We evaluate the carrying value of goodwill during the fourth quarter of each year 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 goodwill is impaired, we compare the fair value of the business to its carrying amount, including goodwill. The fair value of the reporting unit is estimated using the income or discounted cash flows. If 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 implied fair value of reporting unit goodwill to its carrying amount.
Financing for our operations consists primarily of cash flows attributable to our operations. We believe that the liquidity we derivederived from the private placement of our leasing arrangements, our Credit Agreementcommon stock in June 2008 and cash flows attributable to our operations is more than sufficient to fund our capital expenditures, debt maturities and other business needs. We continue to evaluate acquisitions and joint ventures in the ordinary course of business. When opportunities for business acquisitions meet our standards, we believe we will have access to capital sources necessary to take advantage of those opportunities.
DESCRIPTION OF BUSINESSCash Flow from Financing Activities
Corporate History
In December 2006, MediQuip Holdings, Inc. (“MediQuip”), a publicly traded Nevada corporation, divested Westmeria Healthcare Limited, its wholly-owned subsidiary representing substantially all of its preceding operations, and subsequently acquiredFor the six months ended June 30, 2008, cash provided by financing activities was $27.0 million compared to $0.5 million for the same prior year period. During the six months ended June 30, 2008, Deep Down Inc. ("Deep Down"), a Delaware corporation, in a reverse merger transaction so thatcompleted the foregoing described private placement for net proceeds of $37.1 million. In June, 2008, Deep Down waspaid approximately $12.5 million to Prospect to pay the surviving entity for accounting purposes. Due to the structure of such December 2006 transactions, the following discussionbalance due under its Credit Agreement and disclosurerelated interest and early termination fees. In January 2008, in this Prospectus relates to Deep Down and its operations unless otherwise specified.
In June 2006, the former parent entity of Deep Down, Subsea Acquisition Corporation (“Subsea”), a Texas corporation, was formed for the purpose of acquiring service providers to the offshore energy industry and designers and manufacturers of 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.
On November 21, 2006, Subsea acquired all the outstanding capital 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 Subsea’s Series G Preferred Stock from two of the three principal shareholders of Subsea. Since both Subsea and SOS were then under common control and the operations of SOS did not constitute a business, the Company recognized compensation expense to such principal shareholders for the fair value of both series of preferred stock totaling $3,340,792.
On the same day as its acquisition of SOS, Subsea also acquired Deep Down, Inc., a Delaware corporation founded in 1997. Underaccordance with the terms of this transaction, Subsea acquired allthe purchase of Deep Down’s outstanding capital stock in exchange for 5,000 shares of Subsea’s Series D Preferred Stock and 5,000 shares of Subsea’s Series E Preferred Stock. The purchase price, based on the fair value of the Series D and E Preferred stock, was $7,865,471.
Immediately after the completion of the acquisitions ofMako, Deep Down paid $0.9 million of notes payable plus accrued interest of $2,664, and SOS on November 21, 2006, Subsea merged with and into its wholly-owned subsidiary SOS, with Subsea continuing as the surviving company. Immediately thereafter, Subsea merged with and into its wholly-owned subsidiary Deep Down, with Deep Down continuing as the surviving company.received proceeds from Prospect totaling $2.7 million.
On December 14, 2006, after divesting 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, and Deep Down, Inc. continued as a Nevada corporation following consummation of the acquisition.
The financial information and the financial statements of the Company presented in this Prospectus reflect those of Deep Down, Inc. and its subsidiaries, and do not include the financial condition and results of operations of MediQuip or Westmeria Healthcare Limited for periods prior to the December 2006 merger date.
Since December 2006, Deep Down has consummated three strategic acquisitions. On April 2, 2007, Deep Down acquired substantially all of the assets of ElectroWave USA, Inc., a Texas corporation. For purposes of completing the acquisition, Deep Down formed a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada corporation. Effective December 1, 2007, Deep Down acquired all of the outstanding common stock of Mako Technologies, Inc., a Louisiana corporation. For purposes of completing the acquisition, Deep Down formed a wholly-owned subsidiary, Mako Technologies, LLC (“Mako”), a Nevada limited liability company, which merged with and into Mako Technologies, Inc., with Mako as the surviving entity. Effective May 1, 2008, Deep Down acquired all of the outstanding common stock of Flotation Technologies, Inc., a Maine corporation.
Our current operations are the result of the recent acquisitions of Deep Down, ElectroWave, Mako and Flotation (described elsewhere in this Prospectus). 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.
Recent Events
Amendments to Bylaws and Articles of Incorporation
In May 2008, the Board of Directors amended the Bylaws and approved amendments to our Articles of Incorporation subject to shareholder approval.approval, which was obtained on May 16, 2008. The amendments are designed to discourage any tender offer or other attempt to gain control of the CompanyDeep Down in a transaction that is not approved by our Board of Directors, by making it more difficult for a person or group to obtain control of the CompanyDeep Down in a short time and then impose its will on the remaining stockholders, including:
Classified Board of Directors and Removal of Directors. Our Board of Directors is divided into three classes which shall be as nearly equal in number as possible. The directors in each class serve for terms of three years, with the terms of one class expiring each year. Each class currently consists of approximately one-third of the number of directors. Each director will serve until his successor is elected and qualified. A director may not be removed except for cause by the affirmative vote of the holders of 75% of the outstanding shares of capital stock entitled to vote at an election of directors.
Advance Notice Requirements for Nomination of Directors and Proposal of New Business at Annual Stockholder Meetings. Any stockholder desiring to make a nomination for the election of directors or a proposal for new business at a stockholder meeting must submit written notice not less than 30 or more than 60 days in advance of the meeting.
Supermajority Voting Requirement for Amendment of Certain Provisions of the Certificate of Incorporation. Specified provisions contained in the articles of incorporation and bylaws may not be repealed or amended by action of our stockholders except upon the affirmative vote of the holders of not less than seventy-five percent of the outstanding stock entitled to vote. This requirement exceeds the majority vote that would otherwise be required by Nevada law for the repeal or amendment of the articles or bylaws.
Private Placement
On June 5, 2008, Deep Down entered into athe Purchase Agreement (the “Purchase Agreement”) with accredited investors (the “Purchasers”) to sell and issue to the Purchaserscertain purchasers, purchasing in reliance on the exemption from registration in Section 4(2) of the Securities Act of 1933, as amended, (the “Securities Act”), an aggregate of 57,142,857 shares, or $40.0 million of shares, of the Company’s Common Stock (the “Shares”)Deep Down’s common stock at a price of $0.70 per share, for a total purchase price of $40.0 million and net proceeds to Deep Down of approximately $37.1 million. Completion of the private placement was subject to completion of the acquisition of Flotation, as described below. Dahlman Rose & Company, LLC acted as exclusive placement agent for the financing.
Deep Down 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 to Prospect Capital Corporation on June 12, 2008, with the remainder being retained for working capital purposes.
In connection with the private placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep Down filed an S-1 Registration Statement on August 26, 2008. If the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), then for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective, Deep Down shall be required to pay daily damages to the purchasers. Deep Down evaluated the registration rights agreement for liability treatment under FASB Statement No. 5, “Accounting for Contingencies” and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights did not meet the definition of a liability under the authoritative guidance since management believes the liability is not estimable at this time.
Purchase of Flotation.
On June 5, 2008, Deep Down completed the acquisition on 100% of the equity securitiescapital stock of Flotation, a Maine corporation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. The equity intereststock was acquired from the three individual shareholder members of the same family and related technology was acquired from an entity affiliated with thesuch selling stockholders. No prior material relationship existed between the selling shareholders andshareholders. Deep Down any of our affiliates, or any of our directors or officers, or any associate of any of our officers or directors. Deep Down executedannounced the definitive agreement to purchase Flotationclosing on April 17,June 6, 2008 and effectively dated the acquisition for accounting purposes as of May 1, 2008. Deep Down announced the closing on June 6, 2008.
Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTMFlotecTM syntactic foam and polyurethane elastomers. Flotation’s product offerings include distributed buoyancy for flexible pipes and umbilicals, Core Tec™ drilling riser buoyancy modules, ROVitsTM buoyancy, Hydro-Float mooring buoys, StablemoorTM low-drag ADCP deployment solution, Quick-LocTM and cable floats, HardBall TM umbilical floats , FlotectTM cable and pipeline protection, InFlex TM polymer static bend restrictors, and installation buoyancy of any size and depth rating.
TheWe have accounted for the acquisition of Flotation has been accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (FASB) No. 141, Business Combinations (FASB 141) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Flotation.
The preliminary purchase price of Flotation is $23.8was $23.9 million and consistsconsisted of $22.1 million cash and 1,714,286 shares of common stock valued at $0.83 per common share plus transaction costs of $181,227.$251,180. In addition, warrants to purchase 200,000 shares of common sharesstock at $0.70 per share were issued to an entity affiliated entitywith 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 ScholesBlack-Scholes option pricing model. Flotation’s selling shareholders used $1.8 million of the $22.1 million cash received to pay outstanding bank and shareholder debt of Flotation. The purchase price may be adjusted upward or downward, dependant on certainthe amount of Flotation’s working capital targets. Deep Down used $22.1 million in proceeds from the private placement completed on June 5, 2008 to fund the cash requirement of the Flotation acquisition.6, 2008.
Deep Down also issued 600,000 incentive common stock purchase options to employees of Flotation for future 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 ScholesBlack-Scholes option pricing model, and will recognize the related compensation cost ratably over the requisite service period.
Payment of long term debt and exercise of Prospect warrants:
On June 12, 2008, the CompanyDeep Down paid approximately $12.5 million to Prospect Capital Corporation to pay the balance due under its Credit Agreement and related interest and early termination fees. 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 restricted shares of Deep Down common stock.
Critical Accounting Policies
The accompanying discussion and analysis of our financial condition and results of operations is based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 1 “Nature of Business and Summary of Significant Accounting Policies” of the notes to our audited consolidated financial statements included elsewhere in this Prospectus contains a detailed summary of our significant accounting policies. We utilize the following critical accounting policies in the preparation of our financial statements.
Accounts ReceivableTrade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts on trade receivables is our best estimate of the probable amount of credit losses in our existing accounts receivables. A considerable amount of judgment is required 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 on 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.
Consolidation The accompanying financial statements include the accounts 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 and Mako since its acquisition on December 1, 2007. All intercompany accounts and transactions have been eliminated.
Long-Lived AssetsWe 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) “Accounting for Stock Based Compensation.” 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 fiscal 2007, we estimated forfeitures to be 0%, which was an accurate amount for the current fiscal year. 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.
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, 2007:
| Dividend yield | 0% | |
| Risk free interest rate | 3.2% - 5.0% | |
| Expected life | 3 - 4 years | |
| Expected volatility | 52.7% - 61.3% | |
Revenue RecognitionWe generally recognize revenue once the following four criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery of the equipment has occurred or services have been rendered, (iii) the price of the equipment or service is fixed 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 (“FAT”) and customer approval, and recognized upon transfer of title to the customer. Service revenue is recognized as the service is provided. Expenses incurred to date that exceed milestone billings are adjusted during the month-end profitability review and represent the balance in our work-in-progress (“WIP”) account on the accompanying balance sheets. Goodwill and Intangible Assets Goodwill represents the cost in excess of the fair value of net assets acquired in business combinations. Statement of Financial Accounting Standards (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, 2007.
We evaluate the carrying value of goodwill during the fourth quarter of each year 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 goodwill is impaired, we compare the fair value of the business to its carrying amount, including goodwill. The fair value of the reporting unit is estimated using the income or discounted cash flows. If 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 implied fair value of reporting unit goodwill to its carrying amount.
Our intangible assets consist of assets acquired in the purchase of the Mako and Flotation subsidiaries and comprised of customer lists, non-compete covenants with key employees and trademarks related to various technologies. We amortize the intangible assets over their useful lives ranging from 3 to 40 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 included 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 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.
Results of Operations
Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007
Revenue. Revenue generated in the six months ended June 30, 2008 was $14.2 million compared to $7.2 million for the same period last year, an increase of 96%. Our acquisitions accounted for $5.1 million of this increase. Mako was included for the entire period and accounted for $2.7 million of the increase. Flotation was included for two months and accounted for $1.5 million of the increase and ElectroWave was included for six months, but included for only three months in the same period last year and accounted for $0.9 million of the increase. Our existing businesses continued to strengthen with a $1.8 million increase, for a 29% increase over last year’s six month revenues. Contract revenues were up 25% while rentals were up 47%. Our offshore market continues to be strong and we continue to expand our customer base.
Gross Profit. Gross margin for the six months ended June 30, 2008 increased $2.1 million to $4.8 million, for a 79% increase. $1.4 million of the increase is attributable to the inclusion of the acquisitions in this period. The overall gross margin was 34 % for the first six months of 2008 as compared to 37% for the same period last year. The gross margin is slightly lower due to an increase in personnel and personnel related costs for the continued growth.
Selling, General and Administrative Expenses. SG&A for the six months ended June 30, 2008 was $5.4 million compared to $1.8 million for the same period last year for an increase of $3.6 million. The acquisitions of Mako and Flotation represented $1.5 million of the increase. Bad debt increased by $0.8 million due to the write off of two accounts, one of which filed for bankruptcy protection during the quarter ($0.2 million of the total bad debt is included in the Mako subsidiary). Personnel and related costs increased by $1.0 million primarily due to an 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 $0.7 million to in professional accounting, and legal fees to support our various initiatives during the six months ended June 30, 2008 relating to the filing of a registration statement and acquisitions and reporting requirements. Stock based compensation related to employee stock options and restricted stock was approximately $0.3 million in the current fiscal year compared to approximately $40,000 for the comparable prior year period.
Depreciation and amortization. Depreciation expense for the six months ended June 30, 2008 was $0.5 million compared to $0.2 million for the same prior year period due mainly to the acquisitions in fiscal year 2008, though Flotation has only 2 months of depreciation expense since they were acquired May 1, 2008. Fixed assets acquired in the Mako and Flotation subsidiaries totaled $8.1 million. In addition, intangible assets purchased in the Mako and Flotation acquisitions total $19.2 million in the aggregate. Amortization of intangible assets for the quarter ended June 30, 2008 was $0.4 million.
Interest Expense. Interest expense for the six months ended June 30, 2008 was $3.9 million compared to $1.5 million for the same prior year period. In connection with the early payoff of the Credit Agreement, Deep Down 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 to interest expense, along with early termination fees of approximately $446,412. Deep Down paid cash interest related to the Credit Agreement totaling $0.8 million for the six months ended June 30, 2008. For the comparable period of the prior year, $1.4 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 the Credit Agreement in June 2008, early termination fees of approximately $446,412 were recognized as a loss on early extinguishment of debt. In the prior year, Deep Down executed a Securities Redemption Agreement with the former Deep Down CFO 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. Deep Down accreted the remaining discount of $1.1 million attributable to such shares on the date of redemption.
Net loss. Net loss for the six months ended June 30, 2008 was $5.0 million, compared to a net income of $0.8 million for the same prior year period, as discussed above.
EBITDA. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP financial measure. Deep Down uses EBITDA as an unaudited supplemental financial measure to assess the financial performance of its assets without regard to financing methods, capital structures, taxes or historical cost basis; its liquidity and operating performance over time in relation to other companies that own similar assets and that the Company believes calculate EBITDA in a similar manner; and the ability of Deep Down assets to generate cash sufficient for Deep Down to pay potential interest costs. Deep Down also understands that such data are used by investors to assess the Company's 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 Deep Down’s 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 for the six months ended June 30, 2008 was $(1.0) million compared to $2.9 million for the six months ended June 30, 2007. Pro Forma Results of Operations for the Year Ended December 31, 2007 Compared to the Period from Inception, June 29, 2006 to December 31, 2006
On November 21, 2006, Subsea, a company formed on June 29, 2006, acquired Deep Down, Inc., which was founded in 1997. The transaction was accounted for as a purchase according to SFAS 141, “Business Combinations”, as there was a change of control.
As a result, the audited financial results disclosed herein present operating results for the period beginning November 21, 2006 and ending December 31, 2006, the period after which Deep Down was acquired. Management believes this stub period does not give a full view of the operations of Deep Down and, therefore, present pro forma results of operations. The following presentation and discussion of the unaudited pro forma consolidated results of operations has been prepared as if the acquisition of Deep Down had occurred at January 1, 2006. The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.
Deep Down, Inc.
Pro forma Statements of Operations
| For the Year Ended December 31, 2007 and | |
| For the Period Since Inception (June 29, 2006) to December 31, 2006 | |
| |
| | | Historical Results | | | Unaudited Pro forma | |
| | | Year Ended | | | Year Ended | |
| | | December 31, 2007 | | | December 31, 2006 | |
| | | | | | | |
| Revenues | | $ | 19,389,730 | | | $ | 8,821,149 | |
| Cost of sales | | | 13,020,369 | | | | 5,155,399 | |
| Gross profit | | | 6,369,361 | | | | 3,665,750 | |
| | | | | | | | | |
| Operating expenses: | | | | | | | | |
| Selling, general & administrative (1) | | | 4,284,553 | | | | 5,710,324 | |
| Depreciation | | | 426,964 | | | | 166,468 | |
| Total operating expenses | | | 4,711,517 | | | | 5,876,792 | |
| | | | | | | | | |
| Operating income (loss) | | | 1,657,844 | | | | (2,211,042 | ) |
| | | | | | | | | |
| Other income (expense): | | | | | | | | |
| Gain on debt extinguishment | | | 2,000,000 | | | | - | |
| Interest income | | | 94,487 | | | | - | |
| Interest expense (2) | | | (2,430,149 | ) | | | (578,335 | ) |
| Total other income (loss) | | | (335,662 | ) | | | (578,335 | ) |
| | | | | | | | | |
| Income (loss) before income taxes | | | 1,322,182 | | | | (2,789,377 | ) |
| | | | | | | | | |
| Income tax expense | | | (369,673 | ) | | | (22,250 | ) |
| Net income (loss) | | $ | 952,509 | | | $ | (2,811,627 | ) |
| | | | | | | | | |
| | | | | | | | | |
| Basic earnings per share | | $ | 0.01 | | | $ | (0.04 | ) |
| Weighted-average shares outstanding | | | 73,917,190 | | | | 75,862,484 | |
| | | | | | | | | |
| Diluted earnings per share | | $ | 0.01 | | | $ | (0.04 | ) |
| Weighted-average shares outstanding | | | 104,349,455 | | | | 75,862,484 | |
| | | | | | | | | |
| (1) Includes $3.3 million compensation expense from the issuance of Series F and G preferred shares in 2006. | |
| (2) Includes approximately $423,258 additional interest expense from the accretion of the Series E preferred shares in 2006. | |
The following discussion of the unaudited pro forma consolidated results of operations has been prepared as if the acquisition of Deep Down had occurred at January 1, 2006. The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results. The pro forma amounts included below do not include the acquisitions of Mako or Flotation as if they were acquired January 1, 2006.
Revenues
| | | 2007 | | Pro forma 2006 | | Change | | % | |
| Revenues | | $ | 19,389,730 | | $ | 8,821,149 | | $ | 10,568,581 | | | 119.8% | |
Revenues increased by approximately $10.6 million, or 119.8% to $19.4 million for the twelve months ended December 31, 2007 from approximately $8.8 million for the comparable period in 2006. This increase was due primarily to a significant increase in the Company’s core operations at its Deep Down Delaware subsidiary, including increased revenue from the delivery of loose tube steel flying leads; new products such as launch and retrieval systems and an active heave compensated in-line winch system, winch system refurbishments, and increased acceptance of newly developed installation procedures utilizing our rapid deployment cartridges and subsea deployment baskets. In addition, we experienced increased levels of service activity related to installations and recoveries of various subsea equipment. These results were further augmented by ElectroWave revenue of approximately $3.2 million for the nine months since acquisition and Mako revenue of $0.8 million for the one month since acquisition.
Cost of sales
| | | 2007 | | | Pro Forma 2006 | | | Change | | % | |
| Cost of sales | | $ | 13,020,369 | | | $ | 5,155,399 | | | $ | 7,864,970 | | | | 152.6% | |
As a percentage of revenues, cost of sales increased to approximately 67.1% in 2007 from approximately 58.4% in 2006. Gross margins were impacted by increased engineering and other costs associated with new product development, including our new line of Proteus™ custom-engineered active heave compensated in-line winches, deep water rated (4000 meter) launch and retrieval systems, and other products in development. Management expects gross margins on these products to increase on future orders. Management also expects overall margins to increase as a result of its recent acquisition of Mako’s rental and service operations.
Selling, general and administrative expenses
| | | 2007 | | Pro Forma 2006 | | Change | | % | |
| Selling, general and administrative | | $ | 4,284,553 | | $ | 5,710,324 | | $ | (1,425,771 | ) | | -25.0% | |
| Stock based compensation expense | | | (187,394 | ) | | (3,340,792 | ) | | 3,153,398 | | | -94.4% | |
| Selling, general and administrative | | $ | 4,097,159 | | $ | 2,369,532 | | $ | 1,727,627 | | | 72.9% | |
Selling, general and administrative expenses include rent, utilities, general office expenses, insurance, personnel and other costs necessary to conduct business operations. Stock-based compensation expense of approximately $0.2 million in fiscal year 2007 relates to stock option grants during fiscal year 2007 to various consultants and employees, and the $3.3 million stock-based compensation expense for fiscal 2006 related to the Series F and G Preferred Stock which was issued in exchange for the acquisition of 100% of the common stock of Strategic Offshore Services Corporation. See further discussion of the fiscal 2006 transaction in Corporate History appearing elsewhere in this Prospectus.
After adjusting for the stock based compensation expense, selling, general and administrative expenses for the year ended December 31, 2007 was approximately $4.0 million, up approximately $1.7 million from $2.4 million for the comparable period in 2006. The increase is primarily the result of an increased engineering staff to focus on the development of new products and quality control, increased administrative personnel, increased sales staff, and increased costs of functioning as a public company and pursuing acquisitions. As a percentage of revenues, selling, general and administrative expenses decreased to approximately 22% in 2007 from approximately 26.9% in 2006.
For fiscal year 2007, the consolidated selling, general and administrative expenses were as follows: $1.7 million administrative payroll and benefits, $0.2 million insurance cost, $0.8 million in accounting, legal and expenses related to public company reporting requirements, $0.1 million in advertising and sales related expenses, $0.9 million in rental, utility and general office expenses and $0.1 million in property and sales taxes.
Depreciation and amortization expense
| | | 2007 | | | Pro Forma 2006 | | | Change | | | % | |
| Depreciation | | $ | 398,610 | | | $ | 166,468 | | | $ | 232,142 | | | | 139.5% | |
| Amortization | | | 28,354 | | | | - | | | | 28,354 | | | - | |
| Depreciation and amortization | | $ | 426,964 | | | $ | 166,468 | | | $ | 260,496 | | | | 156.5% | |
Depreciation increased by approximately $0.3 million, or 162% to $0.4 million for the twelve months ended December 31, 2007 from approximately $0.2 million for the comparable period in 2006. During fiscal year 2007, we acquired approximately $3.2 million in fixed assets through the acquisition of the Mako subsidiary in December 2007 and approximately $45,500 in fixed assets in the acquisition of ElectroWave in April 2007. Additionally, we purchased approximately $0.8 million in fixed assets during fiscal year 2007, including a 100-ton mobile gantry crane valued at $0.5 million, under a capital lease.
We depreciate our assets using the straight-line method over the estimated useful lives of the respective assets. Buildings are amortized over 36 years, and leasehold improvements are amortized over the shorter of the assets' useful lives or lease terms. Equipment lives range from two to seven years, computers and electronic lives are from two to three years, and furniture and fixtures are two to seven years. Deep Down’s intangible assets consist of $4.4 million in specifically identified intangible assets acquired in the purchase of the Mako subsidiary on December 1, 2007, specifically Mako’s customer list, a non-compete covenant and trademarks related to Mako’s ROVs. We are amortizing the intangible assets over their estimated useful lives on the straight line basis between five and twenty five years.
Interest expense
| | | 2007 | | | Pro Forma 2006 | | | Change | | | % | |
| Cash interest expense | | $ | 594,667 | | | $ | 155,077 | | | $ | 439,590 | | | | 283.5% | |
Amount related to amortization of debt discounts and deferred financing costs | | | 190,491 | | | | - | | | | 190,491 | | | - | |
| Amount related to accretion | | | 1,644,991 | | | | 423,258 | | | | 1,221,733 | | | | 288.6% | |
| Total interest expense | | $ | 2,430,149 | | | $ | 578,335 | | | $ | 1,851,814 | | | | 320.2% | |
Interest expense increased by approximately $1.9 million to $2.4 million for the twelve months ended December 31, 2007 from approximately $0.5 million for the comparable period in 2006.
During fiscal year 2006, in conjunction with the reverse merger with Subsea, Deep Down determined that the Series E and Series G Preferred Stock was more like debt than equity due to their “redeemable exchangeable” nature into notes. The fair value calculated for the Series E and G Preferred Stock issued in exchange for 100% of the Deep Down Delaware common stock and Strategic Offshore Services Corporation using a 20% discount rate was significantly greater than the 6% interest on the three-year term note into which those preferred shares were exchangeable. Deep Down has been accreting the difference between the determined value and the face value of $1,000 per share for which we are obligated as interest expense. During fiscal year 2007, we redeemed all of the Series G Preferred Stock in exchange for 3,250 shares of Series E Preferred Stock. Additionally, a total of 7,750 shares of Series E Preferred Shares were redeemed, which generated non-cash interest expense of $1.6 million, plus approximately $42,000 of non-cash interest expense on the 500 shares of Series E Preferred Stock which remain outstanding at December 31, 2007. The amount of discount associated with the Series E Preferred stock outstanding at December 31, 2007 is $0.1 million.
On August 6, 2007, Deep Down entered into a $6.5 million secured Credit Agreement with Prospect and received an advance of $6.0 million on that date. The Credit Agreement provides 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 $250,000 per quarter beginning September 30, 2008, with the remaining balance outstanding due August 6, 2011. Interest payments are payable monthly, in arrears, on each month end commencing on August 31, 2007. Interest paid through December 31, 2007 was $377,167. Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through December 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 $13.0 million, and the quarterly principal payments increased to $250,000, with the payment dates remaining the same. The interest terms and loan covenants also remained substantially the same under the Amendment. Deep Down was advanced an additional $6.0 million on January 4, 2008 under terms of the Amendment.
Terms of the Credit Agreement also include 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 has a five-year term and becomes exercisable on the two-year anniversary of the original financing, August 6, 2009. The proceeds of the debt were allocated to the warrants based on its estimated relative fair value at the measurement date of when the final agreement was signed and announced and reflected as a discount to the debt. The relative fair market value of these warrants was $1.5 million and is being amortized as interest expense. Interest expense associated with the fair market value of the warrant was $135,931 during 2007.
Additionally, in connection with the initial advance in August 2007, Deep Down pre-paid $180,000 in points to the lender which was treated as a discount to the note. The discount associated with the value of the warrants and the pre-paid points are being amortized into interest expense over the life of the note agreement using the effective interest method. A total of $135,931 has been amortized into interest expense through December 31, 2007.
In connection with the second advance in January 4, 2008, Deep Down pre-paid $180,000 in points to the lender which was treated as a discount to the note.
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 (calculated as the volume weighted average closing price of the common stock for the ten days immediately preceding the closing of the Credit Agreement which took place on August 6, 2007). The warrant has a five-year term and becomes exercisable on the two-year anniversary of the original financing, August 6, 2009. 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. The deferred financing cost is being amortized using the effective interest method over the term of the note. A total of $54,560 of deferred financing cost was amortized into interest expense through December 31, 2007.
In connection with the second advance under the Credit Agreement on January 4, 2008, Deep Down capitalized an additional $261,941 in deferred financing costs. Of this amount, $216,000 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 has 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. The assumptions used in the model included (1) expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate of 3.2% and (4) zero expected dividends. Provisions in the warrant agreement allow for a cashless exercise provision, not to exceed 2% of outstanding common stock at the time of exercise.
Net Income (loss)
Net income increased by approximately $3.8 million to $1.0 million for the twelve months ended December 31, 2007 as compared to a loss of approximately $2.8 million for the comparable period in 2006.
EBITDA
| | | 2007 | | | Pro Forma 2006 | | | Change | | | % | |
| Net income (loss) | | $ | 952,509 | | | $ | (2,811,627 | ) | | $ | 3,764,136 | | | | 133.9% | |
| Tax expense | | | 369,673 | | | | 22,250 | | | | 347,423 | | | | - | |
| Interest | | | 2,335,662 | | | | 578,335 | | | | 1,757,327 | | | | 303.9% | |
| Depreciation and amortization expense | | | 426,964 | | | | 166,468 | | | | 260,496 | | | | 156.5% | |
| EBITDA | | $ | 4,084,808 | | | $ | 2,044,574 | | | $ | 6,129,382 | | | | 299.8% | |
Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP financial measure. Deep Down uses EBITDA as an unaudited supplemental financial measure to assess the financial performance of its assets without regard to financing methods, capital structures, taxes or historical cost basis; its liquidity and operating performance over time in relation to other companies that own similar assets and that the Company believes calculate EBITDA in a similar manner; and the ability of Deep Down assets to generate cash sufficient for Deep Down to pay potential interest costs. Deep Down also understands that such data are used by investors to assess the Company's 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 Deep Down’s 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 increased by approximately $6.1 million to $4.1 million for the twelve months ended December 31, 2007 from approximately $(2.0) million for the comparable period in 2006.
Capital Resources and Liquidity
Financing for our operations consists primarily of cash flows attributable to our operations. We believe that the liquidity we derived from the private placement of our common stock in June 2008 and cash flows attributable to our operations is more than sufficient to fund our capital expenditures, debt maturities and other business needs. We continue to evaluate acquisitions and joint ventures in the ordinary course of business. When opportunities for business acquisitions meet our standards, we believe we will have access to capital sources necessary to take advantage of those opportunities.
As of June 30, 2008, our cash and cash equivalents were $4.1 million. Cash and cash equivalents were $2.2 million plus restricted cash of $0.4 million as of December 31, 2007. Management believes that we have adequate capital resources when combined with its cash position and cash flow from operations to meet current operating requirements.
On June 5, 2008, we sold 57,142,857 shares of Deep Down’s common stock in a 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 to Prospect on June 12, 2008, with the remainder being retained for working capital purposes.
On April 11, 2008, the shareholders of Mako received the final cash installment of $1.2 million under the terms of the securities redemption and shareholder payable agreement.
Cash Flow from Operating Activities
For the six months ended June 30, 2008, cash used in operating activities was $1.4 million as compared to cash provided by operating activities for the same prior year period of 2007 of $0.4 million. Our working capital balances vary due to delivery terms and payments on key contracts, work in progress, and outstanding receivables and payables. Additionally, we recorded the following non-cash charges: amortization of deferred financing costs and debt discount related to the Prospect payoff totaling $2.6 million, share based compensation of $0.3 million, and depreciation and amortization of $0.9 million.
Cash Flow from Investing Activities
For the six months ended June 30, 2008, cash used in investing activities was $23.7 million as compared to $0.6 million for the same prior year period. The majority of the 2008 activity related to the cash paid to Flotation shareholders totaling $22.1 million offset by $0.2 million cash acquired, which was funded by the net proceeds of the private placement as discussed above. Additionally, Deep Down made the final cash payment to the Mako shareholders in the amount of $1.2 million. The restricted cash balance of $0.4 million was released in connection with the payoff of the Credit Agreement. Deep Down used $0.7 million for equipment purchases compared to the same prior year period totaling $0.4 million .
Cash Flow from Financing Activities
For the six months ended June 30, 2008, cash provided by financing activities was $27.0 million compared to $0.5 million for the same prior year period. During the six months ended June 30, 2008, Deep Down completed the foregoing described private placement for net proceeds of $37.1 million. In June, 2008, Deep Down 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, Deep Down paid $0.9 million of notes payable plus accrued interest of $2,664, and received proceeds from Prospect totaling $2.7 million.
Capital Resources and Requirements
We generate our liquidity and capital resources primarily through operations and, when needed, through available capital markets. At June 30, 2008, long-term debt was $1.0 million, of which $47,477 was the current portion.
