. statutory income tax rate to income from continuing operations before income taxes for the reasons set forth below for the years ended December 31, 20082010 and 2007.
| | | December 31, 2008 | | | December 31, 2007 | |
| Federal: | | | | | | |
| Current | | $ | (453,602 | ) | | $ | 402,619 | |
| Deferred | | | (855,703 | ) | | | (75,810 | ) |
| Total Federal | | $ | (1,309,305 | ) | | $ | 326,809 | |
| State: | | | | | | | | |
| Current | | $ | 266,933 | | | $ | 42,864 | |
| Deferred | | | - | | | | - | |
| Total State | | $ | 266,933 | | | $ | 42,864 | |
| Total income tax expense (benefit) | | $ | (1,042,372 | ) | | $ | 369,673 | |
| | | December 31, 2010 | | | December 31, 2009 | |
| Federal: | | | | | | |
| Current | | $ | - | | | $ | 603 | |
| Deferred | | | - | | | | (1,474 | ) |
| Total Federal | | $ | - | | | $ | (871 | ) |
| State: | | | | | | | | |
| Current | | $ | 175 | | | $ | 50 | |
| Deferred | | | - | | | | (205 | ) |
| Total State | | $ | 175 | | | $ | (155 | ) |
| Total income tax benefit | | $ | 175 | | | $ | (1,026 | ) |
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
| | | Year ended | |
| | | December 31, 2010 | | | December 31, 2009 | |
| Income tax expense at federal statutory rate | | | 34.00% | | | | 34.00% | |
| State taxes, net of federal expense | | | -0.41% | | | | 0.98% | |
| Goodwill impairment | | | -4.72% | | | | -10.27% | |
| Valuation allowance | | | -32.32% | | | | -15.44% | |
| State rate differential | | | 2.10% | | | | - | |
| Permanent differences | | | -0.28% | | | | -2.50% | |
| Other, net | | | 0.63% | | | | -0.79% | |
| Total effective rate | | | -1.00% | | | | 5.98% | |
| | | | Year ended |
| | | | December 31, 2008 | | December 31, 2007 |
| Income tax expense at federal statutory rate | 34.0% | | 34.0% |
| State taxes, net of federal expense | | -3.3% | | 0.0% |
| Deferred financing | | -7.6% | | 0.0% |
| Accretion | | -2.1% | | 3.2% |
| Other, net | | -1.4% | | -9.2% |
| | Total effective rate | | 19.6% | | 28.0% |
Income tax benefitexpense was $1,042,372$175 for the year ended December 31, 20082010 compared to income tax expensebenefit of $369,673$1,026 for the previous year.year ended December 31, 2009.
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 followsfollow at December 31, 20082010 and 2007: 2009:
| | | December 31, 2008 | | | December 31, 2007 | |
| Deferred tax assets: | | | | | | |
| Allowance For Bad Debt | | $ | 195,492 | | | $ | 47,528 | |
| Net Operating Loss | | | 1,060,998 | | | | - | |
| Stock Compensation | | | 315,827 | | | | 117,264 | |
| Section 263 (a) Adjustment | | | 21,354 | | | | - | |
| Depreciation on property and equipment | | | - | | | | 32,577 | |
| Charitable Contributions | | | 54 | | | | 54 | |
| Other | | | - | | | | 1,616 | |
| Total deferred tax assets | | $ | 1,593,725 | | | $ | 199,039 | |
| Deferred tax liabilities: | | | | | | | | |
| Depreciation on property and equipment | | $ | (797,224 | ) | | $ | - | |
| Intangible Amortization | | | (1,389,720 | ) | | $ | (5,965 | ) |
| Total deferred tax liabilities | | $ | (2,186,944 | ) | | $ | (5,965 | ) |
| Less: valuation allowance | | | (315,826 | ) | | $ | (117,264 | ) |
| Net deferred tax assets (liabilities) | | $ | (909,045 | ) | | $ | 75,810 | |
| | | December 31, 2010 | | | December 31, 2009 | |
| Deferred tax assets: | | | | | | |
| Allowance for bad debt | | $ | 85 | | | $ | 106 | |
| Net operating loss | | | 4,091 | | | | 4,034 | |
| Stock based compensation | | | 121 | | | | 546 | |
| Section 263 (A) adjustment | | | - | | | | 52 | |
| Investment in joint venture | | | 7,200 | | | | - | |
| Intangible amortization | | | - | | | | 314 | |
| Other | | | 15 | | | | 48 | |
| Total deferred tax assets | | $ | 11,512 | | | $ | 5,100 | |
| Deferred tax liabilities: | | | | | | | | |
