The technological demands of the oil and gas industry continue to increase as offshore exploration and drilling operations expand into deeper and more hostile environments. Conditions encountered in these environments include well pressures of up to 15,000 psi, mixed flows of oil and gas under high pressure that may also be highly corrosive, and water depths in excess of 5,000 feet. We are continually engaged in product development activities to generate new products and to improve existing products and services to meet our customers’ specific needs. We also focus our activities on reducing the overall cost to the customer, which includes not only the initial capital cost but also operating costs associated with its products.
We have an established track record of introducing new products and product enhancements. Our product development work is conducted at our facilities in Channelview, Texas, and in the field.field (and prior to December 31, 2010, in Biddeford, Maine). Our application engineering staff also provides engineering services to customers in connection with the design and sales of our products. Our ability to develop new products and maintain technological advantages is important to our future success.
We believe that the success of our business depends more on the technical competence, creativity and marketing abilities of our employees than on any individual patent, trademark or copyright. Nevertheless, as part of our ongoing product development and manufacturing activities, our policy is to seek patents when appropriate on inventions concerning new products and product improvements. All patent rights for products developed by employees are assigned to us.
A significant portion of our business activities are subject to federal, state, local and foreign laws and regulations and similar agencies of foreign governments. The technical requirements of these laws and regulations are becoming increasingly expensive, complex and stringent. These regulations are administered by various federal, state and local health and safety and environmental agencies and authorities, including the Occupational Safety and Health Administration of the U.S. Department of Labor and the U.S. Environmental Protection Agency. From time to time, we are also subject to a wide range of reporting requirements, certifications and compliance as prescribed by various federal and state governmental agencies. Expenditures relating to such regulations are made in the normal course of our business and are neither material nor place us at any competitive disadvantage. We do not currently expect that compliance with such laws will require us to make material additional expenditures.
We are also affected by tax policies, price controls and other laws and regulations generally relating to the oil and gas industry, generally, 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.
Prior to the reverse merger with MediQuip on December 14, 2006, no public market in our common stock existed. See the discussion of the reverse merger under Corporate History in Item 1 and in Note 1 “Nature of Business” of the notes to our audited consolidated financial statements included elsewhere in this report. Beginning December 14, 2006, our common stock was quoted on the OTC Bulletin Board. The high and low bids for the period from January 1 to December 31, 2007 were $2.35 and $0.16, respectively.OTCBB. These quotes represent inter-dealer quotations, without adjustment for retail mark-up, markdown or commission and may not represent actual transactions. The following table sets, for the periods indicated, the high and low sales prices for our common stock as reported by the OTC Bulletin Board.OTCBB.
To date, we have not paid any cash dividends and our present policy is to retain earnings for use in our business.working capital use. Under the terms of a $13 million borrowing facility from Prospect Capital Corporation,our credit agreement with Whitney National Bank, we are restricted from paying anycash dividends on our common stock, untilunless no default under the credit agreement exists at the time of or would arise after giving effect to any such time asdistribution. We intend to retain operating capital for the borrowing facility is repaid in full.growth of the company operations.
On October 2, 2007, Ironman Energy Capital, L.P. agreed to purchase 3,125,000 restricted shares of common stock of the Company at $0.96 per share, or $3,000,000 in the aggregate. Proceeds were used primarily for working capital and other general corporate purposes.ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
On October 2, 2007, Deep Down exchanged 1,250 shares ($1,250,000 aggregate face value)The following discussion of Series E Redeemable Exchangeable Preferred Stock for 1,213,592 sharesour financial condition and results of common stock. The Preferred Stock had a face value and liquidation preference of $1,000 per share, no dividend preference, and was exchangeable at the holder’s option after June 30, 2007, into 6% subordinated notes due three years from the date of exchange.
On October 2, 2007, Deep Down agreed to eliminate an obligation to pay $20,000 per month for the next 28 months, or an aggregate of $560,000, by exchanging this obligation for 543,689 shares of common stock. This obligation arose out of a series of transactions as disclosed above on May 17, 2007.
On April 22, 2005, MediQuip issued 22,000 Series C convertible preferred stock which remained after the reverse merger. The Series C shares had a face value and a liquidation preference of $12.50 per share, a cumulative dividend of 7% payable at the conversion date, and were convertible into shares of common stock determined by dividing the face amount by a conversion price of $0.0625. These shares carried no voting rights. All of the Series C shares were convertedoperations should be read in the fourth quarter of fiscal 2007 to 4,400,000 shares of Deep Down’s common stock.
Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako Technologies, Inc. (“Mako”), a Louisiana corporation. The total purchase price of Mako was $11,307,000. The first installment of $2,916,667 in cash and 6,574,074 shares of common stock of Deep Down, valued at $0.76 per share was paid on January 4, 2008,conjunction with our consolidated financial statements and the balancenotes to those financial statements appearing elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of $3,205,667 made up of $1,243,578many factors, our actual results may differ materially from those anticipated in cash and 2,802,985 shares of common stock of Deep Down valued at $0.70 will be paid by April 15, 2008. The second payment was based on verification of adjusted EBITDA amounts for Mako for the fiscal year ending December 31, 2007.our forward-looking statements.
In January and March 2008, Deep Down issued 25,866,518 shares of common stock to the holders of 5,000 shares of Series D preferred stock. The Series D preferred shares had a face and liquidation value of $5,000 per share and were convertible into common stock at a conversion price of $0.1933 per share.
this Part II, Item 6. Management’s7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.Operations”, all dollar and share amounts are in thousands of dollars and shares, unless otherwise indicated.
Corporate HistoryRevision of 2009 Consolidated Financial Statements
During 2006, MediQuip Holdings, Inc. (“MediQuip”As discussed in our Form 10Q/A for the quarter ended September 30, 2010, filed with the SEC on March 8, 2011, in conjunction with an internal review meeting of Flotation, our management reviewed the status of one of our long-term fixed price contracts (the “Contract”), that we entered into in November 2008 which is scheduled to be completed in the third quarter of 2011. As a publicly traded Nevada corporation, divested Westmeria Healthcare Limited,result of this review, our management identified errors in the percentage-of-completion accounting model for revenue recognition pertaining to this Contract. We considered the effect of the error to be immaterial to the consolidated financial statements for the year ended December 31, 2009. The audited consolidated balance sheet and statements of operations, cash flows and stockholders’ equity for the year ended December 31, 2009 included in this Annual Report on Form 10-K (the “Report”) have been adjusted to correct the immaterial effects of the error.
The 2009 consolidated balance sheet reflects the increase of $639 to the amounts of billings in excess of costs and estimated earnings on uncompleted contracts and accumulated deficit. On the consolidated statement of operations, revenues and gross profit for the year ended December 31, 2009 were reduced by $639, which resulted in a corresponding $639 increase to operating loss, loss before income taxes and net loss. On the consolidated statement of cash flows, the revision increased net loss by $639 which was offset to billings in excess of costs and estimated earnings on uncompleted contracts, for a net impact to cash flows provided by operations of $0. On the consolidated statement of stockholders’ equity, the revision increased accumulated deficit by $639. See additional discussion in Note 2 "Revision of 2009 Financial Statements" to the consolidated financial statements included in this Report.
General
We are an oilfield services company specializing in complex deepwater and ultra-deepwater oil production distribution system support services, serving the worldwide offshore exploration and production industry. Our services and technological solutions include distribution system installation support and engineering services, umbilical terminations, loose-tube steel flying leads, ROVs and related services. We support subsea engineering, installation, commissioning, and maintenance projects through specialized, highly experienced service teams and engineered technological solutions. Our primary focus is on more complex deepwater and ultra-deepwater oil production distribution system support services and technologies, used between the platform and the wellhead. In connection with our JV, we install buoyancy modules on risers for deepwater drilling; we manufacture collars used with the riser buoyancy and we provide buoyancy repair and maintenance.
Equity Investment in Joint Venture
On December 31, 2010, the Company and its wholly-owned operating subsidiary Flotation, entered into a Contribution Agreement by and subsequently acquired Deep Down, Inc.,among the Company, Flotation, Cuming Flotation Technologies, LLC, a Delaware corporation, in a transaction that was accounted for as a reverse merger, with Deep Down being the surviving entity for accounting purposes. The following discussion describes the history of Deep Down.
On June 29, 2006, Subsea Acquisition Corporationlimited liability company (“Subsea”CFT”), a Texas corporation, was formed with the intent to acquire offshore energy service providers, 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 common stock of Strategic Offshore Services Corporation (“SOS”), a Texas corporation, for 3,000 shares of Subsea’s Series F Preferred Stock and 1,000 shares of Subsea’s Series G Preferred Stock from two common shareholders of Subsea. Since the entities were under common control and the acquired entity did not constitute a business, the Company was charged compensation expense to shareholders for the fair value of both series totaling $3,340,792.
On November 21, 2006, Subsea also acquired Deep Down, Inc.,Flotation Investor, LLC, a Delaware corporationlimited liability company (“Holdings”), pursuant to which was founded in 1997. Under the terms of this transaction, Subsea acquiredFlotation contributed all of Deep Down’s common stockits operating assets and liabilities (except for one intercompany corporate overhead payable) to CFT in exchange for 5,000 sharescommon units of Subsea’s Series D PreferredCFT. Pursuant to the Contribution Agreement, we contributed to CFT $1,400 in cash and all of our rights and obligations under that certain Stock Purchase Agreement, dated May 3, 2010, as amended (the “Cuming SPA”), by and 5,000 sharesamong the Company, Cuming Corporation, a Massachusetts corporation (“Cuming”), and the stockholders of Subsea’s Series E Preferred Stock resultingCuming, in Deep Down becomingexchange for common units of CFT. Concurrently with the closing of the transactions described above, CFT contributed the operating assets and liabilities it acquired from Flotation to Flotation Tech, LLC, a Delaware limited liability company and wholly-owned subsidiary of Subsea. The transaction was accountedCFT.
On December 31, 2010, we entered into a Contract Assignment and Amendment Agreement by and among the Company, CFT and Cuming, pursuant to which we assigned all of our rights and obligations under the Cuming SPA to CFT. Concurrent with our entry into such Contract Assignment and Amendment Agreement, we entered into a Securities Purchase Agreement, by and among the Company and Holdings (the “Securities Purchase Agreement”), pursuant to which we sold and issued to Holdings 20,000 shares of our common stock for under SFAS 141, “Business Combinations,” as a purchase as there was a change of control. Thean aggregate purchase price based onof $1,400. The Securities Purchase Agreement provides Holdings with registration rights for such 20,000 shares only in the fair value of the Series D and E Preferred stock, was $7,865,471.event we fail to maintain current public filings.
Immediately after acquiring Deep Down and SOS on November 21, 2006, Subsea merged with SOS, with Subsea as the surviving company. Immediately thereafter, Subsea merged with Deep Down, with Deep Down as the surviving company.
On
In connection with the consummation of the foregoing described transaction, on December 14, 2006, after divesting31, 2010, the Company and Flotation entered into an Amended and Restated Limited Liability Company Agreement (the “JV LLC Agreement”) of CFT by and among us, Flotation and Holdings, each as a member of the CFT, to provide for the respective rights and obligations of the members of CFT. We and Flotation collectively hold 20% of the common units of CFT. Holdings holds 80% of the common units and 100% of the preferred units, which are entitled to a preferred return until the holder thereof receives a full return of its Westmeria Healthcare Limited subsidiary, MediQuip acquired all 9,999,999 sharesinitial capital contribution. The preferred units have no voting rights. Pursuant to the terms of the JV LLC Agreement, we and Flotation collectively have the right to appoint one director to CFT’s board of directors and Holdings has the right to appoint the other 4 directors. The JV LLC Agreement provides that, without the prior approval of Deep Down common stock and all 14,000 sharesFlotation, certain actions cannot be taken by CFT, including: increasing the number of members of CFT’s board of directors; amending the JV LLC Agreement or the certificate of formation of CFT in a manner that disproportionately adversely affects Deep Down preferred stock for 75,000,000 sharesor Flotation; engaging in activities other than the business of common stock and 14,000 shares of preferred stock of MediQuip. The preferred shares of MediQuip were issuedCFT; declaring or paying dividends or distributions not in accordance with the same designations as Deep Down’s preferred stock. AsJV LLC Agreement; repurchasing or redeeming CFT units; causing a resultmaterial change in the nature of the acquisition, the shareholders ofCFT’s business; engaging in activity that disproportionately affects Deep Down ownedor Flotation as holders of units of CFT; liquidating, dissolving or effecting a majorityrecapitalization or reorganization of the voting stock of MediQuip, which changed its nameCFT; prior to Deep Down, Inc.
On AprilNovember 2, 2007, Deep Down acquired2012, authorizing or issuing any equity securities or other securities with equity features or convertible into equity securities except with regard to incentive plans for management; making loans, advancements, guarantees or investments except under certain circumstances; granting an exclusive license in all or substantially all of the intellectual property rights of CFT; amending any provision of, or entering into a resolution of any dispute with the parties under the Cuming SPA; entering into a transaction with an officer, director or other person who is an affiliate of CFT; incurring any funded indebtedness other than for the purpose of retiring CFT’s indebtedness to Holdings until such time as such indebtedness is fully repaid; or agreeing or committing or causing any subsidiary to agree to or commit to any of the above.
Concurrent with the closing of the joint venture transaction on December 31, 2010, we entered into a Management Services Agreement to be effective as of January 1, 2011, with CFT, pursuant to which we provide CFT the services of certain officers and management personnel. We have amended this Management Services Agreement effective as March 1, 2011 to, among other things, alter the minimum monthly fee we are paid by CFT (due partly to a change in the staffing levels for services and personnel we provide to CFT).
See additional discussion in Note 4 “Investment in Joint Venture” to the consolidated financial statements included in this Report.
Industry and Executive Outlook
Effective May 30, 2010, the United States Department of the Interior, (the “DOI”) ordered a moratorium on all deepwater drilling on the Outer Continental Shelf in response to the April 20, 2010, Deepwater Horizon incident (the “GOM Incident”). Although this moratorium was lifted by the DOI on October 12, 2010, the impact of the GOM Incident on our operations and severity of the industry downturn cannot be predicted with certainty. The timing of market recovery will depend upon several additional factors outside of our control, including the securing of permits, among other required approvals, necessary prior to commencement of deepwater operations in the GOM. Recently, several of our customers have received drilling permits. We expect our operations in the GOM will start improving sometime during the last half of 2011.
Financial markets, which are critical to the funding of the major offshore and deepwater projects, also continued to show some signs of stabilization and recovery and we continue to see an increase in our multi-national bidding activity. Our operations continue to benefit from increased demand for our products and services primarily in Brazil and West Africa.
The deepwater and ultra-deepwater industry remains one of the best frontiers for adding large hydrocarbon reserves with high production flow rates. We are well positioned to supply services and products required to support safe offshore and deepwater projects of our customers. We anticipate demand for our deepwater and ultra-deepwater services and products will continue to grow and we will continue to focus on this sector of the industry worldwide.
For fiscal year 2011, our focus remains on successful execution of our projects, obtaining new project awards and effective cash management.
Results of Operations
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Revenues | | $ | 42,471 | | | $ | 28,810 | | | $ | 13,661 | | | | 47.4 | % |
Revenues
Revenues increased $13,661, or 47.4 percent, to $42,471 for the year ended December 31, 2010 from $28,810 for the previous year. The increase in revenues was due primarily to generally higher demand for our services and products, especially in the GOM and West Africa, leading to higher utilization of our personnel, equipment and ROVs, increased equipment and tooling rentals, greater output of engineered subsea projects (including installation support services) and increased manufacture of products for deepwater and ultra-deepwater projects.
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Cost of sales | | $ | 28,886 | | | $ | 19,888 | | | $ | 8,998 | | | | 45.2% | |
| Gross Profit | | $ | 13,585 | | | $ | 8,922 | | | $ | 4,663 | | | | 52.3% | |
| Gross Profit % | | | 32.0% | | | | 31.0% | | | | | | | | 1.0% | |
Gross profit increased $4,663 to $13,585 for the year ended December 31, 2010, an increase of 52.3 percent over the same period of the prior year, reflecting an overall increase in the gross profit margin to 32 percent from 31 percent. The increases in gross profit and gross profit margin were due to the increased revenues described above and to the larger percentage of service rather than product revenue during the same period last year.
We record depreciation expense related to revenue-generating fixed assets as cost of sales, which totaled $2,327 and $1,615 for the years ended December 31, 2010 and 2009, respectively. The increase in 2010 resulted from the purchases of ROVs and other capital expenditures to increase capacity in 2010 and late in fiscal year 2009.
Selling, general and administrative expenses
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Selling, general & administrative | | $ | 13,963 | | | $ | 14,371 | | | $ | (408 | ) | | | (2.8)% | |
| Selling, general & administrative as a % of revenues | | | 32.9% | | | | 49.9% | | | | | | | | (17.0)% | |
Selling, general and administrative expenses (“SG&A”), as a percent of revenue, decreased 17.0% from the previous fiscal year. SG&A decreased $408 from the previous year, even though revenues for the same period increased by 47.4%. Now that we have completed the JV transaction, we will continue our cost containment program. During the year ended December 31, 2009, we reversed an accrual of $586 for registration penalty expense that was accrued during fiscal 2008. The effect of this accrual reversal in 2009 indicates our SG&A actually declined by $994, which is a significant reduction in SG&A as a result of our cost containment program.