Quantitative and Qualitative Disclosures About Market Risk
Financial market risks relating to our operations result primarily from changes in interest rates. We hold no securities for purposes of trading. Our cash and cash equivalents representing bank deposits at September 30, 2008 are not restricted as to withdrawal. Interest earned on our cash equivalents is sensitive to changes in interest rates. We have no variable rate debt.
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 officer and principal 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 officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
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 management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act, as amended. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. 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's annual or interim financial statements will not be prevented or detected on a timely basis. We have identified the following material weaknesses.
| 1. | As of December 31, 2007, 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. Additionally, we have not developed and effectively communicated to our employees our accounting policies and procedures. This has resulted in inconsistent practices particularly at our ElectroWave division. 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. Since these entity level programs have a pervasive effect across the organization, management has determined that these circumstances constitute a material weakness. |
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| 2. | As of December 31, 2007, at the ElectroWave subsidiary, we did not maintain effective controls over revenue recognition. Specifically, controls were not designed and in place to ensure that billing activities were conducted in a timely manner resulting in contract services revenues being recognized in an incorrect reporting period. Additionally, the lack of consistency applied procedures also resulted in the double billing of a customer. This control deficiency resulted in an adjustment to the consolidated financial statements. Accordingly, management has determined that this control deficiency constitutes a material weakness. |
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| 3. | As of December 31, 2007, we did not maintain effective controls over payables processing. Specifically, controls were not designed and in place to ensure that vender-related and employee-related cash disbursements were appropriately authorized and adequately supported by receiving reports and other supporting documentation. A budget process is not currently in place to monitor spending levels. This material weakness could result in errors in the accounting for accounts payable and expenses. Accordingly, management has determined that this control deficiency constitutes a material weakness. |
Because of these material weaknesses, management has concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2007, based on the criteria established in "Internal Control-Integrated Framework" issued by the COSO.
Changes in Internal Control Over Financial Reporting.
There were no changes in Deep Down’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that occurred during the period covered by this Registration Statement on Form S-1 that have materially affected, or are reasonably likely to materially affect, Deep Down’s internal control over financial reporting except for the impact of its new acquisition of Flotation. With its new acquisition, Deep Down’s management will conduct its annual assessment for its inclusion in its December 31, 2008 Annual Report on Form 10-K.
DESCRIPTION OF BUSINESS
See Management’s Discussion and Analysis of Financial Condition and Results beginning on page 35 for information relating to our Corporate History and Recent Events.
Segments. For the fiscal year ended December 31, 2007, we operated under one operating segment based on analysis of SFAS 131 “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). The operations of Deep Down Delaware and ElectroWave were reviewed collectively by Deep Down’s management due to similarities in products and production processes. The Mako subsidiary was included in the consolidated operations of Deep Down since its acquisition effective December 1, 2007, but constitutes less than 10% of the total revenues for the fiscal year ended December 31, 2007. Therefore, Mako did not meet the quantitative thresholds for segment reporting for this fiscal year.
Management is currently reviewing all operations related to segment reporting under the guidelines of SFAS 131 and plans to begin reporting operating segment(s) by the end of the 2008 fiscal year.
Our 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 and well commissioning. We pride ourselves on the ability to collaborate with the engineering departments of oil and gas operators, installation contractors and subsea equipment manufacturers to find the quickest, safest, and most cost-effective solutions to address all manner of issues in the subsea world. We also provide installation, retrieval, storage and management services in connection with the use of our products.
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 around 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.
Spooling. 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’s 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. Deep Down’s 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 has 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 Company also has 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. Deep Down has been involved in most of the topside connections and commissioning 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% 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.
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.
Bend Stiffener Latchers. Our spring-loaded bend stiffener latcher is used in dynamic installations on floating vessels. Umbilical stiffener latching mechanisms have always caused installation problems as well as expensive diver operations for expansion developments. We believe we have conceived the very first remote operated vehicle (“ROV”) installable latching mechanism. During the umbilical installation, the bend stiffener latcher can be latched in with a ROV and the umbilical can be pulled up the remaining distance and hung off. This allows the bend stiffener latcher to fit onto an existing flange, completely eliminating the need for divers both prior to and during the installation. The bend stiffener latcher can be designed to fit onto any existing flange on the bottom of an existing I-tube.
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 electrometric 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. Electrometric bend limiters are typically provided for small diameter umbilicals or flying leads, as well as for their compliant umbilical section, which turns 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.
Umbilical Splice. We have created a unique 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 design 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.
Intellectual Property. We believe that an important part of the success of our business is our patents, trade secrets, trademarks, copyrights, and other intellectual property rights. We currently own one U.S. patent and there are no foreign counterparts relating to our products and techniques and have applied for five U.S. patents and there are no foreign counterparts related to our products and techniques. We will need to pursue additional protections for our intellectual property as we develop new products or techniques and enhance existing products or techniques.
Drilsys TM, Electrowave TM, Mudsys TM , Aquasox TM , MorayTM, Seastax TM , Quick-Loc®, SeaStax® Quick-Loc® and Flotec®, Proteus™ and FlotectTM are our registered trademarks.
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.
Flotation
Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers. Flotation’s product offerings include distributed buoyancy for flexible pipes 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™ cable and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of any size and depth rating.
The majority of Flotation’s product offerings are made with FlotecTM syntactic foam, a product composed of hollow glass microballoons, combined with epoxy resin and a catalyst. These microballoons or microspheres are very small, 20-120 microns in diameter, and provide the buoyancy to syntactic foam. The microballoons give syntactic foam its light weight, low thermal conductivity and resistance to compressive stress that far exceeds other types of foams. The microballoons come 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.
Because of historic purchaser dissatisfaction with Flotation’s principal competitor, the Company was asked by oil companies to provide buoyancy products 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
Headquartered 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 Equipment Rental. Mako employs a permanent staff of highly qualified technicians and mechanics to maintain and refurbish its equipment in between rentals. Mako carries 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.
Offshore Construction Equipment Rental. Mako carries a wide array of equipment to service the offshore construction industry, including air compressors, air tuggers, blasting equipment, jet pumps, personnel baskets, air tools, welding machines, diesel pumps, and air pumps.
ROV Equipment Rental. Mako provides the latest ROV tooling technology as part of its rental fleet. Mako's ROV tooling rental fleet is constantly growing, with the addition of tools as they are requested by our customers. Mako has, as part of its rental inventory, a 2,000-foot depth-rated inspection / light work class remotely-operated vehicle (ROV) complete with a control van and launch / recovery system. Mako also has, as part of its inventory, a 300-meter depth-rated Seaeye Falcon and a 1,500-meter depth rated Seaeye Lynx observation class ROV. ROV services offered by Mako 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. Mako provides an extensive line of ROV tools, ROV clamps and ROV-friendly hooks and shackles. Mako’s torque tools are state-of-the-art in design.
Environmental Equipment Rental. Mako offers a line of equipment that is specifically designed and built to service the demanding requirements of the environmental industry. Systems are built in-house, housed on skids and include protective frames to ensure that the equipment is well suited for the job site. All rental equipment goes through extensive cleanup and overhaul between rentals, ensuring that when it arrives on site, its ready to go and will perform reliably.
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.
ElectroWave
ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, and commercial business sectors. ElectroWave designs, manufactures, installs, and commissions 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. ElectroWave can take projects from conceptual/system design through installation, commissioning, and support. ElectroWave's understanding of system requirements and its ability to quickly understand its customer’s needs allows them to produce quality products and services on time and on budget.
ElectroWave has 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 is 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 products:
Drillers Display System. ElectroWave has 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. Over 30 of these systems are installed on our customers' rigs worldwide, having over 800 rig-months of operating time, over 1 million hours of cumulative up-time, with a total down time of 2.5 hours. 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. We have these type systems installed on the Coast Guard Ice Breaker Mackinaw, and the 3 Molinari Class Staten Island ferries, the Molinari, Marchi, and Spirit of America.
CCTV System. ElectroWave has tackled some very difficult 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 cameras from hazardous locations where PTZ keyboards cannot be installed.
Ballast Monitoring System. ElectroWave has designed and implemented numerous ballast monitoring systems. A ballast monitoring system is a method of displaying the contents of the tanks on board the vessel. The systems provided by ElectroWave ranges from simple racks of bubbler style display units to integrated PLC touch screen systems visible throughout the vessel. ElectroWave has also offered automated tank reporting systems with our electronic PLC monitoring systems, allowing the operators to keep a liquid load sheet available at any time.
Active Heave Compensation. ElectroWave was approached to implement an algorithm to perform Active Heave Compensation. An "Active Heave Compensator", or AHC, is designed to reduce or eliminate (in this case eliminate) the effects of vessel heave during overboarding operations. This means that a package can be held at a specific location in the water without the motion of the vessel on the waves affecting the position of the package. The customer identified the operational tolerance of the system to be 6" of movement of the package with vessel heave of approximately 20 feet. The system that was implemented is accurate to 0.6" of package movement with vessel heave up to 30 feet. ElectroWave always delivers products to the best of our ability, often exceeding customer requirements and expectations. ElectroWave implemented an Allen Bradley PLC system to take data from a Motion Reference Unit (MRU) and drive hydraulic actuators to compensate for the movement of the vessel.
Manufacturing
Our manufacturing facilities are in Channelview, Texas, a suburb of Houston, where we conduct a broad variety of processes, including machining, fabrication, inspection, assembly and testing. Our Manufactured Systems Division is 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. The manufacturing personnel have over 50 years of combined experience serving commercial, government, military and academic customers in a variety of applications. The facilities encompass over 8 acres, with approximately 60,000 square feet of manufacturing space with 4 overhead cranes and 7,000 square feet of office space. The Company is located with great access to both I-10 and the Houston Ship Channel. The facilities have 120V, 240V and 480V power. Our manufacturing plant is ISO 9001 and American Petroleum Institute certified.
Our manufacturing facility utilizes state-of-the-art computer numerically controlled ("CNC") machine tools and equipment, which contribute to the Company's product quality and timely delivery. We maintain our equipment and tooling in good working condition and upgrade our capabilities as needed to enhance the cost-efficient manufacture of our specialized products. We purchase quality used machine tools and equipment as they become available and store them at our facility to be rebuilt, upgraded or refurbished as needed. 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's 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. Our primary raw material is steel. We routinely purchase raw materials from many suppliers on a purchase order basis and do not have any long-term supply contracts.
Flotation has designed, developed, and assembled its own continuous liquid syntactic foam production machine. This machine allows Flotation 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 of 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.
Customers
Demand for our deep water equipment, surface equipment and offshore rig equipment and services 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. Our customers include Acergy SA; Aker Kvaerner ASA; Amerada Hess Corporation; Anadarko Petroleum Corporation; Atlantic Shipyard; BHP Billiton Limited; BP PLC; Cabett Subsea Products, Inc.; Cal Dive International, Inc.; Cameron International Corporation; Chevron Corporation; Devon Energy Corporation; Diamond Offshore Drilling, Inc.; Dril-Quip, Inc.; Duco Inc.; ExxonMobil Corporation; Helix Energy Solutions Group Inc.; JDR Cable Systems (Holdings) Ltd; Kerr McGee Corporation; Marathon Oil Corporation; Marinette Marine Corporation; Nexen Inc.; Noble Energy Inc.; Oceaneering International, Inc.; Oil States Industries, Inc.; Royal Dutch Shell PLC; Schlumberger Limited; Subsea 7, Inc.; Technip USA Holdings, Inc.; TransOcean Offshore Inc.; United States Coast Guard; Veolia Environmental Services, Inc. and United States Navy.
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 products and services throughout the world directly through our sales personnel in our corporate headquarters in Channelview, Texas. 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. 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 improve existing products 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. 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 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’s principal competitors in the polyurethane area are Trelleborg AB, Balmoral Group, Dunlaw Engineering Ltd., ABCO Industries Limited, and Whitefield Plastics Corporation. Flotation’s principal competitor in the syntactic foam is Trelleborg AB. CRP Group was acquired by the 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 Cumming 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
We have 165 employees as of July 16, 2008.September 30, 2008 . Our employees are not covered by collective bargaining agreements and we 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 compliance with such laws will require us to make material 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.
DESCRIPTION OF PROPERTY
Our principal corporate offices and manufacturing space are located at 15473 East Freeway, Channelview, Texas 77530. We lease the Channelview property which consists of approximately 10.998 acres of land with approximately 60,000 square feet of manufacturing space with four overhead cranes and 7,000 square feet of office space. We lease all buildings, structures, fixtures and other improvements from JUMA, LLC, a company owned by Ronald E. Smith, CEO and a director of Deep Down, Inc. and Mary L. Budrunas, a vice president and a director of Deep Down, Inc. The base rate of $11,000$15,000 per month is payable to JUMA through September 1, 2011,August 31, 2013, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.
ElectroWave’s offices and manufacturing space is located at the same location of Deep Down at 15473 East Freeway, Channelview, Texas 77530. ElectroWave’s facilities are also included in the lease with JUMA, LLC.
Mako Technologies, LLC leases its property and buildings from Sutton Industries. Mako is located at 125 Mako Lane, Morgan City, LA 70380. The lease is for 5 years beginning on June 1, 2006. There is a 5 year option at the expiration of the initial lease. At this location, Mako has its administrative offices and buildings that serve as the support location for the Mako rental equipment.
In connection with the purchase of Flotation, has ownedDeep Down acquired land along with a building and occupiedimprovements with a fair market value of $3.3 million which houses its current Biddeford, Maine46,925 square foot light industrial manufacturing facility for approximately one year. The facility contains approximately 6,000 square feet of office space and approximately 40,000 square feet of manufacturing space.on a 3.61 acre site in Maine. Flotation is in the process of building a second continuous mixer at a cost of $500,000. This mixer will augment the production of foam on the same manufacturing line as the original mixer.
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). |
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The following table sets forth the name, age and position of our directors and executive officers as of July 16,September 30, 2008. There are no other persons who can be classified as a promoter or controlling person in relation to us. Our officers and directors are as follows:
| Name | | Age | | Position Held With The Company |
| Robert E. Chamberlain, Jr. | | 4849 | | Chairman of the Board, Chief Acquisitions Officer, and Director |
| Ronald E. Smith* | | 49 | | President, Chief Executive Officer and Director |
| Eugene L. Butler | | 66 | | Chief Financial Officer and Director |
| Mary L. Budrunas* | | 56 | | Vice-President, Director,Corporate Secretary, and Corporate SecretaryDirector |
| Bradley M. Parro | | 50 | | Vice-President |
_________________________
* Ronald E. Smith and Mary L. Budrunas are husband and wife.
Robert E. Chamberlain, Jr., Chairman of the Board, Chief Acquisitions Officer, 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. Most recently, 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.
Ronald E. Smith, President, Chief Executive Officer and Director . Mr. Smith co-founded Deep Down in 1997 and has served as President and Director of the Company since December 2006. 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.
Eugene L. Butler, Chief Financial Officer and Director. Mr. Butler has served as Chief Financial Officer with Deep Down, Inc. since June 2007. 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 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.
Mary L. Budrunas, Vice-President, DirectorCorporate Secretary, and Corporate Secretary.Director. Ms. Budrunas, co-founder of Deep Down, Inc. along with current chief executive officer Ronald E. Smith, has served as Vice-President and director of the Company since December 2006. Ms. Budrunas is responsible for the Company’s 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 was the Managing Director for Continental Shelf Associates where he was responsible for business development for the 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 offshore oil and gas industry. He also held the position of chief financial officer for oilfield service providers Ceanic Corporation (formerly NASDAQ: DIVE) and Perry Tritech, Inc. His experience includes mergers and acquisitions, corporate restructuring, equity and sub-debt placement, strategic planning and execution and executive financial and operational management. Mr. Parro has a Bachelor of Science degree in finance from the University of Illinois at Urbana-Champaign and a Master of Business Administration degree from Loyola University of Chicago.
Corporate Governance
The Company promotes accountability for adherence to honest and ethical conduct; endeavors to provide full, fair, accurate, timely and understandable disclosures in reports and documents that the Company files with the Securities and Exchange Commission (the “SEC”) and in other public communications made by the Company; and strives to be compliant with applicable governmental laws, rules and regulations. The Company has not formally adopted a written code of business conduct and ethics that governs the Company’s employees, officers and directors as the Company is not required to do so.
There were no material changes to the procedures by which shareholders may recommend nominees to the Company’s Board of Directors.
In lieu of an Audit Committee, the Company’s Board of Directors is responsible for reviewing and making recommendations concerning the selection of outside auditors, reviewing the scope, results and effectiveness of the annual audit of the Company's financial statements and other services provided by the Company’s independent public accountants. The Board of Directors reviews the Company's internal accounting controls, practices and policies. Our Board of Directors has determined that no director qualifies as an audit committee financial expert as defined in Item 407(d) (5) (ii) of Regulation S-B.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers, as well as persons beneficially owning more than 10% of our outstanding common stock, to file reports of ownership and changes in ownership with the SEC within specified time periods. Such officers, directors and shareholders are required to furnish us with copies of all Section 16(a) forms they file.
Based solely on the review of such forms received by us, or written representations from certain reporting persons, not all Section 16(a) filing requirements applicable to our officers, directors and 10% shareholders were complied with within a timely manner during the fiscal year ended December 31, 2007. During 2007, the number of Form 3s that were filed late totaled six; the number of Form 4s that were filed late totaled six; and the number of Form 5s that were filed late totaled seven. However all required reports were filed by December 31, 2007.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table listssets forth certain information, as of September 30, 2008 , concerning the beneficial ownership as of July 16, 2008 of shares of common stock of the Company’s Common StockCompany by (i) all persons and groupseach person known by the Company to beneficially own beneficially more than 5% of the outstanding shares ofCompany’s common stock; (ii) each Director; (iii) the Company’s Common Stock, (ii) each director, (iii) each person who held the office of ChiefNamed Executive Officer at any time during the year ended December 31, 2007,Officers; and (iv) up to two executive officers other than the Chief Executive Officer who were serving as executive officers on December 31, 2007 and to whom the Company paid more than $100,000 in compensation during the last fiscal year, (v) up to two additional persons to whom the Company paid more than $100,000 during the last fiscal year but who were not serving as an executive officer on December 31, 2007, and (vi) all directors and officers as a group. None of the directors, nominees, orexecutive officers of the Company owned any equity security issued byas a group. To the Company’s subsidiaries. Informationknowledge of the Company, all persons listed in the table have sole voting and investment power with respect to officers, directors and their familiesshares, except to the extent that authority is as of July 16, 2008, and is based on the books and records of the Company and information obtained from each individual. Unless otherwise stated, the business address of each individual or group is the same as the address of the Company’s principal executive office.shared with their respective spouse under applicable law.
| Name and address of beneficial owner (2) | Shares | Vested Options / Warrants | Percentage of Voting Rights (1) |
| Ronald E. Smith (3)(4) | 44,629,876 | - | 25.16% |
| Mary L. Budrunas (3) | 44,629,876 | - | 25.16% |
| Robert E. Chamberlain, Jr.(4) | 25,358,375 | - | 14.30% |
| Eugene L. Butler (4) | 350,000 | 1,000,000 (5) | 0.76% (6) |
| All directors and officers as a group (four persons) | 70,338,251 | 1,000,000 | 40.00%(6) |
(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 177,350,630 shares of common stock outstanding as of July 16,September 30, 2008.
(2) The address of each of the beneficial owners is c/o Deep Down, Inc., 15473 East Freeway, Channelview, Texas 77530.
(3) Reflects 26,216,871 shares owned by Ronald E. Smith and 18,413,005 shares owned by Mary L. Budrunas, who are married to each other.
(4) Shares owned include 350,000 shares of restricted stock issued on February 14, 2008 which become fully vested on the second anniversary of the grant, February 14, 2010.
(5) Includes 1,000,000 options to purchase shares of the Company’s common stock at an exercise price of $0.515 per share. Effective May 31, 2007, we hired Eugene L. Butler as our Chief Financial Officer (“CFO”) for an initial term through May 31, 2010 with automatic annual renewals for an additional two years. He received an aggregate of 3,000,000 stock options, of which the first 33% vested on the first anniversary of the agreement, the second 33% on the second anniversary of the agreement and the remaining 33% will vest on the third anniversary of the agreement. The exercise price for the options, $0.515 per share, was determined by the closing market price of the common stock on the date of grant. The options expire on May 31, 2010.
(6) Based on 178,350,630 shares of common stock outstanding, assuming the exercise of all vested options held by Mr. Butler.
Disclosure regarding our equity compensation plans as required by this item is incorporated by reference to the information set forth under the section entitled “Market for Common Equity and Related Stockholder Matters” above.
EXECUTIVE COMPENSATION
The following table summarizes all compensation paid to our Chief Executive Officer, Chief Financial Officer and our two highest compensated named executive officers (the “Named Executive Officers”) for the year ended December 31, 2007 and the period from inception June 29, 2006 to December 31, 2006, respectively.
Summary Compensation Table
| Name and Principal Position | Year | | Salary ($) | | Bonus ($) | | Stock Awards ($) (5) | | Option Awards ($) (3) | | All Other Compensation ($) | | | Total ($) | |
| Ronald E. Smith (4) | 2007 | | $ | 269,231 | | $ | - | | $ | - | | $ | - | | $ | - | | | $ | 269,231 | |
| President, Chief Executive Officer and Director | 2006 | | $ | 27,110 | | $ | 1,710 | | $ | - | | $ | - | | $ | - | | | $ | 28,820 | |
Robert E. Chamberlain, Jr. (1) (4) | 2007 | | $ | 180,000 | | $ | - | | $ | - | | $ | - | | $ | 20,655 | | | $ | 200,655 | |
Chairman of the Board, Chief Acquisition Officer
and Director | 2006 | | $ | 16,670 | | $ | - | | $ | - | | $ | - | | $ | - | | | $ | 16,670 | |
| Mary L. Budrunas | 2007 | | $ | 134,615 | | $ | - | | $ | - | | $ | - | | $ | - | | | $ | 134,615 | |
| Vice-President, Corporate Secretary and Director | 2006 | | $ | 13,070 | | $ | 12,670 | | $ | - | | $ | - | | $ | - | | | $ | 25,740 | |
Eugene L. Butler (2) (4) | 2007 | | $ | 105,000 | | $ | - | | $ | - | | $ | 618,300 | | $ | 14,568 | | | $ | 737,868 | |
| Chief Financial Officer and Director | 2006 | | $ | - | | $ | - | | $ | - | | $ | - | | $ | - | | | $ | - | |
(1) Mr. Chamberlain was paid for consulting services he performed through Strategic Capital Services, Inc. Other compensation consists of auto allowance payments of $1,000 per month and $8,655 for payroll tax reimbursement which were paid during fiscal 2008. Effective January 1, 2008, Mr. Chamberlain’s annual fee for consulting services was increased to $225,000.
(2) Mr. Butler began drawing an annual salary of $180,000 beginning May 31, 2007. Option awards consist of 3,000,000 options granted on that date which vest in three equal annual installments on the first three anniversary dates of the grant date. Other compensation consists of auto allowance payments of $1,000 per month and $7,568 for payroll tax reimbursement which were paid during fiscal 2008. Effective January 1, 2008, Mr. Butler’s annual fee for consulting services was increased to $225,000.
(3) Option awards are based on expense recognized under FAS123(R). Awards granted to Mr. Butler during fiscal year 2007 were granted with a strike price equal to the quoted market price on the day of the grant and were valued at date of grant using Black-Scholes option pricing models with the following assumptions: 5% risk free rate, 52.7% volatility, expected life of 3 years and zero dividends.
On February 14, 2008, Deep Down issued 1,000,000 stock options to MsrsMessrs. Smith, Chamberlain and Butler with an exercise price of $1.50, which was in excess of the day’s closing price of $0.42. The aggregate fair value of such options (excluding estimated forfeitures) was approximately $145,764 based on the Black-Scholes option pricing model using the following estimates: 2.8% risk free rate, 61.3% volatility, an expected life of 3 years and zero dividends. These options are not reflected on the table above since the grant occurred after December 31, 2007.
(4) In June, 2008, in recognition of the successful completion of the acquisition of Flotation and the private placement of common stock, MsrsMessrs, Smith, Chamberlain and Butler were each awarded a cash performance bonus of $100,000 which was paid on June 20, 2008. These bonuses are not reflected on the table above since they occurred after December 31, 2007.
(5) On February 14, 2008, Deep Down issued 350,000 shares of restricted common stock to MsrsMessrs. Smith, Chamberlain and Butler at a price of $0.42, the closing price of Deep Down’s stock on that day. These restricted shares vest over a period of two years. The aggregate fair value of such restricted stock was approximately $441,000. These shares are not reflected on the table above since the grant occurred after December 31, 2007.
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth information concerning equity incentive plan awards for each of the Named Executive Officers, outstanding as of December 31, 2007. The amounts reflected as Market Value are based on the closing price of our Common Shares of $ 0.98 on December 31, 2007 (the last trading day of our fiscal year ended December 31, 2007).
Name | | Number of Securities Underlying Unexercised Options (#) Exercisable | | Number of Securities Underlying Unexercised Options (#) Unexercisable | | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) | | Option Exercise Price ($) | | Option Expiration Date |
| Eugene L. Butler, Chief Financial Officer | | | - | | | 3,000,000 | | | - | | $ | 0.515 | | May 31, 2010 |
The vesting provisions for the Company’s stock options noted above will vest over a three-year period.
See footnotes (3) and (5) of the Summary Compensation Table for options and restricted stock granted during fiscal year 2008.
Employment Agreements
Effective August 6, 2007, we signed an employment agreement with Ronald E. Smith, our President and Chief Executive Officer (“CEO”) for an initial term through August 6, 2010 with automatic annual renewals for an additional two years. Under terms of the employment agreement, Mr. Smith will receive an annual base salary of $250,000 plus $1,000 per month auto allowance.
Effective August 6, 2007, we signed a consulting agreement with Strategic Capital Services, Inc. (“Strategic”) to provide the services of Robert E. Chamberlain, who is our Chairman of the Board and Chief Acquisitions Officer (“CAO”) for an initial term through August 6, 2010 with automatic annual renewals for an additional two years. Under terms of the consulting agreement, Mr. Chamberlain will receive an annual base salary of $180,000, which was increased to $225,000 as of January 1, 2008, plus $1,000 per month auto allowance, and payment to Strategic of an amount equal to Federal and State payroll withholdings customarily withheld for an employee. Such amounts totaling approximately $8,655 were paid in February 2008.
Effective May 31, 2007, we hired Eugene L. Butler as our Chief Financial Officer (“CFO”) for an initial term through May 31, 2010 with automatic annual renewals for an additional two years. Under Mr. Butler's employment agreement, he will receive an annual base salary of $180,000, which was increased to $225,000 as of January 1, 2008. He received an aggregate of 3,000,000 stock options, of which the first 33% will vest on the first anniversary of the agreement, the second 33% on the second anniversary of the agreement and the remaining 33% will vest on the third anniversary of the agreement. The exercise price for the options was determined by the closing market price of the common stock on the date of grant. Mr. Butler’s employment agreement contains an indemnification provision that may require us to, among other things: indemnify Mr. Butler against liabilities that may arise by reason of his status or service as an officer to the fullest extent permitted under law. Effective August 6, 2007, Mr. Butler’s employment agreement was replaced by a consulting agreement with all the same provisions as the previous employment agreement. The consulting agreement contains a provision that Deep Down will remit to Mr. Butler an amount equal to Federal and State payroll withholdings customarily withheld for an employee. Such amounts totaling approximately $7,568 were paid in February 2008.
Effective May 1, 2008, Deep Down entered into an employment agreement with Bradley M. Parro to serve as Vice President of the Company. The employment agreement is for a period of three years, during which time he is to be paid $180,000 per year, and be eligible for bonuses under terms of the Deep Down bonus plan. Mr. Parro is also eligible to receive an automobile allowance of up to $1,000 per month. Additionally, pursuant to the employment agreement, Mr. Parro was granted 300,000 stock options to purchase shares of our common stock at an exercise price of $0.88 per share. The options vest at the rate of one-third of the options on the first, second and third anniversary of May 1, 2008, respectively, and expire ten years from such date. Mr. Parro is not included on the tables above as he was hired after December 31, 2007.
Compensation of Directors
For the year ended December 31, 2007, there were no cash payments or equity grants for compensation to the Company’s former non-employee director, Daniel L. Ritz, Jr. Mr. Ritz resigned as a director of the Company effective March 20, 2007. The directors of the Company are all also executive officers of the Company and as directors do not receive any additional compensation related to the performance of services as directors. The Company may agree to provide compensation to non-employee directors in the future.
CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS
We lease all buildings, structures, fixtures and other improvements from JUMA, LLC, a company owned by Ronald E. Smith, CEO and a director of Deep Down, Inc. and Mary L. Budrunas, a vice president and a director of Deep Down, Inc. The base rate of $15,000 per month is payable to JUMA through September 1, 2011,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 shares of Series D preferred stock owned by the Chief Executive OfficerRonald Smith and director, and his wife, a Vice-President of Deep Down.Mary Budrunas. The Series D preferred shares were redeemed for 23,279,876 shares of common stock.
During the six months ended June 30, 2008, Deep Down granted an aggregate of 1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock options to Ronald E. Smith, Robert E. Chamberlain, Jr., Chairman and Chief Acquisition Officer, and Eugene L. Butler, Chief Financial Officer, under the terms of the Deep Down, Inc. Stock Option Plan. Deep Down also awarded in recognition of their completion of the acquisition of Flotation and private placement of common stock, a performance bonus of $300,000 in the aggregate.
The Company is a party to the employment agreements described herein with various of our officers and directors.
None of the Company’s directors are independent. However, the Company believes that it would be exempt from some of the independence requirements of NASDAQ ® due to the Company’s being a controlled company as defined in the NASDAQ® rules. Under the NASDAQ® standards for “independence”, none of our directors would qualify as independent generally or with respect 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.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL MATTERS
None.
INTEREST OF NAMED EXPERTS AND COUNSEL
The validity of the common stock offered by this Prospectus is being passed upon for us by Sonfield & Sonfield, Houston, Texas, who does not hold any interest in the Company, contingent or otherwise.
LEGAL PROCEEDINGS
From time to time we are involved in legal proceedings arising in the normal course of our business. As of the date of this Prospectus, there are no material pending or threatened legal proceedings regarding the Company which we are aware of.
EXPERTS
The consolidated financial statements of Deep Down, Inc. as of December 31, 2007 and 2006 and for the period from June 29, 2006 (inception) to December 31, 2006 included in this prospectus have been included in reliance on the report dated March 31, 2008 of Malone & Bailey PC, an independent registered public accounting firm, given on the authority of such firm as experts on accounting and auditing. In addition, the historical financial statements of Flotation Technologies, Inc. included in this prospectus have been included in reliance on the report dated June 16, 2008 of Bruzgo & Kremer, LLC, an independent public accounting firm, given on the authority of such firm as experts on accounting and auditing. Further, the financial statements of Mako Technologies, Inc. as of and for the period ended September 30, 2007 and as of and for the year ended December 31, 2006, included in this prospectus have been included in reliance on the report dated March 17, 2008 of Malone & Bailey PC, an independent registered public accounting firm, given on the authority of such firm as experts on accounting and auditing.auditing.
SHARES AVAILABLE FOR FUTURE SALE
As of July 16,September 30, 2008, we had outstanding 177,350,630 shares of our Common Stock, of which 29,002,052 shares are freely tradable or covered by a current registration statement and 57,142,857 shares will be freely tradable under this Prospectus. The remaining 91,205,721 shares of our Common Stock outstanding are “restricted securities” as defined in Rule 144 and are held by our “affiliates” (as that term is defined in Rule 144 under the Securities Act). These restricted securities may be sold in the future pursuant to registration statements filed with the SEC or without registration under the Securities Act to the extent permitted by Rule 144 or other exemptions under the Securities Act.
As of July 16,September 30, 2008 , there were an aggregate of 8,775,000 shares of our Common Stock issuable upon exercise of outstanding stock options and an aggregate of 638,812 shares of stock issuable upon exercise of outstanding warrants. On July 3, 2008, the holder of 4,960,585 warrants exercised the warrants in a cashless exercise for a total of 2,618,129 shares of common stock.