| Depreciation on property and equipment | | $ | (1,649 | ) | | $ | (1,874 | ) |
| Intangible amortization | | | (984 | ) | | | - | |
| Total deferred tax liabilities | | $ | (2,633 | ) | | $ | (1,874 | ) |
| Less: valuation allowance | | | (8,879 | ) | | | (3,226 | ) |
| Net deferred tax liabilities | | $ | - | | | $ | - | |
Deep Down has $3,120,583We have $11,390 in net operating loss (“NOL”) carry forwards available to offset future or prior taxable income. These federal NOL’s will expire in 2028. As ofWe have no uncertain tax positions at December 31, 2008, these NOL’s are not limited under Section 382.2010.
Deep Down has recorded a deferred tax liability of $1,840,563 for the temporary difference arising from the intangible assets acquired in the Mako transaction.
A valuation allowance is established when it is more likely than not that some of the deferred tax assets will not be realized. Management analyzed its current operating results and future projections and determined that a full valuation allowance was needed due to the extent it appliedour cumulative losses in recent years.
Notes to the future benefits related to the stock based compensation. A valuation allowanceConsolidated Financial Statements for the NOL and other deferred tax assets was not needed atYears ended December 31, 2008, based on the more likely than not threshold of the NOL’s being realized.2010 and 2009
(Amounts in thousands except per share amounts)
Note 13:12: Related Party Transactions
Ronald E. Smith, President, CEO and Director of Deep Down and Eugene Butler, Executive Chairman, CFO and Director of Deep Down, were investors in Ship and Sail, Inc. (“Ship and Sail”), a former vendor of Deep Down. During the year ended December 31, 2010, we made payments of $10 to Ship and Sail, and we expensed the prepaid balance of $38 as of December 31, 2009 during the first quarter of 2010. The payments and expense to Ship and Sail related to services provided by that entity for the support of the development of marine technology which is currently being marketed. Ship and Sail discontinued operations in mid-2010, thus there is no longer a related party relationship. As disclosed in the 2009 Form 10-K, we made a deposit for a boat in the amount of $100, which was written off in connection with the discontinued operations of Ship and Sail.
In January 2010, we loaned South Texas Yacht Services, a vendor of Deep Down, leases all buildings, structures, fixtures$100. The owner of South Texas Yacht Services was in a business alliance with Ship and Sail. The note receivable, included in other improvementsassets on the consolidated balance sheet, bears interest at a rate of 5.5 percent per annum and monthly principal and interest payments in the Channelview,amount of $2 commenced in April 2010. The final principal and interest payment is due March 24, 2015. As of March 31, 2011, the payments on this note were current. Additionally, as of September 30, 2010, South Texas location fromYacht Services is no longer a related party as they are no longer in a business alliance with Ship and Sail.
Additionally, during the year ended December 31, 2010, we recorded expenses to JUMA, LLC, a company owned by Ronald E. Smith, President and CEOhis wife Mary L. Budrunas, Corporate Secretary and a directorDirector of Deep Down, and Mary L. Budrunas,in the amount of $35; there is no balance due as of December 31, 2010. Payments related to the monthly rental of a Vice Presidentboat owned by JUMA, in connection with the development of marine technology as discussed above. The board of directors approved the arrangement between JUMA and director of Deep Down. The base rate of $15,000 per month is payable to JUMA, LLC through August 31, 2013, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.