Depreciation and amortization expense (excluded from Cost of sales)
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Depreciation | | $ | 329 | | | $ | 343 | | | $ | (14 | ) | | | (4.1)% | |
| Amortization | | | 1,402 | | | | 6,195 | | | | (4,793 | ) | | | (77.4)% | |
| Depreciation and amortization | | $ | 1,731 | | | $ | 6,538 | | | $ | (4,807 | ) | | | (73.5)% | |
Depreciation and amortization expense consists primarily of depreciation of our fixed assets that are not related to revenue generation, plus amortization of intangible assets, including our customer lists, technology and trademarks. Depreciation and amortization expense, excluded from “Cost of sales” in the accompanying statements of operations, was $1,731 and $6,538 for the years ended December 31, 2010 and 2009, respectively.
Amortization of intangible assets for the year ended December 31, 2010 was $1,402 compared to $6,195 for the year ended 2009. Included in amortization for 2009 was an impairment charge to certain long-lived intangible assets totaling $4,616, due partially to a change in the estimated useful life of some technology intangible assets from twenty-five years to ten years which reduced the fair value measurement of the asset. See further discussion regarding the specific assumptions and test results in Note 6 "Intangible Assets and Goodwill" to the consolidated financial statements included in this Report.
Goodwill impairment
During the year ended December 31, 2010, we recognized an impairment to goodwill in the amount of $4,513 related to the Flotation and Mako reporting units. As of December 31, 2009, we recognized an impairment to goodwill in the amount of $5,537 related to the Deep Down Delaware and Mako reporting units. See further discussion of the related analysis in Note 6 "Intangible Assets and Goodwill" to the consolidated financial statements included in this Report.
Net interest expense
Net interest expense for the year ended December 31, 2010 was $510 compared to $356 for the same prior year period. Net interest expense for the years ended December 31, 2010 and 2009 was generated by our outstanding bank debt, capital leases and our outstanding subordinated debenture.
Loss on contribution of net assets of ElectroWave USA, Inc.,wholly-owned subsidiary
Effective December 31, 2010, we engaged in a Texas corporationjoint venture transaction in which all of Flotation’s operating assets and liabilities (except for one intercompany corporate overhead payable) were contributed, along with other contributions we made, to CFT in return for a 20% common unit ownership interest in CFT. A gain or loss is recognized on the difference between the determined fair value of our investment in CFT and the book value of the net assets contributed. Because the fair value of CFT’s net assets (common equity) was determined to be $17,000, our 20% investment was valued at $3,400. When this amount was compared to the combined book value of Flotation’s net assets of $12,119 plus cash we contributed of $1,400, a loss on contribution in the amount of $10,119 was generated. Based on the financial forecasts of CFT, we believe that the expected equity earnings from our 20% investment in CFT in future years will exceed the loss on contribution of Flotation.
Equity in net loss of joint venture
The transaction with CFT closed on December 31, 2010. The loss of CFT for the year ended December 31, 2010 was comprised of acquisition and legal costs, which were partially offset by the recognition of a bargain purchase gain. There was no operating activity recorded in 2010. We recorded our 20% equity-method portion of CFT’s net loss in the amount of $254 for the year ended December 31, 2010.
Adjusted EBITDA
Our management evaluates our performance based on a non-GAAP measure, Adjusted EBITDA, which consists of earnings (net income or loss) available to common shareholders before cumulative effect of accounting change, net interest expense, income taxes, non-cash stock compensation expense, non-cash impairments, depreciation and amortization, other non-cash items and one-time charges. This measure may not be comparable to similarly titled measures employed by other companies and is not a measure of performance calculated in accordance with U.S. GAAP. The measure should not be considered in isolation or as a substitute for operating income, net income or loss, cash flows provided by operating, investing or financing activities, or other cash flow data prepared in accordance with U.S. GAAP. The amounts included in the Adjusted EBITDA calculation, however, are derived from amounts included in the accompanying consolidated statements of operations data.
We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it is widely used by investors in our industry to measure a company’s operating performance without regard to items such as income taxes, net interest expense, depreciation and amortization, non-cash impairment, non-cash stock compensation expense, non-cash impairments, other non-cash items and one-time charges which can vary substantially from company to company depending upon accounting methods and book value of assets, financing methods, capital structure and the method by which assets were acquired; it helps investors more meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest) and asset base (primarily depreciation and amortization) and actions that do not affect liquidity (stock compensation expense, goodwill impairment and loss on contribution of assets of a wholly-owned subsidiary) from our operating results; and it helps investors identify items that are within our operational control. Depreciation and amortization charges, while a component of operating income, are fixed at the time of the asset purchase or acquisition in accordance with the depreciable lives of the related asset and as such are not a directly controllable period operating charge.
The following is a reconciliation of net loss to Adjusted EBITDA for the years ended December 31, 2010 and 2009:
| | | Year Ended December 31, | | | Increase (Decrease) | |
| | | 2010 | | | 2009 | | | $ | | | % | |
| Net loss | | $ | (17,415 | ) | | $ | (16,781 | ) | | $ | (634 | ) | | | (3.8 | )% |
| Add back interest expense, net of interest income | | | 510 | | | | 356 | | | | 154 | | | | 43.3 | % |
| Add back depreciation and amortization | | | 4,058 | | | | 8,154 | | | | (4,096 | ) | | | (50.2 | )% |
| Add back income tax expense (benefit) | | | 175 | | | | (1,026 | ) | | | 1,201 | | | | 117.1 | % |
| Add back loss on contribution of net assets of wholly-owned subsidiary | | | 10,119 | | | | - | | | | 10,119 | | | | 100.0 | % |
| Add back share-based compensation | | | 727 | | | | 836 | | | | (109 | ) | | | (13.0 | )% |
| Add back goodwill impairment | | | 4,513 | | | | 5,537 | | | | (1,024 | ) | | | (18.5 | )% |
| Adjusted EBITDA | | $ | 2,687 | | | $ | (2,924 | ) | | $ | 5,611 | | | | 191.9 | % |
Adjusted EBITDA was $2,687 for the year ended December 31, 2010 compared to $(2,924) for the previous year. The $5,611 improvement was primarily driven by improved operations and reduced costs, particularly in the second half of the year.
Capital Resources and Liquidity
Overview
As a deepwater service provider, our revenues, profitability, cash flows, and future rate of growth are substantially dependent on the condition of the global oil and gas industry generally, and our customers’ ability to invest capital for offshore exploration, drilling and production and maintain or increase levels of expenditures for maintenance of offshore drilling and production facilities. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility. We enter into large, fixed-price contracts which may require significant lead time and investment. A decline in offshore drilling and production activity could result in lower contract volume or delays in significant contracts which could negatively impact our earnings and cash flows. Our earnings and cash flows could also be negatively affected by delay in payments by significant customers or delays in completion of our contracts for any reason. While our objective is to enter into contracts with our customers that are cash flow positive, we may not always be able to achieve this objective. We are dependent on our cash flows from operations to fund our working capital requirements and the uncertainties noted above create risks that we may not achieve our planned earnings or cash flow from operations, which may require us to raise additional debt or equity capital. There can be no assurance that we could raise additional capital.
During our fiscal years ended December 31, 2010 and 2009, we have supplemented the financing of our capital needs through a combination of debt and equity financings. Most significant in this regard has been our debt facility we have maintained with Whitney National Bank (“Whitney”). Our loans outstanding under the Amended and Restated Credit Agreement with Whitney (the “Restated Credit Agreement”) become due on April 15, 2012. We will need to raise additional debt or equity capital or renegotiate the existing debt prior to such date. We are currently in discussions with several lenders who have expressed interest in refinancing our debt. Our plan is to refinance the outstanding indebtedness under the Restated Credit Agreement or seek terms with Whitney that will provide an extension of such Restated Credit Agreement along with additional liquidity. However, we cannot provide any assurance that any financing will be available to us on acceptable terms or at all. If we are unable to raise additional capital or renegotiate our existing debt, this would have a material adverse impact on our business or would raise substantial doubt about our ability to continue as a going concern. In addition to the foregoing, as of December 31, 2010, we were not in compliance with the financial covenants under the Restated Credit Agreement. On March 25, 2011 we obtained a waiver for these covenants as of December 31, 2010.
Although the factors described above create uncertainty, if our planned financial results are achieved we believe that we will have adequate liquidity to meet our future operating requirements, and we believe we will be able to raise additional capital or renegotiate our existing debt.
The following are summaries regarding our primary sources of capital financing for our fiscal year ended December 31, 2010.
Whitney Credit Agreement
We originally entered into a credit agreement with Whitney in November 2008. The credit agreement originally provided a commitment to lend to us the lesser of $2,000 or 80 percent of eligible receivables. All of this commitment was also available for Whitney to issue letters of credit (“L/C”) for our benefit. In December 2008, we entered into an amendment of the credit agreement that provided for us to receive a term loan in the principal amount of $1,150. Then, in May 2009, we entered into another amendment to the credit agreement providing for us to receive another term loan in the principal amount of $2,100. We used the proceeds from the December 2008 term loan to purchase a piece of equipment (a remotely operated vehicle) and we used the proceeds of the May 2009 term loan to purchase real property in Channelview, Texas. There was $850 outstanding under the revolving credit line available on December 31, 2009. We also used the credit agreement to have Whitney issue an irrevocable transferable standby L/C in the ordinary course of business, with an annual commission rate of 2.4 percent for $1,107 during the year ended December 31, 2009 (which such L/C related to a large contract we expect to have completed during 2011). The Restated Credit Agreement does not obligate Whitney to issue new L/Cs. However on September 1, 2010, Whitney did renew the aforementioned L/C under the same terms for a period of one year to expire on August 31, 2011. We paid the annual commission in advance, and the L/C will remain in effect until it expires.
On April 14, 2011, we entered into a Second Amendment to the Restated Credit Agreement with Whitney, pursuant to which Whitney extended the maturity dates of the respective term loans and the letter of credit facility under the Restated Credit Agreement to April 15, 2012.
Under the original credit agreement with Whitney, we were obligated to repay the December 2008 term loan on the basis of monthly installments of $35, with the initial payment on February 1, 2009 and a final payment on January 2, 2012. Outstanding amounts of principal of the December 2008 term loan accrue interest at a rate of 6.5 percent per annum. Under the terms of the Restated Credit Agreement, the monthly installment payments and interest rate of the December 2008 term loan remain the same. As of December 31, 2010, the outstanding principal amount of the December 2008 term loan was $443.
Under the original credit agreement with Whitney, we were obligated to repay the May 2009 term loan on the basis of monthly installments of $18, with the initial payment on June 1, 2009 and a final payment on May 1, 2024. Outstanding amounts of principal of the May 2009 term loan accrue interest at a rate of 6.5 percent per annum. Under the terms of the Restated Credit Agreement, the monthly installment payments and interest rate of the May 2009 term loan remain the same, and the final balloon payment of $1,834 is now due on April 15, 2012. As of December 31, 2010, the outstanding principal amount of the May 2009 term loan was $1,944.
Upon execution of the Restated Credit Agreement in April 2010, our indebtedness in the amount of $850 outstanding under the revolving credit line of the credit agreement was converted to a term loan. This term loan requires us to make monthly installments in the amount of $40 plus the amount of accrued and unpaid interest beginning on May 1, 2010 with a final payment on February 1, 2012. Outstanding amounts of principal of the April 2010 term loan accrue interest at a rate of 6.5 percent per annum. As of December 31, 2010, the outstanding principal amount of the April 2010 term loan was $530.
Whitney possesses a lien on all of our assets to secure the outstanding indebtedness under the Restated Credit Agreement. Furthermore, each of our subsidiaries has guaranteed our obligations under the Restated Credit Agreement, and as such, our obligations in connection with the Restated Credit Agreement are generally secured by a first priority lien on all of our subsidiaries’ assets. With regard to the Channelview Property purchased with the proceeds of the May 2009 term loan, we also entered into a Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing creating a lien on such property.
On December 31, 2010, we entered into a First Amendment to Amended and Restated Credit Agreement with Whitney, pursuant to which Whitney provided its consent concerning our contribution of Flotation’s assets to CFT and our issuance of shares to Holdings and using the proceeds thereof for a further cash contribution to CFT. This amendment allowed the Company to complete the acquisition of Cuming Corporation and form the JV, which we contributed all of the assets, liabilities and bank debt of the Flotation subsidiary to the JV for our 20% ownership in the JV. However, as a result of this transaction occurring on December 31, 2010, we are required to expense all acquisition costs and write down the value of the contributed assets in order to establish a fair value of our investment in the JV. These expenses and write down caused us to be not in compliance with certain financial covenants under the Restated Credit Agreement. On March 25, 2011 we obtained a waiver for these covenants as of December 31, 2010.
Under the Restated Credit Agreement, as amended and restated, beginning with the quarter ended June 30, 2010, and for each quarter thereafter, we have been obligated to comply with the following financial covenants: (i) total debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) of not greater than 3.0 to 1.0 (“Leverage Ratio”), consolidated EBITDA to consolidated net interest expense and principal payments on the total debt greater than 1.5 to 1.0 (“Fixed Charge Coverage Ratio”), and consolidated net worth after deducting other assets as are properly classified as “Intangible Assets”, plus 50 percent of net income, after provision for taxes (“Tangible Net Worth”) in excess of $15,000. The calculation of EBITDA, with regards to the Leverage Ratio and Fixed Charge Coverage Ratio, allows us to deduct certain non-cash items, specifically asset impairment charges as of December 31, 2009 and going forward. As of both September 30, 2010 and December 31, 2010, we were not in compliance with the Leverage Ratio and the Fixed Charge Coverage Ratio and, as noted above, such circumstance entitles Whitney at its option to accelerate and immediately require all amounts outstanding under the Restated Credit Agreement to become immediately due. Under the Restated Credit Agreement, we continue to have obligations for other covenants, including limitations on issuance of common stock, liens, transactions with affiliates, additional indebtedness and permitted investments, among others.
The Restated Credit Agreement removed a provision from the prior credit agreement with Whitney that permitted us to obtain additional indebtedness from a third party in the event Whitney declined to increase its commitment of indebtedness to us. As such, we expect to have to refinance the indebtedness outstanding under the Restated Credit Agreement at any such time as we seek to obtain new financing from a third party.
During fiscal 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds from TD Bank, N.A. in the principal amount of $2,160 (the “TD Bank Loan”). Under the terms of the TD Bank Loan, we were obligated to make payments in monthly installments of $15, with an initial payment on March 13, 2009 and a final payment of the unpaid principal and accrued interest in February 2029. The interest rate on the TD Bank Loan was 5.75 percent.
The TD Bank Loan was secured by Flotation’s operating premises in Biddeford, Maine under a mortgage and security agreement and a collateral assignment of leases and rents. The TD Bank loan required us to enter into a debt subordination agreement that subordinated any debt Flotation owed to Deep Down, other than accounts payable between them arising in the ordinary course of business. Additionally, the TD Bank Loan required a “negative pledge” that prohibited Flotation and Deep Down from granting security interests in Flotation’s personal property, other than such security interests granted in respect of our credit agreement with Whitney, as appropriate.
Under the TD Bank Loan, we were required to meet certain covenants and restrictions. The financial covenants were reportable annually beginning with the year ended December 31, 2009, and were specific to the Flotation subsidiary financials. At December 31, 2009, we were not in compliance with the financial covenants, and on April 15, 2010, we obtained a waiver for these covenants as of December 31, 2009.
In connection with Flotation’s contribution of all of its assets to CFT on December 31, 2010, CFT assumed the obligations of Flotation under the TD Bank Loan and we were released from the obligations under such loan.
Other Debt
We have a subordinated debenture with a principal amount of $500 which originated from the exchange of preferred stock in a prior year. The debenture has a fixed interest rate of 6.0 percent per annum, which is required to be paid annually beginning March 31, 2009 through maturity on March 31, 2011, when the unpaid principal balance is due.
Equity Financings
Between April 25 and April 30, 2010, we sold 5,150 shares of our common stock in a private placement to accredited investors at a per share price of $0.10 resulting in total proceeds of $501, net of $14 applied to an outstanding vendor invoice for services provided, which we have used for working capital purposes.
On December 31, 2010, we sold 20,000 shares of our common stock in a private placement to Holdings for an aggregate purchase price of $171,407. Deep Down formed$1,400. We then contributed these proceeds to CFT in return for common units of CFT. For a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”),description of the joint venture transaction of which this sale and contribution were a Nevada corporation,part, see “Part II, Item 8. Financial Statements and Supplemental Data” Note 4 "Investment in Joint Venture" to complete the acquisition. Headquarteredconsolidated financial statements.