Until September 4,3, 2008, we have agreed not to directly or indirectly, (1) offer for sale, sell, pledge or otherwise dispose of (or enter into any transaction or device which is designed to, or could be expected to, result in the disposition by the Company at any time in the future of) any shares of common stock, or securities convertible into or exchangeable for common stock, or sell or grant options, rights or warrants with respect to any shares of common stock or securities convertible into or exchangeable for common stock (other than option grants to employees pursuant to existing plans in the ordinary course of business), or (2) enter into any swap or other derivatives transaction that transfer to another, in whole or in part, any of the economic benefits or risks of ownership of such shares of common stock, whether any such transaction described in clause (1) or (2) above is to be settled by delivery of common stock or other securities, in cash or otherwise, without the prior written consent of the Selling Shareholders or Dahlman Rose & Company, LLC.
We may register additional shares in the future in connection with acquisitions, compensation or otherwise. We have not entered into any agreements or understanding regarding any future acquisitions and cannot ensure that we will be able to identify or complete any acquisition in the future. Sales of shares of common stock in the public markets or through Rule 144 may have an adverse effect on prevailing market prices for our common stock.
Rule 144 governs resale of "restricted securities" for the account of any person (other than an issuer), and restricted and unrestricted securities for the account of an "affiliate" of the issuer. Restricted securities generally include any securities acquired directly or indirectly from an issuer or its affiliates which were not issued or sold in connection with a public offering registered under the Securities Act. An affiliate of the issuer is any person who directly or indirectly controls, is controlled by, or is under common control with, the issuer. Affiliates of the Company may include its directors, executive officers, and persons directly or indirectly owning 10% or more of the outstanding common stock. Under new rules adopted by the Commission, unregistered resales of restricted securities of reporting companies are able to be made by non-affiliates and affiliates after such securities have been held for six (6) months (assuming the issuer remains current in its SEC periodic reporting obligations for an additional six months, and subject to any affiliates complying with certain volume limitations and other resale requirements as set forth in Rule 144), and after one (1) year by affiliates and non-affiliates of non-reporting companies, subject to certain requirements under Rule 144, as it has been amended (including that there is current public information regarding the issuer for sales by affiliates and that other volume limitations are complied with for sales of affiliates, as described in greater detail in Rule 144).
SELLING SHAREHOLDERS
We are registering the shares to permit the Selling Shareholders to resell them in the manner contemplated under the “Plan of Distribution” beginning on page 70.69. When we refer to “Selling Shareholders” in this Prospectus, we mean the persons listed in the table below, and the pledgees, donees, transferees, successors, and others who later come to hold any of the Selling Shareholders’ interests in shares of our common stock other than through a public sale.
The shares offered by this Prospectus may be offered from time to time by the Selling Shareholders. They may sell some, all or none of their shares. We do not know how long the Selling Shareholders will hold the shares before selling them. We currently have no agreements, arrangements or understandings with the Selling Shareholders regarding the sale of any of the shares.
The following table sets forth the name of each selling shareholder, the number of shares owned by each Selling Shareholder before this offering, the number of shares that may be offered under this Prospectus, and the number of shares of our common stock owned by the Selling Shareholders after this offering is completed. The number of shares in the column “Number of Shares Being Offered” represents all of the shares that a Selling Shareholder may offer under this Prospectus. The number of shares in the column “Shares Owned after the Offering” assumes the sale of all of the shares offered by the Selling Shareholder under this Prospectus.
The ownership of shares reported in the table below is based upon information provided by each Selling Shareholder and SEC Form 4s, SEC Schedules 13D and 13G, and other public documents filed with the Securities and Exchange Commission. Unless otherwise noted, none of the share amounts set forth below represents more than 5% of our outstanding common stock as of July 16,September 30, 2008. The percentages of shares owned after the offering are based on 177,350,630 shares of our common stock outstanding as of July 16, 2008.September 30, 2008 .
None of the Selling Shareholders have, or within the past three years has had, any position, office or other material relationship with us.
Based on the information provided to us by the Selling Shareholders, none of the Selling Shareholders is, or is affiliated with, a broker-dealer other than Jefferies & Co.Crestview Capital Master, L.L.C., D.E. Shaw Valence Portfolios, L.L.C., Dean O’Connor, Ernest J. Dahlman, III, IOU Limited Partnership, Jefferies & Co., OGI Associates and Dean O’Connor.Schottenfeld Group, LLC. Each of the Selling Shareholders has represented to us that he or it had no agreements or understanding, directly or indirectly, with any person to distribute the securities.
The Selling Shareholders may have sold or transferred, in transactions exempt from the registration requirements of the Securities Act, some or all of their shares since the date on which the information in the table is presented. Information about the Selling Shareholders may change over time.
| | | | | Shares Owned After Offering (3) |
| Name | | Shares of Common Stock Owned Prior to Offering | Number of Shares Being Offered | Number | Percent |
| | | | | | |
| Amended and Restated Declaration of Trust of Morton A. Cohen, dated May 9, 2005 | (a) | 142,857 | 142,857 | 142,857 | * |
| Andrew Steven Codispoti | (b) | 71,429 | 71,429 | 71,429 | * |
| Aquanaut Master Fund Ltd. | (c) | 1,428,571 | 1,428,571 | 1,428,571 | * |
| BlackGold Capital Master Fund L.P. | (d) | 1,428,571 | 1,428,571 | 1,428,571 | * |
| Calm Waters Partnership | (e) | 3,571,429 | 3,571,429 | 3,571,429 | * |
| Capital Structure Opportunities, LP | (f) | 102,000 | 102,000 | 102,000 | * |
| Cardinal Bear LLC | (g) | 1,071,429 | 1,071,429 | 1,071,429 | * |
| Clarion Capital Corporation | (h) | 428,572 | 428,572 | 428,572 | * |
| Clarion World Offshore Fund, Ltd. | (i) | 142,857 | 142,857 | 142,857 | * |
| Crestview Capital Master, LLC | (j) | 357,143 | 357,143 | 357,143 | * |
| D.E. Shaw Valence Portfolios, L.L.C. | (k) | 7,142,857 | 7,142,857 | 7,142,857 | * |
| Dubuque Bank and Trust | (l) | 2,857,143 | 2,857,143 | 2,857,143 | * |
| Dean O'Connor (1) | (m) | 50,000 | 50,000 | 50,000 | * |
| Ernest J. Dahlman, III (2) | (n) | 93,239 | 93,239 | 93,239 | * |
| Greg Imbruce | (o) | 500,000 | 500,000 | 500,000 | * |
| Hare & Co. | (o) | 38,750 | 38,750 | 38,750 | * |
| Invenio Partners | (p) | 285,714 | 285,714 | 285,714 | * |
| IOU Limited Partnership | (q) | 2,071,428 | 2,071,428 | 2,071,428 | * |
| Jacobe Partners, L.P. | (r) | 428,571 | 428,571 | 428,571 | * |
| Jefferies & Co. | (s) | 10,999 | 10,999 | 10,999 | * |
| Mac & Co. | (t) | 106,570 | 106,570 | 106,570 | * |
| Millennium Partners, L.P. | (u) | 7,857,143 | 7,857,143 | 7,857,143 | * |
| Newland Master Fund, Ltd. | (v) | 3,000,000 | 3,000,000 | 3,000,000 | * |
| OGI Associates, LLC | (w) | 2,071,429 | 2,071,429 | 2,071,429 | * |
| PENFIRN Co F/B/O: Roge Partners Fund | (x) | 428,571 | 428,571 | 428,571 | * |
| PENFIRN Co F/B/O: Roge Select Opportunities Fund | (y) | 428,571 | 428,571 | 428,571 | * |
| Penn Capital Management | (z) | 167,000 | 167,000 | 167,000 | * |
| Perella Weinberg Partners Oasis Master Fund L.P. | (aa) | 5,000,000 | 5,000,000 | 5,000,000 | * |
| Peter Kaltmon | (bb) | 74,300 | 74,300 | 74,300 | * |
| Schottenfeld Group, LLC | (cc) | 1,000,000 | 1,000,000 | 1,000,000 | * |
| Tracy W. Krohn | (dd) | 5,714,286 | 5,714,286 | 5,714,286 | * |
| UBS O’Connor LLC F/B/O: O’Connor Pipes Corporate Strategies Master Limited | (ee) | 1,428,571 | 1,428,571 | 1,428,571 | * |
| Wexford Capital, LLC | (ff) | 1,785,715 | 1,785,715 | 1,785,715 | * |
| Wexford Spectrum Trading Limited | (gg) | 5,357,142 | 5,357,142 | 5,357,142 | * |
| Stamatis Molaris | (hh) | 500,000 | 500,000 | 500,000 | * |
| | | 57,142,857 | 57,142,857 | 57,142,857 | * |
| | | | | Shares Owned After Offering (3) |
| Name | | Shares of Common Stock Owned Prior to Offering | Number of Shares Being Offered | Number | Percent |
| | | | | | |
| Amended and Restated Declaration of Trust of Morton A. Cohen, dated May 9, 2005 | (a) | 142,857 | 142,857 | 142,857 | |
| Andrew Steven Codispoti | (b) | 71,429 | 71,429 | 71,429 | |
| Aquanaut Master Fund Ltd. | (c) | 1,428,571 | 1,428,571 | 1,428,571 | |
| BlackGold Capital Master Fund L.P. | (d) | 1,428,571 | 1,428,571 | 1,428,571 | |
| Calm Waters Partnership | (e) | 3,571,429 | 3,571,429 | 3,571,429 | |
| Capital Structure Opportunities, LP | (f) | 102,000 | 102,000 | 102,000 | |
| Cardinal Bear LLC | (g) | 1,071,429 | 1,071,429 | 1,071,429 | |
| Clarion Capital Corporation | (h) | 428,572 | 428,572 | 428,572 | |
| Clarion World Offshore Fund, Ltd. | (i) | 142,857 | 142,857 | 142,857 | |
| Crestview Capital Master, LLC | (j) | 357,143 | 357,143 | 357,143 | |
| D.E. Shaw Valence Portfolios, L.L.C. | (k) | 7,142,857 | 7,142,857 | 7,142,857 | |
| Dubuque Bank and Trust (DBCTO) | (l) | 2,857,143 | 2,857,143 | 2,857,143 | |
| Dean O'Connor (1) | (m) | 50,000 | 50,000 | 50,000 | |
| Ernest J. Dahlman, III (2) | (n) | 93,239 | 93,239 | 93,239 | |
| Greg Imbruce | (o) | 500,000 | 500,000 | 500,000 | |
| Hare & Co. | (p) | 38,750 | 38,750 | 38,750 | |
| Invenio Partners | (q) | 285,714 | 285,714 | 285,714 | |
| IOU Limited Partnership | (r) | 2,071,428 | 2,071,428 | 2,071,428 | |
| Jacobe Partners, L.P. | (s) | 428,571 | 428,571 | 428,571 | |
| Jefferies & Co. | (t) | 10,999 | 10,999 | 10,999 | |
| Mac & Co. | (u) | 106,570 | 106,570 | 106,570 | |
| Millennium Partners, L.P. | (v) | 7,857,143 | 7,857,143 | 7,857,143 | |
| Newland Master Fund, Ltd. | (w) | 3,000,000 | 3,000,000 | 3,000,000 | |
| OGI Associates, LLC | (x) | 2,071,429 | 2,071,429 | 2,071,429 | |
| PENFIRN Co F/B/O: Roge Partners Fund | (y) | 428,571 | 428,571 | 428,571 | |
| PENFIRN Co F/B/O: Roge Select Opportunities Fund | (z) | 428,571 | 428,571 | 428,571 | |
| Oppenheimer Capital Structure Opportunities Master Fund, Ltd. | (aa) | 167,000 | 167,000 | 167,000 | |
| Perella Weinberg Partners Oasis Master Fund L.P. | (bb) | 5,000,000 | 5,000,000 | 5,000,000 | |
| Peter Kaltmon | (cc) | 74,300 | 74,300 | 74,300 | |
| Schottenfeld Group, LLC | (dd) | 1,000,000 | 1,000,000 | 1,000,000 | |
| Tracy W. Krohn | (ee) | 5,714,286 | 5,714,286 | 5,714,286 | |
| UBS O’Connor LLC F/B/O: O’Connor Pipes Corporate Strategies Master Limited | (ff) | 1,428,571 | 1,428,571 | 1,428,571 | |
| Wexford Capital, LLC | (gg) | 1,785,715 | 1,785,715 | 1,785,715 | |
| Wexford Spectrum Trading Limited | (hh) | 5,357,142 | 5,357,142 | 5,357,142 | * |
| Stamatis Molaris | (ii) | 500,000 | 500,000 | 500,000 | * |
| | | 57,142,857 | 57,142,857 | 57,142,857 | |
_____________
* Less than 1%
(1) Mr. O’Connor is an employee of Dahlman Rose & Company, LLC, the placement agent in the Company’s private placement of the shares of common stock being registered for resale by the Selling Shareholders hereby.
(2) Mr. Dahlman is President of Dahlman Rose & Company, LLC, the placement agent in the Company’s private placement of the shares of common stock being registered for resale by the Selling Shareholders hereby.
(3) No amounts are in the excess of 5% based on 177,350,630 shares outstanding on July 16,September 30, 2008. See the Plan of Distribution for further information.
(a) Amended and Restated Declaration of Trust of Morton A. Cohen, dated May 9, 2005 represented by Morton A. Cohen, of 3690 Orange Place Suite 400, Beachwood, OH 44122, has voting and investment control of these shares.
(b) Andrew Steven Codispoti, of 142 W. 57th. St. 18th Floor, New York, NY, 10019, has voting and investment control of these shares. The security holder is a registered broker-dealer and member of FINRA.
(c) Aquanaut Master Fund, Ltd. represented by Magnus Fyhr, of 700 Louisiana # 4260, Houston, TX 77002, has investment and voting control of these shares.
(d) BlackGold Capital Master Fund, L.P. represented by Adam Flikerski and Erik Dybesland, of 1400 Post Oak Blvd., Ste. 300, Houston, TX, 77056 has voting and investment control of these shares.
(e) Calm Waters Partnership, represented by Richard S. Strong, Managing Partner, of 115 S. 84th. St., Suite 200, Milwaukee, WI, 53214, has voting and investment control of these shares.
(f) C/OCapital Structures Opportunities, L.P. c/o Penn Capital Management represented by Eric Green, of the Libertyview Building, 457 Haddonfield Road Suite 210, Cherry Hill, NJ, 08002, has voting and investment control of these shares. (see(See notes o, s, t, zu, aa and bb).cc.)
(g) Cardinal Bear LLC represented by Michael Baxter, member, of 11111 Santa Monica Blvd. Suite 1100, Los Angeles, CA, 90025, has voting and investment control of these shares.
(h) Clarion Capital Corporation represented by Morton A. Cohen, Chairman, of 3690 Orange Place Suite 400, Beachwood, OH 44122 has voting and investment control of these shares. (See note i.)
(i) Clarion World Offshore Fund, Ltd. represented by Morton A. Cohen, Chairman, of 3690 Orange Place Suite 400, Beachwood, OH 44122, has voting and investment control of these shares. (See note h.)
(j) Crestview Capital Master, LLC represented by Stewart Flink, Robert Hoyt and Daniel Warsh, of 95 Revere Drive Suite A, Northbrook, IL, 60062, has voting and investment control over these shares. The security holder is a redistered broker- dealerregistered broker-dealer and member of FINRA.
(k) D.E. Shaw Valence Portfolios, L.L.C., represented by David Quint, Senior Vice President, of 120 W 45th St., 39th Floor, New York, NY, 10036 has voting and investment control of these shares. The selling security holder is under common control with D.E. Shaw Securities, LLC,& Co, L.P., a broker dealerregistered broker-dealer and a FINRA member firm.of FINRA.
(l) Dubuque Bank and Trust (DBTCO), represented by Tom Peckosh and/or Sarah Reicks, of P.O. Box 747, Dubuque, IA, 52004-0747, has voting and investment control of these shares.
(m) Dean O’ Connor represented by Dean O’Connor, Dahlman Rose & Co., of 420 East 54th Street, Apt. 25C, New York, NY, 10022, has voting and investment control of these shares. The security holder is a registered broker-dealer and member of FINRA.
(n) Ernest J. Dahlman, III represented by the Robert Brinberg of Dahlman Rose & Company, LLC, of 142 West 57th St, 18th Floor, New York, NY 10019, has voting and investment control of these shares. The security holder is a registered broker-dealer and member of FINRA.
(o) Greg Imbruce of 93 Rockledge Drive, Stanford, CT, 06902, has voting and investment control of these shares. (See notes f, t, u, aa and cc.)
(p) Hare & Co. c/o Penn Capital Management represented by, Greg Imbruce of 93 Rockledge Drive, Stanford, CT, 06902, has voting and investment control of these shares.
(ol) C/O Penn Capital Management represented by Eric Green, of the Libertyview Building, 457 Haddonfield Road Suite 210, Cherry Hill, NJ, 08002, has voting and investment control of these shares. (see notes f, s, t, z and bb)
(p)(q) Invenio Partners represented by Norman Cohen, Portfolio Manager, of 142 West 57th Street 18th Floor, New York, NY, 10016,10019, has voting and investment control of these shares.
(q)(r) IOU Limited Partnership, represented by George A. Weiss (Weiss Investment Management, LLC), of One State Street 20th Floor, Hartford, CT 06103, has voting and investment control of these shares. The selling security holder is a registered broker dealerbroker-dealer and member of FINRA. (See note x.)
(r)(s) Jacobe Partners, L.P. represented by Jacobe Management, L.P., of 510 Bering Dr. Suite 220, Houston, TX, 77057, has voting and investment control of these shares.
(s) C/O(t) Jefferies & Co. c/o Penn Capital Management represented by Eric Green, of the Libertyview Building, 457 Haddonfield Road Suite 210, Cherry Hill, NJ, 08002, has voting and investment control of these shares. (see(See notes f, o, t, zu, aa and bb)cc.)
(t) C/O(u) Mac & Co. c/o Penn Capital Management represented by Eric Green, of the Libertyview Building, 457 Haddonfield Road Suite 210, Cherry Hill, NJ, 08002, has voting and investment control of these shares (see(See notes f, o, s, zt , aa and bb)cc.)
(u)(v) Millenium Partners, L.P., represented by Terry Feeney of 666 Fifth Avenue 8th Floor, New York, NY 10103, has voting and investment control of these shares.
(v)(w) Newland Master Fund, Ltd., represented by Ken Brodkewitz and Mike Vermut, of 350 Madison Ave. 11th Floor, New York, NY,10017 has voting and investment control over these shares.
(w)(x) OGI Associates, LLC, represented by George A. Weiss ( Weiss Investment Management, LLC), of One State Street 20th Floor, Hartford, CT 06103, has voting and investment control of these shares. The selling security holder is a registered broker dealerbroker-dealer and member of FINRA. (See note r.)
(x)(y) PENFIRN Co. F/B/O: Roge Partners Fund represented by R.W. Roge & Co., Inc., of 1620 Dodge St. Stop 1060, Omaha, NE, 68197, has voting and investment control of these shares. (See note z.)
(y) Penfirn(z) PENFIRN Co. F/B/O: Roge Select Opportunities Fund represented by R.W. Roge & Co., Inc. of 1620 Dodge St. Stop 1060, Omaha, NE, 68197, has voting and investment control of these shares. (See note y.)
(z)(aa) Oppenheimer Capital Structure Opportunities Master Fund, LTD. c/o Penn Capital Management represented by Eric Green, of the Libertyview Building, 457 Haddonfield Road Suite 210, Cherry Hill, NJ, 08002, has voting and investment control of these shares. (see(See notes f, o, s, t, u and bb)cc.)
(aa)(bb) Perella Weinberg Partners Oasis Master Fund L.P. represented by Rod Parsley, of 767 Fifth Avenue. 4th Floor, New York, NY, 10153, has voting and investment control over these shares.
(bb) c/o(cc) Peter Kaltmon C/O Penn Capital Management represented by Eric Green, of the Libertyview Building, 457 Haddonfield Road Suite 210, Cherry Hill, NJ, 08002, has voting and investment control of these shares. (seeshares (See notes f, o, s, t, u and z)aa.)
(cc)(dd) Schottenfeld Group, LLC, represented by Lucas Rosen, member, of 800 Third Ave, New York, NY 10022, has voting and investment control of these shares. The selling security holder is a registered broker dealerbroker-dealer and member of FINRA.
(dd)(ee) Tracy W. Krohn, represented by Tracy W. Krohn, of 9 Greenway Plaza, Suite 300, Houston, TX, 77046, has voting and investment control of these shares.
(ee)(ff) UBS O’Connor LLC F/B/O: O’Connor Pipes Corporate Strategies Master Limited, of One North Wacker Dr. 32nd Floor, Chicago, IL, 60606, states that the security holder is a fund which cedes investment control to UBS O’Connor LLC. The investment manager has voting and investment control of these shares.
(ff)(gg) Wexford Capital, LLC represented by Charles E. Davidson and Joseph Jacobs, managing members, of 411 West Putnam Avenue, Greenwich, CT, 06830, hashave voting and investment control of these shares. (See note hh.)
(gg)(hh) Wexford Spectrum Trading Limited, represented by Charles E. Davidson and Joseph Jacobs, managing members, of Wexford Capital, LLC, of 411 West Putnam Avenue, Greenwich, CT 06830, hashave voting and investment control of these shares. (See note gg.)
(hh)(ii) Stamatis Molaris c/o Fortis Banque (Suisse) SA, represented by R. Stephani, nominee holder, Bd des Philosophes 20, CH-1205 Geneva.
The Selling Shareholders may sell all or a portion of the shares of common stock beneficially owned by them and offered hereby from time to time directly or through one or more underwriters, broker-dealers or agents. If the shares of common stock are sold through underwriters or broker-dealers, the Selling Shareholders will be responsible for underwriting discounts or commissions or agent’s commissions. The shares of common stock may be sold in one or more transactions at fixed prices, at prevailing market prices at the time of the sale, at varying prices determined at the time of sale, or at negotiated prices. These sales may be effected in transactions, which may involve crosses or block transactions,
| · | on any national securities exchange or quotation service on which the securities may be listed or quoted at the time of sale; |
| · | in the over-the-counter market; |
| · | in transactions other than on these exchanges or systems or in the over-the-counter market; |
| · | through the writing of options, whether such options are listed on an options exchange or otherwise; |
| · | ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; |
| · | block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; |
| · | purchases by a broker-dealer as principal and resale by the broker-dealer for its account; |
| · | an exchange distribution in accordance with the rules of the applicable exchange; |
| · | privately negotiated transactions; |
| · | pursuant to Rule 144 under the Securities Act; |
| · | broker-dealers may agree with the Selling Shareholders to sell a specified number of such securities at a stipulated price per security; |
| · | a combination of any such methods of sale; and |
| · | any other method permitted pursuant to applicable law. |
If the Selling Shareholders effect such transactions by selling shares of common stock to or through underwriters, broker-dealers or agents, such underwriters, broker-dealers or agents may receive commissions in the form of discounts, concessions or commissions from the Selling Shareholders or commissions from purchasers of the shares of common stock for whom they may act as agent or to whom they may sell as principal (which discounts, concessions or commissions as to particular underwriters, broker-dealers or agents may be in excess of those customary in the types of transactions involved). In connection with sales of the shares of common stock or otherwise, the Selling Shareholders may enter into hedging transactions with broker-dealers, which may in turn engage in short sales of the shares of common stock in the course of hedging in positions they assume. The Selling Shareholders may also sell shares of common stock short and deliver shares of common stock covered by this Prospectus to close out short positions and to return borrowed shares in connection with such short sales. The Selling Shareholders may also loan or pledge shares of common stock to broker-dealers that in turn may sell such shares.
The Selling Shareholders may pledge or grant a security interest in some or all of the shares of common stock issuable upon conversion of the convertible notes owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell shares of common stock from time to time pursuant to this Prospectus or any amendment to this Prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act of 1933, as amended, amending, if necessary, the list of Selling Shareholders to include the pledgee, transferee or other successors in interest as Selling Shareholders under this Prospectus. The Selling Shareholders also may transfer and donate the shares of common stock in other circumstances in which case the transferees, donees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this Prospectus.
The Selling Shareholders and any broker-dealer participating in the distribution of the shares of common stock may be deemed to be “underwriters” within the meaning of the 1933 Act, and any commission paid, or any discounts or concessions allowed to, any such broker-dealer may be deemed to be underwriting commissions or discounts under the 1933 Act. At the time a particular offering of the shares of common stock is made, a Prospectus supplement, if required, will be distributed which will set forth the aggregate amount of shares of common stock being offered and the terms of the offering, including the name or names of any broker-dealers or agents, any discounts, commissions and other terms constituting compensation from the Selling Shareholders and any discounts, commissions or concessions allowed or reallowed or paid to broker-dealers.
Under the securities laws of some states, the shares of common stock may be sold in such states only through registered or licensed brokers or dealers. In addition, in some states the shares of common stock may not be sold unless such shares of common stock have been registered or qualified for sale in such state or an exemption from registration or qualification is available and is complied with.
The Selling Shareholders may choose not to sell any or may choose to sell less than all of the shares of common stock registered pursuant to the registration statement, of which this Prospectus forms a part.
The Selling Shareholders and any other person participating in such distribution will be subject to applicable provisions of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder, including, without limitation, Regulation M of the 1934 Act, which may limit the timing of purchases and sales of any of the shares of common stock by the Selling Shareholders and any other participating person. Regulation M may also restrict the ability of any person engaged in the distribution of the shares of common stock to engage in market-making activities with respect to the shares of common stock. All of the foregoing may affect the marketability of the shares of common stock and the ability of any person or entity to engage in market-making activities with respect to the shares of common stock.
We will pay all expenses of the registration of the shares of common stock pursuant to the registration rights agreement, including, without limitation, Securities and Exchange Commission filing fees and expenses in compliance with state securities or “blue sky” laws; provided, however, that a Selling Shareholder will pay all underwriting discounts and selling commissions, if any. We will indemnify the Selling Shareholders against liabilities, including some liabilities under the 1933 Act, in accordance with the registration rights agreements, or the Selling Shareholders will be entitled to contribution. We may be indemnified by the Selling Shareholders against civil liabilities, including liabilities under the 1933 Act, that may arise from any written information furnished to us by the Selling Shareholder specifically for use in this Prospectus, in accordance with the related registration rights agreement, or we may be entitled to contribution.
Once sold under the registration statement, of which this Prospectus forms a part, the shares of common stock will be freely tradable in the hands of persons other than our affiliates.
LEGAL MATTERS
The validity of the common stock offered by this Prospectus is being passed upon for us by Sonfield & Sonfield, Houston, Texas.
We file annual, quarterly, and current reports, proxy statements, and other information with the SEC. You may read and copy any document we file at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our filings with the SEC are also available to the public at the SEC’s website at http://www.sec.gov. You may also obtain copies of the documents at prescribed rates by writing to the SEC’s Public Reference Section at 100 F Street, N.E., Washington, D.C. 20549 or from us at no cost by request to our address or telephone below.
Our website is located at http://www.deepdowninc.com. The contents of our website are not part of this Prospectus and should not be relied upon as though they were a part of it.
We have filed with the Commission a registration statement, which contains this Prospectus, on Form S-1 under the Securities Act of 1933. The registration statement relates to the common stock offered by the Selling Shareholders. This Prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules to the registration statement. Please refer to the registration statement and its exhibits and schedules for further information about us and the common stock. Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete and, in each instance, we refer you to the copy of that contract or document filed as an exhibit to the registration statement.
INDEX TO FINANCIAL STATEMENTS
DEEP DOWN, INC.