On March 28, 2008, Deep Down redeemed 4,500 shareswith a termination date of Series D preferred stock owned by Ronald Smith and Mary Budrunas. The Series D preferred shares were redeemed for 23,279,876 shares of common stock.December 31, 2010.
Notes to Consolidated Financial Statements for the Years ended December 31, 20082010 and 20072009
(Amounts in thousands except per share amounts)
Note 14:13: Commitments and Contingencies
Litigation
Deep Down isWe are from time to time involved in legal proceedings arising from the normal course of business. As of the date of this report, Deep Down isReport, we are not currently involved in any material legal proceedings except as noted below.
Deep Down is currently in arbitration with the former stockholders of Flotation Technologies, Inc. regarding the proper calculation of the “Cash Price Adjustment” pursuant to the Stock Purchase Agreement by and between Deep Down, Flotation Technologies, Inc. and its stockholders dated April 17, 2008. Any purchase price adjustment will be allocated to the goodwill balance once the preliminary estimates are finalized within the one year time frame.
In connection with the Private Placement in June 2008, Deep Down filed an initial Registration Statement on Form S-1 on July 21, 2008 to register the shares issued. Pursuant to the Registration Rights Agreement, Deep Down was obligated to have the Registration Statement declared effective by September 3, 2008, the Required Effective Date, or the Company would be required to pay damages to the purchasers in the Private Placement for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective. The Registration statement has not been declared effective by the SEC. Deep Down has evaluated this obligation under the Registration Rights Agreement for liability treatment under FASB Statement No. 5, “Accounting for Contingencies” (“SFAS 5”) and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights met the definition of a liability under the authoritative guidance and has reserved $1,212,120 in potential damages under terms of the Private Placement for the 90-day period September 4 to December 4, 2008. Deep Down obtained an opinion from legal counsel allowing removal of the related stock’s restrictive legends, which was deemed to be equivalent and thus satisfying the registration rights requirements.proceedings.
Leases
Deep Down leasesWe lease certain offices, facilities, equipment and vehicles under noncancelablenon-cancellable operating and capital leases expiring at various dates through 2016.
At December 31, 2008,2010, future minimum contractual obligations were as follows:
| Years ended December 31,: | | Capital Leases | | | Operating Leases | |
| 2009 | | $ | 96,428 | | | $ | 738,264 | |
| 2010 | | | 96,428 | | | | 646,871 | |
| 2011 | | | 96,428 | | | | 531,033 | |
| 2012 | | | 96,428 | | | | 481,531 | |
| 2013 | | | 96,428 | | | | 384,080 | |
| Thereafter | | | 16,072 | | | | 376,131 | |
| Total minimum lease payments | | $ | 498,212 | | | $ | 3,157,910 | |
| Residual principal balance | | | 105,000 | | | | | |
| Amount representing interest | | | (166,912 | ) | | | | |
| Present value of minimum lease payments | | $ | 436,300 | | | | | |
| Less current maturities of capital lease obligations | | | 50,192 | | | | | |
| Long-term contractal obligations | | $ | 386,108 | | | | | |
| Years ended December 31,: | | Capital Leases | | | Operating Leases | |
| 2011 | | $ | 195 | | | $ | 295 | |
| 2012 | | | 180 | | | | 231 | |
| 2013 | | | 172 | | | | 194 | |
| 2014 | | | 82 | | | | 150 | |
| 2015 | | | 58 | | | | 150 | |
| Thereafter | | | - | | | | 25 | |
| Total minimum lease payments | | $ | 687 | | | $ | 1,045 | |
| Residual principal balance | | | 105 | | | | | |
| Amount representing interest | | | (158 | ) | | | | |
| Present value of minimum lease payments | | $ | 634 | | | | | |
| Less current maturities of capital lease obligations | | | 129 | | | | | |
| Long-term contractal obligations | | $ | 505 | | | | | |
Rent expense totaled $525,627$596 and $186,866$711 for the years ended December 31, 20082010 and 2007,2009, respectively.