Cash Flows
For the year ended December 31, 2010, cash used in Channelview, Texas, ElectroWave offers products and services involving electronic monitoring and control systemsoperating activities was $4,043 as compared to cash provided by operating activities of $2,532 for the energy, military,prior year. Our working capital balances vary due to delivery terms and commercial business markets.payments on key contracts, costs and estimated earnings in excess of billings on uncompleted contracts, and outstanding receivables and payables. For the year ended December 31, 2009, we recorded depreciation and amortization of $8,154, which included $4,616 additional amortization due to the impairment of two long-lived intangible assets. The net intangible assets and other operating assets and liabilities of Flotation were contributed to CFT effective December 31, 2010, as discussed above.
EffectiveFor the year ended December 1, 2007, Deep Down acquired all31, 2010, cash provided by investing activities was $5,946 compared to cash used in investing activities of $6,611 for the prior year. During the year ended December 31, 2010, we used $2,634 to purchase property and equipment and $278 for capitalized software. Additionally, we contributed $1,400 to the joint venture with CFT, which was generated by the sale of 20,000 shares of our common stock at $0.07 per common share, and contributed the net assets and liabilities of Mako Technologies, Inc. (“Mako”)Flotation to CFT, which resulted in a loss of $10,119. For the year ended December 31, 2009, we used $6,117 to purchase property and equipment related to plant improvements and the purchase of ROVs, plus $614 for a total purchase pricecapitalized software.
For the year ended December 31, 2010, cash provided by financing activities was $915 which represented net proceeds from the sale of $11.3 million including transaction fees. Deep Down formed a wholly-owned subsidiary, Mako Technologies, LLCstock of $1,901, offset by $961 in principal payments on long term debt and $25 value of stock canceled for payroll taxes related to completeemployee restricted stock vestings. During the acquisition. Headquartered in Morgan City, Louisiana, Mako serves the growing offshore petroleumyear ended December 31, 2009, cash provided by financing activities was $2,496 which consisted of borrowings of $3,000 and marine industries with technical support services, and products vital to offshore petroleum production, through rentalsprinciple payments 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.$504.
The Company’s historical financial statements reflect those of Deep Down, Inc. and its subsidiaries, and do not include the results of MediQuip or Westmeria Healthcare Limited for periods prior to the reverse merger date of December 14, 2006.Critical Accounting Policies and Estimates
The accompanying discussion and analysis of our financial condition and results of operations is based uponon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United StatesStates. The preparation of America. Note 1 “Naturethese financial statements in accordance with U.S. GAAP requires us to make estimates and judgments that may affect assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition and related allowances, costs and estimated earnings incurred in excess of Businessbillings on uncompleted contracts, inventory, impairments of long-lived assets, including intangible assets, impairments of goodwill, income taxes including the valuation allowance for deferred tax assets, billings in excess of costs and Summaryestimated earnings on uncompleted contracts; contingencies and litigation, and share-based payments. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of Significant Accounting Policies”which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.
We believe the notesfollowing accounting policies are critical to our audited consolidated financial statements included elsewhere in this report contains a detailed summarybusiness operations and the understanding of our operations and include the more significant accounting policies. We utilize the following critical accounting policiesjudgments and estimates used in the preparation of our consolidated financial statements.
Accounts Receivable Trade 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 accompanyingconsolidated financial statements include the accounts of Deep Down, Inc. 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. subsidiaries.
All intercompany transactions and balances have been eliminated in consolidation.
Collectability of Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. Estimates are used in determining our allowance for doubtful accounts and transactionsare based on our historical level of write-offs and judgments management makes about the creditworthiness of significant customers based on ongoing credit evaluations. Further, we monitor current economic trends that might impact the level of credit losses in the future. Since we cannot predict with certainty future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates. Additional allowances may be required if the economy or the financial condition of our customers deteriorates. If we determined that a smaller or larger allowance was appropriate, we would record a credit or a charge to selling, general and administrative expense in the period in which we made such a determination.
Revenue Recognition
We recognize revenue once the following four criterions are met: (i) persuasive evidence of an arrangement exists, (ii) delivery of the equipment has occurred or services have been eliminated.rendered, (iii) the price of the equipment or service is fixed and determinable and (iv) collectability is reasonably assured. Fabrication and sale of equipment billings are contingent upon satisfaction of a significant condition of sale milestone, including but not limited to, factory acceptance testing and customer approval, and recognized upon transfer of title to the customer. Service revenue is recognized as the service is provided, and “time and material” contracts are billed on a bi-weekly or monthly basis as costs are incurred. Customer billings for shipping and handling charges are included in revenue.
From time to time, we enter into large fixed price contracts which we determine that recognizing revenues for these types of contracts is appropriate using the percentage-of-completion method, which compares the percentage of costs incurred to date to the estimated total costs for the contract. This method is appropriate because management considers total costs the best available measure of progress.
Total costs include all direct material and labor costs plus all indirect costs related to contract performance, such as supplies, equipment repairs, employee travel and supervisor time. Selling, general and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts (if any) are made in the period in which such losses are determined. Changes in job performance, job conditions, and total contract values may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Unapproved change orders are accounted for in revenue and cost when it is probable that the costs will be recovered through a change in the contract price. In circumstances where recovery is considered probable but the revenues cannot be reliably estimated, costs attributable to change orders are deferred pending determination of contract price.
Costs and estimated earnings in excess of billings on uncompleted contracts arise when revenues are recorded on a percentage-of-completion basis but cannot be invoiced under the terms of the contract. Such amounts are invoiced upon completion of contractual milestones. Billings in excess of costs and estimated earnings on uncompleted contracts arise when milestone billings are permissible under the contract, but the related costs have not yet been incurred. All contract costs are recognized currently on jobs formally approved by the customer and contracts are not shown as complete until virtually all anticipated costs have been incurred and the items are shipped to the customer.
Assets and liabilities related to costs and estimated earnings in excess of billings on uncompleted contracts, as well as billings in excess of costs and estimated earnings on uncompleted contracts, have been classified as current. The contract cycle for certain long-term contracts may extend beyond one year, thus complete collection of amounts related to these contracts may extend beyond one year, though such long-term contracts include contractual milestone billings as discussed above.
All intercompany revenue balances and transactions were eliminated in consolidation.
Long-Lived Assets
Long-Lived AssetsLong-lived assets include property, plant and equipment and long-lived intangible assets. Our intangible assets generally consist of assets acquired in the purchases of the Mako and Flotation subsidiaries and are comprised of customer lists, non-compete covenants with key employees and trademarks related to Mako’s ROVs and to Flotation’s branding, processes, materials and technology. We evaluateamortize intangible assets over their useful lives ranging from six to twenty-five years on a straight-line basis. We make judgments and estimates in conjunction with the carrying value of these assets, including amounts to be capitalized, depreciation and amortization methods, useful lives and the valuation of acquired long-lived intangible assets.
We test for the impairment of long-lived assets forupon the occurrence of a triggering event. We base our evaluation on impairment whenever changes in circumstances indicate thatindicators such as the carrying amountnature of the assetassets, the future economic benefit of the assets, any historical or future profitability measurements and other external market conditions or factors that may not be recoverable. Recoverability of assets to be held and used is measured by a comparison ofpresent. If these impairment indicators are present or other factors exist that indicate the carrying amount of an asset to futuremay not be recoverable, we determine whether an impairment has occurred through the use of an undiscounted cash flows analysis of the asset at the lowest level for which identifiable cash flows exist. The undiscounted cash flow analysis consists of estimating the future cash flows that are directly associated with and expected to be generated byarise from the use and eventual disposition of the asset over its remaining useful life. These cash flows are inherently subjective and require significant estimates based upon historical experience and future expectations reflected in our budgets and internal projections. If the undiscounted cash flows do not exceed the carrying value of the long-lived asset, an impairment has occurred, and we recognize a loss for the difference between the carrying amount and the estimated fair value of the asset. If assets are considered to be impaired,The fair value of the impairment to be recognizedasset is measured byusing quoted market prices or, in the amount byabsence of quoted market prices, is based on an estimate of discounted cash flows. Cash flows are generally discounted at an interest rate commensurate with our weighted average cost of capital for a similar asset.
We assessed the conditions and concluded, as of December 31, 2009, that a triggering event had occurred that required an impairment analysis of long-lived intangible assets (see further discussion below related to Goodwill annual testing). For the year ended December 31, 2009, we recorded impairment charges totaling $4,616 to several long-lived intangible assets, which total impairment charges were recorded on the carrying amounts exceedstatement of operations as amortization expense. There was no impairment of long-lived assets for the year ended December 31, 2010. Unanticipated changes in revenue, gross margin, or long-term growth factor could result in a material impact on the estimated fair values of our long-lived assets which could result in long-lived asset impairments in future periods. See further discussion in Note 6 "Intangible Assets and Goodwill" to the assets. Assetsconsolidated financial statements included in this Report. Additionally, the net intangible assets of Flotation were contributed 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.CFT effective December 31, 2010, as discussed above.
Stock-Based CompensationGoodwill
Goodwill represents the cost in excess of the fair value of net assets acquired in business combinations. We account for stock-based compensation issued to employeesevaluate the carrying value of goodwill annually on December 31 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 onbetween 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.
The test for goodwill impairment is a two-step approach. The first step is to compare the estimated fair value of any reporting units within the Company that have goodwill with the recorded net book value (including the goodwill) of the reporting unit. If the estimated fair value of the reporting unit is higher than the recorded net book value, no impairment is deemed to exist and no further testing is required. If, however, the estimated fair value of the reporting unit is below the recorded net book value, then a second step must be performed to determine the goodwill impairment required, if any. In this second step, the estimated fair value from the first step is used as the purchase price in a hypothetical acquisition of the reporting unit. Purchase business combination accounting rules are followed to determine a hypothetical purchase price allocation to the reporting unit’s assets and liabilities. The residual amount of goodwill that results from this hypothetical purchase price allocation is compared to the carrying value of goodwill for the reporting unit, and the carrying value is written down to the hypothetical amount, if lower.
At December 31, 2010 and 2009, respectively, our management completed the annual impairment test of goodwill. There was no indication of impairment for the year ended December 31, 2010. Management’s calculations indicated as of December 31, 2009, due to a number of factors, including the global economic environment, increased costs of capital and the decrease in our market capitalization, that the calculations for the reporting units of Deep Down Delaware, Mako and Flotation each indicated their respective net book value exceeded its fair value and, accordingly, goodwill for each unit was considered to be potentially impaired. We used the estimated fair value of each reporting unit from the first step as the purchase price in a hypothetical acquisition of the respective reporting unit. See Note 6 "Intangible Assets and Goodwill" to the consolidated financial statements for a discussion of testing inputs and assumptions. We recognized a goodwill impairment of $3,056 for Deep Down Delaware, $2,481 for Mako and $0 for Flotation for the year ended December 31, 2009. Remaining goodwill by reporting unit was $4,472, $2,874 and $2,083 for the Deep Down Delaware, Mako and Flotation reporting units, respectively, as of December 31, 2009.
Additionally, we assessed market conditions and concluded, as of September 30, 2010, that a triggering event had occurred that required an impairment analysis of goodwill for each reporting unit. Management’s calculations indicated, due to a number of factors, including the global economic environment, increased costs of capital and the decrease in our market capitalization, that the calculations for the reporting units of Mako and Flotation each indicated their respective net book value exceeded its fair value and, accordingly, we estimated the implied fair value of the goodwill for each reporting unit. The calculation for Deep Down Delaware did not indicate any impairment of goodwill. We used the estimated fair value of each reporting unit from the first step as the purchase price in a hypothetical acquisition of the respective reporting unit. We recognized a goodwill impairment of $2,430 for Mako and $2,083 for Flotation reporting units as of the nine months ended September 30, 2010. The impairment was recorded in operating expenses in the consolidated statement of operations for the year ended December 31, 2010. This non-cash charge did not impact our liquidity position, debt covenants or cash flows.
Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions, among others. Unanticipated changes in revenue, gross margin, long-term growth factor or discount rate could result in a material impact on the estimated fair values of our reporting units, which could result in additional goodwill impairments in future periods.
Share-based Compensation
We record share-based payment awards determinedexchanged for employee services at fair value on the date of grant date utilizingand expense the Black-Scholes pricing modelawards in the consolidated statements of operations over the requisite employee service period. Share-based compensation expense includes an estimate for forfeitures and is generally recognized over the expected term of the award on a straight-line basis. At December 31, 2010, we had two types of share-based employee compensation: stock 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.restricted stock.
Key assumptions used in the Black-Scholes model for both stock options and warrantoption valuations include (1) expected volatility (2) expected term (3) discount rate and (4) expected dividend yield. Since we do not have a sufficient trading history to determine the volatility of our own stock, we based our estimates of volatility on a representative peer group consisting of companies in the same industry, with similar market capitalizations and similar stage of development. Additionally, we continue to use the simplified method related to employee option grants.
The fair valueIncome Taxes
We follow the asset and liability method of each stock option or warrant grant is estimated onaccounting for income taxes. This method takes into account the datedifferences between financial statement treatment and tax treatment of the grant using the Black-Scholes modelcertain transactions. Deferred tax assets and is based on the following key assumptionsliabilities are recognized 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 Recognition We generally recognize revenue oncefuture tax consequences attributable to differences between the following four criteriafinancial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are met: (i) persuasive evidence of an arrangement exists, (ii) delivery ofmeasured using enacted tax rates expected to apply to taxable income in the equipment has occurredyears in which those temporary differences are expected to be recovered 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 satisfactionsettled. The effect 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 revenuechange in tax rates is recognized as income or expense in the serviceperiod that includes the enactment date. Our effective tax rates for 2010 and 2009 were (1.0) percent, and 5.98 percent, respectively.
We record a valuation allowance to reduce the carrying value of our deferred tax assets when it is provided. Expenses incurredmore likely than not that some or all of the deferred tax assets will expire before realization of the benefit or that future deductibility is not probable. The ultimate realization of the deferred tax assets depends upon our ability to dategenerate sufficient taxable income of the appropriate character in the future. This requires management to use estimates and make assumptions regarding significant future events such as the taxability of entities operating in the various taxing jurisdictions. In evaluating our ability to recover our deferred tax assets, we consider all reasonably available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions, including the amount of future state, and federal pretax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment. When the likelihood of the realization of existing deferred tax assets changes, adjustments to the valuation allowance are charged, in the period in which the determination is made, either to income or goodwill, depending upon when that exceed milestone billings are adjusted duringportion of the month-end profitability review and represent the balance in our work-in-progress (“WIP”) account on the accompanying balance sheets.
All intercompany revenue accounts and balances were eliminated in consolidations during the month-end profitability review.
valuation allowance was originally created.
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 evaluaterecord an estimated tax liability or tax benefit for income and other taxes based on what we determine will likely be paid in the carrying valuevarious tax jurisdictions in which we operate. We use our best judgment in the determination of goodwill duringthese amounts. However, the fourth quarterliabilities ultimately realized and paid are dependent upon various matters, including resolution of each yeartax audits, and between annual evaluations if events occurmay differ from amounts recorded. An adjustment to the estimated liability would be recorded as a provision or circumstances changebenefit to income tax expense in the period in which it becomes probable 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 comparingactual liability or benefit differs from the implied fair value of reporting unit goodwill to its carryingrecorded amount.
Our intangible assets consist of assets acquiredfuture effective tax rates could be adversely affected by changes in the purchasevaluation of our deferred tax assets or liabilities or changes in tax laws or interpretations thereof. If and when our deferred tax assets are no longer fully reserved, we will begin to provide for taxes at the Mako subsidiaryfull statutory rate. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and comprisedother tax authorities. We regularly assess the likelihood of customer lists, non-compete covenants with key employees and trademarks relatedadverse outcomes resulting from these examinations to Mako’s ROVs. We amortizedetermine the intangible assets over their useful lives ranging from 5 to 25 years on a straight line basis.adequacy of our provision for income taxes.
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 beenRecent Accounting Pronouncements
Recent Accounting Pronouncements are included in “Part II, Item 8. Financial Statements” Note 1 to 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“Summary of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes,Significant Accounting Policies.” 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.
Pro-Forma Results of Operations
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
| | | 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.
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 2007 relates to stock option grants during fiscal 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 above.
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 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 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 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 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 which 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 $1000 per share for which we are obligated as interest expense. During fiscal 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 due to the items discussed above ..
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.
Sources and Uses of Cash for the year ended December 31, 2007
Cash flows for the period through the year ended December 31, 2007, were as follows:
Operating Cash Flows
Cash required by operating activities of continuing operations was $3,006,136. Our working capital balances vary due to on delivery terms and payments on key contracts; work in process, and outstanding receivables and payables. The increase in accounts receivable is primarily due to our sales and deliveries to large integrated international oil companies. Historically, due to the credit strength of our customers, we have not experienced material adjustments to our accounts receivable and believe our accounts receivables from our customers are collectible.
Investing Cash Flows
The cash used from investing activities of $1,358,429 is primarily due to purchases of equipment of $830,965 and restricted cash of $375,000 plus $152,464 related to acquisition costs.