Deep Down, Inc.
| Unaudited Consolidated Financial Statements | | | | |
| | | | |
Condensed Consolidated Balance Sheets as of March 31,June 30, 2008 and December 31, 2007 | | | F-2 | |
| | | | |
Condensed Consolidated Statements of Operations for the three months ended March 31,Three and Six Months Ended June 30, 2008 and 2007 | | | F-3 | |
| | | | |
Condensed Consolidated StatementsStatement of Cash FlowsStockholders’ Equity for the three months ended March 31,Six Months Ended June 30, 2008 and 2007 | | | F-4 | |
| Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007 | | | F-5 | |
Notes to CondensedUnaudited Consolidated Financial Statements | | | F-5F-7 | |
| Audited Consolidated Financial Statements | | | | |
| | | | |
| Reports of Independent Registered Public Accounting Firm | | | F-13 | |
| | | F-19 | |
| Consolidated Balance Sheets as of December 31, 2007 and 2006 | | | F-14 | |
| | | F-20 | |
| Consolidated Statements of Operations For the Year Ended December 31, 2007 and For the Period Since Inception (June 29, 2006) to December 31, 2006 | | | F-15 | |
| | | F-21 | |
| Consolidated Statements of Stockholders’ Equity For the Year Ended December 31, 2007 and For the Period Since Inception (June 29, 2006) to December 31, 2006 | | | F-16 | |
| | | F-22 | |
| Consolidated Statements of Cash Flows For the Year Ended December 31, 2007 and For the Period Since Inception (June 29, 2006) to December 31, 2006 | | | F-17F-23 | |
| Notes to Consolidated Financial Statements | | | F-25 | |
| | | | | |
Notes to Consolidated Financial StatementsFlotation Technologies, Inc. | | | F-19 | |
Flotation Technologies, Inc. | | |
| | | | | |
Reviewed Financial Statements of Flotation Technologies, Inc. for the three month interim period ended March 31, 2008 and Unaudited Financial Statements for the three month interim period ended March 31, 2007 | | | F-48 | |
| | | | |
| Audited Financial Statements and Supplemental Information of Flotation Technologies, Inc. for the years ended December 31, 2007 and 2006 | | | F-61 | |
| | | |
| | | |
| Mako Technologies, Inc. | | | | |
| | | | |
Audited Financial Statements of Mako Technologies, Inc. for the Nine Months ended September 30, 2007 and the Year Ended December 31, 2006 | | | F-76 | |
| | | | |
PART I. FINANCIAL INFORMATION | ITEM 1. | FINANCIAL STATEMENTS |
DEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
| | | June 30, 2008 | | | December 31, 2007 | |
| ASSETS | | | | | | |
| Cash and equivalents | | $ | 4,085,543 | | | $ | 2,206,220 | |
| Restricted cash | | | - | | | | 375,000 | |
| Accounts receivable, net of allowance of $818,992 and $139,787 respectively | | | 8,614,961 | | | | 7,190,466 | |
| Prepaid expenses and other current assets | | | 710,213 | | | | 312,058 | |
| Inventory | | | 179,343 | | | | 502,253 | |
| Lease receivable, short-term | | | 414,000 | | | | 414,000 | |
| Work in progress | | | 681,790 | | | | 945,612 | |
| Receivable from Prospect, net | | | - | | | | 2,687,333 | |
| Total current assets | | | 14,685,850 | | | | 14,632,942 | |
| Property and equipment, net | | | 10,651,053 | | | | 5,172,804 | |
| Other assets, net of accumulated amortization of $0 and $54,560 respectively | | | 550,819 | | | | 1,109,152 | |
| Lease receivable, long-term | | | 500 | | | | 173,000 | |
| Intangibles, net | | | 18,745,713 | | | | 4,369,647 | |
| Goodwill | | | 13,001,556 | | | | 10,594,144 | |
| Total assets | | $ | 57,635,491 | | | $ | 36,051,689 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDER'S EQUITY | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 3,070,105 | | | $ | 3,569,826 | |
| Deferred revenue | | | 725,521 | | | | 188,030 | |
| Payable to Mako shareholders | | | - | | | | 3,205,667 | |
| Current portion of long-term debt | | | 47,477 | | | | 995,177 | |
| Total current liabilities | | | 3,843,103 | | | | 7,958,700 | |
| Long-term debt, net of accumulated discount of $0 and $1,703,258 respectively | | | 919,381 | | | | 10,698,818 | |
| 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 | | | 4,762,484 | | | | 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, 174,732,501 | | | | | | | | |
| and 85,976,526 shares issued and outstanding, respectively | | | 174,733 | | | | 85,977 | |
| Paid-in capital | | | 60,000,402 | | | | 14,849,847 | |
| Accumulated deficit | | | (7,302,128 | ) | | | (2,347,308 | ) |
| Total stockholders' equity | | | 52,873,007 | | | | 12,588,516 | |
| Total liabilities and stockholders' equity | | $ | 57,635,491 | | | $ | 36,051,689 | |
| | | | | | | | | |
| See accompanying notes to unaudited consolidated financial statements. | |
| | | March 31, 2008 | | | December 31, 2007 | |
| ASSETS | | | | | | |
| Cash and equivalents | | $ | 3,115,818 | | | $ | 2,206,220 | |
| Restricted cash | | | 562,500 | | | | 375,000 | |
| Accounts receivable, net of allowance of $141,736 and $139,787 respectively | | | 7,469,386 | | | | 7,190,466 | |
| Prepaid expenses and other current assets | | | 418,984 | | | | 312,058 | |
| Inventory | | | 502,253 | | | | 502,253 | |
| Lease receivable, short-term | | | 414,000 | | | | 414,000 | |
| Work in progress | | | 1,106,891 | | | | 945,612 | |
| Receivable from Prospect, net | | | - | | | | 2,687,333 | |
| Total current assets | | | 13,589,832 | | | | 14,632,942 | |
| Property and equipment, net | | | 5,058,557 | | | | 5,172,804 | |
| Other assets, net of accumulated amortization of $111,854 and $54,560 respectively | | | 1,052,550 | | | | 1,109,152 | |
| Lease receivable, long-term | | | 69,500 | | | | 173,000 | |
| Intangibles, net | | | 4,284,588 | | | | 4,369,647 | |
| Goodwill | | | 10,660,669 | | | | 10,594,144 | |
| Total assets | | $ | 34,715,696 | | | $ | 36,051,689 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 2,966,215 | | | $ | 3,569,826 | |
| Deferred revenue | | | 135,000 | | | | 188,030 | |
| Payable to Mako shareholders | | | 1,243,571 | | | | 3,205,667 | |
| Current portion of long-term debt | | | 330,399 | | | | 995,177 | |
| Total current liabilities | | | 4,675,185 | | | | 7,958,700 | |
| Long-term debt, net of accumulated discount of $1,585,088 and $1,703,258 respectively | | | 11,054,959 | | | | 10,698,818 | |
| 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 | | | 15,730,144 | | | | 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, 115,846,019 | | | | | | | | |
| and 85,976,526 shares issued and outstanding, respectively | | | 115,846 | | | | 85,977 | |
| Paid-in capital | | | 21,306,461 | | | | 14,849,847 | |
| Accumulated deficit | | | (2,436,755 | ) | | | (2,347,308 | ) |
| Total stockholders' equity | | | 18,985,552 | | | | 12,588,516 | |
| Total liabilities and stockholders' equity | | $ | 34,715,696 | | | $ | 36,051,689 | |
| | | | | | | | | |
See accompanying notes to unaudited consolidated financial statements. | |
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| | | Three Months Ended | |
| | | March 31, | |
| | | 2008 | | | 2007 | |
| Revenues: | | | | | | |
| Contract revenue | | $ | 5,337,529 | | | $ | 1,602,281 | |
| Rental revenue | | | 941,936 | | | | 496,113 | |
| Total revenues | | | 6,279,465 | | | | 2,098,394 | |
| Cost of sales | | | 3,876,371 | | | | 1,252,089 | |
| Gross Profit | | | 2,403,094 | | | | 846,305 | |
| | | | | | | | | |
| Operating expenses: | | | | | | | | |
| Selling, general & administrative | | | 1,762,247 | | | | 659,651 | |
| Depreciation and amortization | | | 298,149 | | | | 64,025 | |
| Total operating expenses | | | 2,060,396 | | | | 723,676 | |
| Operating income | | | 342,698 | | | | 122,629 | |
| Other income (expense): | | | | | | | | |
| Gain on sale of assets | | | 28,355 | | | | - | |
| Interest income | | | 39,164 | | | | - | |
| Interest expense | | | (769,030 | ) | | | (231,887 | ) |
| Total other expense | | | (701,511 | ) | | | (231,887 | ) |
| Loss before income taxes | | | (358,813 | ) | | | (109,258 | ) |
| Income tax benefit | | | 269,366 | | | | - | |
| Net loss | | $ | (89,477 | ) | | $ | (109,258 | ) |
| Earnings per share: | | | | | | | | |
| Basic and diluted | | $ | (0.00 | ) | | $ | (0.00 | ) |
| | | | | | | | | |
| Weighted-average common shares outstanding | | | 87,185,242 | | | | 81,036,838 | |
See accompanying notes to unaudited consolidated financial statements.| | | For the Three Months Ended | | | For the Six Months Ended | |
| | | June 30, | | | June 30, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | | | |
| Revenues | | | | | | | | | | | | | | |
| Contract revenue | | $ | 5,670,385 | | | $ | 4,508,635 | | | $ | 11,007,914 | | | $ | 6,110,916 | |
| Rental revenue | | | 2,249,811 | | | | 636,153 | | | | 3,191,747 | | | | 1,132,266 | |
| Total revenues | | | 7,920,196 | | | | 5,144,788 | | | | 14,199,661 | | | | 7,243,182 | |
| Cost of sales | | | 5,496,427 | | | | 3,293,313 | | | | 9,372,798 | | | | 4,545,402 | |
| Gross profit | | | 2,423,769 | | | | 1,851,475 | | | | 4,826,863 | | | | 2,697,780 | |
| Operating expenses: | | | | | | | | | | | | | | | | |
| Selling, general & administrative | | | 3,681,643 | | | | 1,103,902 | | | | 5,443,890 | | | | 1,763,622 | |
| Depreciation and amortization | | | 543,128 | | | | 90,196 | | | | 841,277 | | | | 154,221 | |
| Total operating expenses | | | 4,224,771 | | | | 1,194,098 | | | | 6,285,167 | | | | 1,917,843 | |
| Operating income (loss) | | | (1,801,002 | ) | | | 657,377 | | | | (1,458,304 | ) | | | 779,937 | |
| Other income (expense): | | | | | | | | | | | | | | | | |
| Gain (loss) on debt extinguishment | | | (446,412 | ) | | | 2,000,000 | | | | (446,412 | ) | | | 2,000,000 | |
| Interest income | | | 27,346 | | | | 16,290 | | | | 66,510 | | | | 16,290 | |
| Interest expense | | | (2,690,534 | ) | | | (1,276,770 | ) | | | (3,459,564 | ) | | | (1,508,657 | ) |
| Other expense | | | (39,771 | ) | | | - | | | | (11,416 | ) | | | - | |
| Total other income (expense) | | | (3,149,371 | ) | | | 739,520 | | | | (3,850,882 | ) | | | 507,633 | |
| Income (loss) before income taxes | | | (4,950,373 | ) | | | 1,396,897 | | | | (5,309,186 | ) | | | 1,287,570 | |
| Benefit from (provision for) income taxes | | | 85,000 | | | | (447,363 | ) | | | 354,366 | | | | (447,363 | ) |
| Net income (loss) | | $ | (4,865,373 | ) | | $ | 949,534 | | | $ | (4,954,820 | ) | | $ | 840,207 | |
| Earnings per share: | | | | | | | | | | | | | | | | |
| Basic | | $ | (0.04 | ) | | $ | 0.01 | | | $ | (0.05 | ) | | $ | 0.01 | |
| Weighted-average common shares outstanding | | | 132,666,860 | | | | 67,870,171 | | | | 109,326,053 | | | | 74,417,132 | |
| | | | | | | | | | | | | | | | | |
| Diluted | | $ | (0.04 | ) | | $ | 0.01 | | | $ | (0.05 | ) | | $ | 0.01 | |
| Weighted-average common shares outstanding | | | 132,666,860 | | | | 93,799,839 | | | | 109,326,053 | | | | 100,315,405 | |
| | | | | | | | | | | | | | | | | |
| See accompanying notes to unaudited consolidated financial statements. | |
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWSTOCKHOLDERS’ EQUITY
(Unaudited)
| | | Three Months Ended | |
| | | March 31, | |
| | | 2008 | | | 2007 | |
| Cash flows from operating activities: | | | | | | |
| | | | | | | |
| Net loss | | $ | (89,447 | ) | | $ | (109,258 | ) |
| Adjustments to reconcile net income to net cash | | | | | | | | |
| used in operating activities: | | | | | | | | |
| Amortization of debt discount | | | 231,760 | | | | 179,587 | |
| Amortization of deferred financing costs | | | 56,915 | | | | - | |
| Share-based compensation | | | 105,162 | | | | - | |
| Allowance for doubtful accounts | | | 3,949 | | | | - | |
| Depreciation and amortization | | | 298,150 | | | | 64,025 | |
| Gain on disposal of equipment | | | 58,115 | | | | - | |
| Changes in assets and liabilities: | | | | | | | | |
| Accounts receivable | | | (282,869 | ) | | | (181,220 | ) |
| Prepaid expenses and other current assets | | | (107,239 | ) | | | 15,111 | |
| Finished goods | | | - | | | | (355,568 | ) |
| Construction in progress | | | (161,279 | ) | | | 64,170 | |
| Accounts payable and accrued liabilities | | | (603,631 | ) | | | 395,236 | |
| Deferred revenue | | | (53,030 | ) | | | 72,000 | |
| Net cash provided by (used in) operating activities | | | (543,444 | ) | | | 144,083 | |
| Cash flows from investing activities: | | | | | | | | |
| Cash paid for final acquisition costs | | | (66,525 | ) | | | - | |
| Cash paid for third party debt | | | - | | | | (366,134 | ) |
| Cash received from sale of ElectroWave receivables | | | - | | | | 261,068 | |
| Purchases of equipment | | | (156,958 | ) | | | (290,373 | ) |
| Restricted cash | | | (187,500 | ) | | | - | |
| Net cash used in investing activities | | | (410,983 | ) | | | (395,439 | ) |
| 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 | | | - | | | | 950,000 | |
| Proceeds from sales-type lease | | | 103,500 | | | | - | |
| Proceeds from Prospect Capital | | | 2,687,333 | | | | - | |
| Payments of long-term debt | | | (926,808 | ) | | | (113,129 | ) |
| Net cash provided by financing activities | | | 1,864,025 | | | | 336,871 | |
| Change in cash and equivalents | | | 909,598 | | | | 85,515 | |
| Cash and equivalents, beginning of period | | | 2,206,220 | | | | 12,462 | |
| Cash and equivalents, end of period | | $ | 3,115,818 | | | $ | 97,977 | |
| | | | | | | | | |
| Supplemental schedule of noncash investing | | | | | | | | |
| and financing activities: | | | | | | | | |
| Fixed assets purchased with capital lease | | $ | - | | | $ | 525,000 | |
| Exchange of preferred stock | | $ | 4,419,244 | | | $ | 3,366,778 | |
| Redemption of preferred stock for debt | | $ | 500,000 | | | $ | - | |
| Common Shares issued as restricted stock | | $ | 1,200 | | | $ | - | |
| Stock issued for payment of shareholder debt | | $ | 1,962,078 | | | $ | - | |
| Supplemental Disclosures: | | | | | | | | |
| Cash paid for interest | | $ | 480,356 | | | $ | 52,301 | |
| Cash paid for taxes | | $ | 275,000 | | | $ | - | |
| | | | | | | | | |
| | |
| See accompanying notes to unaudited consolidated financial statements. | |
| | | For the Six Months Ended June 30, 2008 | |
| | | Common Stock | | | Paid-in | | | Accumulated | | | | |
| | | Shares | | | Amount | | | Capital | | | Deficit | | | Total | |
| | | | | | | | | | | | | | | | |
| Balance at December 31, 2007 | | | 85,976,532 | | | $ | 85,977 | | | $ | 14,849,847 | | | $ | (2,347,308 | ) | | $ | 12,588,516 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (4,954,820 | ) | | | (4,954,820 | ) |
| 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 | | | 1,200,000 | | | | 1,200 | | | | (1,200 | ) | | | | | | | - | |
| Stock issued in private placement | | | 57,142,857 | | | | 57,143 | | | | 37,002,527 | | | | | | | | 37,059,670 | |
| Cashless exercise of stock options | | | 29,339 | | | | 29 | | | | (29 | ) | | | | | | | - | |
| Stock based compensation | | | - | | | | - | | | | 253,669 | | | | | | | | 253,669 | |
| Balance at June 30, 2008 | | | 174,732,501 | | | $ | 174,733 | | | $ | 60,000,402 | | | $ | (7,302,128 | ) | | $ | 52,873,007 | |
| | | | | | | | | | | | | | | | | | | | | |
| See accompanying notes to unaudited consolidated financial statements. | |
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
| | | Six Months Ended | |
| | | June 30, | |
| | | 2008 | | | 2007 | |
| Cash flows from operating activities: | | | | | | |
| | | | | | | |
| Net loss | | $ | (4,954,820 | ) | | $ | 840,208 | |
| Adjustments to reconcile net income to net cash | | | | | | | | |
| used in operating activities: | | | | | | | | |
| Gain on extinguishment of debt | | | - | | | | (2,000,000 | ) |
| Interest income | | | (30,467 | ) | | | (16,290 | ) |
| Amortization of debt discount | | | 1,816,847 | | | | 1,391,506 | |
| Amortization of deferred financing costs | | | 762,700 | | | | - | |
| Share-based compensation | | | 253,669 | | | | 39,565 | |
| Bad debt expense | | | 832,328 | | | | - | |
| Depreciation and amortization | | | 898,998 | | | | 154,221 | |
| Loss on disposal of equipment | | | 9,136 | | | | - | |
| Changes in assets and liabilities: | | | | | | | | |
| Lease receivable | | | - | | | | (750,000 | ) |
| Accounts receivable | | | (254,958 | ) | | | (531,356 | ) |
| Prepaid expenses and other current assets | | | (586,618 | ) | | | 1,655 | |
| Inventory | | | (179,343 | ) | | | (472,253 | ) |
| Work in progress | | | 1,135,005 | | | | (119,552 | ) |
| Accounts payable and accrued liabilities | | | (1,601,586 | ) | | | 1,808,987 | |
| Deferred revenue | | | 537,491 | | | | 80,628 | |
| Net cash provided by operating activities | | $ | (1,361,618 | ) | | $ | 427,319 | |
| Cash flows from investing activities: | | | | | | | | |
| Cash paid for acquisition of Flotation | | | (22,116,140 | ) | | | - | |
| Cash paid for acquisition of Mako | | | (1,319,967 | ) | | | - | |
| Cash paid for third party debt | | | - | | | | (432,475 | ) |
| Cash received from sale of ElectroWave receivables | | | - | | | | 261,068 | |
| Cash deficit acquired an acquisition of a business | | | - | | | | (18,974 | ) |
| Purchases of equipment | | | (687,060 | ) | | | (442,788 | ) |
| Restricted cash | | | 375,000 | | | | - | |
| Net cash used in investing activities | | $ | (23,748,167 | ) | | $ | (633,169 | ) |
| 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 | | | | 960,000 | |
| Proceeds from long term debt | | | 2,687,333 | | | | - | |
| Proceeds from sales-type lease | | | 172,500 | | | | 69,000 | |
| Borrowings on debt - related party | | | - | | | | 150,000 | |
| Payments of long-term debt | | | (12,930,395 | ) | | | (222,307 | ) |
| Net cash provided by (used in) financing activities | | $ | 26,989,108 | | | $ | 456,693 | |
| Change in cash and equivalents | | | 1,879,323 | | | | 250,843 | |
| Cash and equivalents, beginning of period | | | 2,206,220 | | | | 12,462 | |
| Cash and equivalents, end of period | | $ | 4,085,543 | | | $ | 263,305 | |
| | | | | | | | | |
| See accompanying notes to unaudited consolidated financial statements. | |
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
| | | Six Months Ended | |
| | | June 30, | |
| | | 2008 | | | 2007 | |
| Supplemental schedule of noncash investing | | | | | | |
| and financing activities: | | | | | | |
| Acquisition of a business | | $ | - | | | $ | (190,381 | ) |
| Exchange of receivables for acquisition of a business | | $ | - | | | $ | 171,407 | |
| 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 | | | $ | - | |
| Fixed assets purchased with capital lease | | $ | - | | | $ | 525,000 | |
| Fixed assets transferred from Inventory | | $ | 502,253 | | | $ | - | |
| Exchange of Series D preferred stock | | $ | 4,419,244 | | | | | |
| Exchange of Series E preferred stock | | $ | - | | | $ | 3,366,778 | |
| Redemption of Series E preferred stock | | $ | - | | | $ | 2,000,000 | |
| Exchange of Series E preferred stock for subordinated debenture | | $ | 500,000 | | | $ | - | |
| Common shares issued as restricted stock | | $ | 1,200 | | | $ | - | |
| Supplemental Disclosures: | | | | | | | | |
| Cash paid for interest | | $ | 880,017 | | | $ | 117,151 | |
| Cash paid for pre-payment penalties | | $ | 446,413 | | | $ | - | |
| Cash paid for taxes | | $ | 275,000 | | | $ | - | |
| | | | | | | | | |
| See accompanying notes to unaudited consolidated financial statements. | |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESGENERAL
Nature of Business
Deep Down, Inc., a Nevada corporation (“Deep Down Nevada” or “Deep Down” or the “Company”), is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), and Mako Technologies, LLC (“Mako”), a Nevada limited liability company.company, and Flotation Technologies, Inc. (“Flotation”), a Maine corporation. The results of Flotation are included in the consolidated financial statements herein effective May 1, 2008, the effective date of acquisition for accounting purposes.
Deep Down Delaware provides installation management, engineering services, support services and storage management services for the subsea controls, umbilicals and offshore pipeline industries. Deep Down Delaware also fabricates component parts for subsea distribution systems and assemblies.
ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, marine and commercial business sectors.
Mako serves the growing offshore petroleum and marine industries with technical support services and products vital 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.
Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers. Flotation’s product offerings include distributed buoyancy for flexible pipes 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™ cable and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of any size and depth rating.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X relating to smaller reporting companies. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31,June 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008.
The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
For further information, refer to the audited consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-KSB/A (Amendment No. 1)3) for the year ended December 31, 2007 filed on May 1,August 8, 2008.
Prior period information presented in these financial statements includes reclassifications which were made to conform such information to the current period presentation. These reclassifications had no material effect on our previously reported net loss or stockholders' equity.
Principles of Consolidation
The unaudited consolidated financial statements include the accounts of Deep Down’s wholly-owned subsidiaries after the elimination of significant intercompany accounts and transactions.
NOTE 2: ACCOUNTS RECEIVABLE
Accounts receivable includes an allowance for uncollectible accounts of $141,736$818,992 and $139,787 as of March 31,June 30, 2008 and December 31, 2007, respectively. Bad debt expense totaled $3,949$832,328 and $1,852$11,555 for the threesix months ended March 31,June 30, 2008 and March 31,June 30, 2007, respectively.
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3: PROPERTY AND EQUIPMENT
Property and equipment include the following:
| | | March 31, 2008 | | | December 31, 2007 | |
| Building | | $ | 231,055 | | | $ | 195,305 | |
| Furniture and fixtures | | | 63,777 | | | | 63,777 | |
| Vehicles and trailers | | | 112,162 | | | | 112,162 | |
| Leasehold improvements | | | 113,614 | | | | 75,149 | |
| Equipment | | | 2,021,054 | | | | 2,004,167 | |
| Rental Equipment | | | 3,144,560 | | | | 3,144,559 | |
| Total | | | 5,686,222 | | | | 5,595,118 | |
| Less: Accumulated depreciation | | | (627,665 | ) | | | (422,314 | ) |
| Property and equipment, net | | $ | 5,058,557 | | | $ | 5,172,804 | |
| | | June 30, 2008 | | | December 31, 2007 | |
| Land | | $ | 2,270,439 | | | $ | 13,148 | |
| Building | | | 1,246,072 | | | | 182,156 | |
| Furniture and fixtures | | | 139,044 | | | | 63,777 | |
| Vehicles and trailers | | | 99,837 | | | | 112,162 | |
| Leasehold improvements | | | 301,919 | | | | 75,149 | |
| Equipment | | | 3,834,594 | | | | 2,004,167 | |
| Rental Equipment | | | 3,659,714 | | | | 3,144,559 | |
| Total | | | 11,551,619 | | | | 5,595,117 | |
| Less: Accumulated depreciation | | | (900,566 | ) | | | (422,314 | ) |
| Property and equipment, net | | $ | 10,651,053 | | | $ | 5,172,804 | |
Depreciation expense for the threesix months ended March 31,June 30, 2008 and March 31,June 30, 2007 was approximately $213,090$505,063 and $64,025,$154,221, respectively.
To accommodate our growth in operations during the six months ended June 30, 2008, we leased additional property from JUMA and incurred $98,139 in leasehold improvements to stabilize the ground and prepare the surface for the movement and storage of the heavy equipment we manufacture and rent at our corporate headquarters.
In connection with the purchase of Flotation, Deep Down acquired land along with a building and improvements with a fair market value of $3,264,100 which houses its 46,925 square foot light industrial manufacturing facility on a 3.61 acre site in Maine.
On June 30, 2008, Deep Down transferred equipment with a cost basis of $502,253 from inventory to its rental equipment fleet.
NOTE 4: LONG-TERM DEBT
The following table summarizes long-term debt:
| | | March 31, 2008 | | | December 31, 2007 | |
| Secured credit agreement with Prospect Capital Corporation | | | | |
| quarterly principal payments of $250,000 beginning | | | | | | |
| September 30, 2008; monthly interest payments, | | | | | | |
| interest fixed at 15.5%; balance due August 2011; | | | | | | |
| secured by all assets | | $ | 12,000,000 | | | $ | 12,000,000 | |
| Debt discount, net of amortization of $254,101 and $135,931 respectively | | | (1,585,088 | ) | | | (1,703,258 | ) |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 8.25% per annum, | | | | | | | | |
| maturing June 10, 2008, cross-collateralized | | | | | | | | |
| by Mako assets, paid January 2008. | | | - | | | | 289,665 | |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing September 28, 2010, collateralized by Mako | | | | | | | | |
| life insurance policy and equipment, paid January 2008. | | | - | | | | 320,027 | |
| Revolving line-of-credit of $500,000 from a bank, | | | | | | | | |
| matured October 13, 2007 or on demand, interest rate is | | | | | | | | |
| at a variable rate resulting in a rate of 8.30% as of | | | | | | | | |
| September 30, 2007, collateralized by Mako equipment, | | | | | | | | |
| paid January 2008. | | | - | | | | 151,705 | |
| Note payable to a bank payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing January 25, 2011, collateralized by Mako | | | | | | | | |
| equipment and life insurance policy, paid January 2008 | | | - | | | | 154,647 | |
| Total secured credit agreement and bank debt | | | 10,414,912 | | | | 11,212,786 | |
| 6% Subordinated Debenture beginning March 31, 2008; annual | | | | - | |
| interest payments, interest fixed at 6%; matures March 31, 2011 | | | 500,000 | | | | - | |
| Capital lease of equipment, monthly lease payments, | | | | | | | | |
| interest imputed at 11.2% | | | 470,446 | | | | 481,209 | |
| Total long-term debt | | | 11,385,358 | | | | 11,693,995 | |
| Current portion of long-term debt | | | (330,399 | ) | | | (995,177 | ) |
| Long-term debt, net of current portion | | $ | 11,054,959 | | | $ | 10,698,818 | |
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS| | | June 30, 2008 | | | December 31, 2007 | |
| Secured credit agreement with Prospect Capital Corporation | | | | | | |
| quarterly principal payments of $250,000 beginning | | | | | | |
| September 30, 2008; monthly interest payments, | | | | | | |
| interest fixed at 15.5%; balance due August 2011; | | | | | | |
| secured by all assets | | $ | - | | | $ | 12,000,000 | |
| Debt discount, net of amortization of $254,101 and $135,931 respectively | | | - | | | | (1,703,258 | ) |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 8.25% per annum, | | | | | | | | |
| maturing June 10, 2008, cross-collateralized | | | | | | | | |
| by Mako assets, paid January 2008. | | | - | | | | 289,665 | |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing September 28, 2010, collateralized by Mako | | | | | | | | |
| life insurance policy and equipment, paid January 2008. | | | - | | | | 320,027 | |
| Revolving line-of-credit of $500,000 from a bank, | | | | | | | | |
| matured October 13, 2007 or on demand, interest rate is | | | | | | | | |
| at a variable rate resulting in a rate of 8.30% as of | | | | | | | | |
| September 30, 2007, collateralized by Mako equipment, | | | | | | | | |
| paid January 2008. | | | - | | | | 151,705 | |
| Note payable to a bank payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing January 25, 2011, collateralized by Mako | | | | | | | | |
| equipment and life insurance policy, paid January 2008 | | | - | | | | 154,647 | |
| Total secured credit agreement and bank debt | | | - | | | | 11,212,786 | |
| 6% Subordinated Debenture beginning March 31, 2008; annual | | | | | | | - | |
| interest payments, interest fixed at 6%; matures March 31, 2011 | | | 507,479 | | | | - | |
| Capital lease of equipment, monthly lease payments, | | | | | | | | |
| interest imputed at 11.2% | | | 459,379 | | | | 481,209 | |
| Total long-term debt | | | 966,858 | | | | 11,693,995 | |
| Current portion of long-term debt | | | (47,477 | ) | | | (995,177 | ) |
| Long-term debt, net of current portion | | $ | 919,381 | | | $ | 10,698,818 | |
Secured Credit Agreement
On August 6, 2007, Deep Down entered into a $6.5 million secured credit agreement, (the “Credit Agreement”) with Prospect Capital Corporation, (“Prospect”) and received an advance of $6.0 million 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. Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through June 2008.
On December 21, 2007, Deep Down entered into an amendment to ourthe 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 from $6.5 million to $13.0 million. Amounts borrowed were $6.0 million. Quarterly principal payments increased to $250,000 beginning September 30, 2008, with2008. Cash interest paid for the remaining balance outstanding due August 6, 2011. Interest paid through March 31,three and six months ended June 30, 2008 was $480,356.$361,667 and $821,500, respectively. Under the Credit Agreement, we areDeep Down was required to meet certain covenants and restrictions. We must alsorestrictions as well as maintain a debt service reserve account of $750,000.account. As of MarchDecember 31, 2008, $562,5002007, $375,000 is separately classified as “Restricted cash” on the accompanying balance sheet. At March 31, 2008, Deep Down is not in compliance with certain financial covenants or the requirement to have life insurance on the CEO in the amount of $3,000,000. Deep Down has obtained waivers from the lender for all the covenants that are not in compliance.sheets.
In connection with the second advance under the Credit Agreement on January 4, 2008, Deep Down capitalized an additional $261,941$261,946 in deferred financing costs. Of this amount, $216,000 was paid in cash to various third parties related to the financing, and the remainder of $45,946 represents the Black ScholesBlack-Scholes valuation of warrants issued to one of these third party vendors. The warrant was grantedissued to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share. The warrant has
On June 12, 2008, Deep Down paid $12,492,912 to Prospect to pay 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 approximately $446,412 were recognized as a five-year termloss on early extinguishment of debt. Since the warrants issued in connection with the original Credit Agreement and is immediately exercisable. The fair value of the warrantAmendment dated January 4, 2008 were detachable, there was estimatedno change to be $45,946 based on the Black Scholes pricing model. The assumptions usedthese equity instruments.
On July 3, 2008, Prospect exercised their outstanding 4,960,585 warrants in the model included (1) expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate of 3.2% and (4) zero expected dividends. Provisions in the warrant agreement allow for a cashless exercise provision, not to exceed 2%for a total of outstanding2,618,129 shares of Deep Down common stock atstock.
In January 2008, in accordance with the timeterms of exercise.the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664.
The following table summarizes interest expense for the three months ended March 31, 2008 and March 31, 2007:
| | | Three Months Ended | |
| | | March 31, | |
| | | 2008 | | | 2007 | |
| Interest Expense | | $ | 480,356 | | | $ | 52,300 | |
| Accretion | | | 113,589 | | | | 179,587 | |
| Amortization of debt discount | | | 118,171 | | | | - | |
| Amortization of deferred financing | | | 56,914 | | | | - | |
| | | $ | 769,030 | | | $ | 231,887 | |
Exchange of Remaining Series E Redeemable Exchangeable Preferred Stock to 6% Subordinated Debenture
On March 31, 2008, 500 shares of the Series E Redeemable Exchangeable Preferred Stock (“Series E”) were exchanged into a 6% Subordinated Debenture (the “Debenture”) in an outstanding principal amount of $500,000 (the “Debenture”).$500,000. The Debenture has a fixed interest rate of 6% interest per annum to be paid annually on March 31st through maturity on March 31, 2011. 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 6% Subordinated Debenture due three years from the date of the exchange. These shares carried voting rights equal to 690 votes per share. The Series E Preferred Stock was valued based on the discounted value of expected future cash flows (using a discount rate of 20%). At inception, Deep Down evaluated the Series E and has classified as debt instruments from the date of issuance since the Series E are exchangeable at the option of the holder thereof into Debenture. The difference between the face value of the Series E and the discounted book value recorded on the balance sheet, or original issue discount, was recorded as non-cash interest expense for the duration of the term. Upon exchange into the $500,000 subordinated debentureDebenture, Deep Down recorded $113,589 in interest expense for the accretion up to face value.
During See the quarter ended March 31, 2008 and in accordance withadditional discussion of the terms of the purchaseSeries E preferred stock at Note 6. Interest expense on the Debenture of Mako, Deep Down paid $916,044 of notes payable.
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSapproximately $7,479 has been recognized for the three and six months ended June 30, 2008.
NOTE 5: BUSINESS COMBINATIONSACQUISITIONS
Purchase of Mako Technologies, Inc.Inc.
Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako Technologies, Inc. Pursuant to the agreement and plan of merger, twoMako. Two installments were paid to the Mako shareholders. The first installment of $2,916,667 in cash and 6,574,074 restricted shares of common stock of Deep Down, valued at $0.76 per share, was paid on January 4, 2008. The second installment of 2,802,969 restricted shares of common stock of Deep Down, valued at $0.70 per share, was issued on March 28, 2008. The final cash payment of $1,243,571, which was paid on April 11, 2008, is reflected aswas included in the “Payable to Mako shareholders” balance on the accompanying balance sheets.sheet at December 31, 2007.
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 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 from the purchase date.
The acquistion of Mako was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations” (“SFAS 141”) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Mako.
Purchase of Flotation Technologies, Inc.
On June 5, 2008, Deep Down completed the acquisition of 100% of the capital of Flotation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. The equity interest was acquired from the three individual shareholder members of the same family and related technology was acquired from an entity affiliated with the selling stockholders. No prior material relationship existed between the selling shareholders and Deep Down, any of our affiliates, or any of our directors or officers, or any associate of any of our officers or directors. Deep Down executed the definitive agreement to purchase Flotation on April 17, 2008 and effectively dated the acquisition for accounting purposes as of May 1, 2008. Deep Down announced the closing on June 6, 2008.
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 $23,895,830 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 $251,180. 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 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. Flotation’s selling shareholders used approximately $1,800,000 of the $22,100,000 cash received to pay outstanding debt of Flotation. The purchase price may be adjusted upward or downward, dependant on certain working capital targets.
Deep Down sold 57,142,857 shares to accredited investors on June 5, 2008, for approximately $37,059,670 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.