Notes to Consolidated Financial Statements for the Years ended December 31, 2008 and 2007
Letters of Credit
Certain customers could require us to postissue a bankstandby letter of credit guarantee. These lettersin the normal course of credit assure our creditors that we will performbusiness to ensure performance under terms of ourthe contract and with associated vendors and subcontractors. In the event of default, the creditor maycould demand payment from the issuing bank under a letter of credit. To date, there have been no significant expenses related to letters of credit for the periods reported. We were contingently liableamount of the L/C. Our Restated Credit Agreement with Whitney provides for securedL/Cs, as discussed in Note 7, “Long-Term Debt”. During the year ended December 31, 2009, we issued a $1,107 irrevocable transferrable standby L/C in the normal course of business, with an annual commission rate of 2.4 percent. This L/C was renewed on September 1, 2010 for one year under the same terms and unsecured letters of credit of $135,000remains outstanding under the Restated Credit Agreement as of December 31, 2008, which is offset by restricted cash in the same amount.
In December 2008, Deep Down amended the credit agreement with Whitney Bank as more fully described in Note 7. The credit agreement provides for letters of credit, which Deep Down executed a letter of credit with a customer for $1,107,456 subsequent to December 31, 2008. See further discussion at Note 15.
Additionally, Deep Down has a letter of credit in the amount of $135,855 representing a performance guarantee that was filed with the planning office of the City of Biddeford, Maine related to improvements planned to the Flotation site. The offsetting restricted cash is reflected on the balance sheet.
Note 15: Subsequent Events
Deep Down’s credit agreement with Whitney Bank provides for letters of credit, which Deep Down executed an irrevocable transferrable standby letter of credit with a customer for $1,107,456 on February 10, 2009. The letter of credit was executed as a guarantee of performance by Deep Down and its subsidiaries on a contract, allows partial and multiple drawings, and expires August 31, 2009 with an automatic one-year extension period unless cancelled 90 days in advance of the expiration date.
Amendment to credit agreement and new loan agreement
On March 5, 2009, Deep Down’s wholly owned subsidiary, Flotation, obtained loan proceeds in the principal amount of approximately $1,840,000 pursuant to a loan agreement Flotation and Deep Down entered into with TD Bank, N.A. (“TD Bank”) as of February 13, 2009. This loan agreement provides a further commitment to Flotation for advancement of principal in the amount of $320,000. Loans under the loan agreement are generally secured by Flotation’s operational premises in Biddeford, Maine under a mortgage and security agreement and a collateral assignment of leases and rents. In connection with the loan agreement, TD Bank required that Deep Down enter into a debt subordination agreement that subordinated any debt Flotation owes to Deep Down other than accounts payable between them arising in the ordinary course of business. Furthermore, as part of the loan agreement TD Bank required a “negative pledge” that prohibits Flotation and Deep Down from granting security interests in Flotation’s personal property, other than such security interests granted in respect of Deep Down’s primary facility for borrowed money (as currently held with Whitney Bank). Deep Down is obligated to repay proceeds funded on March 5, 2009 based on a schedule of monthly installments of approximately $13,000, with an initial payment on March 13, 2009 and a final payment of all remaining outstanding and unpaid principal and accrued interest in February 2016. However, upon advancement of any portion of the $320,000 additional principal amount available under the loan agreement, TD Bank will recalculate the monthly installments to an amount that will fully amortize the then outstanding principal balance over a 20-year amortization schedule.
In connection with such loan for Flotation, Deep Down entered into a second amendment of its existing credit facility with Whitney Bank to permit such loan and the security and other arrangements relating to Flotation’s loan agreement. The terms of the second amendment also included a guarantor’s consent and agreement, to be signed by each of Deep Down’s subsidiaries as guarantors of the obligations of Deep Down under such existing credit facility, that Whitney Bank required as a condition to the effectiveness of the second amendment. Additionally, Whitney Bank required that Deep Down International Holdings, LLC, a Nevada limited liability company and wholly owned subsidiary of Deep Down formed in February 2009, enter into joinder agreements for the guaranty and security agreement arrangements generally required of Deep Down’s subsidiaries under the existing credit facility. Deep Down International Holdings, LLC currently has no material assets or operations.2010.