Financing Cash Flows
Net cash provided from financing activities was $6,558,323. This was primarily due to long-term debt issuance of $6,204,799 and common stock proceeds net of expenses of $3,960,000.
Liquidity and Capital Resources
We generate our liquidity and capital resources primarily through operations and, when needed, through debt issues and equity offerings. Our total bank loans outstanding at December 31, 2007 was $916,044 which were Mako bank loans that were paid in full from the Prospect Capital loan. During 2007, we paid approximately $2.7 million in outstanding debt including bank loans, equipment lease obligations, and redemption of Series E preferred stock.
Debt and Liquidity
Total borrowings at December 31, 2007, comprised the following:
A long-term debt obligation to Prospect Capital Corporation with monthly principal and interest payments, interest fixed at 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. We borrowed a total of $12.5 million on the $13.0 million facility from Prospect Capital.
At December 31, 2007 certain bank debt of Mako was outstanding in the aggregate of $916,044 which was paid in full with the advance of funds from the Prospect Capital loan in January 2008.
A capital lease obligation was outstanding for approximately $481,000 for the lease of a crane.
Outlook for 2008
We plan to meet our cash requirements in 2008 with cash generated from operations. Due to the expanding growth of our company and the strength of the industry in which we operate, we believe that we have access to capital to fund and expand our operations. In addition, 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.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
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.
Inflation and Seasonality
We do not believe that our operations are significantly impacted by inflation. Our business is not seasonal in nature.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7. Financial Statements.This item is not applicable for smaller reporting companies.
ITEM 8. FINANCIAL STATEMENTS
The financial statements and schedules are included herewith commencing on page F-1.
ReportReports of Independent Registered Public Accounting Firm
Firms | F-2 |
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| Consolidated Balance Sheets | F-3
F-4 |
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| Consolidated Statements of Operations | F-4
F-5 |
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Consolidated Statements of Changes in Stockholders’ Equity (Deficit) | F-5
F-6 |
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| Consolidated Statements of Cash Flows | F-6
F-7 |
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| Notes to Consolidated Financial Statements | F-8 |
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 8A. Controls and Procedures.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
. We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officerChief Executive Officer and principal financial officer,Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, our principal executive officerChief Executive Officer and principal financial officerChief Financial Officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective due to the material weaknesses described below to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officerChief Executive Officer and principal financial officer,Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. This determination was in response to the SEC comment letter received February 26, 2009, in which the SEC stated that they require that we present the audited predecessor financial statements for Deep Down, Inc. for the period from January 1, 2006 through November 20, 2006 prior to its purchase by the successor entity, in accordance with Rule 310(a) of Regulation S-B. We have supplemented this Form 10-K/A with this required information.
Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
Management’s Report on Internal Control Over Financial Reporting.
Our managementManagement is responsible for the fair presentation of the consolidated financial statements of Deep Down, Inc. Management is also responsible for establishing and maintaining adequatea system of internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
(i)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(ii)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of our management assessedand directors; and
(iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, our management usedbased on the criteria set forthframework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Commission. Based on this evaluation, our management concluded our internal control over financial reporting was not effective as of December 31, 2010.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company'sour annual or interim financial statements will not be prevented or detected on a timely basis. We have identified the following material weaknesses.weaknesses as of December 31, 2010:
| 1. | As of December 31, 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 to the Company’s employees, officers and directors. Additionally, we have not developed and effectively communicated to our employees its accounting policies and procedures. This has resulted in inconsistent practices particularly at its 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 entityWe did not maintain effective monitoring controls. Specifically, we did not have sufficient personnel with an appropriate 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 thesetechnical accounting knowledge, experience, and training who could execute appropriate monitoring and review controls, particularly in situations where transactions were complex or non-routine. This material weakness contributed to the additional material weaknesses discussed below.
We did not have adequate controls to provide reasonable assurance that revenue was recorded in accordance with GAAP. Specifically, we did not have appropriately designed or effectively operating management hasreview controls performed by individuals with appropriate technical expertise to ensure that the accounting for contracts under the percentage-of-completion method was appropriate. This material weakness resulted in material errors that caused a restatement of our interim financial statements for the fiscal periods ended March 31, 2010, June 30, 2010, and September 30, 2010.
We did not have an adequate internal control designed to prevent or detect and correct erroneous information in our project cost accounting application. This material weakness resulted in material errors that caused a restatement of our interim financial statements for the fiscal periods ended March 31, 2010, June 30, 2010, and September 30, 2010.
As a result of the material weaknesses described above, we concluded that the Companywe did not maintain effective internal control over financial reporting as of December 31, 2007,2010 based on the criteria established in "Internal Control-Integrated Framework" issued by the COSO.Framework.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC.
Changes in Internal Control Over Financial Reporting. Management has implemented the following changes to our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the fiscal quarter ended December 31, 2010 which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting:
· | During the fourth quarter of fiscal 2010 and into 2011, Management has increased review of the processes related to the recognition of revenue accounted for under the percentage-of-completion methodology, including the timely review of cost estimates at completion for all material percentage-of-completion contracts. Effective with the Restatement and during the fourth quarter of fiscal 2010, Management corrected the errors identified in the labor and burden rates applied to the project costs used in the percentage-of-completion accounting model. |
· | As discussed elsewhere in this Form 10-K, the Flotation subsidiary was contributed to CFT effective December 31, 2010. We retain a 20% equity ownership interest in the joint venture. |
Management’s remediation plans. In our efforts to continuously improve our internal controls, management has taken steps to enhance the following controls and procedures subsequent to the end of fiscal 2007December 31, 2010 as part of our remediation efforts:efforts in addressing the material weaknesses above:
| · | The ElectroWave division was re-structured and re-organized in the fourth quarter of 2007. A majority of the accounting activities have been transferred to Deep Down Delaware’s accounting department to streamline and centralize accounting. |
· | During the quarter ended March 31, 2011, management strengthened management review controls surrounding revenue recognition to provide reasonable assurance that revenue was recorded in accordance with GAAP, including review by operating and finance management of all estimates to complete for percentage-of-completion contracts. |
· | In responseManagement also plans to complete and distribute an Accounting Policy and Procedures manual. |
· | Though the operations of Flotation were contributed to CFT effective December, 31, 2010, we plan to monitor improvements to the further growth ofJV’s internal controls deemed necessary by the business,JV’s management, hired a corporate controller in January 2008. He is responsible for the coordination and integration of the accounting activities of each of our current and future subsidiary operations. With his relevant experience with the policies and procedures for compliance with regulations promulgated by Sarbanes-Oxley, our goal isparticularly those related to reach full compliance during 2008.revenue recognition. |
| · | Management hired a corporate human resource and safety manager in March 2008 who will be responsible for designing, planning and implementing human resource programs and policies including benefits, staffing, compensation, employee relations, training, and health and safety programs. She will oversee the human resource functions for our current and future subsidiary operations. |
ITEM 9B. OTHER INFORMATION
| · | Management has prepared an Employee Handbook and Code of Conduct and plans to circulate these documents throughout the organization and obtain signed acknowledgements from employees. |
None.
| · | Management plans to document its accounting policies and procedures to increase consistency among divisions. This includes the creation or expansion of checklists which serve to manage close processes. |
| · | Management has increased documentation around certain authorization and review controls. |
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Item 8B. Other Information.
None.
PART III
Item 9. | Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of the Exchange Act. |
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth the names, ages and positions of all of our directors and executive officers.
| Name | | Age | | Position Held With The CompanyDeep Down |
RobertRonald E. Chamberlain, Jr.Smith(2) | | 4852 | | Chairman of the Board, Chief Acquisitions Officer, and Director |
Ronald E. Smith* | | 49 | | President, Chief Executive Officer and Director |
Eugene L. Butler (1) | | 6569 | | Executive Chairman and Chief Financial Officer |
Mary L. Budrunas(2) | | 59 | | Vice President, Corporate Secretary and Director |
Mary L. Budrunas*Michael J. Newbury | | 5643 | | Vice-President, Director,Vice President Operations and Corporate SecretaryBusiness Development |
Michael D. TealMark R. Hollinger | | 5153 | | Corporate ControllerDirector |
_________________________
*(1) Mr. Butler was appointed our Executive Chairman of the Board effective September 1, 2009. Effective April 29, 2010, in connection with Gay Mayeux’s appointment as Chief Financial Officer, the Board accepted the resignation of Mr. Butler as Chief Financial Officer. We continued to employ Mr. Butler as Executive Chairman of the Board under the Employment Agreement dated January 1, 2010. Mr. Butler was then was reappointed as Chief Financial Officer upon Ms. Mayeux’s departure, effective January 24, 2011.
(2) Ronald E. Smith and Mary L. Budrunas are married to each other.
Robert E. Chamberlain, Jr., ChairmanBiographical information regarding each of our directors and named executive officers is as follows. The following paragraphs also include specific information about each director’s experience, qualifications, attributes or skills that led the Board of Directors to the conclusion that the individual should serve on the Board as of the Board, Chief Acquisitions Officer,time of this filing, in light of our business and Director. Mr. Chamberlain has served as Chairman and Director of the Company since December 2006. Mr. Chamberlain has a B.S. in Chemical Engineering and a B.S. in Biomedical Engineering from Northwestern University's Technological Institute and an MBA from Northwestern University's Kellogg Graduate School of Management. Mr. Chamberlain served as Vice President with Solomon Brothers Inc. (1986 to 1992), where his responsibilities included mergers, acquisitions, leveraged buyouts, merchant banking, divestitures, corporate finance, capital raises, restructurings and new product development in both the private and public markets. From 1992 through 1995, Mr. Chamberlain served as Vice President for Laidlaw Securities and Dickinson & Co. where he was responsible for generating public and private equity transactions. Since 1995, Mr. Chamberlain has assisted small emerging growth companies gain access to the capital markets and develop well articulated strategic objectives through consulting companies he controlled. 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.structure:
Ronald E. Smith, President, Chief Executive Officer and Director. Mr. Smith co-founded Deep Down in 1997 and has served as our Chief Executive Officer, President and Director of the Company since December 2006. Prior to December 2006, Mr. Smith was Deep Down’s President. Mr. Smith graduated from Texas A&M University with a Bachelor of Science degree in Ocean Engineering in 1981. Mr. Smith worked both onshore and offshore in management positions for Ocean Drilling and Exploration Company (ODECO), Oceaneering Multiflex, Mustang Engineering and Kvaerner before founding Deep Down. Mr. Smith’s interests include all types of offshore technology, nautical innovations, state of the art communications, diving technology, hydromechanics, naval architecture, dynamics of offshore structures, diving technology and marketing of new or innovative concepts. Mr. Smith is directly responsible for the invention or development of many innovative solutions for the offshore industry, including the first steel tube flying lead installation system.
Mr. Smith is qualified for service on the Board due to his extensive background in many aspects of the offshore industry, spanning almost three decades. Mr. Smith’s wide range of knowledge and experience with the various technologies and platforms in the deepwater industry brings invaluable expertise to our Board.
Eugene L. Butler, Executive Chairman and Chief Financial Officer. Mr. Butler has served as Chief Financial officerOfficer and Director with Deep Down Inc. since June 2007, and was appointed Executive Chairman of the Board effective September 1, 2009. Mr. Butler was Managing Director of CapSources, Inc., an investment banking firm specializing in mergers, acquisitions and restructurings, from 2002 until 2007. Prior to this, he has served in various capacities as a director, president, chief executive officer, chief financial officer and chief operating officer for Weatherford International, Inc., a $2 billionmulti-billion multinational service and equipment corporation serving the worldwide energy market, from 1974 to 1991. He was elected to Weatherford’s boardBoard of directorsDirectors in May of 1978, elected president and chief operating officer in 1979, and president and chief executive officer in 1984. He successfully developed and implemented a turnaround strategy eliminating debt and returning the company to profitability during a severe energy recession. Mr. Butler also expanded operations into international markets allowing Weatherford to become a major worldwide force with its offshore petroleum products and services. Mr. Butler graduated from Texas A&M University in 1963, and served as an officer in the U.S. Navy until 1969 when he joined Arthur Andersen & Co. Mr. Butler is distinguished by numerous medals and decorations, including the Bronze Star with combat “V” and the Presidential Unit Citation for his service with the river patrol force in Vietnam. Mr. Butler also serves on the Board of Powell Industries, Inc. (Nasdaq: POWL) since 1991, where he is the Chairman of the Audit Committee and on the Governance Committee. Mr. Butler is a Certified Public Accountant.
In addition to his extensive knowledge of us, Mr. Butler is qualified for service on the Board based on his leadership skills and long-standing senior management experience in the energy and petroleum industries. Additionally, his background in public accounting and investment banking, familiarity with complex accounting issues and financial statements, as well as his service on the board, including various committees, of another public company, provide invaluable financial expertise and overall insight to our Board.
Mary L. Budrunas, Vice-President, Corporate Secretary and Director. Ms. Budrunas, co-founder of Deep Down, Inc. along with current chief executive officer RonRonald E. Smith, and has served as our Vice-President, Corporate Secretary and director of the CompanyDirector since December 2006. Ms. BudranusBudrunas is responsible for the Company’sour administrative functions, including human resources and accounting. Ms. Budrunas has more than 30-years30 years of logistical management experience in manufacturing, fabrication, and industrial sourcing in the oil and gas industry. Prior to Ms. Budrunas co-founding Deep Down in 1997, she managed the purchasing efforts of many projects over a 10-year period for Mustang Engineering, and previously directed procurement for a large petroleum drilling and production facility project in Ulsan, Korea.
Ms. Budrunas is qualified for service on the Board based on her extensive oil and gas industry experience. Such expertise provides valuable insight to the Board.
Michael J. Newbury, Vice President Operations and Business Development. Mr. Newbury joined Deep Down in March 2009 in the role of Corporate Business Development Manager, bringing more than 19 years of international experience and relationships in offshore business development, sales and marketing, and subsea service project support. Mr. Newbury’s initial role at Deep Down was the improvement in our marketing, sales and commercial aspects, additionally to oversee large project opportunities and to strengthen our contractual functions. In February 2010, Mr. Newbury was promoted to Vice President Business Development and was tasked with the additional responsibilities of corporate operations and interfacing with all of our business units. Prior to joining us, Mr. Newbury held various positions with increasing authority and responsibility with such companies as Subsea 7 from 2002 to 2009, a $2 billion multi-national service and equipment corporation serving the worldwide energy market, General Manager, North and Central America – i-Tech Division, Commercial Manager, North and Central America – ROV, Survey & DGPS, Business Development Manager, North America; Halliburton Subsea (US) 1999 – 2002, Senior Manager – Business Development, Operations Project Manager – ROV and Marine; Subsea International (US) 1997 – 1999, Safety, Quality and Environmental Group Manager & Human Resources & Payroll Manager, and Subsea Offshore Limited (Great Yarmouth and Aberdeen UK) 1990-1997, General Manager, HSEQ Global Manager, Quality Assurance Global Manager, Quality Assurance Engineer. Mr. Newbury has worked in most major oil producing regions of the world, including the Gulf of Mexico, Central America, North Sea, Asia, and Australia. Mr. Newbury’s main areas of focus over the past eight years have been in offshore business development, tendering, and contract negotiation. Mr. Newbury graduated in 1990 with a Bachelor of Science in Business Management.
Mark R. Hollinger, Director. Mr. Hollinger joined the Board as an independent director effective April 12, 2010, and was appointed Chairman of the Audit Committee of the Board of Directors. Mr. Hollinger is currently President of MacDermid Offshore Solutions at MacDermid, Inc. (“MacDermid”), which provides specialty fluids used for the hydraulic controls of valves in the offshore drilling and production systems; a position he has held since September 2007. Prior to MacDermid, Mr. Hollinger served as President of Merix Corporation from May 1999 to January 2007 and Chief Executive Officer from September 1999 to January 2007. During the past five years, Mr. Hollinger served on the board of directors of Merix Corporation and Simple Tech, as well as several non-profit board of directors. Mr. Hollinger holds an MBA in Finance from The Ohio State University.
Mr. Hollinger is qualified for service on the Board based on his experience and expertise in management, plus his knowledge of the international energy market and business strategy, and is a financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K. Also, Mr. Hollinger’s past and current service on the Boards of other public companies brings a depth of experience and perspective to our Board.
Michael D. Teal, Corporate Controller. Mr. Teal has served as corporate controller since January 2008. Mr. Teal has significant experience in mergers and acquisitions, business development, business valuations, investment analysis, strategic planning, debt financing, equity issues, bank lines, and financial planning. His background has primarily been in the energy industry encompassing refining, natural gas, power generation, oil and gas exploration, marine services, and risk management. Since 1984, Mr. Teal has held various corporate-level positions in accounting, treasury, and corporate finance functions with major energy companies, most notably Valero Energy Corporation, The Coastal Corporation, and El Paso Corporation. He also was a consultant providing consultation services to major Houston and Dallas corporations and was recently a Senior Consultant with Sirius Solutions. Mr. Teal graduated from the University of Texas at San Antonio in 1981 with a Bachelor of Business Administration degree in financial accounting. He earned his Master of Business Administration degree from Our Lady of the Lake University in San Antonio, Texas in 1984. In 1988, he became a Texas-licensed Certified Public Accountant.