The table below reflects the breakdown of the purchase price as noted above:
| Summary of purchase price: | | | |
| Cash | | $ | 22,100,000 | |
| Certain transaction costs | | | 251,180 | |
| Fair market value of common stock | | | 1,422,857 | |
| Fair market value of warrants issued | | | 121,793 | |
| Total purchase price | | $ | 23,895,830 | |
The purchase price of $23,895,830 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 | | | 4,846,190 | |
| Intangibles | | | 14,797,000 | |
| Goodwill | | | 2,157,307 | |
| Total assets acquired | | $ | 25,028,143 | |
| | | | | |
| Accounts payable and accrued liabilities | | | 1,132,313 | |
| Total liabilities acquired | | $ | 1,132,313 | |
| Net assets acquired | | $ | 23,895,830 | |
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 $1,200,000 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 | | | Average Remaining | |
| | | 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 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 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 following unaudited pro forma combined condensed financial statements are based on the historical financial statements ofinclude Flotation and Mako and Deep Down after giving effect to the acquisition of Mako. The unaudited pro forma condensed combined statements of operations for the three months ended March 31, 2007 isperiods presented as if the acquisitionacquisitions had taken placeoccurred on January 1, 2007 by combining the historicalfirst date of the respective periods and are presented for informational purposes only. These results are not necessarily indicative of the results of Mako and Deep Down.
operations that actually would have been achieved had the acquisitions been consummated as of the beginning of the period presented, or are they intended to be a projection of future results. The unaudited pro forma results were as follows:
| Deep Down, Inc. | |
| Unaudited Pro forma Statements of Operations | |
| | |
| | | | | | | | | | | | |
| | | Historical | | | Historical | | | | | | |
| | | Deep Down | | | Mako | | | | | Pro Forma | |
| | | Quarter Ended | | | Quarter Ended | | | | | Quarter Ended | |
| | | March 31, | | | March 31, | | Pro Forma | | | March 31, | |
| | | 2007 | | | 2007 | | Adjustments | | | 2007 | |
| | | | | | | | | | | | |
| Revenues | | $ | 2,098,394 | | | $ | 849,929 | | $ | - | | | $ | 2,948,323 | |
| Cost of sales | | | 1,252,089 | | | | 561,116 | | | | | | | 1,813,205 | |
| | | | | | | | | | | | | | | | |
| Gross profit | | | 846,305 | | | | 288,813 | | | - | | | | 1,135,118 | |
| Operating expenses | | | 723,676 | | | | 406,933 | | | 93,039 | | (a) | | 1,223,648 | |
| Total other income (expense) | | | (231,887 | ) | | | (17,974 | ) | | (266,123 | ) | (b) | | (515,984 | ) |
| | | | | | | | | | | | | | | | |
| Net loss | | $ | (109,258 | ) | | $ | (136,094 | ) | $ | (359,162 | ) | | $ | (604,514 | ) |
| | | | | | | | | | | | | | | | |
| Earnings per share: | | | | | | | | | | | | | | | |
| Basic and diluted | | $ | - | | | | | | | | | | $ | (0.01 | ) |
| Weighted-average common shares outstanding | | | 81,036,838 | | | | | | | | | (c) | | 90,413,881 | |
| Unaudited Pro Forma Combined Condensed Statements of Operations | |
| | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months ended June 30, 2008 | | For the Six Months ended June 30, 2008 | |
| | Historical | | | | | | | | Historical | | | | | | | |
| | | | One Month | | | | | | | | | | Four Months | | | | | | Combined | |
| | | | April 30, | | Flotation | | | | Combined | | | | April 30, | | Flotation | | | | Condensed | |
| | | | 2008 | | Pro Forma | | | | Pro Forma | | | | 2008 | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Flotation | | Entries | | | | Results | | Deep Down | | Flotation | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | | | | | |
| Revenues | $ | 7,920,196 | | $ | 1,064,364 | | $ | - | | | | $ | 8,984,560 | | $ | 14,199,661 | | $ | 5,941,472 | | $ | - | | | | $ | 20,141,133 | |
| Cost of sales | | 5,496,427 | | | 627,224 | | | - | | | | | 6,123,651 | | | 9,372,798 | | | 4,005,179 | | | - | | | | | 13,377,977 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 2,423,769 | | | 437,140 | | | - | | | | | 2,860,909 | | | 4,826,863 | | | 1,936,293 | | | - | | | | | 6,763,156 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 4,224,771 | | | 305,220 | | | 75,604 | | (d/e | ) | | 4,605,595 | | | 6,285,167 | | | 968,179 | | | 302,416 | | (d/e | ) | | 7,555,762 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | (1,801,002 | ) | | 131,920 | | | (75,604 | ) | | | | (1,744,686 | ) | | (1,458,304 | ) | | 968,114 | | | (302,416 | ) | | | | (792,606 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | (3,149,371 | ) | | (22,467 | ) | | - | | | | | (3,171,838 | ) | | (3,850,882 | ) | | (57,335 | ) | | - | | | | | (3,908,217 | ) |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | (4,950,373 | ) | | 109,453 | | | (75,604 | ) | | | | (4,916,524 | ) | | (5,309,186 | ) | | 910,779 | | | (302,416 | ) | | | | (4,700,823 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | 85,000 | | | - | | | (12,524 | ) | (f) | | | 72,476 | | | 354,366 | | | - | | | (225,094 | ) | (f) | | | 129,272 | |
| Net income (loss) | $ | (4,865,373 | ) | $ | 109,453 | | $ | (88,128 | ) | | | $ | (4,844,048 | ) | $ | (4,954,820 | ) | $ | 910,779 | | $ | (527,510 | ) | | | $ | (4,571,551 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | $ | (0.04 | ) | | | | | | | | | $ | (0.03 | ) | $ | (0.05 | ) | | | | | | | | | $ | (0.03 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 132,666,860 | | | | | | | | (g) | | | 174,707,676 | | | 109,326,053 | | | | | | | | (g) | | | 161,161,117 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | $ | (0.04 | ) | | | | | | | | | $ | (0.03 | ) | $ | (0.05 | ) | | | | | | | | | $ | (0.03 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 132,666,860 | | | | | | | | (g) | | | 174,707,676 | | | 109,326,053 | | | | | | | | (g) | | | 161,161,117 | |
(a) AmortizationThe historical results of the intangible assets at a rate of $28,353 per month for three months; plus $7,980 adjustment to historical depreciation expense to adjust to purchase accounting asset values.
(b) Represents cash interest plus amortization of deferred financing costs and debt discounts. Interest is payable at 15.5% on the outstanding principal, and the related fees are amortized using the effective interest method over the four-year life of the loan.
(c) A total of 9,377,043 shares were issuedDeep Down for the total transaction. These pro formathree and six months ended June 30, 2008 contain two months of results for Flotation operations since its acquisition was effective May 1, 2008. 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 31, 2008 and the total of 58,857,143 common shares of Deep Down issued in June 2008; 57,142,857 in connection with the Private Placement, and 1,714,286 to Flotation shareholders, as if all these shares were issued January 1, 20072008.
DEEP DOWN, INC.| Unaudited Pro Forma Combined Condensed Statement of Operations | |
| For the Three Months ended June 30, 2007 | |
| | | | | | | | | | | | | | | | Combined | |
| | Historical | | Mako | | | | Flotation | | | | Condensed | |
| | | | | | | | Pro Forma | | | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Mako | | Flotation | | Entries | | | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | |
| Revenues | $ | 5,144,788 | | $ | 1,768,876 | | $ | 1,329,446 | | $ | - | | | | $ | - | | | | $ | 8,243,110 | |
| Cost of sales | | 3,293,313 | | | 561,385 | | | 974,265 | | | - | | | | | - | | | | | 4,828,963 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 1,851,475 | | | 1,207,491 | | | 355,181 | | | - | | | | | - | | | | | 3,414,147 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 1,177,876 | | | 957,572 | | | 711,176 | | | 122,367 | | (a) | | | 226,811 | | (d/e | ) | | 3,195,802 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | 673,599 | | | 249,919 | | | (355,995 | ) | | (122,367 | ) | | | | (226,811 | ) | | | | 218,345 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | 723,230 | | | (28,571 | ) | | 1,399,087 | | | (266,269 | ) | (b) | | | - | | | | | 1,827,477 | |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | 1,396,829 | | | 221,348 | | | 1,043,092 | | | (388,636 | ) | | | | (226,811 | ) | | | | 2,045,822 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | (447,363 | ) | | (17,309 | ) | | - | | | 143,795 | | | | | (302,024 | ) | (f) | | | (622,901 | ) |
| Net income (loss) | $ | 949,466 | | $ | 204,039 | | $ | 1,043,092 | | $ | (244,841 | ) | | | $ | (528,835 | ) | | | $ | 1,422,921 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 67,870,171 | | | | | | | | | | | | | | | | (c/g | ) | | 136,104,357 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 93,799,839 | | | | | | | | | | | | | | | | (c/g | ) | | 162,034,025 | |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
| Unaudited Pro Forma Combined Condensed Statement of Operation | |
| For the Six Months ended June 30, 2007 | |
| | | | | | | | | | | | | | | | Combined | |
| | Historical | | Mako | | | | Flotation | | | | Condensed | |
| | | | | | | | Pro Forma | | | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Mako | | Flotation | | Entries | | | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | |
| Revenues | $ | 7,243,182 | | $ | 2,618,805 | | $ | 2,351,057 | | $ | - | | | | $ | - | | | | $ | 12,213,044 | |
| Cost of sales | | 4,545,402 | | | 1,122,501 | | | 1,463,530 | | | - | | | | | - | | | | | 7,131,433 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 2,697,780 | | | 1,496,304 | | | 887,527 | | | - | | | | | - | | | | | 5,081,611 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 1,901,552 | | | 1,364,505 | | | 1,376,736 | | | 244,734 | | (a) | | | 453,624 | | (d/e | ) | | 5,341,151 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | 796,228 | | | 131,799 | | | (489,209 | ) | | (244,734 | ) | | | | (453,624 | ) | | | | (259,540 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | 491,343 | | | (46,545 | ) | | 1,390,538 | | | (532,391 | ) | (b) | | | - | | | | | 1,302,945 | |
Income (loss) from continuing operations | | 1,287,571 | | | 85,254 | | | 901,329 | | | (777,125 | ) | | | | (453,624 | ) | | | | 1,043,405 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Income tax expense | | (447,363 | ) | | (17,309 | ) | | - | | | 287,536 | | | | | (165,651 | ) | (f) | | | (342,787 | ) |
| Net income (loss) | $ | 840,208 | | $ | 67,945 | | $ | 901,329 | | $ | (489,589 | ) | | | $ | (619,275 | ) | | | $ | 700,618 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | - | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 74,417,132 | | | | | | | | | | | | | | | | (c/g | ) | | 142,651,318 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | - | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 100,315,405 | | | | | | | | | | | | | | | | (c/g | ) | | 168,549,591 | |
The unaudited pro forma combined condensed statements include the following pro forma assumptions and entries for Mako:
| a) | Amortization of the intangible assets at a rate of $40,789 per month for the respective periods. |
| b) | Represents cash interest plus amortization of deferred financing costs and debt discounts for the Credit Agreement. Interest is payable at 15.5% on the outstanding principal, and the related fees are 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. |
Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.
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 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. |
The table below reflects the assumptions used for warrant and option grants related to Flotation during the six months ended June 30, 2008:
| Risk free interest rate | 2.52% - 3.18% |
| Expected life of options | 2 - 2.5 years |
| Expected volatility | 51.7% - 61.3% |
NOTE 6: PREFERRED STOCK
Series D Redeemable Convertible Preferred Stock Classified as Temporary Equity Instruments
On March 28, 2008, the remaining outstanding 5,000 shares of Series D redeemable convertible preferred stock (“Series D”) were converted into 25,866,518 restricted 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. TheseThe Series D had been valued at inception at $4,419,244 based on the Black-Scholes fair value of the Series D.
Exchange of Series E Redeemable Exchangeable Preferred Stock Classified as Debt Instruments to 6% Subordinated Debenture
On March 31, 2008, 500 shares carried voting rights equal to one vote for every share of common stockthe Series E Preferred Stock were exchanged into which the preferred stock is convertible. These shares were redeemable at their6% Debenture in an outstanding principal amount of $500,000. The Series E had a face value on an annual basis within 120 days after each calendar year-end beginning withand liquidation preference of $1,000 per share, no dividend preference, and were exchangeable at the year ending December 31, 2007 based on an amount equal to 15.625%holder’s option into 6% Subordinated Debenture due three years from the date of annualthe exchange. See additional discussion of the Debenture in Note 4.
NOTE 7: COMMON STOCK
Private Placement
On June 5, 2008, Deep Down sold 57,142,857 shares, for $40,000,000 at a per-share price of $0.70. After transaction costs, net income. Inproceeds were $37,059,670. Dahlman Rose & Company, LLC acted as exclusive placement agent for the event that a holder declined redemption, such amounts would have been reallocated to the other preferred stock holders that had elected to redeem.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, with the remainder being retained for working capital purposes.
In connection with the private placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep Down filed an S-1 Registration Statement on July 21, 2008. If the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), then for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective, Deep Down shall be required to pay daily damages to the purchasers. Deep Down evaluated the Series D preferred stockregistration rights agreement for liability or equity presentationtreatment under Financial Accounting Standards Board (“FASB”) Statement No. 5, “Accounting for Contingencies” and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the Series D preferred stock were more appropriately classified as “Temporary equity” onregistration rights did not meet the accompanying balance sheets due todefinition of a liability under the conditional redemption feature.authoritative guidance since management believes the liability is not estimable at this time.
NOTE 7:8: STOCK OPTIONSBASED COMPENSATION AND WARRANTS
Stock Options and Warrants
Deep Down has a stock based compensation plan - the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). We account for stock-based compensation expense under Statement of Financial Accounting (“SFAS”) No. 123 (Revised 2004), “Share-based Payment,” (“SFAS No. 123(R)”). The exercise price of the options, as well as the vesting period, is established by Deep Down’s boardBoard of directors.Directors. 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% of issued and outstanding common shares. During the threesix months ended March 31,June 30, 2008, Deep Down granted 3,250,0004,200,000 options and 1,200,000 shares of restricted stock and cancelled 625,000875,000 options due to forfeitures under the Plan.
The total stock based compensation expense for the three months ended March 31, 2008 and March 31, 2007, was $105,162 and -0-, respectively. The unamortized portion of the estimated fair value of these stock options is $ 1,203,721 at March 31, 2008. Based on the shares of common stock outstanding at March 31,June 30, 2008, there are 9,252,000approximately 16,235,000 options available for grant under the Plan as of that date.
During the three months ended March 31,Restricted Stock
On February 14, 2008, Deep Down grantedissued an aggregate of 1,200,000 shares of restricted common stock to certain officersRonald E. Smith, CEO; Robert E. Chamberlain, Chairman; and Eugene L. Butler, CFO under terms of the Plan. The shares were valued at a price of $0.42 based on the closing price of common stock on that date. The shares vest on the second anniversary of the grant date, and Deep Down is amortizing the related stock based compensation of $504,000 over the 2 year period. For the six months ended June 30, 2008 Deep Down recognized a total of $94,500 in stock based compensation related to these issued shares of restricted stock.
The following table summarizes Deep Down’s restricted stock activity for the six months ended June 30, 2008:
| | | Restricted Shares | | | Weighted- Average Grant Price | | | Aggregate Intrinsic Value | |
| Outstanding at December 31, 2007 | | | - | | | | | | | |
| Grants | | | 1,200,000 | | | $ | 0.42 | | | | |
| Outstanding at June 30,2008 | | | 1,200,000 | | | $ | 0.42 | | | $ | 624,000 | |
During the six months ended June 30, 2008, Deep Down granted 4,200,000 options under the Plan as detailed below. On June 17, 2008, a cashless exercise of 50,000 employee stock options for 29,339 net common shares was issued in accordance with terms of the Plan.
During the six months ended June 30, 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 days’ closing prices. The fair value of such options was approximately $114,737 based on the Black-Scholes option pricing model. Additionally, Deep Down issued 600,000 stock options to employees of Deep Down. These restricted shares vest over a period of two years.Flotation in connection with that acquisition.
On February 14, 2008, Deep Down determinedissued an aggregate of 3,000,000 stock options to Ronald E. Smith, Robert E. Chamberlain, and Eugene L. Butler, with an exercise price of $1.50, which was in excess of the day’s closing price of $0.42. The fair market value of such options was approximately $145,764 based on the dateBlack-Scholes option pricing model.
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 be $504,000determine 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 is recognizing the expense ratably over the vesting period.similar stage of development.
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Summary of Stock Options
| | | Options Underlying Shares | | | Weighted- Average Exercise Price | | | Weighted- Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value (In-The- Money) Options) | |
| Outstanding at December 31, 2007 | | | 5,500,000 | | | $ | 0.58 | | | | | | | |
| Grants | | | 3,250,000 | | | | 1.44 | | | | | | | |
| Cancellations | | | (625,000 | ) | | | 0.76 | | | | | | | |
| Outstanding at March 31, 2008 | | | 8,125,000 | | | $ | 0.91 | | | | 3.5 | | | $ | 816,500 | |
| Exercisable at March 31, 2008 | | | 625,000 | | | $ | 0.76 | | | | 4.0 | | | $ | 72,500 | |
The following table summarizes Deep Down’s stock option activity for the six months ended June 30, 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, 2007 | | 5,500,000 | | $ | 0.58 | | | | | |
| Grants | | 4,200,000 | | | 1.35 | | | | | |
| Exercises | | (50,000 | ) | | 0.50 | | | | | |
| Forfeitures | | (875,000 | ) | | 0.74 | | | | | |
| Outstanding at June 30,2008 | | 8,775,000 | | $ | 0.93 | | | 3.0 | | $ | 1,944,750 | |
| Exerciseable at June 30,2008 | | 1,970,834 | | $ | 0.60 | | | 2.7 | | $ | 729,292 | |
The following summarizes Deep Down’s outstanding options and their respective exercise prices at March 31,June 30, 2008:
Exercise Price | | Shares Underlying Options Underlying
Shares
| |
| $ | 0.30 - 0.49 | | | 175,000 | |
| $ | 0.50 - 0.69 | | | 4,175,0004,125,000 | |
| $ | 0.70 - 0.99 | | | 425,000525,000 | |
| $ | 1.00 - 1.29 | | | 350,000950,000 | |
| $ | 1.30 - 1.50 | | | 3,000,000 | |
| | | | | 8,125,0008,775,000 | |
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 yearsix months ended December 31, 2007:June 30, 2008:
| Dividend yield | | 0% |
| Risk free interest rate | | 2.64% - 5.00%2.84% |
Expected termlife of options | | 3 - 4 years |
| Expected volatility | | 53%53.3% - 61%63.3% |
Summary of Warrants
RelatedIn connection with the purchase of Flotation, warrants to purchase 200,000 common shares at $0.70 per share were issued to an entity affiliated with the selling stockholders 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 financingunderlying shares of Securedcommon 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 related to Flotation.
On August 6, 2007, as part of the Credit Agreement Amendment and second advancedescribed above in January 2008,Note 4, Deep Down issued 4,960,585 detachable warrants to its creditor. All warrants were issued with an exercise price of $0.507, expired in five years (or earlier in the event of termination) and vested on the earlier of the second anniversary of the agreement or upon payment in full of the debt. On July 3, 2008, the creditor exercised all of its outstanding 4,960,585 warrants for a total of 2,618,129 restricted shares of Deep Down common stock in a cashless exercise.
Additionally, related to the Credit Agreement described in Note 4, Deep Down issued 320,000 detachable warrants at an exercise price of $0.75 per share to a third party related to the financing. The warrant has a five-year term and became exercisable in connection with the early payoff of the debt. Also, in connection with the Amendment to the Credit Agreement, Deep Down issued detachable warrants to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share to athe same third party. The warrant has a five-year term and iswas immediately exercisable. The assumptions usedSee the additional discussion concerning such warrants in the Black Scholes model included (1) expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate of 3.18% and (4) zero expected dividends.
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
A summary of warrant transactions follows:
| | | Options Underlying Shares | | | Weighted- Average Exercise Price | | | Weighted- Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value (In-The- Money) Options) | |
| Outstanding at December 31, 2007 | | | 5,399,397 | | | $ | 0.53 | | | | | | | |
| Outstanding at March 31, 2008 | | | 5,399,397 | | | | 0.53 | | | | 4.5 | | | $ | 892,905 | |
| Exercisable at March 31, 2008 | | | 118,812 | | | $ | 1.01 | | | | 4.8 | | | $ | - | |
| | Shares Underlying Warrants | | Weighted- Average Exercise Price | | Weighted- Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (In-The-Money) | |
| Outstanding at December 31, 2007 | | 5,399,397 | | $ | 0.53 | | | | | |
| Grants | | 200,000 | | | 0.70 | | | | | |
| Outstanding at June 30,2008 | | 5,599,397 | | $ | 0.54 | | | 4.4 | | $ | 2,241,852 | |
| Exerciseable at June 30,2008 | | 5,399,397 | | $ | 0.54 | | | 4.4 | | $ | 2,193,852 | |
During the three months ended March 31, 2008, 1,200,000 shares of restricted common stock were granted to certain employees and officers of Deep Down.
The following table summarizes Deep Down’s outstanding warrants and their respective exercise prices at March 31,June 30, 2008:
Exercise Price | | Options Underlying Shares |
| $ | 0.51 | | 4,960,585 |
| | 0.75 | | 320,000 |
| $ | 1.01 | | 118,812 |
| | | | 5,399,397 |
| Exercise Price | | Shares Underlying Warrants | |
| $ | 0.51 | | | 4,960,585 | |
| $ | 0.70 - 0.99 | | | 520,000 | |
| $ | 1.01 | | | 118,812 | |
| | | | | 5,599,397 | |
The fair value of each 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 six months ended June 30, 2008:
| Dividend yield | 0% |
| Risk free interest rate | 2.52% - 3.18% |
| Expected life of options | 2 - 2.5 years |
| Expected volatility | 51.7% - 61.3% |
NOTE 8:9: COMMITMENTS AND CONTINGENCIES
Litigation
We are from time to time involved in legal proceedings arising in the normal course of business. As of the date of this Quarterly Report on Form 10-Q, there are no pending or threatened material legal proceedings.
Operating Leases
Deep Down leases land under an operating lease and is responsible for related maintenance, insurance and property taxes. On May 1, 2008, Deep Down and JUMA, LLC, a related party, amended the original lease that began as of September, 2006 to provide for the additional acreage leased resulting in a $4,000 per month increase in rent. See Note 10 below for further discussion of the related party.
NOTE 9:10: RELATED PARTY TRANSACTIONS
We paid approximately $82,000 toDeep Down leases all buildings, structures, fixtures and other improvements at the Channelview, Texas location from JUMA, LLC, a corporationcompany owned by Ronald E. Smith, CEO and a director of Deep Down and Mary L. Budrunas, a vice president and a director of Deep Down. The base rate of $15,000 per month is payable to JUMA 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 shares of Series D preferred stock owned by Ronald Smith and Mary Budrunas. The Series D preferred shares were redeemed for costs associated with the preparation23,279,876 shares of the additional land recently purchased by JUMA for our operations. The costs were associated with permitting, land clearing, other closing costs and preparation.common stock.
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10: RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006,During the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair valuesix months ended June 30, 2008, Deep Down granted an aggregate of 1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock options to Ronald E. Smith, President and Chief Executive Officer, Robert E. Chamberlain, Jr., Chairman and Chief Acquisition Officer, and Eugene L. Butler, Chief Financial Officer, 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 liabilityterms 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 affects 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, is currently evaluating the impact of SFAS No. 157 on its financial position and result of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair ValueInc. Stock Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 with early adoption allowed.Plan. Deep Down has not yet determined the impact, if any, that adopting this standard might have on its financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”) and No. 160, Non-controlling Interestsalso awarded 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 non-controlling interests at fair value during a step-acquisition, and the recognition of contingent consideration astheir completion 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 re-characterized as non-controlling interests and classified as a component of equity. SFAS No. 141(R) and SFAS No. 160 are effective for both publicFlotation 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 adoptionplacement of common stock, a performance bonus of $300,000 in 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 is currently evaluating the effects of these pronouncements on its financial position and results of operations.aggregate.
NOTE 11: SUBSEQUENT EVENTS
Stock Purchase Agreement with Flotation Technologies, Inc.
On April 17,July 3, 2008, we announced the executionProspect exercised their outstanding 4,960,585 warrants in a cashless exercise for a total of a Stock Purchase Agreement to purchase all2,618,129 shares of the outstanding capital stock of Flotation Technologies, Inc. The total purchase price for the acquisition is expected to be approximately $23.3 million. Our closing of the purchase remains subject to several conditions, including our obtaining financing for the payment of the purchase price.Deep Down common stock.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMNature of Business
To the Board of Directors and Stockholders of Deep Down, Inc., Houston, Texasa Nevada corporation (“Deep Down Nevada” or “Deep Down” or the “Company”), is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), Mako Technologies, LLC (“Mako”), a Nevada limited liability company, and Flotation Technologies, Inc. (“Flotation”), a Maine corporation. The results of Flotation are included in the consolidated financial statements herein effective May 1, 2008, the effective date of acquisition for accounting purposes.
We have audited the accompanying consolidated balance sheets of Deep Down Inc. (the “Company”Delaware provides installation management, engineering services, support services and storage management services for the subsea controls, umbilicals and offshore pipeline industries. Deep Down Delaware also fabricates component parts for subsea distribution systems and assemblies.
ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, marine and commercial business sectors.
Mako serves the growing offshore petroleum and marine industries with technical support services and products vital to offshore petroleum production, through rentals of its remotely operated vehicles (“ROV”), astopside and subsea equipment and diving support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.
Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers. Flotation’s product offerings include distributed buoyancy for flexible pipes 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™ cable and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of December 31, 2007any size and 2006depth rating.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted for interim financial information and with the related consolidated statementsinstructions to Form 10-Q and Article 8 of operations, stockholders’ equity (deficit),Regulation S-X relating to smaller reporting companies. Accordingly, they do not include all of the information and cash flowsfootnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. We have also audited the accompanying statements of operations, stockholders’ deficit and cash flows for the period from inception (June 29, 2006) through2008. The balance sheet at December 31, 2006. These2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
For further information, refer to the audited consolidated financial statements areand footnotes thereto included in our Annual Report on Form 10-KSB/A (Amendment No. 3) for the responsibilityyear ended December 31, 2007 filed on August 8, 2008.
Prior period information presented in these financial statements includes reclassifications which were made to conform such information to the current period presentation. These reclassifications had no material effect on our previously reported net loss or stockholders' equity.
Principles of the Company’s management. Our responsibility is to express an opinion on theseConsolidation
The unaudited consolidated financial statements based on our audits.
We conducted our audits in accordance withinclude the standards of 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. Deep Down is not required to have, nor were we engaged to perform an audit of internal control over financial reporting. Our audits included the 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 effectivenessaccounts of Deep Down’s internal control over financial reporting. Accordingly,wholly-owned subsidiaries after the elimination of significant intercompany accounts and transactions.
NOTE 2: ACCOUNTS RECEIVABLE
Accounts receivable includes an allowance for uncollectible accounts of $818,992 and $139,787 as of June 30, 2008 and December 31, 2007, respectively. Bad debt expense totaled $832,328 and $11,555 for the six months ended June 30, 2008 and June 30, 2007, respectively.
NOTE 3: PROPERTY AND EQUIPMENT
Property and equipment include the following:
| | | June 30, 2008 | | | December 31, 2007 | |
| Land | | $ | 2,270,439 | | | $ | 13,148 | |
| Building | | | 1,246,072 | | | | 182,156 | |
| Furniture and fixtures | | | 139,044 | | | | 63,777 | |
| Vehicles and trailers | | | 99,837 | | | | 112,162 | |
| Leasehold improvements | | | 301,919 | | | | 75,149 | |
| Equipment | | | 3,834,594 | | | | 2,004,167 | |
| Rental Equipment | | | 3,659,714 | | | | 3,144,559 | |
| Total | | | 11,551,619 | | | | 5,595,117 | |
| Less: Accumulated depreciation | | | (900,566 | ) | | | (422,314 | ) |
| Property and equipment, net | | $ | 10,651,053 | | | $ | 5,172,804 | |
Depreciation expense for the six months ended June 30, 2008 and June 30, 2007 was approximately $505,063 and $154,221, respectively.
To accommodate our growth in operations during the six months ended June 30, 2008, we express no such opinion. An audit includes examining,leased additional property from JUMA and incurred $98,139 in leasehold improvements to stabilize the ground and prepare the surface for the movement and storage of the heavy equipment we manufacture and rent at our corporate headquarters.
In connection with the purchase of Flotation, Deep Down acquired land along with a building and improvements with a fair market value of $3,264,100 which houses its 46,925 square foot light industrial manufacturing facility on a test3.61 acre site in Maine.
On June 30, 2008, Deep Down transferred equipment with a cost basis evidence supportingof $502,253 from inventory to its rental equipment fleet.
NOTE 4: LONG-TERM DEBT
The following table summarizes long-term debt:
| | | June 30, 2008 | | | December 31, 2007 | |
| Secured credit agreement with Prospect Capital Corporation | | | | | | |
| quarterly principal payments of $250,000 beginning | | | | | | |
| September 30, 2008; monthly interest payments, | | | | | | |
| interest fixed at 15.5%; balance due August 2011; | | | | | | |
| secured by all assets | | $ | - | | | $ | 12,000,000 | |
| Debt discount, net of amortization of $254,101 and $135,931 respectively | | | - | | | | (1,703,258 | ) |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 8.25% per annum, | | | | | | | | |
| maturing June 10, 2008, cross-collateralized | | | | | | | | |
| by Mako assets, paid January 2008. | | | - | | | | 289,665 | |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing September 28, 2010, collateralized by Mako | | | | | | | | |
| life insurance policy and equipment, paid January 2008. | | | - | | | | 320,027 | |
| Revolving line-of-credit of $500,000 from a bank, | | | | | | | | |
| matured October 13, 2007 or on demand, interest rate is | | | | | | | | |
| at a variable rate resulting in a rate of 8.30% as of | | | | | | | | |
| September 30, 2007, collateralized by Mako equipment, | | | | | | | | |
| paid January 2008. | | | - | | | | 151,705 | |
| Note payable to a bank payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing January 25, 2011, collateralized by Mako | | | | | | | | |
| equipment and life insurance policy, paid January 2008 | | | - | | | | 154,647 | |
| Total secured credit agreement and bank debt | | | - | | | | 11,212,786 | |
| 6% Subordinated Debenture beginning March 31, 2008; annual | | | | | | | - | |
| interest payments, interest fixed at 6%; matures March 31, 2011 | | | 507,479 | | | | - | |
| Capital lease of equipment, monthly lease payments, | | | | | | | | |
| interest imputed at 11.2% | | | 459,379 | | | | 481,209 | |
| Total long-term debt | | | 966,858 | | | | 11,693,995 | |
| Current portion of long-term debt | | | (47,477 | ) | | | (995,177 | ) |
| Long-term debt, net of current portion | | $ | 919,381 | | | $ | 10,698,818 | |
Secured Credit Agreement
On August 6, 2007, Deep Down entered into a $6.5 million secured credit agreement, (the “Credit Agreement”) with Prospect Capital Corporation, (“Prospect”) and received an advance of $6.0 million on that date. The Credit Agreement provided for a 4-year term, an annual interest rate of 15.5%, with the amountsability to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and disclosuresprincipal 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. Deep Down paid the financial statements. An audit also includes assessingfull 15.5% and did not exercise the accounting principles usedPIK feature for the monthly periods through June 2008.
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 from $6.5 million to $13.0 million. Amounts borrowed were $6.0 million. Quarterly principal payments increased to $250,000 beginning September 30, 2008. Cash interest paid for the three and significant estimates made by management,six months ended June 30, 2008 was $361,667 and $821,500, respectively. Under the Credit Agreement, Deep Down was required to meet certain covenants and restrictions as well as evaluating the overall financial statement presentation. We believe that our audit providesmaintain a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Deep Down, Inc. asdebt service reserve account. As of December 31, 2007, and 2006, and$375,000 is separately classified as “Restricted cash” on the results of its operations and cash flows for the periods described, in conformity with U.S. generally accepted accounting principles.
/s/ MALONE & BAILEY, PC
www.malone-bailey.com
Houston, Texas
March 31, 2008accompanying balance sheets.
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, $216,000 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 warrant was issued to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share.
On June 12, 2008, Deep Down paid $12,492,912 to Prospect to pay 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 approximately $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.
In January 2008, in accordance with the terms of the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664.
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 (“Series E”) were exchanged into a 6% Subordinated Debenture (the “Debenture”) in an outstanding principal amount of $500,000. The Debenture has a fixed interest rate of 6% interest per annum to be paid annually on March 31st through maturity on March 31, 2011. Upon exchange into the Debenture, Deep Down recorded $113,589 in interest expense for the accretion up to face value. See the additional discussion of the terms of the Series E preferred stock at Note 6. Interest expense on the Debenture of approximately $7,479 has been recognized for the three and six months ended June 30, 2008.