Corporate Governance
The Company promotesWe promote accountability for adherence to honest and ethical conduct; endeavorswe endeavor to provide full, fair, accurate, timely and understandable disclosure in reports and documents that the Company fileswe file with the SEC and in other public communications made by the Company;us and strive to be compliant with applicable governmental laws, rules and regulations. The Company has not formallyWe have adopted a written codeDirectors Code of businessBusiness Conduct to promote honest and ethical conduct and ethics that governscompliance with applicable laws, rules, regulations and standards on the part of our board of directors. This code addresses several matters, including conflicts of interest, corporate opportunities, confidentiality, fair dealing, protection and proper use of Company assets, compliance with laws, rules and regulations (including insider trading laws), and encouraging the reporting of any illegal or unethical behavior. We have also adopted Financial Officer’s Code of Business Conduct to promote honest and ethical conduct, proper disclosure of financial information in the Company’s periodic reports, and compliance with applicable laws, rules, and regulations by the Company’s officers and management personnel, including the Company’s chief executive officer, chief financial officer and controller. The policies established by this code are aimed at preventing wrongdoing and at promoting honest and ethical conduct, including ethical handling of actual and apparent conflicts of interest, the full, fair, accurate, timely and understandable disclosure in public communications, compliance with applicable laws, rules and regulations, and accountability for adherence to the Company’s employees, officers and directors ascode through prompt internal reporting of violations of the Company is not required to do so.code.
There were no material changesUntil the addition of Mr. Hollinger to the procedures by which shareholders may recommend nominees to the Company’s board of directors.
Inour Board, in lieu of an Audit Committee, the Company’sour Board of Directors iswas responsible for reviewing and making recommendations concerning the selection of outside auditors, reviewing the scope, results and effectiveness of the annual audit of the Company'sour financial statements and other services provided by the Company’sour independent public accountants. We created an Audit Committee in April 2010 who will perform these functions. The Board of Directors reviews the Company'sour internal accounting controls, practices and policies. Our Board of Directors has determined that no directorMr. Hollinger, Chairman of the Audit Committee, qualifies as an independent audit committee financial expert as defined in Item 407(d) (5) (ii) of Regulation S-B.S-K.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors, and executive officers, as well as persons beneficially owningwho own more than 10%ten percent of a registered class of our outstanding common stock,equity securities, to file reports of securities ownership and changes in such ownership with the SEC within specified time periods. Such officers,SEC. Officers, directors and greater than ten percent shareholders also are required by rules promulgated by the SEC to furnish us with copies of all Section 16(a) forms they file.
Based solely on itsupon a review of the copies of such forms received byfurnished to us or written representations from certain reporting persons, notof our officers and directors, we believe that all Section 16(a) filing requirements applicable to our officers, directors and 10% shareholders were complied withinfiled on a timely manner duringbasis, except that Mr. Newbury and Mr. Hollinger were each not timely in the fiscal year ended December 31, 2007. During 2007, the numberfiling of one Form 3, that were filed late totaled six;Mr. Hollinger was not timely in the numberfiling of two Form 4 that were filed late totaled six;4s and Ms. Budrunas was not timely in the numberfiling of one Form 5 that were filed late totaled seven. However all required reports have been filed by December 31, 2007.5.
ITEMItem 10. 11. Executive Compensation.EXECUTIVE COMPENSATION
The following table summarizes all compensation paid to our Chief Executive 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 ($) | | | Stock Awards ($)(4) | | | 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, 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 Msrs 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) On February 14, 2008, Deep Down issued 350,000 shares of restricted common stock to Msrs 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 ontotal compensation earned in the closing price of our Common Shares of $ 0.98 on December 31, 2007 (the last trading day of our fiscal yearyears ended December 31, 2007)2010 and 2009 by our Chief Executive Officer and our three highest compensated executive officers other than our CEO, which included one executive who resigned in January 2011 (collectively, our “Named Executive Officers” or “NEOs”).
Summary Compensation Table
| Name and Principal Position | Year | | Salary ($) | | | Bonus ($) (6) | | | Stock Awards ($) (1) | | | Option Awards ($) (1) | | | All Other Compensation ($) (2) | | | Total | |
| Ronald E. Smith | 2010 | | $ | 362,250 | | | $ | - | | | $ | - | | | $ | - | | | $ | 18,000 | | | $ | 380,250 | |
| President and Chief Executive Officer | 2009 | | $ | 345,000 | | | $ | - | | | $ | 93,000 | | | $ | - | | | $ | 12,000 | | | $ | 450,000 | |
| Eugene L. Butler | 2010 | | $ | 325,500 | | | $ | - | | | $ | - | | | $ | - | | | $ | 46,817 | | | $ | 372,317 | |
| Executive Chairman and Chief Financial Officer (3) | 2009 | | $ | 310,000 | | | $ | - | | | $ | 93,000 | | | $ | 771,600 | | | $ | 24,348 | | | $ | 1,198,948 | |
| Gay Stanley Mayeux | 2010 | | $ | 163,462 | | | $ | - | | | $ | 87,500 | | | $ | 61,600 | | | $ | 12,000 | | | $ | 324,562 | |
| Vice President and Chief Financial Officer (4) | 2009 | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Michael J. Newbury | 2010 | | $ | 190,000 | | | $ | - | | | $ | - | | | $ | 18,150 | | | $ | 12,000 | | | $ | 220,150 | |
Vice President of Operations and Business Development (5) | 2009 | | $ | 109,615 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 109,615 | |
(1) Included in the “Stock Awards” and “Option Awards” columns are the aggregate grant date fair values of restricted stock awards and option awards made in 2010 and 2009. The grant date fair values of the awards were computed in accordance with FASB ASC Topic 718. A total of 2,000,000 option awards which were originally issued on February 14, 2008 were cancelled in March 2010 and not reissued (such cancellation has no impact on compensation, since we are required to expense the remaining unamortized stock based compensation at the time of cancellation). For a discussion of the assumptions and methodologies used to value the stock and option awards reported in the table above, see Note 8 “Share-Based Compensation” to our consolidated financial statements included in this Report. All options are for the purchase of our common stock. Stock awards are grants of restricted stock representing time-vesting shares.
(2) The amounts in the “All Other Compensation” column for 2010 were attributed to the following:
| · | Option AwardsMr. Smith: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,500 per month). |
| · | Mr. Butler: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,500 per month), payroll tax reimbursement of $13,517 and healthcare premium reimbursement of $13,800. |
| Ms. Mayeux: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,500 per month) for the eight months of her employment. |
| Mr. Newbury: Amounts included for the year ended 2010 consisted of a vehicle allowance ($1,000 per month). |
Name | | Number of Securities Underlying Unexercised Options (#) Exercisable | | Number of Securities Underlying Unexercised Options (#) Unexercisable | | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) | | Option Exercise Price ($) | | Option Expiration Date |
| Eugene L. Butler, Chief Financial Officer | | | - | | | 3,000,000 | | | - | | $ | 0.515 | | May 31, 2010 |
(4) Ms. Mayeux was hired as Chief Financial Officer effective April 29, 2010, and resigned effective January 24, 2011.
(5) Mr. Newbury was hired by Deep Down effective March 30, 2009 as Manager of Business Development and was promoted to Vice President of Operations and Business Development effective February 17, 2010.
(6) There were no bonuses awarded in 2010 or 2009 due to our current cost containment efforts.
The vesting provisions for the Company’s stock options noted above will vest over a three year period.
Narrative Disclosure to Summary Compensation Table
Employment AgreementsAll of the compensation described in the foregoing table, other than those amounts shown in the “Bonus”, “Stock Awards” and “Option Awards” columns, was paid to the NEOs pursuant to agreements with Deep Down.
Effective August 6, 2007, we signedMr. Smith has an employment agreement with Ronald E. Smith,to serve as our President and Chief Executive Officer, (“CEO”)which provided initially for an initialannual cash compensation of $345,000, and a monthly vehicle allowance of $1,000. Effective January 1, 2010, Mr. Smith’s annual cash compensation was increased to $362,250, and a monthly vehicle allowance of $1,500. The term of Mr. Smith’s employment agreement is through August 6, 2010 withJanuary 1, 2013, and is subject to further automatic annual renewals for annual periods up to 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 $270,000 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 $270,000 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.
Compensation of Directors
For the year ended December 31, 2007, there were no2009, Mr. Butler had a consulting agreement between Deep Down and Eugene L. Butler & Associates to serve as our Chief Financial Officer. Mr. Butler’s consulting agreement provided for annual cash payments or equity grantscompensation of $310,000 effective January 1, 2009; also a monthly vehicle allowance of $1,000 and reimbursement for federal and state payroll withholdings customarily withheld for an employee which are included in the “All Other Compensation” column. Effective January 1, 2010, Mr. Butler’s consulting agreement was replaced by an employment agreement. The employment agreement provides for Mr. Butler to receive cash compensation of $325,500 and a monthly vehicle allowance of $1,500. The term of Mr. Butler’s employment agreement is through January 1, 2013, and is subject to the Company’s former non-employee director, Daniel L. Ritz, Jr. Mr. Ritzfurther automatic renewals for annual periods up to an additional two years.
Ms. Mayeux had an employment agreement to serve as our Vice President and Chief Financial Officer, which provided for annual cash compensation of $250,000, and a monthly vehicle allowance of $1,500. The term of Ms. Mayeux’s employment agreement was through January 1, 2013; Ms. Mayeux resigned as a director offrom the Company effective January 24, 2011.
Mr. Newbury has an employment agreement to serve as our Vice President Operations and Business Development, which provides for annual cash compensation of $190,000, and a monthly vehicle allowance of $1,000. The term of Mr. Newbury’s employment agreement is through February 17, 2012, and is subject to automatic renewals for annual periods unless cancelled by either party upon 90 days notice.
The amount included for 2010 in the “Stock Awards” column above reflects a grant of 1,000,000 restricted shares of our common stock provided to Ms. Mayeux on May 25, 2010 under the Plan. The grant of restricted shares of our common stock was scheduled to vest over three years ratably beginning one year from grant date, provided that the officer continues to be employed with Deep Down through the vesting date. All these shares were cancelled and returned to the Company upon resignation of Ms. Mayeux on January 24, 2011.
The amounts included for 2009 in the “Stock Awards” column above reflect grants of 750,000 restricted shares of our common stock provided to each of Messrs. Smith, and Butler on March 20, 2007. The other directors23, 2009 under the Plan. Each of the Company are all also executive officersgrants of restricted shares of our common stock vested in its entirety on March 23, 2011.
The amounts included for Ms. Mayeux for 2010 in the “Option Awards” column above reflect awards to purchase 1,000,000 shares of our common stock granted to Ms. Mayeux on April 29, 2010 under the Plan. The options were scheduled to vest over three years ratably beginning one year from grant date, and had an exercise price of $0.105. These options were cancelled and returned to the Company and as directors do not receive any additional compensation related toupon the performanceresignation of services as directors. Ms. Mayeux on January 24, 2011.
The Company may agree to provide compensation to non-employee directorsamounts included for Mr. Newbury for 2010 in the future.“Option Awards” column above reflect awards to purchase 250,000 shares of our common stock granted to Mr. Newbury on February 19, 2010 under the Plan. The options are scheduled to vest over three years ratably beginning one year from grant date, and have an exercise price of $0.122.
The amounts included for Mr. Butler for 2009 in the “Option Awards” column above reflect awards to purchase 2,000,000 and 10,000,000 shares of our common stock granted to Mr. Butler on March 23, 2009 and September 1, 2009, respectively, under the Plan. The options vest over three years ratably beginning one year from grant date, and have an exercise price of $0.124 and $0.10, respectively.
Outstanding Equity Awards at December 31, 2010
The following tables present information regarding the outstanding equity awards held by each of the NEOs as of December 31, 2010. Mr. Smith had no outstanding option awards on that date.
Option Awards
| Name | | | | Number of Securities Underlying Unexercised Options Exercisable | | Number of Securities Underlying Unexercised Options Unexercisable (#) | | Option Exercise Price ($/Sh) | | |
| Eugene L. Butler | | 9/1/2009 | | 3,333,333 | | 6,666,667 (1) | | 0.10 | | 9/1/2014 |
| | | 3/23/2009 | | 666,667 | | 1,333,333 (2) | | 0.12 | | 3/23/2014 |
| Gay Stanley Mayeux | | 4/29/2010 | | - | | 1,000,000 (3) | | 0.11 | | 4/29/2015 |
| Michael J. Newbury | | 2/19/2010 | | - | | 250,000 (4) | | 0.12 | | 2/19/2015 |
Item 11.(1) | Security OwnershipThe remaining unvested portion of Certain Beneficial Ownersthis option award is scheduled to vest in equal installments on September 1, 2011 and Management and Related Stockholder Matters.September 1, 2012, provided that Mr. Butler continues to be employed with Deep Down through those vesting dates. |
| (2) | A total of 666,667 options that were unexercisable at December 31, 2010 vested on March 23, 2011. The remaining 666,666 unvested options are scheduled to vest on March 23, 2012, provided that Mr. Butler continues to be employed with Deep Down through that vesting date. |
| (3) | These unvested options were cancelled in connection with Ms. Mayeux’s resignation effective January 24, 2011. |
| (4) | A total of 83,334 options vested on February 19, 2011. The unvested portions of this option award are scheduled to vest in equal installments on February 19, 2012 and February 19, 2013, provided that Mr. Newbury continues to be employed with Deep Down through those vesting dates. |
Stock Awards
| Name | | | | Number of Shares or Units of Stock That Have Not Vested (#) | | Market Value of Shares or Units of Stock that Have Not Vested ($)(1) | | Number of Shares or Units of Stock That Vested (#) | | Market Value of Shares or Units of Stock that Have Vested ($)(1) |
| Ronald E. Smith | | 3/23/2009 | | 750,000 | (2) | $60,000 | | - | | - |
| | | 2/14/2008 | | | | | | 350,000 (3) | | $28,000 |
| Eugene L. Butler | | 3/23/2009 | | 750,000 | (2) | $60,000 | | - | | - |
| | | 2/14/2008 | | | | | | 350,000 (3) | | $28,000 |
| Gay Stanley Mayeux | | 5/25/2010 | | 1,000,000 | (4) | $80,000 | | - | | - |
| (1) | The market value is calculated by multiplying the number of shares by the closing price of our common stock of $ 0.08 on December 31, 2010. |
| (2) | This restricted stock award vested in its entirety on March 23, 2011. |
| (3) | This restricted stock award was granted on February 14, 2008, and vested in its entirety on February 14, 2010. |
| (4) | This unvested restricted stock award was cancelled in connection with Ms. Mayeux’s resignation effective January 24, 2011. |
Benefits payable upon change in control
Each of Mr. Butler’s and Mr. Smith’s (the “Executive”) employment agreements contain provisions related to change in control. Ms. Mayeux’ employment agreement contained the same provisions, however her agreement was terminated in connection with her departure in January 2011.
In the event of termination of the Executive’s employment for any reason, he will be entitled to receive all accrued, unpaid salary and vacation time through the date of termination and all benefits to which the Executive is entitled or vested under the terms of all employee benefit and compensation plans, agreements and arrangements in which the Executive is a participant as of the date of termination. In addition, subject to executing a general release in favor of us, the Executive will be entitled to receive certain severance payments in the event his employment is terminated by the Company “other than for cause” or by the Executive with “good reason.” These severance payments include the following:
(i) a lump sum in cash equal to one times the Executive’s annual base salary (at the rate in effect on the date of termination), provided, however, that is such termination occurs prior to the date that is twelve months following a change of control, then such payment will be equal to three times the Executive’s annual base salary (at the rate in effect on the date of termination);
(ii) a lump sum in cash equal to the average annual bonus paid to the Executive for the prior two full fiscal years preceding the date of termination; provided, however, that is such termination occurs prior to the date that is twelve months following a change of control, then such payment will be equal to two times the average annual bonus paid to the Executive for the prior two full fiscal years preceding the date of termination;
(iii) a lump sum in cash equal to a pro rata portion of the annual bonus payable for the period in which the date of termination occurs based on the actual performance under our annual incentive bonus arrangement; provided, however, that such pro rata portion shall be calculated based on the Executive’s annual bonus for the previous fiscal year; provided further that if no previous annual bonus has been paid to the Executive, then the lump sum cash payment shall be no less than fifty percent of Executive’ annual base salary; and
(iv) if the Executive’s termination occurs prior to the date that is twelve months following a Change of Control (as defined in the Employment Agreement), then each and every share option, restricted share award and other equity-based award that is outstanding and held by the Executive shall immediate vest and become exercisable.
Each of the Executives have agreed to not, during the respective term of his employment and for a one-year period after his termination, engage in Competition (as defined in the Employment Agreement) with us, solicit business from any of our customer or potential customers, solicit the employment or services of any person employed by or a consultant us on the date of termination or with six months prior thereto, or otherwise knowingly interfere with our business or accounts or any of our subsidiaries.