NOTE 5: ACQUISITIONS
Purchase of Mako Technologies, Inc.
Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako. Two installments were paid to the Mako shareholders. The first installment of $2,916,667 in cash and 6,574,074 restricted shares of common stock of Deep Down, valued at $0.76 per share, was paid on January 4, 2008. The second installment of 2,802,969 restricted shares of common stock of Deep Down, valued at $0.70 per share, was issued on March 28, 2008. The final cash payment of $1,243,571, which was paid on April 11, 2008, was included in the “Payable to Mako shareholders” balance on the accompanying balance sheet at December 31, 2007.
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 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 from the purchase date.
The acquistion of Mako was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations” (“SFAS 141”) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Mako.
Purchase of Flotation Technologies, Inc.
On June 5, 2008, Deep Down completed the acquisition of 100% of the capital of Flotation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. The equity interest was acquired from the three individual shareholder members of the same family and related technology was acquired from an entity affiliated with the selling stockholders. No prior material relationship existed between the selling shareholders and Deep Down, any of our affiliates, or any of our directors or officers, or any associate of any of our officers or directors. Deep Down executed the definitive agreement to purchase Flotation on April 17, 2008 and effectively dated the acquisition for accounting purposes as of May 1, 2008. Deep Down announced the closing on June 6, 2008.
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 $23,895,830 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 $251,180. 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 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. Flotation’s selling shareholders used approximately $1,800,000 of the $22,100,000 cash received to pay outstanding debt of Flotation. The purchase price may be adjusted upward or downward, dependant on certain working capital targets.
Deep Down sold 57,142,857 shares to accredited investors on June 5, 2008, for approximately $37,059,670 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.
The table below reflects the breakdown of the purchase price as noted above:
| Summary of purchase price: | | | |
| Cash | | $ | 22,100,000 | |
| Certain transaction costs | | | 251,180 | |
| Fair market value of common stock | | | 1,422,857 | |
| Fair market value of warrants issued | | | 121,793 | |
| Total purchase price | | $ | 23,895,830 | |
The purchase price of $23,895,830 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 | | | 4,846,190 | |
| Intangibles | | | 14,797,000 | |
| Goodwill | | | 2,157,307 | |
| Total assets acquired | | $ | 25,028,143 | |
| | | | | |
| Accounts payable and accrued liabilities | | | 1,132,313 | |
| Total liabilities acquired | | $ | 1,132,313 | |
| Net assets acquired | | $ | 23,895,830 | |
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 $1,200,000 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 | | | Average Remaining | |
| | | 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 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 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 following unaudited pro forma combined condensed financial statements include Flotation and Mako for the periods presented as if the acquisitions had occurred on the first date of the respective periods and are presented for informational purposes only. These results are not necessarily indicative of the results of operations that actually would have been achieved had the acquisitions been consummated as of the beginning of the period presented, or are they intended to be a projection of future results. The unaudited pro forma results were as follows:
| Unaudited Pro Forma Combined Condensed Statements of Operations | |
| | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months ended June 30, 2008 | | For the Six Months ended June 30, 2008 | |
| | Historical | | | | | | | | Historical | | | | | | | |
| | | | One Month | | | | | | | | | | Four Months | | | | | | Combined | |
| | | | April 30, | | Flotation | | | | Combined | | | | April 30, | | Flotation | | | | Condensed | |
| | | | 2008 | | Pro Forma | | | | Pro Forma | | | | 2008 | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Flotation | | Entries | | | | Results | | Deep Down | | Flotation | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | | | | | |
| Revenues | $ | 7,920,196 | | $ | 1,064,364 | | $ | - | | | | $ | 8,984,560 | | $ | 14,199,661 | | $ | 5,941,472 | | $ | - | | | | $ | 20,141,133 | |
| Cost of sales | | 5,496,427 | | | 627,224 | | | - | | | | | 6,123,651 | | | 9,372,798 | | | 4,005,179 | | | - | | | | | 13,377,977 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 2,423,769 | | | 437,140 | | | - | | | | | 2,860,909 | | | 4,826,863 | | | 1,936,293 | | | - | | | | | 6,763,156 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 4,224,771 | | | 305,220 | | | 75,604 | | (d/e | ) | | 4,605,595 | | | 6,285,167 | | | 968,179 | | | 302,416 | | (d/e | ) | | 7,555,762 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | (1,801,002 | ) | | 131,920 | | | (75,604 | ) | | | | (1,744,686 | ) | | (1,458,304 | ) | | 968,114 | | | (302,416 | ) | | | | (792,606 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | (3,149,371 | ) | | (22,467 | ) | | - | | | | | (3,171,838 | ) | | (3,850,882 | ) | | (57,335 | ) | | - | | | | | (3,908,217 | ) |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | (4,950,373 | ) | | 109,453 | | | (75,604 | ) | | | | (4,916,524 | ) | | (5,309,186 | ) | | 910,779 | | | (302,416 | ) | | | | (4,700,823 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | 85,000 | | | - | | | (12,524 | ) | (f) | | | 72,476 | | | 354,366 | | | - | | | (225,094 | ) | (f) | | | 129,272 | |
| Net income (loss) | $ | (4,865,373 | ) | $ | 109,453 | | $ | (88,128 | ) | | | $ | (4,844,048 | ) | $ | (4,954,820 | ) | $ | 910,779 | | $ | (527,510 | ) | | | $ | (4,571,551 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | $ | (0.04 | ) | | | | | | | | | $ | (0.03 | ) | $ | (0.05 | ) | | | | | | | | | $ | (0.03 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 132,666,860 | | | | | | | | (g) | | | 174,707,676 | | | 109,326,053 | | | | | | | | (g) | | | 161,161,117 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | $ | (0.04 | ) | | | | | | | | | $ | (0.03 | ) | $ | (0.05 | ) | | | | | | | | | $ | (0.03 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 132,666,860 | | | | | | | | (g) | | | 174,707,676 | | | 109,326,053 | | | | | | | | (g) | | | 161,161,117 | |
The historical results of Deep Down for the three and six months ended June 30, 2008 contain two months of results for Flotation operations since its acquisition was effective May 1, 2008. 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 31, 2008 and the total of 58,857,143 common shares of Deep Down issued in June 2008; 57,142,857 in connection with the Private Placement, and 1,714,286 to Flotation shareholders, as if all these shares were issued January 1, 2008.
| Unaudited Pro Forma Combined Condensed Statement of Operations | |
| For the Three Months ended June 30, 2007 | |
| | | | | | | | | | | | | | | | Combined | |
| | Historical | | Mako | | | | Flotation | | | | Condensed | |
| | | | | | | | Pro Forma | | | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Mako | | Flotation | | Entries | | | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | |
| Revenues | $ | 5,144,788 | | $ | 1,768,876 | | $ | 1,329,446 | | $ | - | | | | $ | - | | | | $ | 8,243,110 | |
| Cost of sales | | 3,293,313 | | | 561,385 | | | 974,265 | | | - | | | | | - | | | | | 4,828,963 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 1,851,475 | | | 1,207,491 | | | 355,181 | | | - | | | | | - | | | | | 3,414,147 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 1,177,876 | | | 957,572 | | | 711,176 | | | 122,367 | | (a) | | | 226,811 | | (d/e | ) | | 3,195,802 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | 673,599 | | | 249,919 | | | (355,995 | ) | | (122,367 | ) | | | | (226,811 | ) | | | | 218,345 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | 723,230 | | | (28,571 | ) | | 1,399,087 | | | (266,269 | ) | (b) | | | - | | | | | 1,827,477 | |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | 1,396,829 | | | 221,348 | | | 1,043,092 | | | (388,636 | ) | | | | (226,811 | ) | | | | 2,045,822 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | (447,363 | ) | | (17,309 | ) | | - | | | 143,795 | | | | | (302,024 | ) | (f) | | | (622,901 | ) |
| Net income (loss) | $ | 949,466 | | $ | 204,039 | | $ | 1,043,092 | | $ | (244,841 | ) | | | $ | (528,835 | ) | | | $ | 1,422,921 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 67,870,171 | | | | | | | | | | | | | | | | (c/g | ) | | 136,104,357 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 93,799,839 | | | | | | | | | | | | | | | | (c/g | ) | | 162,034,025 | |
| Unaudited Pro Forma Combined Condensed Statement of Operation | |
| For the Six Months ended June 30, 2007 | |
| | | | | | | | | | | | | | | | Combined | |
| | Historical | | Mako | | | | Flotation | | | | Condensed | |
| | | | | | | | Pro Forma | | | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Mako | | Flotation | | Entries | | | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | |
| Revenues | $ | 7,243,182 | | $ | 2,618,805 | | $ | 2,351,057 | | $ | - | | | | $ | - | | | | $ | 12,213,044 | |
| Cost of sales | | 4,545,402 | | | 1,122,501 | | | 1,463,530 | | | - | | | | | - | | | | | 7,131,433 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 2,697,780 | | | 1,496,304 | | | 887,527 | | | - | | | | | - | | | | | 5,081,611 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 1,901,552 | | | 1,364,505 | | | 1,376,736 | | | 244,734 | | (a) | | | 453,624 | | (d/e | ) | | 5,341,151 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | 796,228 | | | 131,799 | | | (489,209 | ) | | (244,734 | ) | | | | (453,624 | ) | | | | (259,540 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | 491,343 | | | (46,545 | ) | | 1,390,538 | | | (532,391 | ) | (b) | | | - | | | | | 1,302,945 | |
Income (loss) from continuing operations | | 1,287,571 | | | 85,254 | | | 901,329 | | | (777,125 | ) | | | | (453,624 | ) | | | | 1,043,405 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Income tax expense | | (447,363 | ) | | (17,309 | ) | | - | | | 287,536 | | | | | (165,651 | ) | (f) | | | (342,787 | ) |
| Net income (loss) | $ | 840,208 | | $ | 67,945 | | $ | 901,329 | | $ | (489,589 | ) | | | $ | (619,275 | ) | | | $ | 700,618 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | - | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 74,417,132 | | | | | | | | | | | | | | | | (c/g | ) | | 142,651,318 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | - | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 100,315,405 | | | | | | | | | | | | | | | | (c/g | ) | | 168,549,591 | |
The unaudited pro forma combined condensed statements include the following pro forma assumptions and entries for Mako:
| a) | Amortization of the intangible assets at a rate of $40,789 per month for the respective periods. |
| b) | Represents cash interest plus amortization of deferred financing costs and debt discounts for the Credit Agreement. Interest is payable at 15.5% on the outstanding principal, and the related fees are 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. |
Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.
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 Inc.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 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. |
The table below reflects the assumptions used for warrant and option grants related to Flotation during the six months ended June 30, 2008:
| Risk free interest rate | 2.52% - 3.18% |
Consolidated Balance SheetsExpected life of options | 2 - 2.5 years |
| Expected volatility | 51.7% - 61.3% |
| | | December 31, 2007 | | | December 31, 2006 | |
| Assets | | | | | | |
| Cash and equivalents | | $ | 2,206,220 | | | $ | 12,462 | |
| Restricted cash | | | 375,000 | | | | - | |
| Accounts receivable, net of allowance of $139,787 and $81,809 | | | 7,190,466 | | | | 1,264,228 | |
| Prepaid expenses and other current assets | | | 312,058 | | | | 156,975 | |
| Inventory | | | 502,253 | | | | - | |
| Lease receivable, short term | | | 414,000 | | | | - | |
| Work in progress | | | 945,612 | | | | 916,485 | |
| Receivable from Prospect, net | | | 2,687,333 | | | | - | |
| Total current assets | | | 14,632,942 | | | | 2,350,150 | |
| Property and equipment, net | | | 5,172,804 | | | | 845,200 | |
| Other assets, net of accumulated amortization of $54,560 and $0 | | | 1,109,152 | | | | - | |
| Lease receivable, long term | | | 173,000 | | | | - | |
| Intangibles, net | | | 4,369,647 | | | | - | |
| Goodwill | | | 10,594,144 | | | | 6,934,213 | |
| Total assets | | $ | 36,051,689 | | | $ | 10,129,563 | |
| | | | | | | | | |
| Liabilities and Stockholders' Equity (Deficit) | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 3,569,826 | | | $ | 816,490 | |
| Deferred revenue | | | 188,030 | | | | 190,000 | |
| Payable to Mako Shareholders | | | 3,205,667 | | | | - | |
| Current portion of long-term debt | | | 995,177 | | | | 410,731 | |
| Total current liabilities | | | 7,958,700 | | | | 1,417,221 | |
| Long-term debt, net of accumulated discount of $1,703,258 and $0 | | | 10,698,818 | | | | 757,617 | |
| Series E redeemable exchangeable preferred stock, 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 | | | | | | | | |
| 500 and 5,000 issued and outstanding, respectively | | | 386,411 | | | | 3,486,376 | |
| Series G redeemable exchangeable preferred stock, 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 1,000 issued and outstanding, respectively | | | - | | | | 697,275 | |
| Total liabilities | | | 19,043,929 | | | | 6,358,489 | |
| | | | | | | | | |
| Temporary equity: | | | | | | | | |
| SeriSeries 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 5,000 issued and outstanding | | | 4,419,244 | | | | 4,419,244 | |
| SeriSeries F 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 of all series of Preferred stock -0- and 3,000 issued and outstanding, respectively | | | - | | | | 2,651,547 | |
| Total temporary equity | | | 4,419,244 | | | | 7,070,791 | |
| | | | | | | | | |
| Stockholders' equity (deficit): | | | | | | | | |
| Series C convertible preferred stock, $0.001 par value, 7% cumulative dividend, | | | | | | | | |
| authorized 10,000,000 aggregate shares of all series of Preferred stock | | | | | | | | |
| -0- and 22,000 shares issued and outstanding, respectively | | | - | | | | 22 | |
| Common stock, $0.001 par value, 490,000,000 shares authorized, 85,976,526 | | | | | | | | |
| and 82,870,171 shares issued and outstanding, respectively | | | 85,977 | | | | 82,870 | |
| Paid in capital | | | 14,849,847 | | | | (82,792 | ) |
| Accumulated deficit | | | (2,347,308 | ) | | | (3,299,817 | ) |
| Total stockholders' equity (deficit) | | | 12,588,516 | | | | (3,299,717 | ) |
| Total liabilities and stockholders' equity | | $ | 36,051,689 | | | $ | 10,129,563 | |
Series D Redeemable Convertible Preferred Stock Classified as Temporary Equity Instruments
On March 28, 2008, the outstanding 5,000 shares of Series D redeemable convertible preferred stock (“Series D”) were converted into 25,866,518 restricted 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.
Exchange of Series E Redeemable Exchangeable Preferred Stock Classified as Debt Instruments to 6% Subordinated Debenture
On March 31, 2008, 500 shares of the Series E Preferred Stock were exchanged into the 6% 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 6% Subordinated Debenture due three years from the date of the exchange. See additional discussion of the Debenture in Note 4.
NOTE 7: COMMON STOCK
Private Placement
See accompanying notesOn June 5, 2008, Deep Down sold 57,142,857 shares, for $40,000,000 at a per-share price of $0.70. After transaction costs, net proceeds were $37,059,670. Dahlman Rose & Company, LLC acted as exclusive placement agent for the financing.
Deep Down used $22,100,000 of the net proceeds to consolidated financial statements.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, with the remainder being retained for working capital purposes.
In connection with the private placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep Down filed an S-1 Registration Statement on July 21, 2008. If the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), then for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective, Deep Down shall be required to pay daily damages to the purchasers. Deep Down evaluated the registration rights agreement for liability treatment under Financial Accounting Standards Board (“FASB”) Statement No. 5, “Accounting for Contingencies” and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights did not meet the definition of a liability under the authoritative guidance since management believes the liability is not estimable at this time.
NOTE 8: STOCK BASED COMPENSATION AND WARRANTS
Deep Down, Inc. | |
Consolidated Statements of Operations | |
For the Year Ended December 31, 2007 and | |
For the Period Since Inception (June 29, 2006) to December 31, 2006 | |
Deep Down has a stock based compensation plan - the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). We account for stock-based compensation expense under Statement of Financial Accounting (“SFAS”) No. 123 (Revised 2004), “Share-based Payment,” (“SFAS No. 123(R)”). The exercise price of the options, as well as the vesting period, is established by Deep Down’s Board of Directors. 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% of issued and outstanding common shares. During the six months ended June 30, 2008, Deep Down granted 4,200,000 options and 1,200,000 shares of restricted stock and cancelled 875,000 options due to forfeitures under the Plan. Based on the shares of common stock outstanding at June 30, 2008, there are approximately 16,235,000 options available for grant under the Plan as of that date.
Restricted Stock
On February 14, 2008, Deep Down issued an aggregate of 1,200,000 shares of restricted common stock to Ronald E. Smith, CEO; Robert E. Chamberlain, Chairman; and Eugene L. Butler, CFO under terms of the Plan. The shares were valued at a price of $0.42 based on the closing price of common stock on that date. The shares vest on the second anniversary of the grant date, and Deep Down is amortizing the related stock based compensation of $504,000 over the 2 year period. For the six months ended June 30, 2008 Deep Down recognized a total of $94,500 in stock based compensation related to these issued shares of restricted stock.
The following table summarizes Deep Down’s restricted stock activity for the six months ended June 30, 2008:
| | | | | | From Inception | |
| | | Year Ended | | | June 29, 2006 to | |
| | | December 31, 2007 | | | December 31, 2006 | |
| | | | | | | |
| Revenues | | | | | | |
| Contract revenue | | $ | 15,652,848 | | | $ | 978,047 | |
| Rental revenue | | | 3,736,882 | | | | - | |
| | | | | | | | | |
| Total revenues | | | 19,389,730 | | | | 978,047 | |
| Cost of sales | | | 13,020,369 | | | | 565,700 | |
| | | | | | | | | |
| Gross profit | | | 6,369,361 | | | | 412,347 | |
| | | | | | | | | |
| Operating expenses: | | | | | | | | |
| Selling, general & administrative | | | 4,284,553 | | | | 3,600,627 | |
| Depreciation and amortization | | | 426,964 | | | | 27,161 | |
| | | | | | | | | |
| Total operating expenses | | | 4,711,517 | | | | 3,627,788 | |
| | | | | | | | | |
| Operating income (loss) | | | 1,657,844 | | | | (3,215,441 | ) |
| | | | | | | | | |
| Other income (expense): | | | | | | | | |
| Gain on debt extinguishment | | | 2,000,000 | | | | - | |
| Interest income | | | 94,487 | | | | - | |
| Interest expense | | | (2,430,149 | ) | | | (62,126 | ) |
| | | | | | | | | |
| Total other income (expense) | | | (335,662 | ) | | | (62,126 | ) |
| | | | | | | | | |
| Income (loss) before income taxes | | | 1,322,182 | | | | (3,277,567 | ) |
| | | | | | | | | |
| Income tax expense | | | (369,673 | ) | | | (22,250 | ) |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) |
| | | | | | | | | |
| | | | | | | | | |
| Basic earnings (loss) per share | | $ | 0.01 | | | $ | (0.04 | ) |
| Weighted-average shares outstanding, basic | | | 73,917,190 | | | | 76,701,569 | |
| | | | | | | | | |
| Diluted earnings (loss) per share | | $ | 0.01 | | | $ | (0.04 | ) |
| Weighted-average shares outstanding, fully-diluted | | | 104,349,455 | | | | 76,701,569 | |
| | | Restricted Shares | | | Weighted- Average Grant Price | | | Aggregate Intrinsic Value | |
| Outstanding at December 31, 2007 | | | - | | | | | | | |
| Grants | | | 1,200,000 | | | $ | 0.42 | | | | |
| Outstanding at June 30,2008 | | | 1,200,000 | | | $ | 0.42 | | | $ | 624,000 | |
During the six months ended June 30, 2008, Deep Down granted 4,200,000 options under the Plan as detailed below. On June 17, 2008, a cashless exercise of 50,000 employee stock options for 29,339 net common shares was issued in accordance with terms of the Plan.
During the six months ended June 30, 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 days’ closing prices. The fair value of such options was approximately $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 price of $1.50, which was in excess of the day’s closing price of $0.42. The fair value of such options was approximately $145,764 based on the Black-Scholes option pricing model.
See accompanying notesAdditionally, on January 22, 2008, Deep Down issued 250,000 stock options to consolidated financial statements.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.
Summary of Stock Options
Deep Down is expensing all stock options on a straight line basis over their respective expected service periods. The total stock based compensation expense for the six months ended June 30, 2008 and June 30, 2007, was $159,169 and $39,565, respectively. The unamortized portion of the estimated fair value of outstanding stock options is $949,885 at June 30, 2008.
The following table summarizes Deep Down’s stock option activity for the six months ended June 30, 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, 2007 | | 5,500,000 | | $ | 0.58 | | | | | |
| Grants | | 4,200,000 | | | 1.35 | | | | | |
| Exercises | | (50,000 | ) | | 0.50 | | | | | |
| Forfeitures | | (875,000 | ) | | 0.74 | | | | | |
| Outstanding at June 30,2008 | | 8,775,000 | | $ | 0.93 | | | 3.0 | | $ | 1,944,750 | |
| Exerciseable at June 30,2008 | | 1,970,834 | | $ | 0.60 | | | 2.7 | | $ | 729,292 | |
The following summarizes Deep Down’s outstanding options and their respective exercise prices at June 30, 2008:
Deep Down, Inc.Exercise Price | | Shares Underlying Options | |
Statements of Stockholders' Equity$ | 0.30 - 0.49 | | | 175,000 | |
For the Year Ended December 31, 2007 and$ | 0.50 - 0.69 | | | 4,125,000 | |
For the Period Since Inception (June 29, 2006) to December 31, 2006$ | 0.70 - 0.99 | | | 525,000 | |
| $ | 1.00 - 1.29 | | | 950,000 | |
| $ | 1.30 - 1.50 | | | 3,000,000 | |
| | | | 8,775,000 | |
| | | Common Stock | | | Series C Preferred Stock | | | Paid-in | | | Retained | | | | |
| | | Shares | | | Amount | | | Shares | | | Amount | | | Capital | | | Earnings | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance at June 29, 2006 (inception) (a) | | | 75,000,000 | | | $ | 75,000 | | | | - | | | $ | - | | | $ | (74,900 | ) | | $ | - | | | $ | 100 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | | - | | | | - | | | | - | | | | - | | | | - | | | | (3,299,817 | ) | | | (3,299,817 | ) |
| Reverse merger with MediQuip (a) | | | 7,870,171 | | | | 7,870 | | | | 22,000 | | | | 22 | | | | (7,892 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2006 | | | 82,870,171 | | | | 82,870 | | | | 22,000 | | | | 22 | | | | (82,792 | ) | | $ | (3,299,817 | ) | | | (3,299,717 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | | - | | | | - | | | | - | | | | - | | | | - | | | | 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 | | | 85,976,526 | | | $ | 85,977 | | | | - | | | $ | - | | | $ | 14,849,847 | | | $ | (2,347,308 | ) | | $ | 12,588,516 | |
(a) Shares were stated at par value| Dividend yield | 0% |
| Risk free interest rate | 2.64% - 2.84% |
| Expected life of options | 3 years |
| Expected volatility | 53.3% - 63.3% |
Summary of $0.01 in error, the correct par value of $0.001 is reflected,Warrants
In connection with the offsetpurchase of Flotation, warrants to Paid-in Capitalpurchase 200,000 common shares at $0.70 per share were issued to an entity affiliated with the selling stockholders 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 related to Flotation.
See accompanying notesOn August 6, 2007, as part of the Credit Agreement described above in Note 4, Deep Down issued 4,960,585 detachable warrants to consolidated financial statements.its creditor. All warrants were issued with an exercise price of $0.507, expired in five years (or earlier in the event of termination) and vested on the earlier of the second anniversary of the agreement or upon payment in full of the debt. On July 3, 2008, the creditor exercised all of its outstanding 4,960,585 warrants for a total of 2,618,129 restricted shares of Deep Down common stock in a cashless exercise.
Additionally, related to the Credit Agreement described in Note 4, Deep Down issued 320,000 detachable warrants at an exercise price of $0.75 per share to a third party related to the financing. The warrant has a five-year term and became exercisable in connection with the early payoff of the debt. Also, in connection with the Amendment to the Credit Agreement, Deep Down issued detachable warrants to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share to the same third party. The warrant has a five-year term and was immediately exercisable. See the additional discussion concerning such warrants in Note 4.
A summary of warrant transactions follows:
| | Shares Underlying Warrants | | Weighted- Average Exercise Price | | Weighted- Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (In-The-Money) | |
| Outstanding at December 31, 2007 | | 5,399,397 | | $ | 0.53 | | | | | |
| Grants | | 200,000 | | | 0.70 | | | | | |
| Outstanding at June 30,2008 | | 5,599,397 | | $ | 0.54 | | | 4.4 | | $ | 2,241,852 | |
| Exerciseable at June 30,2008 | | 5,399,397 | | $ | 0.54 | | | 4.4 | | $ | 2,193,852 | |
The following summarizes Deep Down’s outstanding warrants and their respective exercise prices at June 30, 2008:
| Exercise Price | | Shares Underlying Warrants | |
| $ | 0.51 | | | 4,960,585 | |
| $ | 0.70 - 0.99 | | | 520,000 | |
| $ | 1.01 | | | 118,812 | |
| | | | | 5,599,397 | |
The fair value of each 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 six months ended June 30, 2008:
Deep Down, Inc.Dividend yield | 0% |
Consolidated Statement of Cash FlowsRisk free interest rate | 2.52% - 3.18% |
For the Year Ended December 31, 2007 andExpected life of options | 2 - 2.5 years |
For the Period Since Inception (June 29, 2006) to December 31, 2006Expected volatility | 51.7% - 61.3% |
| | | | | | | | | |
| | | | For the Year Ended December 31, 2007 | | | | From Inception June 29, 2006 to December 31, 2006 | |
| Cash flows from operating activities: | | | | | | | | |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) |
| Adjustments to reconcile net income to net cash | | | | | | | | |
| used in operating activities: | | | | | | | | |
| Gain on extinguishment of debt | | | (2,000,000 | ) | | | - | |
| Amortization of debt discount | | | 1,780,922 | | | | 48,179 | |
| Amortization of deferred financing costs | | | 54,016 | | | | - | |
| Share-based compensation | | | 187,394 | | | | 3,340,792 | |
| Allowance for doubtful accounts | | | 108,398 | | | | - | |
| Depreciation and amortization | | | 426,964 | | | | 27,163 | |
| Gain on disposal of equipment | | | 24,336 | | | | - | |
| Changes in assets and liabilities: | | | | | | | | |
| Lease receivable | | | (863,000 | ) | | | - | |
| Accounts receivable | | | (4,388,146 | ) | | | (251,001 | ) |
| Prepaid expenses and other current assets | | | (54,310 | ) | | | 23,335 | |
| Inventory | | | (502,253 | ) | | | - | |
| Work in progress | | | 246,278 | | | | (90,326 | ) |
| Accounts payable and accrued liabilities | | | 1,022,726 | | | | 145,433 | |
| Deferred revenue | | | (1,970 | ) | | | - | |
| | | | | | | | | |
| Net cash used in operating activities | | | (3,006,136 | ) | | | (56,242 | ) |
| | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | |
| Cash acquired in acquisition of a business | | | 261,867 | | | | 101,497 | |
| 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 | | | (830,965 | ) | | | - | |
| Restricted cash | | | (375,000 | ) | | | - | |
| | | | | | | | | |
| Net cash (used in) provided by investing activities | | | (1,358,429 | ) | | | 101,497 | |
| | | | | | | | | |
| 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 | | | 3,960,000 | | | | - | |
| Proceeds from sales-type lease | | | 276,000 | | | | - | |
| Borrowings on debt - related party | | | (150,000 | ) | | | - | |
| Payments on debt - related party | | | 150,000 | | | | - | |
| Borrowings on long-term debt | | | 6,204,779 | | | | - | |
| Deferred financing fees | | | (442,198 | ) | | | - | |
| Prepaid points | | | (180,000 | ) | | | - | |
| Payments of long-term debt | | | (2,760,258 | ) | | | (32,893 | ) |
| | | | | | | | | |
| Net cash provided by (used in) financing activities | | | 6,558,323 | | | | (32,893 | ) |
| | | | | | | | | |
| Change in cash and equivalents | | | 2,193,758 | | | | 12,362 | |
| Cash and equivalents at beginning of year | | | 12,462 | | | | 100 | |
| | | | | | | | | |
| Cash and equivalents at end of period | | $ | 2,206,220 | | | $ | 12,462 | |
Litigation
We are from time to time involved in legal proceedings arising in the normal course of business. As of the date of this Quarterly Report on Form 10-Q, there are no pending or threatened material legal proceedings.
Operating Leases
Deep Down leases land under an operating lease and is responsible for related maintenance, insurance and property taxes. On May 1, 2008, Deep Down and JUMA, LLC, a related party, amended the original lease that began as of September, 2006 to provide for the additional acreage leased resulting in a $4,000 per month increase in rent. See accompanying notesNote 10 below for further discussion of the related party.
NOTE 10: RELATED PARTY TRANSACTIONS
Deep Down leases all buildings, structures, fixtures and other improvements at the Channelview, Texas location from JUMA, LLC, a company owned by Ronald E. Smith, CEO and a director of Deep Down and Mary L. Budrunas, a vice president and a director of Deep Down. The base rate of $15,000 per month is payable to consolidated financial statements.JUMA 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 shares 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.
During the six months ended June 30, 2008, Deep Down granted an aggregate of 1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock options to Ronald E. Smith, President and Chief Executive Officer, Robert E. Chamberlain, Jr., Chairman and Chief Acquisition Officer, and Eugene L. Butler, Chief Financial Officer, under the terms of the Deep Down, Inc. Stock Option Plan. Deep Down also awarded in recognition of their completion of the acquisition of Flotation and private placement of common stock, a performance bonus of $300,000 in the aggregate.
NOTE 11: SUBSEQUENT EVENTS
Deep Down, Inc. |
Consolidated Statements of Cash Flows |
For the Year Ended December 31, 2007 and |
For the Period Since Inception (June 29, 2006) to December 31, 2006
|
| | | | | | From Inception | |
| | | Year Ended | | June 29, 2006 to | |
| | | December 31, 2007 | | December 31, 2006 | |
| | | | | | | |
| Supplemental schedule of noncash investing | | | | | | |
| and financing activities: | | | | | | |
| Acquisition of a business – Electrowave | | $ | (190,381 | ) | | $ | - | |
| Exchange of receivables for acquisition of a business | | $ | 171,407 | | | $ | - | |
| Acquisition of a business – Mako | | $ | 280,680 | | | $ | - | |
| Net receivable from lender-Prospect Capital | | $ | 2,687,333 | | | $ | - | |
| Transfer work in progress to fixed assets | | $ | 110,181 | | | $ | - | |
| Fixed assets purchased with capital lease | | $ | 525,000 | | | $ | - | |
| Exchange of preferred stock | | $ | 3,366,778 | | | $ | - | |
| Redemption of preferred stock | | $ | 4,935,463 | | | $ | - | |
| Common stock issued for notes payable | | $ | 560,000 | | | $ | - | |
| Creation of debt discount due to warrants issued to lender | | $ | 1,479,189 | | | $ | - | |
| Creation of deferred financing cost due to warrants issued to third party | | $ | 159,066 | | | $ | - | |
| | | | | | | | | |
| Supplemental Disclosures: | | | | | | | | |
| Cash paid for interest | | $ | 594,667 | | | $ | - | |
| Cash paid for taxes | | $ | 114,970 | | | $ | - | |
See accompanying notes to consolidated financial statements.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.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Note 1: Nature of Business and Summary of Significant Accounting Policies
Nature of Business
Deep Down, Inc., a Nevada corporation (“Deep Down Nevada” or “Deep Down” or the “Company”), is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), Mako Technologies, LLC (“Mako”), a Nevada limited liability company, and Flotation Technologies, Inc. (“Flotation”), a Maine corporation. The results of Flotation are included in the consolidated financial statements herein effective May 1, 2008, the effective date of acquisition for accounting purposes.