The Employment Agreements also provide that we, to the extent permitted by applicable law and our by-laws, will defend, indemnify and hold harmless the Executive from any and all claims, demands or causes of action, including reasonable attorneys’ fees and expenses, suffered or incurred by the Executive as a result of the assertion or filing of any claim, demand, litigation or other proceedings based upon statements, acts or omissions made by or on behalf of the Executive pursuant to the Employment Agreement or in the course and scope of the Executive’s employment with us. We will also maintain and pay all applicable premiums for directors’ and officers’ liability insurance which shall provide full coverage for the defense and indemnification of the Executives, to the fullest extent permitted by applicable law.
Compensation Committee Report
We do not have a separate compensation committee. Accordingly, to the extent that decisions are made regarding the compensation policies pursuant to which our named executive officers are compensated, they are made by our Board.
In light of the foregoing, the Board has reviewed and discussed with management the Compensation Discussion and Analysis set forth above and determined that it be included in this annual report for the year ended December 31, 2010.
Submitted by:
Ronald E. Smith
Mary L. Budrunas
Eugene L. Butler
Mark R. Hollinger
Notwithstanding anything to the contrary set forth in any previous filings under the Securities Act, as amended, or the Exchange Act, as amended, that incorporate future filings, including this annual report, in whole or in part, the foregoing Compensation Committee Report shall not be incorporated by reference into any such filings.
Option Exercises and Stock Vested During the Year Ended December 31, 2010
There were no options exercised by NEOs during the year ended December 31, 2010. All of the restricted stock issued on February 14, 2008 became fully vested on February 14, 2010. Additionally, 666,667 option granted to Mr. Butler on March 23, 2009 vested on March 23, 2010. All of the restricted stock issued on May 25, 2010 was cancelled in connection with the resignation of the executive effective January 24, 2011.
Compensation of Directors
The following table provides certain information with respect to the 2010 compensation of our directors who served in such capacity during the year. The 2010 compensation of those directors who are also our named executive officers is disclosed in the Summary Compensation Table above. We refer to our directors who are neither employed by us nor by our principal stockholders as outside directors. Compensation for our outside directors consists of equity and cash as described below. Our outside director as of the date of this statement is Mark R. Hollinger.
| Name | | Fees Earned or Paid in Cash ($) | | | Stock Awards ($) (1) | | | Option Awards ($) (1) | | | All Other Compensation ($) | | | Total | |
Eugene L. Butler (2) | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Ronald E. Smith (2) | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Mary L. Budrunas (2) | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Mark R. Hollinger | | $ | 32,500 | | | $ | 87,500 | | | $ | 50,800 | | | $ | - | | | $ | 170,800 | |
| (1) | Included in the “Stock Awards” and “Option Awards” columns are the aggregate grant date fair values of restricted stock awards and option awards made to our outside director in 2010. The grant date fair values of the awards were computed in accordance with FASB ASC Topic 718. For a discussion of the assumptions and methodologies used to value the stock and option awards reported in the table above, see Note 8 “Share-Based Compensation” to our consolidated financial statements included in this Report. All options are for the purchase of our common stock. Stock awards are grants of restricted stock representing time-vesting shares. In May 2010, we granted 1,000,000 restricted shares, par value $0.001 per share for a total of $1,000, to Mr. Hollinger. The shares were valued at $0.0875 per share and vest over three years in equal tranches on the grant date anniversary, with continued service on our Board of Directors; we are amortizing the related share-based compensation of $87,500 over the three-year requisite service period. Additionally, in May 2010, we granted option awards to purchase 1,000,000 shares of our common stock to Mr. Hollinger. The options are scheduled to vest over three years ratably beginning one year from grant date, and have an exercise price of $0.09. |
| Each of our directors who also serve as our executive officers do not receive any additional compensation for their performance of services as directors. We may agree to provide compensation to these directors in the future. |
Equity Compensation
We have not formalized equity compensation for outside directors.
Cash Compensation
We pay our outside directors an annual retainer of $12,000, plus meeting fees of $2,000 per meeting of the Board of Directors attended in person and $1,000 per meeting attended by telephone or other electronic means. All directors are also entitled to reimbursement of expenses. Outside directors serving in specified committee positions also receive the following additional annual retainers:
| Chairman of the Audit Committee | | $ | 10,000 | |
| Chairman of the Compensation Committee | | $ | 10,000 | |
| Chairman of the Governance Committee | | $ | 5,000 | |
Each committee member receives $1,000 for each meeting of a committee of the Board of Directors attended in person or by telephone or other electronic means.
Our outside director fees are payable in cash or, at the election of each director, which is made on an annual basis, in shares of stock determined by the current market price of the stock at the time of each payment.
Determining Director Compensation
The Board of Directors makes all decisions regarding the compensation of the Board of Directors. The Chief Executive Officer makes periodic recommendations regarding director compensation based on his subjective judgment and review of available survey data, and the Board of Directors may exercise its discretion in modifying or approving any adjustments or awards to the directors.
Compensation Policy Related to Risk Management
We do not believe that there are any risks arising from our compensation policies and practices for our employees that are reasonably likely to have a material adverse effect on us.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information, as of March 31, 2008,April 15, 2011, concerning the beneficial ownership of shares of Common Stock of the CompanyDeep Down by (i) each person known by the Companyus to beneficially own more than 5%5 percent of the Company’s Common Stock;outstanding shares of our common stock; (ii) each Director; (iii) the Company’s Namedour “Named Executive Officers;Officers” (as determined under Item 402(m) of Regulation S-K); and (iv) all directors and executive officers of the CompanyDeep Down as a group. To theour knowledge, of the Company, all persons listed in the table have sole voting and investment power with respect to their shares, except to the extent that authority is shared with their respective spouse under applicable law.
Name and address of beneficial owner (2) | Shares | Options / Warrants | Percent (1) |
Ronald E. Smith (3)(4) | 44,629,876 | - | 38.5% |
Mary L. Budrunas (3)(4) | 44,629,876 | - | 38.5% |
Robert E. Chamberlain, Jr. (4) | 25,350,000 | - | 21.9% |
Eugene L. Butler (4) | 350,000 | - | 0.3% |
| All directors and officers as a group | 70,329,876 | - | 60.7% |
(1) A person is deemed to be Unless otherwise indicated, 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 outstandingaddress 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 115,846,019 shares of common stock outstanding as of March 28, 2008.
(2) The address of each of the beneficial ownersindividuals listed below is c/o Deep Down, Inc., 15473 East Freeway, Channelview,8827 W. Sam Houston Pkwy N., Suite 100, Houston, Texas 77530.77040.
(3) Reflects 6,652,871 shares owned by Ron Smith and 16,627,005 shares owned by Mary L. Budrunas through the conversion of Series D Preferred Stock on March 28, 2008, plus 19,564,000 shares owned by Ron Smith and 1,786,000 shares owned by Mary L. Budrunas directly.| Name of Beneficial Owner (1) | | Shares of Common Stock Beneficially Owned | | Percent of Common Stock Outstanding |
| | | | | | |
| Directors and Executive Officers: | | | | |
| Ronald E. Smith (2) | | 45,337,301 | | | 22.0% |
| Mary L. Budrunas (2) | | 45,337,301 | | | 22.0% |
| Eugene L. Butler (4) | | 5,674,092 | | | 2.7% |
| Michael J. Newbury (5) | | 83,334 | | | * |
| Mark R. Hollinger (6) | | 1,166,666 | | | * |
| All directors and officers as a group (5 persons) | 52,261,393 | (7) | | 24.7% |
| | | | | | |
| 5% Shareholders: | | | | | |
| Flotation Investor, LLC | | 20,000,000 | | | 9.7% |
| 767 Fifth Avenue, 17th Floor | | | | | |
| New York, New York 10153 | | | | | |
| Robert E. Chamberlain, Jr. (3) | | 19,750,975 | | | 9.6% |
| 2909 N. Island Drive | | | | | |
| Seabrook, Texas 77586 | | | | | |
| | | | | | |
| * Less than 1% | | | | | |
(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.
| (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 206,399,155 shares of common stock outstanding as of April 13, 2011. |
| (2) | Mr. Smith and Ms. Budrunas are husband and wife. Shares include 26,724,296 shares owned directly by Mr. Smith and 18,613,005 shares owned directly by Ms. Budrunas. Such shares also include 350,000 shares of restricted stock issued to Mr. Smith on February 14, 2008 which vested on February 14, 2010, and 750,000 shares of restricted stock issued to Mr. Smith on March 23, 2009 which vested on March 23, 2011. |
| (3) | Shares include 350,000 shares of restricted stock issued to Mr. Chamberlain on February 14, 2008, and 750,000 shares of restricted stock issued to Mr. Chamberlain on March 23, 2009 which were fully vested on September 1, 2009 in connection with Mr. Chamberlain’s Severance and Separation Agreement, plus 750,000 shares of restricted stock issued to Mr. Chamberlain on September 1, 2009 which vested on, September 1, 2010, in connection with such Severance and Separation Agreement. |
| (4) | Shares include 350,000 shares of restricted stock issued to Mr. Butler on February 14, 2008 which vested on February 14, 2010 and 750,000 shares of restricted stock issued to Mr. Butler on March 23, 2009 which vested on March 23, 2011, plus 4,666,667 shares of Deep Down’s common stock that Mr. Butler has the right to acquire by exercise of stock options which vested during 2010 and 2011. |
| (5) | Includes 83,334 shares of Deep Down’s common stock that Mr. Newbury has the right to acquire by exercise of stock options which vested February 11, 2011. |
| (6) | Includes 500,000 shares of restricted stock purchased by Mr. Hollinger in April 2010 as part of a private placement, plus 333,333 shares of Deep Down’s common stock that Mr. Hollinger has the right to acquire by exercise of stock options which vest on May 31, 2011, and 333,333 shares of restricted stock issued to Mr. Hollinger on May 31, 2011 which will vest on May 31, 2011. |
| (7) | Shares include 5,416,667 shares of Deep Down’s common stock that executive officers and directors have the right to acquire by exercise of stock options or restricted stock that are vested within 60 days of April 15, 2011. |
Disclosure regarding our equity compensation plans as required by this item is incorporated by reference to the information set forth under Item 5 “Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Part II Item 5 of this report.
Item 12. Certain RelationshipsITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Review and Approval of Related Person Transactions
Our board of directors and management recognize that related person transactions present a heightened risk of conflicts of interest, and therefore we review all relationships and transactions in which we and our directors, director nominees and executive officers or their immediate family members, as well as holders of more than 5 percent of any class of our voting securities and their family members, have a direct or indirect material interest. As required under SEC rules, transactions that are determined to be directly or indirectly material to us or a related person are disclosed in the appropriate annual and/or quarterly statements filed with the SEC.
Ronald E. Smith, President, CEO and Director Independence.of Deep Down and Eugene Butler, Executive Chairman, CFO and Director of Deep Down, were investors in Ship and Sail, Inc. (“Ship and Sail”), a former vendor of Deep Down. During the year ended December 31, 2010, we made payments of $10,000 to Ship and Sail, and we expensed the prepaid balance of $38,000 as of December 31, 2009 during the first quarter of 2010. The payments and expense to Ship and Sail related to services provided by that entity for the support of the development of marine technology which is currently being marketed. Ship and Sail discontinued operations in mid-2010, thus there is no longer a related party relationship. As disclosed in the 2009 Form 10-K, we made a deposit for a boat in the amount of $100,000 which was written off in connection with the discontinued operations of Ship and Sail.
We lease all buildings, structures, fixturesIn January 2010, we loaned South Texas Yacht Services, a vendor of Deep Down, $100,000. The owner of South Texas Yacht Services was in a business alliance with Ship and Sail. The note receivable, included in other improvements fromassets on the consolidated balance sheet, bears interest at a rate of 5.5 percent per annum and monthly principal and interest payments in the amount of $2,000 commenced in April 2010. The final principal and interest payment is due March 24, 2015. As of March 31, 2011, the payments on this note were current. Additionally, as of September 30, 2010, South Texas Yacht Services is no longer a related party as they are no longer in a business alliance with Ship and Sail.
Additionally, during the year ended December 31, 2010, we recorded expenses to JUMA, LLC, a company owned by Ronald E. Smith, CEO and a directorhis wife Mary L. Budrunas, Corporate Secretary and Director of Deep Down, Inc.in the amount of $35,000; there is no balance due as of December 31, 2010. Payments related to the monthly rental of a boat owned by JUMA, in connection with the development of marine technology as discussed above. The board of directors approved the arrangement between JUMA and Mary L. Budrunas, a vice president and a director of Deep Down Inc. The base ratewith a termination date of $11,000 per month is payableDecember 31, 2010. No future payments are anticipated to JUMA through September 1, 2011, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.JUMA.
The Company is a partyUntil the addition of Mr. Hollinger to the employment agreements described aboveour Board in Item 10.
None of the Company’s directors is 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”,April 2010, none of our Directors was independent. We feel additional independent directors would qualifywill add strength and perspective to our Board of Directors and will increase our internal control process as discussed above, thus we are actively working towards adding additional independent generally or with respectmembers to any specific independence requirements for any committee member.our Board.
Item 13. Exhibits.
The exhibits as indexed immediately following the signature page of this Report are included as part of this Form 10-KSB/A.
ItemITEM 14. Principal Accountant Fees and Services.PRINCIPAL ACCOUNTANT FEES AND SERVICES
We retained KPMG, LLP (“KPMG”) as our principal accountant in 2010. We had no relationship with KPMG prior to their retention as our principal accountant. The following table sets forth the aggregate fees paid to Malone & Bailey, PC KPMG for audit services rendered in connection with the Company'sour consolidated financial statements and reports for the year ended December 31, 2007 and the period ended December 31, 20062010, and for other services rendered during those yearsthat year on behalf of the CompanyDeep Down and its subsidiaries:subsidiaries, and fees billed to us by PricewaterhouseCoopers LLP for audit and other services during 2009:
| | | December 31, 2007 | | December 31, 2006 | | | December 31, 2010 | | | December 31, 2009 | |
| (i) Audit Fees | | $ | 205,967 | | $ | 164,695 | | | $ | 821,700 | | | $ | 502,023 | |
| (ii) Audit Related Fees | | 165,931 | | - | | | | - | | | | - | |
| (iii) Tax Fees | | 16,260 | | - | | | | 118,307 | | | | 5,250 | |
| (iv) All Other Fees | | - | | - | | | | - | | | | - | |
Audit Fees:Fees: Consists of fees billed for professional services rendered for the audit of the Company’sDeep Down’s consolidated financial statements, the review of interim condensed consolidated financial statements included in quarterly reports, and other offering documentation, services that are normally provided by Malone & Bailey, PC in connection with statutory and regulatory filings or engagements and attest services, except those not required by statute or regulation.
Audit-Related Fees:Fees: Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit and review of the Company’sDeep Down’s consolidated financial statements and are not reported under "Audit Fees." These services include auditing work on proposed transactions, including the audit of Mako Technologies, Inc., attest services that are not required by statute or regulation, and consultations concerning financial accounting and reporting standards.
Tax Fees:Fees: Consists of tax compliance, tax preparation and other tax services. Tax compliance and tax preparation consists of fees billed for professional services related to assistance with tax returns. Other tax services consist of fees billed for other miscellaneous tax consulting.
All Other Fees: None.
Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors
The Audit Committee of the Board of Directors pre-approves all audit and permissible non-audit services provided by Malone & Bailey, PC.KPMG. These services may include audit services, audit-related services, tax services and other services. The Audit Committee of the Board of Directors may also pre-approve particular services on a case-by-case basis and may delegate pre-approval authority to one or more directors. If so delegated, the director must report any pre-approval decision to the Board of Directors at its first meeting after the pre-approval was obtained.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedules. See the consolidated financial statements and related footnotes commencing on page F-1 of this report.