Deep Down Delaware provides installation management, engineering services, support services and storage management services for the subsea controls, umbilicals and offshore pipeline industries. Deep Down Delaware also fabricates component parts for subsea distribution systems and assemblies.
ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, marine and commercial business sectors.
Mako serves the growing offshore petroleum and marine industries with technical support services and products vital 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.
Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers. Flotation’s product offerings include distributed buoyancy for flexible pipes 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™ cable and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of any size and depth rating.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X relating to smaller reporting companies. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008. The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
For further information, refer to the audited consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-KSB/A (Amendment No. 3) for the year ended December 31, 2007 filed on August 8, 2008.
Prior period information presented in these financial statements includes reclassifications which were made to conform such information to the current period presentation. These reclassifications had no material effect on our previously reported net loss or stockholders' equity.
Principles of Consolidation
The unaudited consolidated financial statements include the accounts of Deep Down’s wholly-owned subsidiaries after the elimination of significant intercompany accounts and transactions.
NOTE 2: ACCOUNTS RECEIVABLE
Accounts receivable includes an allowance for uncollectible accounts of $818,992 and $139,787 as of June 30, 2008 and December 31, 2007, respectively. Bad debt expense totaled $832,328 and $11,555 for the six months ended June 30, 2008 and June 30, 2007, respectively.
NOTE 3: PROPERTY AND EQUIPMENT
Property and equipment include the following:
| | | June 30, 2008 | | | December 31, 2007 | |
| Land | | $ | 2,270,439 | | | $ | 13,148 | |
| Building | | | 1,246,072 | | | | 182,156 | |
| Furniture and fixtures | | | 139,044 | | | | 63,777 | |
| Vehicles and trailers | | | 99,837 | | | | 112,162 | |
| Leasehold improvements | | | 301,919 | | | | 75,149 | |
| Equipment | | | 3,834,594 | | | | 2,004,167 | |
| Rental Equipment | | | 3,659,714 | | | | 3,144,559 | |
| Total | | | 11,551,619 | | | | 5,595,117 | |
| Less: Accumulated depreciation | | | (900,566 | ) | | | (422,314 | ) |
| Property and equipment, net | | $ | 10,651,053 | | | $ | 5,172,804 | |
Depreciation expense for the six months ended June 30, 2008 and June 30, 2007 was approximately $505,063 and $154,221, respectively.
To accommodate our growth in operations during the six months ended June 30, 2008, we leased additional property from JUMA and incurred $98,139 in leasehold improvements to stabilize the ground and prepare the surface for the movement and storage of the heavy equipment we manufacture and rent at our corporate headquarters.
In connection with the purchase of Flotation, Deep Down acquired land along with a building and improvements with a fair market value of $3,264,100 which houses its 46,925 square foot light industrial manufacturing facility on a 3.61 acre site in Maine.
On June 30, 2008, Deep Down transferred equipment with a cost basis of $502,253 from inventory to its rental equipment fleet.
NOTE 4: LONG-TERM DEBT
The following table summarizes long-term debt:
| | | June 30, 2008 | | | December 31, 2007 | |
| Secured credit agreement with Prospect Capital Corporation | | | | | | |
| quarterly principal payments of $250,000 beginning | | | | | | |
| September 30, 2008; monthly interest payments, | | | | | | |
| interest fixed at 15.5%; balance due August 2011; | | | | | | |
| secured by all assets | | $ | - | | | $ | 12,000,000 | |
| Debt discount, net of amortization of $254,101 and $135,931 respectively | | | - | | | | (1,703,258 | ) |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 8.25% per annum, | | | | | | | | |
| maturing June 10, 2008, cross-collateralized | | | | | | | | |
| by Mako assets, paid January 2008. | | | - | | | | 289,665 | |
| Note payable to a bank, payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing September 28, 2010, collateralized by Mako | | | | | | | | |
| life insurance policy and equipment, paid January 2008. | | | - | | | | 320,027 | |
| Revolving line-of-credit of $500,000 from a bank, | | | | | | | | |
| matured October 13, 2007 or on demand, interest rate is | | | | | | | | |
| at a variable rate resulting in a rate of 8.30% as of | | | | | | | | |
| September 30, 2007, collateralized by Mako equipment, | | | | | | | | |
| paid January 2008. | | | - | | | | 151,705 | |
| Note payable to a bank payable in monthly | | | | | | | | |
| installments bearing interest at 7.85% per annum, | | | | | | | | |
| maturing January 25, 2011, collateralized by Mako | | | | | | | | |
| equipment and life insurance policy, paid January 2008 | | | - | | | | 154,647 | |
| Total secured credit agreement and bank debt | | | - | | | | 11,212,786 | |
| 6% Subordinated Debenture beginning March 31, 2008; annual | | | | | | | - | |
| interest payments, interest fixed at 6%; matures March 31, 2011 | | | 507,479 | | | | - | |
| Capital lease of equipment, monthly lease payments, | | | | | | | | |
| interest imputed at 11.2% | | | 459,379 | | | | 481,209 | |
| Total long-term debt | | | 966,858 | | | | 11,693,995 | |
| Current portion of long-term debt | | | (47,477 | ) | | | (995,177 | ) |
| Long-term debt, net of current portion | | $ | 919,381 | | | $ | 10,698,818 | |
Secured Credit Agreement
On August 6, 2007, Deep Down entered into a $6.5 million secured credit agreement, (the “Credit Agreement”) with Prospect Capital Corporation, (“Prospect”) and received an advance of $6.0 million 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. Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through June 2008.
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 from $6.5 million to $13.0 million. Amounts borrowed were $6.0 million. Quarterly principal payments increased to $250,000 beginning September 30, 2008. Cash interest paid for the three and six months ended June 30, 2008 was $361,667 and $821,500, respectively. Under the Credit Agreement, Deep Down was required to meet certain covenants and restrictions as well as maintain a debt service reserve account. As of December 31, 2007, $375,000 is separately classified as “Restricted cash” on the accompanying balance sheets.
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, $216,000 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 warrant was issued to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share.
On June 12, 2008, Deep Down paid $12,492,912 to Prospect to pay 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 approximately $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.
In January 2008, in accordance with the terms of the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664.
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 (“Series E”) were exchanged into a 6% Subordinated Debenture (the “Debenture”) in an outstanding principal amount of $500,000. The Debenture has a fixed interest rate of 6% interest per annum to be paid annually on March 31st through maturity on March 31, 2011. Upon exchange into the Debenture, Deep Down recorded $113,589 in interest expense for the accretion up to face value. See the additional discussion of the terms of the Series E preferred stock at Note 6. Interest expense on the Debenture of approximately $7,479 has been recognized for the three and six months ended June 30, 2008.
NOTE 5: ACQUISITIONS
Purchase of Mako Technologies, Inc.
Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako. Two installments were paid to the Mako shareholders. The first installment of $2,916,667 in cash and 6,574,074 restricted shares of common stock of Deep Down, valued at $0.76 per share, was paid on January 4, 2008. The second installment of 2,802,969 restricted shares of common stock of Deep Down, valued at $0.70 per share, was issued on March 28, 2008. The final cash payment of $1,243,571, which was paid on April 11, 2008, was included in the “Payable to Mako shareholders” balance on the accompanying balance sheet at December 31, 2007.
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 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 from the purchase date.
The acquistion of Mako was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations” (“SFAS 141”) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Mako.
Purchase of Flotation Technologies, Inc.
On June 5, 2008, Deep Down completed the acquisition of 100% of the capital of Flotation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. The equity interest was acquired from the three individual shareholder members of the same family and related technology was acquired from an entity affiliated with the selling stockholders. No prior material relationship existed between the selling shareholders and Deep Down, any of our affiliates, or any of our directors or officers, or any associate of any of our officers or directors. Deep Down executed the definitive agreement to purchase Flotation on April 17, 2008 and effectively dated the acquisition for accounting purposes as of May 1, 2008. Deep Down announced the closing on June 6, 2008.
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 $23,895,830 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 $251,180. 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 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. Flotation’s selling shareholders used approximately $1,800,000 of the $22,100,000 cash received to pay outstanding debt of Flotation. The purchase price may be adjusted upward or downward, dependant on certain working capital targets.
Deep Down sold 57,142,857 shares to accredited investors on June 5, 2008, for approximately $37,059,670 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.
The table below reflects the breakdown of the purchase price as noted above:
| Summary of purchase price: | | | |
| Cash | | $ | 22,100,000 | |
| Certain transaction costs | | | 251,180 | |
| Fair market value of common stock | | | 1,422,857 | |
| Fair market value of warrants issued | | | 121,793 | |
| Total purchase price | | $ | 23,895,830 | |
The purchase price of $23,895,830 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 | | | 4,846,190 | |
| Intangibles | | | 14,797,000 | |
| Goodwill | | | 2,157,307 | |
| Total assets acquired | | $ | 25,028,143 | |
| | | | | |
| Accounts payable and accrued liabilities | | | 1,132,313 | |
| Total liabilities acquired | | $ | 1,132,313 | |
| Net assets acquired | | $ | 23,895,830 | |
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 $1,200,000 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 | | | Average Remaining | |
| | | 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 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 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 following unaudited pro forma combined condensed financial statements include Flotation and Mako for the periods presented as if the acquisitions had occurred on the first date of the respective periods and are presented for informational purposes only. These results are not necessarily indicative of the results of operations that actually would have been achieved had the acquisitions been consummated as of the beginning of the period presented, or are they intended to be a projection of future results. The unaudited pro forma results were as follows:
| Unaudited Pro Forma Combined Condensed Statements of Operations | |
| | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months ended June 30, 2008 | | For the Six Months ended June 30, 2008 | |
| | Historical | | | | | | | | Historical | | | | | | | |
| | | | One Month | | | | | | | | | | Four Months | | | | | | Combined | |
| | | | April 30, | | Flotation | | | | Combined | | | | April 30, | | Flotation | | | | Condensed | |
| | | | 2008 | | Pro Forma | | | | Pro Forma | | | | 2008 | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Flotation | | Entries | | | | Results | | Deep Down | | Flotation | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | | | | | |
| Revenues | $ | 7,920,196 | | $ | 1,064,364 | | $ | - | | | | $ | 8,984,560 | | $ | 14,199,661 | | $ | 5,941,472 | | $ | - | | | | $ | 20,141,133 | |
| Cost of sales | | 5,496,427 | | | 627,224 | | | - | | | | | 6,123,651 | | | 9,372,798 | | | 4,005,179 | | | - | | | | | 13,377,977 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 2,423,769 | | | 437,140 | | | - | | | | | 2,860,909 | | | 4,826,863 | | | 1,936,293 | | | - | | | | | 6,763,156 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 4,224,771 | | | 305,220 | | | 75,604 | | (d/e | ) | | 4,605,595 | | | 6,285,167 | | | 968,179 | | | 302,416 | | (d/e | ) | | 7,555,762 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | (1,801,002 | ) | | 131,920 | | | (75,604 | ) | | | | (1,744,686 | ) | | (1,458,304 | ) | | 968,114 | | | (302,416 | ) | | | | (792,606 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | (3,149,371 | ) | | (22,467 | ) | | - | | | | | (3,171,838 | ) | | (3,850,882 | ) | | (57,335 | ) | | - | | | | | (3,908,217 | ) |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | (4,950,373 | ) | | 109,453 | | | (75,604 | ) | | | | (4,916,524 | ) | | (5,309,186 | ) | | 910,779 | | | (302,416 | ) | | | | (4,700,823 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | 85,000 | | | - | | | (12,524 | ) | (f) | | | 72,476 | | | 354,366 | | | - | | | (225,094 | ) | (f) | | | 129,272 | |
| Net income (loss) | $ | (4,865,373 | ) | $ | 109,453 | | $ | (88,128 | ) | | | $ | (4,844,048 | ) | $ | (4,954,820 | ) | $ | 910,779 | | $ | (527,510 | ) | | | $ | (4,571,551 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | $ | (0.04 | ) | | | | | | | | | $ | (0.03 | ) | $ | (0.05 | ) | | | | | | | | | $ | (0.03 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 132,666,860 | | | | | | | | (g) | | | 174,707,676 | | | 109,326,053 | | | | | | | | (g) | | | 161,161,117 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | $ | (0.04 | ) | | | | | | | | | $ | (0.03 | ) | $ | (0.05 | ) | | | | | | | | | $ | (0.03 | ) |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 132,666,860 | | | | | | | | (g) | | | 174,707,676 | | | 109,326,053 | | | | | | | | (g) | | | 161,161,117 | |
The historical results of Deep Down for the three and six months ended June 30, 2008 contain two months of results for Flotation operations since its acquisition was effective May 1, 2008. 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 31, 2008 and the total of 58,857,143 common shares of Deep Down issued in June 2008; 57,142,857 in connection with the Private Placement, and 1,714,286 to Flotation shareholders, as if all these shares were issued January 1, 2008.
| Unaudited Pro Forma Combined Condensed Statement of Operations | |
| For the Three Months ended June 30, 2007 | |
| | | | | | | | | | | | | | | | Combined | |
| | Historical | | Mako | | | | Flotation | | | | Condensed | |
| | | | | | | | Pro Forma | | | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Mako | | Flotation | | Entries | | | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | |
| Revenues | $ | 5,144,788 | | $ | 1,768,876 | | $ | 1,329,446 | | $ | - | | | | $ | - | | | | $ | 8,243,110 | |
| Cost of sales | | 3,293,313 | | | 561,385 | | | 974,265 | | | - | | | | | - | | | | | 4,828,963 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 1,851,475 | | | 1,207,491 | | | 355,181 | | | - | | | | | - | | | | | 3,414,147 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 1,177,876 | | | 957,572 | | | 711,176 | | | 122,367 | | (a) | | | 226,811 | | (d/e | ) | | 3,195,802 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | 673,599 | | | 249,919 | | | (355,995 | ) | | (122,367 | ) | | | | (226,811 | ) | | | | 218,345 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | 723,230 | | | (28,571 | ) | | 1,399,087 | | | (266,269 | ) | (b) | | | - | | | | | 1,827,477 | |
| Income (loss) from | | | | | | | | | | | | | | | | | | | | | | |
| continuing operations | | 1,396,829 | | | 221,348 | | | 1,043,092 | | | (388,636 | ) | | | | (226,811 | ) | | | | 2,045,822 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | (447,363 | ) | | (17,309 | ) | | - | | | 143,795 | | | | | (302,024 | ) | (f) | | | (622,901 | ) |
| Net income (loss) | $ | 949,466 | | $ | 204,039 | | $ | 1,043,092 | | $ | (244,841 | ) | | | $ | (528,835 | ) | | | $ | 1,422,921 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings (loss) per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 67,870,171 | | | | | | | | | | | | | | | | (c/g | ) | | 136,104,357 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings (loss) per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | 0.01 | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 93,799,839 | | | | | | | | | | | | | | | | (c/g | ) | | 162,034,025 | |
| Unaudited Pro Forma Combined Condensed Statement of Operation | |
| For the Six Months ended June 30, 2007 | |
| | | | | | | | | | | | | | | | Combined | |
| | Historical | | Mako | | | | Flotation | | | | Condensed | |
| | | | | | | | Pro Forma | | | | Pro Forma | | | | Pro Forma | |
| | Deep Down | | Mako | | Flotation | | Entries | | | | Entries | | | | Results | |
| | | | | | | | | | | | | | | | | |
| Revenues | $ | 7,243,182 | | $ | 2,618,805 | | $ | 2,351,057 | | $ | - | | | | $ | - | | | | $ | 12,213,044 | |
| Cost of sales | | 4,545,402 | | | 1,122,501 | | | 1,463,530 | | | - | | | | | - | | | | | 7,131,433 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | 2,697,780 | | | 1,496,304 | | | 887,527 | | | - | | | | | - | | | | | 5,081,611 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | 1,901,552 | | | 1,364,505 | | | 1,376,736 | | | 244,734 | | (a) | | | 453,624 | | (d/e | ) | | 5,341,151 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | 796,228 | | | 131,799 | | | (489,209 | ) | | (244,734 | ) | | | | (453,624 | ) | | | | (259,540 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total other income (expense) | | 491,343 | | | (46,545 | ) | | 1,390,538 | | | (532,391 | ) | (b) | | | - | | | | | 1,302,945 | |
Income (loss) from continuing operations | | 1,287,571 | | | 85,254 | | | 901,329 | | | (777,125 | ) | | | | (453,624 | ) | | | | 1,043,405 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Income tax expense | | (447,363 | ) | | (17,309 | ) | | - | | | 287,536 | | | | | (165,651 | ) | (f) | | | (342,787 | ) |
| Net income (loss) | $ | 840,208 | | $ | 67,945 | | $ | 901,329 | | $ | (489,589 | ) | | | $ | (619,275 | ) | | | $ | 700,618 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | - | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| basic per share amounts | | 74,417,132 | | | | | | | | | | | | | | | | (c/g | ) | | 142,651,318 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings per share | $ | 0.01 | | | | | | | | | | | | | | | | | | $ | - | |
| Shares used in computing | | | | | | | | | | | | | | | | | | | | | | |
| diluted per share amounts | | 100,315,405 | | | | | | | | | | | | | | | | (c/g | ) | | 168,549,591 | |
The unaudited pro forma combined condensed statements include the following pro forma assumptions and entries for Mako:
| a) | Amortization of the intangible assets at a rate of $40,789 per month for the respective periods. |
| b) | Represents cash interest plus amortization of deferred financing costs and debt discounts for the Credit Agreement. Interest is payable at 15.5% on the outstanding principal, and the related fees are 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. |
Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.
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 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. |
The table below reflects the assumptions used for warrant and option grants related to Flotation during the six months ended June 30, 2008:
| Risk free interest rate | 2.52% - 3.18% |
| Expected life of options | 2 - 2.5 years |
| Expected volatility | 51.7% - 61.3% |
NOTE 6: PREFERRED STOCK
Series D Redeemable Convertible Preferred Stock Classified as Temporary Equity Instruments
On March 28, 2008, the outstanding 5,000 shares of Series D redeemable convertible preferred stock (“Series D”) were converted into 25,866,518 restricted 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.
Exchange of Series E Redeemable Exchangeable Preferred Stock Classified as Debt Instruments to 6% Subordinated Debenture
On March 31, 2008, 500 shares of the Series E Preferred Stock were exchanged into the 6% 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 6% Subordinated Debenture due three years from the date of the exchange. See additional discussion of the Debenture in Note 4.
NOTE 7: COMMON STOCK
Private Placement
On June 5, 2008, Deep Down sold 57,142,857 shares, for $40,000,000 at a per-share price of $0.70. After transaction costs, net proceeds were $37,059,670. Dahlman Rose & Company, LLC acted as exclusive placement agent for the 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, with the remainder being retained for working capital purposes.
In connection with the private placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep Down filed an S-1 Registration Statement on July 21, 2008. If the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), then for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective, Deep Down shall be required to pay daily damages to the purchasers. Deep Down evaluated the registration rights agreement for liability treatment under Financial Accounting Standards Board (“FASB”) Statement No. 5, “Accounting for Contingencies” and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights did not meet the definition of a liability under the authoritative guidance since management believes the liability is not estimable at this time.
NOTE 8: STOCK BASED COMPENSATION AND WARRANTS
Deep Down has a stock based compensation plan - the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). We account for stock-based compensation expense under Statement of Financial Accounting (“SFAS”) No. 123 (Revised 2004), “Share-based Payment,” (“SFAS No. 123(R)”). The exercise price of the options, as well as the vesting period, is established by Deep Down’s Board of Directors. 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% of issued and outstanding common shares. During the six months ended June 30, 2008, Deep Down granted 4,200,000 options and 1,200,000 shares of restricted stock and cancelled 875,000 options due to forfeitures under the Plan. Based on the shares of common stock outstanding at June 30, 2008, there are approximately 16,235,000 options available for grant under the Plan as of that date.
Restricted Stock
On February 14, 2008, Deep Down issued an aggregate of 1,200,000 shares of restricted common stock to Ronald E. Smith, CEO; Robert E. Chamberlain, Chairman; and Eugene L. Butler, CFO under terms of the Plan. The shares were valued at a price of $0.42 based on the closing price of common stock on that date. The shares vest on the second anniversary of the grant date, and Deep Down is amortizing the related stock based compensation of $504,000 over the 2 year period. For the six months ended June 30, 2008 Deep Down recognized a total of $94,500 in stock based compensation related to these issued shares of restricted stock.
The following table summarizes Deep Down’s restricted stock activity for the six months ended June 30, 2008:
| | | Restricted Shares | | | Weighted- Average Grant Price | | | Aggregate Intrinsic Value | |
| Outstanding at December 31, 2007 | | | - | | | | | | | |
| Grants | | | 1,200,000 | | | $ | 0.42 | | | | |
| Outstanding at June 30,2008 | | | 1,200,000 | | | $ | 0.42 | | | $ | 624,000 | |
During the six months ended June 30, 2008, Deep Down granted 4,200,000 options under the Plan as detailed below. On June 17, 2008, a cashless exercise of 50,000 employee stock options for 29,339 net common shares was issued in accordance with terms of the Plan.
During the six months ended June 30, 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 days’ closing prices. The fair value of such options was approximately $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 price of $1.50, which was in excess of the day’s closing price of $0.42. The fair value of such options was approximately $145,764 based on the Black-Scholes option pricing model.
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.
Summary of Stock Options
Deep Down is expensing all stock options on a straight line basis over their respective expected service periods. The total stock based compensation expense for the six months ended June 30, 2008 and June 30, 2007, was $159,169 and $39,565, respectively. The unamortized portion of the estimated fair value of outstanding stock options is $949,885 at June 30, 2008.
The following table summarizes Deep Down’s stock option activity for the six months ended June 30, 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, 2007 | | 5,500,000 | | $ | 0.58 | | | | | |
| Grants | | 4,200,000 | | | 1.35 | | | | | |
| Exercises | | (50,000 | ) | | 0.50 | | | | | |
| Forfeitures | | (875,000 | ) | | 0.74 | | | | | |
| Outstanding at June 30,2008 | | 8,775,000 | | $ | 0.93 | | | 3.0 | | $ | 1,944,750 | |
| Exerciseable at June 30,2008 | | 1,970,834 | | $ | 0.60 | | | 2.7 | | $ | 729,292 | |
The following summarizes Deep Down’s outstanding options and their respective exercise prices at June 30, 2008:
| Exercise Price | | Shares Underlying Options | |
| $ | 0.30 - 0.49 | | | 175,000 | |
| $ | 0.50 - 0.69 | | | 4,125,000 | |
| $ | 0.70 - 0.99 | | | 525,000 | |
| $ | 1.00 - 1.29 | | | 950,000 | |
| $ | 1.30 - 1.50 | | | 3,000,000 | |
| | | | 8,775,000 | |
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 six months ended June 30, 2008:
| Dividend yield | 0% |
| Risk free interest rate | 2.64% - 2.84% |
| Expected life of options | 3 years |
| Expected volatility | 53.3% - 63.3% |
Summary of Warrants
In connection with the purchase of Flotation, warrants to purchase 200,000 common shares at $0.70 per share were issued to an entity affiliated with the selling stockholders 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 related to Flotation.
On August 6, 2007, as part of the Credit Agreement described above in Note 4, Deep Down issued 4,960,585 detachable warrants to its creditor. All warrants were issued with an exercise price of $0.507, expired in five years (or earlier in the event of termination) and vested on the earlier of the second anniversary of the agreement or upon payment in full of the debt. On July 3, 2008, the creditor exercised all of its outstanding 4,960,585 warrants for a total of 2,618,129 restricted shares of Deep Down common stock in a cashless exercise.
Additionally, related to the Credit Agreement described in Note 4, Deep Down issued 320,000 detachable warrants at an exercise price of $0.75 per share to a third party related to the financing. The warrant has a five-year term and became exercisable in connection with the early payoff of the debt. Also, in connection with the Amendment to the Credit Agreement, Deep Down issued detachable warrants to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share to the same third party. The warrant has a five-year term and was immediately exercisable. See the additional discussion concerning such warrants in Note 4.
A summary of warrant transactions follows:
| | Shares Underlying Warrants | | Weighted- Average Exercise Price | | Weighted- Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (In-The-Money) | |
| Outstanding at December 31, 2007 | | 5,399,397 | | $ | 0.53 | | | | | |
| Grants | | 200,000 | | | 0.70 | | | | | |
| Outstanding at June 30,2008 | | 5,599,397 | | $ | 0.54 | | | 4.4 | | $ | 2,241,852 | |
| Exerciseable at June 30,2008 | | 5,399,397 | | $ | 0.54 | | | 4.4 | | $ | 2,193,852 | |
The following summarizes Deep Down’s outstanding warrants and their respective exercise prices at June 30, 2008:
| Exercise Price | | Shares Underlying Warrants | |
| $ | 0.51 | | | 4,960,585 | |
| $ | 0.70 - 0.99 | | | 520,000 | |
| $ | 1.01 | | | 118,812 | |
| | | | | 5,599,397 | |
The fair value of each 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 six months ended June 30, 2008:
| Dividend yield | 0% |
| Risk free interest rate | 2.52% - 3.18% |
| Expected life of options | 2 - 2.5 years |
| Expected volatility | 51.7% - 61.3% |
NOTE 9: COMMITMENTS AND CONTINGENCIES
Litigation
We are from time to time involved in legal proceedings arising in the normal course of business. As of the date of this Quarterly Report on Form 10-Q, there are no pending or threatened material legal proceedings.
Operating Leases
Deep Down leases land under an operating lease and is responsible for related maintenance, insurance and property taxes. On May 1, 2008, Deep Down and JUMA, LLC, a related party, amended the original lease that began as of September, 2006 to provide for the additional acreage leased resulting in a $4,000 per month increase in rent. See Note 10 below for further discussion of the related party.
NOTE 10: RELATED PARTY TRANSACTIONS
Deep Down leases all buildings, structures, fixtures and other improvements at the Channelview, Texas location from JUMA, LLC, a company owned by Ronald E. Smith, CEO and a director of Deep Down and Mary L. Budrunas, a vice president and a director of Deep Down. The base rate of $15,000 per month is payable to JUMA 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 shares 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.
During the six months ended June 30, 2008, Deep Down granted an aggregate of 1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock options to Ronald E. Smith, President and Chief Executive Officer, Robert E. Chamberlain, Jr., Chairman and Chief Acquisition Officer, and Eugene L. Butler, Chief Financial Officer, under the terms of the Deep Down, Inc. Stock Option Plan. Deep Down also awarded in recognition of their completion of the acquisition of Flotation and private placement of common stock, a performance bonus of $300,000 in the aggregate.
NOTE 11: SUBSEQUENT EVENTS
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.
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 sheets of Deep Down, Inc. (the “Company”), as of December 31, 2007 and 2006 and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2007. We have also audited the accompanying statements of operations, stockholders’ deficit and cash flows for the period from inception (June 29, 2006) through December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of 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. Deep Down is not required to have, nor were we engaged to perform an audit of internal control over financial reporting. Our audits included the 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 Deep Down’s internal control over financial reporting. Accordingly, we express no such opinion. 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Deep Down, Inc. as of December 31, 2007 and 2006, and the results of its operations and cash flows for the periods described, in conformity with U.S. generally accepted accounting principles.
/s/ MALONE & BAILEY, PC
www.malone-bailey.com
Houston, Texas
March 31, 2008
| Deep Down, Inc. |
| Consolidated Balance Sheets |
| | | December 31, 2007 | | | December 31, 2006 | |
| Assets | | | | | | |
| Cash and equivalents | | $ | 2,206,220 | | | $ | 12,462 | |
| Restricted cash | | | 375,000 | | | | - | |
| Accounts receivable, net of allowance of $139,787 and $81,809 | | | 7,190,466 | | | | 1,264,228 | |
| Prepaid expenses and other current assets | | | 312,058 | | | | 156,975 | |
| Inventory | | | 502,253 | | | | - | |
| Lease receivable, short term | | | 414,000 | | | | - | |
| Work in progress | | | 945,612 | | | | 916,485 | |
| Receivable from Prospect, net | | | 2,687,333 | | | | - | |
| Total current assets | | | 14,632,942 | | | | 2,350,150 | |
| Property and equipment, net | | | 5,172,804 | | | | 845,200 | |
| Other assets, net of accumulated amortization of $54,560 and $0 | | | 1,109,152 | | | | - | |
| Lease receivable, long term | | | 173,000 | | | | - | |
| Intangibles, net | | | 4,369,647 | | | | - | |
| Goodwill | | | 10,594,144 | | | | 6,934,213 | |
| Total assets | | $ | 36,051,689 | | | $ | 10,129,563 | |
| | | | | | | | | |
| Liabilities and Stockholders' Equity (Deficit) | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 3,569,826 | | | $ | 816,490 | |
| Deferred revenue | | | 188,030 | | | | 190,000 | |
| Payable to Mako Shareholders | | | 3,205,667 | | | | - | |
| Current portion of long-term debt | | | 995,177 | | | | 410,731 | |
| Total current liabilities | | | 7,958,700 | | | | 1,417,221 | |
| Long-term debt, net of accumulated discount of $1,703,258 and $0 | | | 10,698,818 | | | | 757,617 | |
| Series E redeemable exchangeable preferred stock, 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 | | | | | | | | |
| 500 and 5,000 issued and outstanding, respectively | | | 386,411 | | | | 3,486,376 | |
| Series G redeemable exchangeable preferred stock, 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 1,000 issued and outstanding, respectively | | | - | | | | 697,275 | |
| Total liabilities | | | 19,043,929 | | | | 6,358,489 | |
| | | | | | | | | |
| Temporary equity: | | | | | | | | |
| SeriSeries 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 5,000 issued and outstanding | | | 4,419,244 | | | | 4,419,244 | |
| SeriSeries F 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 of all series of Preferred stock -0- and 3,000 issued and outstanding, respectively | | | - | | | | 2,651,547 | |
| Total temporary equity | | | 4,419,244 | | | | 7,070,791 | |
| | | | | | | | | |
| Stockholders' equity (deficit): | | | | | | | | |
| Series C convertible preferred stock, $0.001 par value, 7% cumulative dividend, | | | | | | | | |
| authorized 10,000,000 aggregate shares of all series of Preferred stock | | | | | | | | |
| -0- and 22,000 shares issued and outstanding, respectively | | | - | | | | 22 | |
| Common stock, $0.001 par value, 490,000,000 shares authorized, 85,976,526 | | | | | | | | |
| and 82,870,171 shares issued and outstanding, respectively | | | 85,977 | | | | 82,870 | |
| Paid in capital | | | 14,849,847 | | | | (82,792 | ) |
| Accumulated deficit | | | (2,347,308 | ) | | | (3,299,817 | ) |
| Total stockholders' equity (deficit) | | | 12,588,516 | | | | (3,299,717 | ) |
| Total liabilities and stockholders' equity | | $ | 36,051,689 | | | $ | 10,129,563 | |
See accompanying notes to consolidated financial statements.
| Deep Down, Inc. | |
| Consolidated Statements of Operations | |
| For the Year Ended December 31, 2007 and | |
| For the Period Since Inception (June 29, 2006) to December 31, 2006 | |
| | | | | | From Inception | |
| | | Year Ended | | | June 29, 2006 to | |
| | | December 31, 2007 | | | December 31, 2006 | |
| | | | | | | |
| Revenues | | | | | | |
| Contract revenue | | $ | 15,652,848 | | | $ | 978,047 | |
| Rental revenue | | | 3,736,882 | | | | - | |
| | | | | | | | | |
| Total revenues | | | 19,389,730 | | | | 978,047 | |
| Cost of sales | | | 13,020,369 | | | | 565,700 | |
| | | | | | | | | |
| Gross profit | | | 6,369,361 | | | | 412,347 | |
| | | | | | | | | |
| Operating expenses: | | | | | | | | |
| Selling, general & administrative | | | 4,284,553 | | | | 3,600,627 | |
| Depreciation and amortization | | | 426,964 | | | | 27,161 | |
| | | | | | | | | |
| Total operating expenses | | | 4,711,517 | | | | 3,627,788 | |
| | | | | | | | | |
| Operating income (loss) | | | 1,657,844 | | | | (3,215,441 | ) |
| | | | | | | | | |
| Other income (expense): | | | | | | | | |
| Gain on debt extinguishment | | | 2,000,000 | | | | - | |
| Interest income | | | 94,487 | | | | - | |
| Interest expense | | | (2,430,149 | ) | | | (62,126 | ) |
| | | | | | | | | |
| Total other income (expense) | | | (335,662 | ) | | | (62,126 | ) |
| | | | | | | | | |
| Income (loss) before income taxes | | | 1,322,182 | | | | (3,277,567 | ) |
| | | | | | | | | |
| Income tax expense | | | (369,673 | ) | | | (22,250 | ) |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) |
| | | | | | | | | |
| | | | | | | | | |
| Basic earnings (loss) per share | | $ | 0.01 | | | $ | (0.04 | ) |
| Weighted-average shares outstanding, basic | | | 73,917,190 | | | | 76,701,569 | |
| | | | | | | | | |
| Diluted earnings (loss) per share | | $ | 0.01 | | | $ | (0.04 | ) |
| Weighted-average shares outstanding, fully-diluted | | | 104,349,455 | | | | 76,701,569 | |
See accompanying notes to consolidated financial statements.
| Deep Down, Inc. |
| Statements of Stockholders' Equity |
| For the Year Ended December 31, 2007 and |
| For the Period Since Inception (June 29, 2006) to December 31, 2006 |
| | | Common Stock | | | Series C Preferred Stock | | | Paid-in | | | Retained | | | | |
| | | Shares | | | Amount | | | Shares | | | Amount | | | Capital | | | Earnings | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance at June 29, 2006 (inception) (a) | | | 75,000,000 | | | $ | 75,000 | | | | - | | | $ | - | | | $ | (74,900 | ) | | $ | - | | | $ | 100 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | | - | | | | - | | | | - | | | | - | | | | - | | | | (3,299,817 | ) | | | (3,299,817 | ) |
| Reverse merger with MediQuip (a) | | | 7,870,171 | | | | 7,870 | | | | 22,000 | | | | 22 | | | | (7,892 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2006 | | | 82,870,171 | | | | 82,870 | | | | 22,000 | | | | 22 | | | | (82,792 | ) | | $ | (3,299,817 | ) | | | (3,299,717 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | | - | | | | - | | | | - | | | | - | | | | - | | | | 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 | | | 85,976,526 | | | $ | 85,977 | | | | - | | | $ | - | | | $ | 14,849,847 | | | $ | (2,347,308 | ) | | $ | 12,588,516 | |
(a) Shares were stated at par value of $0.01 in error, the correct par value of $0.001 is reflected, with the offset to Paid-in Capital
See accompanying notes to consolidated financial statements.
| Deep Down, Inc. | |
| Consolidated Statement of Cash Flows | |
| For the Year Ended December 31, 2007 and | |
| For the Period Since Inception (June 29, 2006) to December 31, 2006 | |
| | | | | | | |
| | | For the Year Ended December 31, 2007 | | | From Inception June 29, 2006 to December 31, 2006 | |
| Cash flows from operating activities: | | | | | | |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) |
| Adjustments to reconcile net income to net cash | | | | | | | | |
| used in operating activities: | | | | | | | | |
| Gain on extinguishment of debt | | | (2,000,000 | ) | | | - | |
| Amortization of debt discount | | | 1,780,922 | | | | 48,179 | |
| Amortization of deferred financing costs | | | 54,016 | | | | - | |
| Share-based compensation | | | 187,394 | | | | 3,340,792 | |
| Allowance for doubtful accounts | | | 108,398 | | | | - | |
| Depreciation and amortization | | | 426,964 | | | | 27,163 | |
| Gain on disposal of equipment | | | 24,336 | | | | - | |
| Changes in assets and liabilities: | | | | | | | | |
| Lease receivable | | | (863,000 | ) | | | - | |
| Accounts receivable | | | (4,388,146 | ) | | | (251,001 | ) |
| Prepaid expenses and other current assets | | | (54,310 | ) | | | 23,335 | |
| Inventory | | | (502,253 | ) | | | - | |
| Work in progress | | | 246,278 | | | | (90,326 | ) |
| Accounts payable and accrued liabilities | | | 1,022,726 | | | | 145,433 | |
| Deferred revenue | | | (1,970 | ) | | | - | |
| | | | | | | | | |
| Net cash used in operating activities | | | (3,006,136 | ) | | | (56,242 | ) |
| | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | |
| Cash acquired in acquisition of a business | | | 261,867 | | | | 101,497 | |
| 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 | | | (830,965 | ) | | | - | |
| Restricted cash | | | (375,000 | ) | | | - | |
| | | | | | | | | |
| Net cash (used in) provided by investing activities | | | (1,358,429 | ) | | | 101,497 | |
| | | | | | | | | |
| 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 | | | 3,960,000 | | | | - | |
| Proceeds from sales-type lease | | | 276,000 | | | | - | |
| Borrowings on debt - related party | | | (150,000 | ) | | | - | |
| Payments on debt - related party | | | 150,000 | | | | - | |
| Borrowings on long-term debt | | | 6,204,779 | | | | - | |
| Deferred financing fees | | | (442,198 | ) | | | - | |
| Prepaid points | | | (180,000 | ) | | | - | |
| Payments of long-term debt | | | (2,760,258 | ) | | | (32,893 | ) |
| | | | | | | | | |
| Net cash provided by (used in) financing activities | | | 6,558,323 | | | | (32,893 | ) |
| | | | | | | | | |
| Change in cash and equivalents | | | 2,193,758 | | | | 12,362 | |
| Cash and equivalents at beginning of year | | | 12,462 | | | | 100 | |
| | | | | | | | | |
| Cash and equivalents at end of period | | $ | 2,206,220 | | | $ | 12,462 | |
See accompanying notes to consolidated financial statements.
| Deep Down, Inc. |
| Consolidated Statements of Cash Flows |
| For the Year Ended December 31, 2007 and |
| For the Period Since Inception (June 29, 2006) to December 31, 2006 |
| | | | | | From Inception | |
| | | Year Ended | | June 29, 2006 to | |
| | | December 31, 2007 | | December 31, 2006 | |
| | | | | | | |
Supplemental schedule of noncash investing and financing activities: | | | | | | |
| Acquisition of a business – Electrowave | | $ | (190,381 | ) | | $ | - | |
| Exchange of receivables for acquisition of a business | | $ | 171,407 | | | $ | - | |
| Acquisition of a business – Mako | | $ | 280,680 | | | $ | - | |
| Net receivable from lender-Prospect Capital | | $ | 2,687,333 | | | $ | - | |
| Transfer work in progress to fixed assets | | $ | 110,181 | | | $ | - | |
| Fixed assets purchased with capital lease | | $ | 525,000 | | | $ | - | |
| Exchange of preferred stock | | $ | 3,366,778 | | | $ | - | |
| Redemption of preferred stock | | $ | 4,935,463 | | | $ | - | |
| Common stock issued for notes payable | | $ | 560,000 | | | $ | - | |
| Creation of debt discount due to warrants issued to lender | | $ | 1,479,189 | | | $ | - | |
| Creation of deferred financing cost due to warrants issued to third party | | $ | 159,066 | | | $ | - | |
| | | | | | | | | |
| Supplemental Disclosures: | | | | | | | | |
| Cash paid for interest | | $ | 594,667 | | | $ | - | |
| Cash paid for taxes | | $ | 114,970 | | | $ | - | |
See accompanying notes to consolidated financial statements.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Note 1: Nature of Business and Summary of Significant Accounting Policies
Nature of Business
Deep Down, Inc. (“Deep Down Nevada”), a Nevada corporation, is the parent company to its wholly owned subsidiaries: Deep Down, Inc. (“Deep Down Delaware”) a Delaware corporation, ElectroWave USA, Inc., a Texas corporation, (“ElectroWave”), and Mako Technologies, LLC (“Mako”).
| · | Deep Down Delaware provides installation management, engineering services, support services and storage management services for the subsea controls, umbilicals and pipeline industries offshore. Deep Down Delaware also fabricates component parts for subsea distribution systems and assemblies. |
| · | ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, and commercial business sectors. |
| · | Mako serves the growing offshore petroleum and marine industries with technical support services, and products vital to offshore petroleum production, through rentals of its remotely operated vehicles (“ROV’s”) , topside and subsea equipment, and diving support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys. |
On June 29, 2006, Subsea Acquisition Corporation (“Subsea”) was formed with the intent to acquire service providers to the offshore industry, and designers and manufacturers of 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. On November 21, 2006, Subsea acquired Deep Down, Inc., a Delaware corporation founded in 1997. Under the terms of this transaction, all of Deep Down, 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, with the surviving company operating as Deep Down Inc. The purchase price was based on the fair value of the Series D and E Preferred stock of $7,865,471.
On April 2, 2007, Deep Down purchased all of the assets and certain liabilities of ElectroWave USA, Inc. a Texas corporation for $171,407. Deep Down formed a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada corporation, to complete the acquisition.
On December 1, 2007, Deep Down purchased 100% of the common stock of Mako Technologies, Inc., a Louisiana corporation for a total purchase price of $11,307,000, including transaction fees of $188,369. Deep Down formed a wholly-owned subsidiary, Mako, LLC (“Mako”), a Nevada limited liability corporation, to complete the acquisition. See further discussion in Note 3 “Business Combinations”.
Summary of Significant Accounting Policies
Principles of consolidation:
The consolidated financial statements include the accounts of Deep Down Nevada and its wholly-owned subsidiaries for the year ended December 31, 2007 and the period from inception June 29, 2006 to December 31, 2006.
All significant inter-company transactions and balances have been eliminated in consolidation.
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.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Cash and Equivalents and Restricted Cash
Deep Down considers 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, Deep Down is 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.
Fair Value of Financial Instruments
The estimated fair value of Deep Down’s financial instruments is as follows at December 31, 2007:
| · | Cash and equivalents, accounts receivable and accounts payable - The carrying amounts approximated fair value due to the short-term maturity of these instruments. |
| · | Preferred Stock - Series D, E, F and G – The carrying amounts approximate the fair value |
| · | Long-term debt - The fair value closely approximates the carrying value of Deep Down’s debt instruments due to the short time the debt has been outstanding and that similar debt was issued under an Amendment to the Credit Agreement dated December 21, 2007. See discussion of the terms at Note 6. |
Accounts Receivable
Deep Down provides an allowance for doubtful accounts on trade receivables based on historical collection experience and a specific review of each customer’s trade receivable balance. When specific accounts are determined to be uncollectable, they are expensed to bad debt expense in that period. Until August 2007, Deep Down had factored some of its receivables with a bank. See further discussion in Note 4. At December 31, 2007 and 2006, Deep Down estimated its allowance for doubtful accounts to be $139,787 and $81,809, 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 $100,000. Deep Down had approximately $2.6 million of uninsured cash balances at December 31, 2007.
As of December 31, 2007, four of Deep Down’s customers accounted for 11%, 9%, 7% and 7% of total accounts receivable, respectively. For the year ended December 31, 2007, Deep Down’s four largest customers accounted for 7%, 7%, 6% and 6% of total revenues, respectively. For the period from inception June 29, 2006 to December 31, 2006, Deep Down’s four largest customers accounted for 16%, 14%, 13% and 11% of total revenues, respectively.
Inventory and Work in Progress
Inventory is stated at lower of cost (first-in, first out) or net realizable value. Inventory consists of an A-frame that is being marketed to customers requiring off-shore launching or overboarding activities. Work in Progress is made up primarily unbilled amounts of labor and third party material costs that are in process but not yet billed to a customer. Amounts at December 31, 2007 and 2006 were $945,612 and $916,485, respectively.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the respective assets. Buildings are amortized over 36 years, and leasehold improvements are amortized over the shorter of the assets' useful lives or lease terms. Equipment lives range from two to seven years, computers and electronic lives are from two to three years, and furniture and fixtures are two to seven years.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Replacements and betterments are capitalized, while maintenance and repairs are expensed as incurred. It is Deep Down’s policy to include amortization expense on assets acquired under capital leases with depreciation expense on owned assets.
Goodwill and Intangible Assets
Goodwill represents the cost in excess of the fair value of net assets acquired in business combinations. Statement of financial accounting standards (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, 2007.
Deep Down evaluates the carrying value of goodwill during the fourth quarter of each year 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 goodwill is impaired, Deep Down compares the fair value of the business to its carrying amount, including goodwill. The fair value of the reporting unit is estimated using an income, or discounted cash flow approach. If 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 implied fair value of reporting unit goodwill to its carrying amount.
Deep Down’s intangible assets consist of assets acquired in the purchase of the Mako subsidiary, specifically customer list, a non-compete covenant and trademarks related to Mako’s ROVs. Deep Down is amortizing the intangible assets over their useful lives ranging from 5 to 25 years on the straight line basis
Long-Lived Assets
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," requires that Deep Down periodically review the carrying amounts of its property and equipment and its finite-lived intangible assets to determine whether current events or circumstances indicate that such carrying amounts may not be recoverable. The carrying 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.
Lease Obligations
Deep Down leases land and buildings under noncancelable operating leases. Deep Down leases its corporate headquarters 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. Deep Down also leases a 100-ton mobile gantry crane under a capital lease, which is included with Equipment on the consolidated balance sheet.
At the inception of the lease, Deep Down evaluates each agreement to determine whether the lease will be accounted for as an operating or capital lease. The term of the lease used for this evaluation includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured and failure to exercise such option would result in an economic penalty.
Revenue Recognition
Deep Down’s contract revenue 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. Service revenue is recognized as the service is provided. Rental revenue is recognized pro-rata over the period the rental occurs based on daily or monthly rates. Shipping and handling charges paid by Deep Down are included in cost of goods sold.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Income Taxes
Deep Down has 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 included 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.
Stock Based Compensation
Effective with its inception, June 29, 2006, Deep Down accounts for stock-based compensation issued to employees and non-employees as required by SFAS No. 123(R) “Accounting for Stock Based Compensation” (“SFAS No. 123(R)”). Under these provisions, Deep Down records expense based on the fair value of the awards utilizing the Black-Scholes pricing model for options and warrants.
Earnings per Common Share
SFAS No. 128, Earnings Per Share (“EPS”) requires earnings per share to be computed and reported as both basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income by the weighted average number of common shares and dilutive common stock equivalents (convertible notes and interest on the notes, stock awards and stock options) outstanding during the period. Dilutive EPS reflects the potential dilution that could occur if options to purchase common stock were exercised for shares of common stock. Deep Down had no dilutive securities as of December 31, 2006. The following is a reconciliation of the number of shares (denominator) used in the basic and diluted EPS computations:
| | | | | | From Inception | |
| | | Year Ended | | | June 26, 2006 to | |
| | | December 31, 2007 | | | December 31, 2006 | |
| Numerator for basic and diluted earnings per share: | | | | | | |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) |
| | | | | | | | | |
| Denominator for basic earnings per share: | | | | | | | | |
| Weighted average shares outstanding (basic) | | | 73,917,190 | | | | 76,701,659 | |
| | | | | | | | | |
| Denominator for diluted earnings per share: | | | | | | | | |
| Weighted average shares outstanding (basic) | | | 73,917,190 | | | | 76,701,659 | |
| Effect of dilutive securities | | | 30,432,265 | | | | - | |
| Weighted average shares outstanding (diluted) | | | 104,349,455 | | | | 76,701,659 | |
Dividends
Deep Down has no formal dividend policy or obligations. Our loan documents have a restrictive provision whereby dividends are not permitted to be paid on the Company’s common stock.
Reclassifications:
Certain amounts have been reclassified to be consistent with the presentation for all periods, with no effect on the net loss or stockholders’ equity.
Advertising costs:
Advertising and promotion costs, which totaled approximately $58,303 and $0 during the twelve months ended December 31, 2007 and the period from inception June 29, 2006 to December 31, 2006, respectively, are expensed as incurred.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) – an interpretation of FASB Statement No. 109, Accounting for Income Taxes (“SFAS No. 109”) (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109 and prescribes 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 return. Guidance is also provided on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Deep Down adopted the provisions of FIN 48 in 2007 and no material uncertain tax positions were identified. Thus, the adoption of FIN 48 did not have an impact on Deep Down’s financial statements.
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 affects 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 is currently evaluating the impact of SFAS No. 157 on its financial position and result of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 with early adoption allowed. Deep Down has not yet determined the impact, if any, that adopting this standard might have on its 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. Deep Down is currently evaluating the effects of these pronouncements on its financial position and results of operations.
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 2007, and has not exercised any shares, 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.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Note 2: Lease receivable
On May 18, 2007, Deep Down entered into a sales lease agreement with an unrelated third party. The leased equipment includes an a-frame, winching system, and hydraulic power unit, all constructed by Deep Down. The term of the lease is two years, and includes a purchase option for $35,000 at the conclusion of this term. Monthly rental payments, in the amount of $34,500 are due beginning May, 2007 through April 2009. The lease has been accounted for as a sales-type lease under the rules of FASB No. 13, Accounting for Leases.
| | | | | | | Principal | | | Unearned income | |
| Minimum lease payments receivable | | $ | 828,000 | | | | | | | |
| Estimated residual value of leased property | | | 35,000 | | | | | | | |
| | | | 863,000 | | | $ | 863,000 | | | $ | (113,000 | ) |
| Less: Unearned interest income | | | (113,000 | ) | | | | | | | | |
| Net investment in sales-type leases | | | 750,000 | | | | | | | | | |
| Net payments received | | | (217,975 | ) | | | (276,000 | ) | | | 58,025 | |
| Lease balance December 31, 2007 | | $ | 532,025 | | | $ | 587,000 | | | $ | (54,975 | ) |
| Current portion | | | | | | $ | 414,000 | | | $ | (54,975 | ) |
| Long-term portion | | | | | | $ | 173,000 | | | | | |
Note 3: Business Combinations
Purchase of Mako Technologies, Inc.
Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako, Technologies Inc., a Louisiana corporation. Deep Down formed a wholly owned subsidiary, Mako Technologies, LLC, (“Mako”) a Nevada limited liability corporation, to complete the acquisition. Headquartered in Morgan City, Louisiana, Mako serves the growing offshore petroleum and marine industries with technical support services, and products vital to offshore petroleum production, through rentals of its ROV’s, topside and subsea equipment, and diving support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.
The acquisition of Mako has been accounted for using purchase accounting since Deep Down acquired substantially all of the assets, debts, employees, intangible contracts and business of Mako.
The purchase price in the original agreement was based on a maximum of $5.0 million in cash and 11,269,841 restricted shares of common stock of Deep Down valued at $0.76 per share, the market price of Deep Down’s common stock on December 18, 2007, the date of the press release announcing the purchase, for a value of $8.6 million for a total potential purchase price of approximately $13.6 million. Included in the purchase price is approximately $188,369 of transaction costs incurred by Deep Down.
The first installment of $2,916,667 in cash and 6,574,074 shares of restricted common stock of Deep Down, valued at $0.76 per share was paid on January 4, 2008 and the balance of $3,205,667 made up of $1,243,578 in cash and 2,802,985 shares of restricted common stock of Deep Down valued at $0.70 will be paid by April 15, 2008. This second installment was based on verification of adjusted EBITDA amounts of Mako for the fiscal year ending December 31, 2007. These amounts were verified and agreed upon by all the parties on March 27, 2008 and the total $3,025,667 is presented as a payable to Mako shareholders at December 31, 2007.
On December 21, 2007, Deep Down signed an amendment to its original credit agreement with Prospect Capital for an additional $6.5 million for the Mako acquisition. On January 4, 2008, Deep Down received an additional advance of $6.0 million under its secured credit agreement (the “Credit Agreement”) with Prospect Capital Corporation (“Prospect”) to fund the cash portion of its acquisition of Mako.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
The first payment to shareholders of Mako is reflected on the accompanying consolidated balance sheet as of December 31, 2007 due to the certainty of payment, and the intention of all parties to complete this payment prior to fiscal year end. The second payment of $3,025,667 is reflected as a payable to shareholders due to the timing of payments in the subsequent fiscal year. The financing with Prospect is also reflected as of December 31, 2007 since the funds were generally used to pay the shareholders of Mako. The net proceeds received 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 sheetsheets at December 31, 2007.
The table below reflects the breakdown of the purchase price payments:
| | | 1st Installment | | | 2nd Installment | | | Total | |
| Common Stock Par | | $ | 6,574 | | | $ | 2,803 | | | $ | 9,377 | |
| Common Stock Paid in Capital | | | 4,989,723 | | | | 1,959,287 | | | | 6,949,010 | |
| Cash | | | 2,916,667 | | | | 1,243,577 | | | | 4,160,244 | |
| Amounts for Mako Shareholders | | $ | 7,912,964 | | | $ | 3,205,667 | | | $ | 11,118,631 | |
The purchase price of $11,307,000 included approximately $188,369 of transaction expenses, plus the assumption of leases of real and personal property and ongoing accounts payable and bank loans in exchange for substantially all of the assets, including construction in progress, fixed assets and accounts receivable and the transfer of all employees. 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:
| Cash and cash equivalents | | $ | 280,841 | |
| Accounts receivable | | | 1,515,074 | |
| Construction in progress | | | 279,590 | |
| Prepaid expenses | | | 179,583 | |
| Property, plant and equipment | | | 3,235,456 | |
| Intangibles | | | 4,398,000 | |
| Goodwill | | | 3,066,153 | |
| Total assets acquired | | | 12,954,697 | |
| | | | | |
| Accounts payable and accrued expenses | | | 828,313 | |
| Long term debt | | | 819,384 | |
| Total liabilities acquired | | | 1,647,697 | |
| Net assets acquired | | $ | 11,307,000 | |
Deep Down hired an independent valuation expert to provide a preliminary estimate for the fair market value of the assets purchased. As a result, part of the purchase price was allocated to specifically identified intangible assets. The following table below summarizes the intangible assets purchased in the transaction:
| | | Estimated | | | Remaining | |
| | | Fair Value | | | Useful Life | |
| | | | | | | |
| Customer List | | $ | 1,071,000 | | | | 8 | |
| Non-Compete Covenant | | | 458,000 | | | | 5 | |
| Trademarks | | | 2,869,000 | | | | 25 | |
| | | $ | 4,398,000 | | | | | |
The allocation of the purchase price was based on preliminary estimates. Estimates and assumptions are subject to change upon the receipt of management’s review of the final amounts and final tax returns. This final evaluation of net assets acquired is expected to be completed no later than one year from the acquisition date and any future changes in the value of the net assets acquired will be offset by a corresponding change in goodwill.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Additionally, as part of Prospect’s requirements, Deep Down paid $918,709, as the remaining balances due on Mako’s long-term debt and accrued interest, in January 2008.
The following unaudited pro forma combined condensed financial statements are based on the historical financial statements of Mako and Deep Down after giving effect to the acquisition of Mako. The unaudited pro forma combined condensed combined statements of operations for the twelve months ended December 31, 2007 isare presented as if the acquisition had taken place on January 1, 2007 by combining the historical results of Mako and Deep Down.
The unaudited pro forma results were as follows:
| Deep Down, Inc. |
| Unaudited Pro forma Statements of Operations |
| | | | | | Historical | | | | | | | | |
| | | Historical | | | Mako | | | | | | | | |
| | | Deep Down | | | Eleven Months | | | | | | | Pro Forma | |
| | | Year Ended | | | Ended | | | | | | | Year Ended | |
| | | December 31, | | November 30, | | | Pro Forma | | | | December 31, | |
| | | 2007 | | | 2007 | | | Adjustments | | | | 2007 | |
| | | | | | | | | | | | | | |
| Revenues | | $ | 19,389,730 | | | $ | 5,494,388 | | | $ | - | | | | $ | 24,884,118 | |
| Cost of sales | | | 13,020,369 | | | | 2,298,597 | | | | - | | | | | 15,318,966 | |
| Gross profit | | | 6,369,361 | | | | 3,195,791 | | | | - | | | | | 9,565,152 | |
| Operating expenses | | | 4,711,517 | | | | 2,455,728 | | | | 311,882 | | (c) | | | 7,479,127 | |
| Total other income | | | (335,662 | ) | | | (65,705 | ) | | | (1,059,573 | ) | (d) | | | (1,460,940 | ) |
| Income tax expense | | | (369,673 | ) | | | (319,432 | ) | | | - | | | | | (689,105 | ) |
| Net income (loss) | | $ | 952,509 | | | $ | 354,926 | | | $ | (1,371,455 | ) | | | $ | (64,020 | ) |
| | | | | | | | | | | | | | | | | | |
| Basic earnings per share | | $ | 0.01 | | | | | | | | | | | | $ | - | |
| Shares used in computing basic per share amounts | | | 73,917,190 | | | | | | | | | | (e) | | | 83,276,238 | |
| | | | | | | | | | | | | | | | | | |
| Diluted earnings per share | | $ | 0.01 | | | | | | | | | | | | $ | - | |
| Shares used in computing diluted per share amounts | | | 104,349,455 | | | | | | | | | | (e) | | | 113,708,503 | |
| (c) | Amortization of the intangible assets at a rate of $28,353 per month for eleven months. One month is included in the historical Deep Down total. |
| (d) | Represents cash interest plus amortization of deferred financing costs and debt discounts. Interest is payable at 15.5% on the outstanding principal, and the related fees are amortized using the effective interest method over the four-year life of the loan. |
| (e) | A total of 9,377,059 shares were issued for the total transaction. These pro forma amounts give effect as if shares were issued January 1, 2007. |
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Purchase of ElectroWave USA, Inc.
On April 2, 2007, Deep Down purchased all of the assets and certain liabilities of ElectroWave USA, Inc., a Texas corporation. Deep Down formed a wholly ownedwhollyowned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada corporation, to complete the acquisition. ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, and commercial business sectors.
The acquisition of ElectroWave has been accounted for using purchase accounting as Deep Down acquired substantially all of the assets, debts, employees, intangible contracts and business of ElectroWave.
The purchase price of $171,407 includes the payment of bank and other debts of ElectroWave totaling $432,475, net of $261,068 received from the factoring of ElectroWave’s receivables. The purchase included the assumption of leases of real and personal property and ongoing accounts payable in exchange for substantially all of the assets, including inventory, fixed assets and accounts receivable and the transfer of all employees. 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:
| Purchase Price: | | | |
| Cash paid for third party debt | | $ | 432,475 | |
| Cash received from sale of ElectroWave receivables | | | (261,068 | ) |
| Cash purchase price | | $ | 171,407 | |
| | | | | |
| Accounts receivable | | $ | 133,587 | |
| Construction in progress | | | 105,723 | |
| Property, plant and equipment, net | | | 45,502 | |
| Capitalized R&D assets | | | 270,094 | |
| Goodwill | | | 350,854 | |
| Total assets acquired | | | 905,760 | |
| | | | | |
| Cash deficit | | $ | 18,974 | |
| Accrued liabilities | | | 715,379 | |
| Total liabilities acquired | | | 734,353 | |
| Net assets acquired | | $ | 171,407 | |
The allocation of the purchase price was based on preliminary estimates. Estimates and assumptions are subject to change upon the receipt of management’s review of the final amounts and final tax returns. This final evaluation of net assets acquired is expected to be completed no later than one year from the acquisition date and any future changes in the value of the net assets acquired will be offset by a corresponding change in goodwill.
No pro forma amounts are presented as the impact would not be material.
In addition, Deep Down may issue up to an aggregate of 460 shares of convertible preferred stock over the next two years, as an additional contingent purchase cost, if the operations of ElectroWave reach certain financial milestones based on net income for the fiscal years ending December 31, 2008 and 2009. For the period from acquisition April 2, 2007 through December 31, 2007, ElectroWave had a net loss, so no additional consideration is due for that time frame. The contingent consideration for the fiscal years ending December 31, 2008 and 2009 is not considered in the initial purchase price allocation due to its uncertain nature.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Purchase of Deep Down, Inc. by Subsea on November 21, 2006
On November 21, 2006, Subsea acquired Deep Down, Inc., a Delaware corporation founded in 1997. Under the terms of this transaction, all of Deep Down, 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, Inc., with the surviving company operating as Deep Down, Inc. The purchase price based on the fair value of the Series D and E Preferred stock was $7,865,471. This transaction was accounted for as a purchase, with Subsea being the acquirer based on the change in voting control. 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 preliminary fair values of the assets acquired and liabilities assumed at the date of acquisition:
| Cash and cash equivalents | | $ | 101,497 | |
| Accounts receivable | | | 1,013,227 | |
| Inventory | | | 168,672 | |
| Prepaid expenses | | | 11,638 | |
| Construction in progress | | | 826,159 | |
| Property, plant and equipment, net | | | 872,363 | |
| Goodwill | | | 7,177,137 | |
| Total assets acquired | | | 10,170,693 | |
| | | | | |
| Accounts payable | | | 671,057 | |
| Accrued liabilities | | | 432,924 | |
| Current portion of long term debt | | | 403,057 | |
| Long term debt | | | 798,184 | |
| Total liabilities acquired | | | 2,305,222 | |
| Net assets acquired | | $ | 7,865,471 | |
During fiscal 2007, Deep Down paid approximately $242,924 to the former shareholders of the Sub-chapter S corporation Deep Down, Inc. (Delaware), which represents the income taxes due on the income from the time of purchase through the filing of revised tax status as a C-Corporation, which is reflected as an adjustment to goodwill since these payments related to the original agreements. There will be no further adjustments to goodwill as the one year period of evaluation has passed, and the final tax returns have been filed.
Note 4: Accounts Receivable
Management has established an allowance for uncollectible accounts of $139,787 and $81,809 as of December 31, 2007 and 2006. Bad debt expense totaled $ 110,569 and $1,294 for the year ended December 31, 2007 and the period from inception June 29, 2006 to December 31, 2006, respectively.
Until August 2007, Deep Down factored certain accounts receivables with a bank. Under the terms of the arrangement, Deep Down received proceeds equal to 80% of the value of the receivable at the date of transfer. Upon collection of the receivable, the bank remits the remaining 20%, less fees and interest. Fees ranged from 0.25% to 2% depending on the age of the receivable and interest is prime plus 2%. The arrangement contained provisions that indicated Deep Down was responsible for up to 20% of end-user customer payment defaults on factored receivables. As of December 31, 2007, all receivables under this arrangement have been collected and Deep Down no longer has a factoring program.
Notes to Consolidated Financial Statements for the year ended December 31, 2007
and the period from inception (June 29, 2006) through December 31, 2006
Note 5: Property and Equipment
Property and equipment consisted of the following as of December 31, 2007 and 2006:
| | | December 31, 2007 | | December 31, 2006 | | | December 31, 2007 | | December 31, 2006 | |
| Building | | $ | 195,305 | | | $ | 46,474 | | | $ | 195,305 | | | $ | 46,474 | |
| Furniture and fixtures | | | 63,777 | | | | 11,806 | | | | 63,777 | | | | 11,806 | |
| Vehicles and trailers | | | 112,162 | | | | 66,662 | | | | 112,162 | | | | 66,662 | |
| Leasehold improvements | | | 75,149 | | | | - | | | | 75,149 | | | | - | |
| Rental equipment | | | 3,144,559 | | | | - | | | | 3,144,559 | | | | - | |
| Equipment | | | 2,004,166 | | | | 747,419 | | | | 2,004,166 | | | | 747,419 | |
| | | | | | | | | | | | | | | |
| Total | | | 5,595,118 | | | | 872,361 | | | | 5,595,118 | | | | 872,361 | |
| Less: Accumulated depreciation | | | (422,314 | ) | | | (27,161 | ) | | | (422,314 | ) | | | (27,161 | ) |
| Property and equipment, net | | $ | 5,172,804 | | | $ | 845,200 | | | $ | 5,172,804 | | | $ | 845,200 | |
In February 2007, Deep Down entered into a capital lease transaction for the lease of a 100-ton mobile gantry crane valued at $525,000, which is included with Equipment above.
Depreciation expense was $426,964 and $27,161 for the year ended December 31, 2007 and the period from inception June 29, 2006 to December 31, 2006, respectively. Accumulated depreciation on equipment under capital lease is $62,500 at December 31, 2007.