(b) Exhibits.
| Exhibit Number | | Description of Exhibit |
| 2.1 | | Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc. (incorporated by reference from Exhibit 2.1 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.1 | | Articles of Incorporation of Deep Down, Inc. (conformed to include the amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008 (incorporated by reference from Exhibit A to our Schedule 14C filed on August 15, 2008). |
| 3.2 | | Amended and Restated By Laws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008). |
| 3.3 | | Form of Certificate of Designations of Series D Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.4 | | Form of Certificate of Designations of Series E Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.5 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.5 | | Form of Certificate of Designations of Series F Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.6 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 3.6 | | Form of Certificate of Designations of Series G Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.7 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 4.1 | | Common Stock Purchase Warrant for 320,000 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated August 6, 2007 (incorporated herein by reference from Exhibit 4.2 to our Form 10-KSB filed with the Commission on April 1, 2008). |
| 4.2 | | Common Stock Purchase Warrant for 118,812 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated January 4, 2008 (incorporated herein by reference from Exhibit 4.3 to our Form 10-KSB filed with the Commission on April 1, 2008). |
| 4.3 | | Common Stock Purchase Warrant for 200,000 shares of common stock of Deep Down, Inc. issued to Subsea, LLC dated June 6, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 8-K/A (Amendment No. 2) filed with the Commission on June 9, 2008). |
| 4.4 | | Registration Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect Capital Corporation (incorporated herein by reference from Exhibit 4.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
| 4.5 | | Securities Purchase Agreement, dated December 31, 2010, by and among Deep Down, Inc. and Flotation Investor, LLC (incorporated herein by reference from Exhibit 10.3 to our Form 8-K filed with the Commission on January 5, 2011). |
| 4.6 | | 6% Subordinated Debenture of Deep Down, Inc. dated March 31, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 10-Q filed with the Commission on May 16, 2008). |
| 10.1 | | Amended and Restated Credit Agreement, entered into as of April 14, 2010, between Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.31 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.2 | | First Amendment to Amended and Restated Credit Agreement, dated December 31, 2010, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.4 to our Form 8-K filed with the Commission on January 5, 2011). |
| 10.3 | | Guaranty, dated as of November 11, 2008, by ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.2 to our Form 10-Q filed with the Commission on November 14, 2008). |
| 10.4 | | Joinder to Guaranty, dated as of February 13, 2009, by Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.5 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
| 10.5 | | Security Agreement, dated as of November 11, 2008, among Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed with the Commission on November 14, 2008). |
| 10.6 | | Joinder to Security Agreement, dated as of February 13, 2009, by Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.7 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.7 | | First Amendment to Security Agreement, dated as of December 18, 2008, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 8-K filed with the Commission on December 19, 2008). |
| 10.8 | | Second Amendment to Security Agreement, executed as of May 29, 2009, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc., for the benefit of Whitney National Bank (incorporated by reference from Exhibit 10.4 to our Form 8-K filed on June 2, 2009). |
| 10.9 | | Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing, executed as of May 29, 2009, by Deep Down, Inc., as grantor, in favor of Gary M. Olander, as trustee, for the benefit of Whitney National Bank, as beneficiary (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on June 2, 2009). |
| 10.10 | | Ratification of Guaranty, Security Agreement, and Intercreditor Agreement, dated April 14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc., a Delaware corporation, each a guarantor, and Whitney National Bank, a national banking association, as lender (incorporated by reference from Exhibit 10.36 to our Form 10-K filed with the Commission on April 15, 2011). |
| 10.11 | | First Modification to Deed of Trust, dated April 14, 2010, executed by Deep Down, Inc., as grantor, for the benefit of Whitney National Bank, as lender (incorporated by reference from Exhibit 10.37 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.12 | | First Modification to Assignment of Leases and Rents, dated April 14, 2010, executed by Deep Down, Inc., as assignor, and Whitney National Bank, as assignee (incorporated by reference from Exhibit 10.38 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.13 | | ROV Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.32 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.14 | | RE Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.33 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.15 | | RLOC Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.34 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.16 | | LC Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.35 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.17 | | Office Building Lease, dated November 24, 2008, between Deep Down, Inc. and A-K-S-L 49 Beltway 8, L.P. (incorporated herein by reference from Exhibit 10.18 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.18† | | Severance and Separation Agreement, dated September 1, 2009, by and between Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr. (“Consultant”) and Deep Down, Inc. (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed with the Commission on November 16, 2009). |
| 10.19 | | Loan Agreement entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.22 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.20 | | Mortgage and Security Agreement, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.23 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
| 10.21 | | Collateral Assignment of Leases and Rents, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.24 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.22 | | Commercial Note, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.25 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.23 | | Debt Subordination Agreement, entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc. and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.26 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.24 | | Purchase and Sale Agreement, dated May 22, 2009, by and between Deep Down, Inc. and JUMA Properties, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on June 2, 2009). |
| 10.25† | | Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 15, 2010). |
| 10.26† | | Amended and Restated Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 15, 2010). |
| 10.27† | | Employment Agreement, dated effective as of February 17, 2010, between Deep Down, Inc. and Michael J. Newbury (incorporated by reference from Exhibit 10.30 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.28† | | Employment Agreement, dated effective as of April 29 2010, between Deep Down, Inc. and Gay Stanley Mayeux (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010). |
| 10.29† | | Stock Option, Stock Warrant and Stock Award Plan (incorporated by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008). |
| 10.30 | | Stock Purchase Agreement, dated May 3, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010). |
| 10.31 | | Amendment No. 1 to Stock Purchase Agreement, dated July 13, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on July 14, 2010). |
| 10.32 | | Amendment No. 2 to Stock Purchase Agreement, dated October 4, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on October 4, 2010). |
| 10.33 | | Amendment No. 3 to Stock Purchase Agreement, dated effective as of October 31, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on November 8, 2010). |
| 10.34 | | Agreement and Amendment No. 4 to Stock Purchase Agreement, dated effective as of November 30, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on December 9, 2010). |
| 10.35 | | Waiver Agreement, dated April 28, 2010, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on May 5, 2010). |
| 10.36 | | Contribution Agreement, dated December 31, 2010, by and among Deep Down, Inc., Flotation Technologies, Inc., Cuming Flotation Technologies, LLC and Flotation Investor, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 5, 2011). |
| 10.37 | | Contract Assignment and Amendment Agreement, dated December 31, 2010, by and among Deep Down, Inc., Cuming Flotation Technologies, LLC and Cuming Corporation (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 5, 2011). |
| 10.38 | | Amended and Restated Limited Liability Company Agreement of Cuming Flotation Technologies, LLC, dated December 31, 2010 (incorporated by reference from Exhibit 10.5 to our Form 8-K filed January 5, 2011). |
| 10.39 | | Management Services Agreement, dated effective as of January 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.6 to our Form 8-K filed January 5, 2011). |
| 10.40 | | First Amendment to Management Services Agreement, dated effective as of March 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed March 8, 2011). |
| 10.41* | | Waiver, dated March 25, 2011, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower. |
| 10.42* | | Second Amendment to Amended and Restated Credit Agreement, dated April 14, 2011, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC. |
| Exhibit Number | | Description of Exhibit |
| 14.1 | | Directors Code of Business Conduct (incorporated herein by reference from Exhibit 14.1 to our Form 10-K filed with the Commission on April 15, 2010). |
| 14.2 | | Financial Officer’s Code of Business Conduct (incorporated herein by reference from Exhibit 14.2 to our Form 10-K filed with the Commission on April 15, 2010). |
| 16.1 | | Letter, dated July 14, 2009, from Malone & Bailey, PC to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed on July 14, 2009). |
| 16.2 | | Letter, dated June 30, 2010, from PricewaterhouseCoopers LLP to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed July 7, 2010). |
| 21.1* | | Subsidiary list. |
| 24.1* | | Power of Attorney (set forth immediately following the registrant’s signatures to this report). |
| 31.1* | | Rule 13a-14(a)/15d-14(a) Certification of the President and Chief Executive Officer of Deep Down, Inc. |
| 31.2* | | Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep Down, Inc. |
| 32.1* | | Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc. |
| 32.2* | | Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc. |
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrantregistrant caused this Reportreport to be signed on its behalf by the undersigned, thereunto duly authorized.
DEEP DOWN, INC.
DEEP DOWN, INC. (Registrant) | | |
| | |
| | |
| /s/ RONALD E. SMITH | | |
Ronald E. Smith President and Chief Executive Officer Dated: April 15, 2011 | | |
| | |
| | |
| /s/ EUGENE L. BUTLER | | |
Eugene L. Butler Chief Financial Officer Dated: April 15, 2011 | | |
/s/ RONALD E. SMITH ��
Ronald E. Smith, President and Chief Executive Officer
(Principal Executive Officer)
Dated: March 31, 2009
/s/ EUGENE L. BUTLER
Eugene L. Butler
Chief Financial Officer (Principal Financial Officer)
Dated: March 31, 2009
POWER OF ATTORNEY
KNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints RONALD E. SMITH and EUGENE L. BUTLER, and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and re-substititonre-substitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K/A,10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person hereby ratifying and confirming all that said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrantregistrant and in the capacities and on the dates indicated.
Signatures | | Title | | Date |
| | | | |
| /s/ RONALD E. SMITH | | President, Chief Executive Officer and Director | March 31, 2009 | April 15, 2011 |
Ronald E. Smith | | (Principal Executive Officer) | | |
| | | | |
| | | | |
| /s/ EUGENE L. BUTLER | | Executive Chairman and Chief Financial Officer and Director | | April 15, 2011 |
| Eugene L. Butler | | (Principal Financial Officer) | |
| Officer and Principal | | |
| | | | |
/s/ ROBERT E. CHAMBERLAIN, JR. | | Chairman, Chief Acquisitions Officer and Director | |
Robert E. Chamberlain, Jr. | Accounting Officer) | | |
| | | | |
| | | | |
| /s/ MARY L. BUDRUNAS | | Vice-President, Director,Corporate Secretary and Corporate SecretaryDirector | | April 15, 2011 |
| Mary L. Budrunas | | | | |
| | | | |
| | | | |
| /s/ MARK R. HOLLINGER | | Director | | April 15, 2011 |
| Mark R. Hollinger | | | | |
EXHIBIT INDEX
| Exhibit Number | | Description of Exhibit |
| 2.1 | |
*2.1
| Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc. |
3.1 | Certificate of Incorporation of MediQuip Holdings, Inc. (incorporated by reference from Exhibit 3.12.1 to our Annual ReportForm 10-KSB/A filed with the Commission on Form 10-KSB forMay 1, 2008).
|
| 3.1 | | Articles of Incorporation of Deep Down, Inc. (conformed to include the fiscal year ended December 31, 2007amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008 (incorporated by reference from Exhibit A to our Schedule 14C filed on March 31,August 15, 2008). |
| 3.2 | Certificate
| Amended and Restated By Laws of Amendment to Articles of Incorporation providing for Change of Name to Deep Down, Inc. (incorporated by reference from Exhibit 3.2B to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007Schedule 14C filed on March 31,August 15, 2008). |
*3.3
| By Laws of Deep Down, Inc.
|
*3.4
| Form of Certificate Designationof Designations of Series D Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
*3.5
3.4 | | Form of Certificate Designationof Designations of Series E Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.5 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
*3.6
3.5 | | Form of Certificate Designationof Designations of Series F Redeemable Convertible Preferred Stock (incorporated herein by reference from Exhibit 3.6 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
*3.7
3.6 | | Form of Certificate Designationof Designations of Series G Redeemable Exchangeable Preferred Stock (incorporated herein by reference from Exhibit 3.7 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
*4.1 | Common Stock Purchase Warrant for 4,960,585 common stock of Deep Down, Inc. issued to Prospect Capital Corporation effective May 25, 2007.
|
4.2 | Common Stock Purchase Warrant for 320,000 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated August 6, 2007 (incorporated herein by reference from Exhibit 4.2 to our Annual Report on Form 10-KSB forfiled with the fiscal year ended December 31, 2007 filedCommission on March 31,April 1, 2008). |
4.34.2 | | Common Stock Purchase Warrant for 118, 812118,812 shares of common stock of Deep Down, Inc. issued to Dragonfly Capital Partners, LLC dated January 4, 2008 (incorporated herein by reference from Exhibit 4.3 to our Annual Report on Form 10-KSB forfiled with the fiscal year ended December 31, 2007 filedCommission on March 31,April 1, 2008). |
*4.3 | | Common Stock Purchase Warrant for 200,000 shares of common stock of Deep Down, Inc. issued to Subsea, LLC dated June 6, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 8-K/A (Amendment No. 2) filed with the Commission on June 9, 2008). |
| 4.4 | | Registration Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect Capital Corporation.Corporation (incorporated herein by reference from Exhibit 4.4 to our Form 10-KSB/A filed with the Commission on May 1, 2008). |
*10.1
4.5 | | Securities Purchase Agreement, dated December 31, 2010, by and among Deep Down, Inc. and Flotation Investor, LLC (incorporated herein by reference from Exhibit 10.3 to our Form 8-K filed with the Commission on January 5, 2011). |
| 4.6 | | 6% Subordinated Debenture of Deep Down, Inc. dated March 31, 2008 (incorporated herein by reference from Exhibit 4.1 to our Form 10-Q filed with the Commission on May 16, 2008). |
| 10.1 | | Amended and Restated Credit Agreement, datedentered into as of August 6, 2007, amongApril 14, 2010, between Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the financial institutionsGuarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC (incorporated herein by reference from timeExhibit 10.31 to time party thereto, and Prospect Capital Corporation.our Form 10-K filed with the Commission on April 15, 2010). |
| 10.2 | | First Amendment to Amended and Restated Credit Agreement, dated as of December 21, 2007,31, 2010, by and among Deep Down, Inc., as borrower, and Prospect Capital Corporation,Whitney National Bank, as agentlender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc. and Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.4 to our Form 8-K filed with the Commission on January 5, 2011). |
| 10.3 | | Guaranty, dated as of November 11, 2008, by ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.2 to our Form 10-Q filed with the Commission on November 14, 2008). |
| 10.4 | | Joinder to Guaranty, dated as of February 13, 2009, by Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.5 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
| 10.5 | | Security Agreement, dated as of November 11, 2008, among Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed with the Commission on November 14, 2008). |
| 10.6 | | Joinder to Security Agreement, dated as of February 13, 2009, by Deep Down International Holdings, LLC (incorporated herein by reference from Exhibit 10.7 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.7 | | First Amendment to Security Agreement, dated as of December 18, 2008, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National Bank (incorporated herein by reference from Exhibit 10.3 to our Form 8-K filed with the Commission on December 19, 2008). |
| 10.8 | | Second Amendment to Security Agreement, executed as of May 29, 2009, by Deep Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc., for the benefit of Whitney National Bank (incorporated by reference from Exhibit 10.4 to our Form 8-K filed on June 2, 2009). |
| 10.9 | | Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing, executed as of May 29, 2009, by Deep Down, Inc., as grantor, in favor of Gary M. Olander, as trustee, for the benefit of Whitney National Bank, as beneficiary (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on June 2, 2009). |
| 10.10 | | Ratification of Guaranty, Security Agreement, and Intercreditor Agreement, dated April 14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down, Inc., a Delaware corporation, each a guarantor, and Whitney National Bank, a national banking association, as lender (incorporated by reference from Exhibit 4.110.36 to our Annual ReportForm 10-K filed with the Commission on Form 10-KSBApril 15, 2011). |
| 10.11 | | First Modification to Deed of Trust, dated April 14, 2010, executed by Deep Down, Inc., as grantor, for the fiscal year ended December 31, 2007benefit of Whitney National Bank, as lender (incorporated by reference from Exhibit 10.37 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.12 | | First Modification to Assignment of Leases and Rents, dated April 14, 2010, executed by Deep Down, Inc., as assignor, and Whitney National Bank, as assignee (incorporated by reference from Exhibit 10.38 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.13 | | ROV Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.32 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.14 | | RE Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.33 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.15 | | RLOC Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.34 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.16 | | LC Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated by reference from Exhibit 10.35 to our Form 10-K filed with the Commission on April 15, 2010). |
| 10.17 | | Office Building Lease, dated November 24, 2008, between Deep Down, Inc. and A-K-S-L 49 Beltway 8, L.P. (incorporated herein by reference from Exhibit 10.18 to our Form 10-K filed with the Commission on March 31, 2008)16, 2009). |
| 10.18† | | Severance and Separation Agreement, dated September 1, 2009, by and between Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr. (“Consultant”) and Deep Down, Inc. (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed with the Commission on November 16, 2009). |
| 10.19 | | Loan Agreement entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated herein by reference from Exhibit 10.22 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.20 | | Mortgage and Security Agreement, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.23 to our Form 10-K filed with the Commission on March 16, 2009). |
| Exhibit Number | | Description of Exhibit |
| 10.21 | | Collateral Assignment of Leases and Rents, entered into as of February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.24 to our Form 10-K filed with the Commission on March 16, 2009). |
*10.3
10.22 | Guarantee and Collateral Agreement, dated
| Commercial Note, entered into as of August 6, 2007,February 13, 2009, by Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit 10.25 to our Form 10-K filed with the Commission on March 16, 2009). |
| 10.23 | | Debt Subordination Agreement, entered into as of February 13, 2009, by and among Flotation Technologies, Inc., Deep Down, Inc., as borrower and as Grantor, and Prospect Capital Corporation as Administrative AgentTD Bank, N.A. (incorporated herein by reference from Exhibit 10.26 to our Form 10-K filed with the Commission on March 16, 2009). |
10.4†10.24 | Consulting
| Purchase and Sale Agreement, dated as of August 6, 2007,May 22, 2009, by and between Deep Down, Inc. and Strategic Capital Services, Inc. regarding the services of Robert ChamberlainJUMA Properties, LLC (incorporated by reference from Exhibit 10.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 20078-K filed on March 31, 2008)June 2, 2009). |
10.5†10.25† | | Employment Agreement, dated effective as of August 6, 2007,January 1, 2010, between Deep Down, Inc. and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 15, 2010). |
| 10.26† | | Amended and Restated Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.210.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 20078-K filed on March 31, 2008)January 15, 2010). |
10.6†10.27† | Consulting
| Employment Agreement, dated effective as of August 6, 2007,February 17, 2010, between Deep Down, Inc. and Eugene L. Butler & Associates regarding the services of Eugene L. ButlerMichael J. Newbury (incorporated by reference from Exhibit 10.310.30 to our Annual ReportForm 10-K filed with the Commission on April 15, 2010). |
| 10.28† | | Employment Agreement, dated effective as of April 29 2010, between Deep Down, Inc. and Gay Stanley Mayeux (incorporated by reference from Exhibit 10.1 to our Form 10-KSB for the fiscal year ended December 31, 20078-K filed on March 31, 2008)May 5, 2010). |
*10.7†
10.29† | 2003 Directors, Officers and Consultants
| Stock Option, Stock Warrant and Stock Award Plan.Plan (incorporated by reference from Exhibit 4.10 to our Form S-1 Registration Statement (file no. 333-152435) filed with the Commission on July 21, 2008). |
*10.8†
10.30 | Form of Option Grant
| Stock Purchase Agreement, under 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan. |
10.9 | Agreement and Plan of Mergerdated May 3, 2010, among Deep Down, Inc., Mako Technologies, LLC, Mako Technologies, Inc.Cuming Corporation and the shareholders of Mako Technologies, Inc. dated December 17, 2007Selling Stockholders named therein (incorporated by reference from Exhibit 2.110.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 20078-K filed on March 31, 2008)May 5, 2010).
|
*10.10
10.31 | | Amendment No. 1 to Stock Purchase Agreement, and Plan of Reorganizationdated July 13, 2010, among Deep Down, Inc., ElectroWave (USA), Inc., a Nevada corporation, ElectroWave (USA) Inc., a Texas corporation, Pinemont IV, Martin L. KershmanCuming Corporation and Ronald W. Nance. |
10.11 | Lease Agreement dated September 1, 2006 between Deep Down, Inc., a Delaware corporation, as tenant, and JUMA, L.L.C.the Selling Stockholders named therein (incorporated by reference from Exhibit 10.410.1 to our Annual ReportForm 8-K filed on July 14, 2010).
|
| 10.32 | | Amendment No. 2 to Stock Purchase Agreement, dated October 4, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 10-KSB for8-K filed on October 4, 2010). |
| 10.33 | | Amendment No. 3 to Stock Purchase Agreement, dated effective as of October 31, 2010, among Deep Down, Inc., Cuming Corporation and the fiscal year endedSelling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on November 8, 2010). |
| 10.34 | | Agreement and Amendment No. 4 to Stock Purchase Agreement, dated effective as of November 30, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on December 9, 2010). |
| 10.35 | | Waiver Agreement, dated April 28, 2010, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on May 5, 2010). |
| 10.36 | | Contribution Agreement, dated December 31, 20072010, by and among Deep Down, Inc., Flotation Technologies, Inc., Cuming Flotation Technologies, LLC and Flotation Investor, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on March 31, 2008)January 5, 2011). |
*10.12
10.37 | Lease
| Contract Assignment and Amendment Agreement, dated JuneDecember 31, 2010, by and among Deep Down, Inc., Cuming Flotation Technologies, LLC and Cuming Corporation (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 5, 2011). |
| 10.38 | | Amended and Restated Limited Liability Company Agreement of Cuming Flotation Technologies, LLC, dated December 31, 2010 (incorporated by reference from Exhibit 10.5 to our Form 8-K filed January 5, 2011). |
| 10.39 | | Management Services Agreement, dated effective as of January 1, 2006,2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.6 to our Form 8-K filed January 5, 2011). |
| 10.40 | | First Amendment to Management Services Agreement, dated effective as of March 1, 2011, by and among Deep Down, Inc. and Cuming Flotation Technologies, LLC (incorporated by reference from Exhibit 10.1 to our Form 8-K filed March 8, 2011). |
| 10.41* | | Waiver, dated March 25, 2011, by and between MakoWhitney National Bank, as lender, and Deep Down, Inc., as borrower. |
| 10.42* | | Second Amendment to Amended and Restated Credit Agreement, dated April 14, 2011, by and among Deep Down, Inc., as borrower, and Whitney National Bank, as lender, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., as LesseeMako Technologies, LLC, Deep Down, Inc. and Sutton Industries, as Lessor.Deep Down International Holdings, LLC. |
| Exhibit Number | | Description of Exhibit |
| 14.1 | | Directors Code of Business Conduct (incorporated herein by reference from Exhibit 14.1 to our Form 10-K filed with the Commission on April 15, 2010). |
*21.1
14.2 | Subsidiary List
| Financial Officer’s Code of Business Conduct (incorporated herein by reference from Exhibit 14.2 to our Form 10-K filed with the Commission on April 15, 2010). |
24.116.1 | | Letter, dated July 14, 2009, from Malone & Bailey, PC to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed on July 14, 2009). |
| 16.2 | | Letter, dated June 30, 2010, from PricewaterhouseCoopers LLP to the Securities and Exchange Commission (incorporated by reference from Exhibit 16.1 to our Form 8-K filed July 7, 2010). |
| 21.1* | | Subsidiary list. |
| 24.1* | | Power of Attorney (set forth immediately following the registrant’s signatures to this report). |
*31.1
31.1* | | Rule 13a-14(a)/15d-14(a) Certification of the President and Chief Executive Officer of Deep Down, Inc. |
*31.2
31.2* | | Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep Down, Inc. |
*32.1
32.1* | | Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc. |
*32.2
32.2* | | Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc. |
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
ReportReports of Independent Registered Public Accounting FirmFirms | F-2 |
| | |
| Consolidated Balance Sheets | F-3F-4 |
| | |
| Consolidated Statements of Operations | F-4F-5 |
| | |
| Consolidated Statements of Changes in Stockholders’ Equity | F-5F-6 |
| | |
| Consolidated Statements of Cash Flows | F-6F-7 |
| | |
| Notes to the Consolidated Financial Statements | F-8 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Independent Auditors’ Report
The Board of Directors and Stockholders of
Deep Down, Inc., Houston, Texas:
We have audited the accompanying consolidated balance sheetssheet of Deep Down, Inc. (the “Company”),and subsidiaries as of December 31, 2007 and 20062010, and the related consolidated statementsstatement of operations, statement of changes in stockholders’ equity (deficit), and cash flows for the year ended December 31, 2007. We have also audited the accompanying statements of operations, changes stockholders’ deficit and cash flows for the period from inception (June 29, 2006) through December 31, 2006 (Successor), and for the 324 day period from January 1, 2006 to November 20, 2006 (Predecessor).then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.audit.
We conducted our auditsaudit in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. Deep DownThe Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our auditsaudit 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’sthe Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Deep Down, Inc. and subsidiaries as of December 31, 2010, and the results of their operations and their cash flows for the year then ended in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
April 15, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Deep Down, Inc.
We have audited the accompanying consolidated balance sheet of Deep Down, Inc. and its subsidiaries as of December 31, 2009, and the related consolidated statement of operations, shareholders' equity and cash flows for the year ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Deep Down, Inc. as ofand their subsidiaries at December 31, 2007 and 2006,2009, and the results of itstheir operations and their cash flows for the periods described,year ended December 31, 2009 in conformity with U.S.accounting principles generally accepted accounting principles.
in the United States of America.
/s/ MALONE & BAILEY, PC
www.malone-bailey.comPRICEWATERHOUSE COOPERS LLP
Houston, Texas
March 31, 2008
ExceptApril 15, 2010, except for the effects of the matter discussed in Note 142, as to which the date is dated March 30, 2009
Deep Down, Inc. |
Consolidated Balance Sheets
|
April 15, 2011
| | | 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: | | | | | | | | |
| 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 5,000 issued and outstanding | | | 4,419,244 | | | | 4,419,244 | |
Series 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 | |
Deep Down, Inc. | |
Consolidated Statements of Operations | |
| | | Successor | | | Successor | | | Predecessor | |
| | | Company | | | Company | | | Company | |
| | | | | | | | | | |
| | | Year Ended December 31, 2007 | | | Period since inception, June 29, 2006 to December 31, 2006 (1) | | | For the 324-Day Period from January 1, 2006 to November 20, 2006 | |
| | | | | | | | | | |
| Revenues | | | | | | | | | |
| Contract revenue | | $ | 15,652,848 | | | $ | 978,047 | | | $ | 7,843,102 | |
| Rental revenue | | | 3,736,882 | | | | - | | | | - | |
| Total revenues | | | 19,389,730 | | | | 978,047 | | | | 7,843,102 | |
| | | | | | | | | | | | | |
| Cost of sales | | | 13,020,369 | | | | 565,700 | | | | 4,589,699 | |
| | | | | | | | | | | | | |
| Gross profit | | | 6,369,361 | | | | 412,347 | | | | 3,253,403 | |
| | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | |
| Selling, general & administrative | | | 4,284,553 | | | | 3,600,627 | | | | 2,115,947 | |
| Depreciation | | | 426,964 | | | | 27,161 | | | | 139,307 | |
| | | | | | | | | | | | | |
| Total operating expenses | | | 4,711,517 | | | | 3,627,788 | | | | 2,255,254 | |
| | | | | | | | | | | | | |
| Operating income (loss) | | | 1,657,844 | | | | (3,215,441 | ) | | | 998,149 | |
| | | | | | | | | | | | | |
| Other income (expense): | | | | | | | | | | | | |
| Gain on debt extinguishment | | | 2,000,000 | | | | - | | | | - | |
| Interest income | | | 94,487 | | | | - | | | | - | |
| Interest expense | | | (2,430,149 | ) | | | (62,126 | ) | | | (141,130 | ) |
| | | | | | | | | | | | | |
| Total other income (expense) | | | (335,662 | ) | | | (62,126 | ) | | | (141,130 | ) |
| | | | | | | | | | | | | |
| Income (loss) from continuing operations | | | 1,322,182 | | | | (3,277,567 | ) | | | 857,019 | |
| Income tax provision | | | (369,673 | ) | | | (22,250 | ) | | | - | |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) | | $ | 857,019 | |
| | | | | | | | | | | | | |
| Basic earnings (loss) per share | | $ | 0.01 | | | $ | (0.04 | ) | | | | |
| Weighted average common shares outstanding | | | 73,917,190 | | | | 76,701,659 | | | | | |
| | | | | | | | | | | | | |
| Diluted earnings (loss) per share | | $ | 0.01 | | | $ | (0.04 | ) | | | | |
| Weighted average common shares outstanding | | | 104,349,455 | | | | 76,701,569 | | | | | |
(1) Consistent with the provisions of FAS 141 regarding Business Combinations, this column contains the operating results of SubSea Acquisition Corporation ("Subsea") since its inception on June 29, 2006, plus the operating results of Deep Down, Inc. from November 21, 2006, its acquisition date by Subsea.
Deep Down, Inc. and Subsea subsequently completed a parent subsidiary merger with its parent assuming the name Deep Down, Inc.
SeeDEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
| (In thousands, except par value amounts) | | December 31, 2010 | | | December 31, 2009 | |
| ASSETS | | | | | | |
| Current assets: | | | | | | |
| Cash and cash equivalents | | $ | 3,730 | | | $ | 912 | |
| Accounts receivable, net of allowance of $245 and $304, respectively | | | 5,518 | | | | 7,662 | |
| Inventory | | | 223 | | | | 896 | |
| Costs and estimated earnings in excess of billings on uncompleted contracts | | | - | | | | 267 | |
| Prepaid expenses and other current assets | | | 267 | | | | 225 | |
| Total current assets | | | 9,738 | | | | 9,962 | |
| Property, plant and equipment, net | | | 11,676 | | | | 20,011 | |
| Investment in joint venture | | | 3,146 | | | | - | |
| Intangibles, net | | | 2,908 | | | | 12,342 | |
| Goodwill | | | 4,916 | | | | 9,429 | |
| Other assets | | | 1,240 | | | | 960 | |
| Total assets | | $ | 33,624 | | | $ | 52,704 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 5,719 | | | $ | 2,865 | |
| Billings in excess of costs and estimated earnings on uncompleted contracts | | | 446 | | | | 4,984 | |
| Deferred revenues | | | 315 | | | | 89 | |
| Current portion of long-term debt | | | 1,609 | | | | 1,497 | |
| Total current liabilities | | | 8,089 | | | | 9,435 | |
| Long-term debt, net | | | 2,443 | | | | 5,379 | |
| Total liabilities | | | 10,532 | | | | 14,814 | |
| | | | | | | | | |
| Commitments and contingencies (Note 13) | | | | | | | | |
| | | | | | | | | |
| Stockholders' equity: | | | | | | | | |
Common stock, $0.001 par value, 490,000 shares authorized, 207,399 and 180,451 shares, respectively, issued and outstanding | | | 207 | | | | 180 | |
| Additional paid-in capital | | | 63,751 | | | | 61,161 | |
| Accumulated deficit | | | (40,866 | ) | | | (23,451 | ) |
| Total stockholders' equity | | | 23,092 | | | | 37,890 | |
| Total liabilities and stockholders' equity | | $ | 33,624 | | | $ | 52,704 | |
The accompanying notes toare an integral part of the consolidated financial statements.
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
Deep Down, Inc. |
Statements of Changes in Stockholders' Equity |
| | | | | | | | | | | | | | | Additional | | | | | | | |
| | | Common Stock | | | Series C Preferred Stock | | | Paid-in | | | Accumulated | | | | |
| | | Shares | | | Amount | | | Shares | | | Amount | | | Capital | | | Deficit | | | Total | |
Balance at December 31, 2005 (Predecessor) | | | 1,000 | | | $ | 201,000 | | | | - | | | $ | - | | | $ | 37,430 | | | $ | 693,951 | | | $ | 932,381 | |
| Contribution to capital - Juma gain | | | - | | | | | | | | | | | | | | | | 191,766 | | | | | | | | 191,766 | |
| Distribution of capital - Juma | | | - | | | | | | | | | | | | | | | | | | | | (492,406 | ) | | | (492,406 | ) |
| Distributions of capital | | | | | | | | | | | | | | | | | | | | | | | (557,502 | ) | | | (557,502 | ) |
| Net income | | | | | | | | | | | | | | | | | | | | | | | 857,019 | | | | 857,019 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance November 21, 2006(Predecessor) | | | 1,000 | | | | 201,000 | | | | - | | | | - | | | | 229,196 | | | | 501,062 | | | | 931,258 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Purchase accounting | | | (1,000 | ) | | | (201,000 | ) | | | | | | | | | | | (229,196 | ) | | | (501,062 | ) | | | (931,258 | ) |
| Purchase by Subsea | | | 9,999,999 | | | | 100 | | | | | | | | | | | | | | | | | | | | 100 | |
| Exchange shares by DDI | | | (9,999,999 | ) | | | | | | | | | | | | | | | | | | | | | | | - | |
| Exchange adjustment | | | 75,000,000 | | | | 749,900 | | | | | | | | | | | | (749,900 | ) | | | | | | | - | |
| Reclassification of par value (a) | | | | | | | (675,000 | ) | | | | | | | | | | | 675,000 | | | | | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at June 29, 2006 (inception) (Successor) | | | 75,000,000 | | | | 75,000 | | | | - | | | | - | | | | (74,900 | ) | | | - | | | | 100 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reverse merger with MediQuip | | | 7,870,171 | | | | 7,870 | | | | 22,000 | | | | 22 | | | | (7,892 | ) | | | - | | | | - | |
| Net loss | | | - | | | | - | | | | - | | | | - | | | | - | | | | (3,299,817 | ) | | | (3,299,817 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2006 (Successor) | | | 82,870,171 | | | | 82,870 | | | | 22,000 | | | | 22 | | | | (82,792 | ) | | | (3,299,817 | ) | | | (3,299,717 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | - | | | | - | | | | 952,509 | | | | 952,509 | |
| Shares repurchased | | | (25,000,000 | ) | | | (25,000 | ) | | | | | | | | | | | (225,000 | ) | | | | | | | (250,000 | ) |
| Redemption of Preferred | | | 3,463,592 | | | | 3,464 | | | | | | | | | | | | 3,840,314 | | | | | | | | 3,843,778 | |
| Redemption of Preferred C | | | 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 | |
| Debt discount | | | | | | | | | | | | | | | | | | | 1,638,255 | | | | | | | | 1,638,255 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2007 (Successor) | | | 85,976,526 | | | $ | 85,977 | | | | - | | | $ | - | | | $ | 14,849,847 | | | $ | (2,347,308 | ) | | $ | 12,588,516 | |
| | | | |
| (In thousands, except per share amounts) | | 2010 | | | 2009 | |
| | | | | | | |
| Revenues | | $ | 42,471 | | | $ | 28,810 | |
| Cost of sales: | | | | | | | | |
| Cost of sales | | | 26,559 | | | | 18,272 | |
| Depreciation expense | | | 2,327 | | | | 1,616 | |
| Total cost of sales | | | 28,886 | | | | 19,888 | |
| Gross profit | | | 13,585 | | | | 8,922 | |
| Operating expenses: | | | | | | | | |
| Selling, general and administrative | | | 13,964 | | | | 14,371 | |
| Depreciation and amortization | | | 1,731 | | | | 6,538 | |
| Goodwill impairment | | | 4,513 | | | | 5,537 | |
| Total operating expenses | | | 20,208 | | | | 26,446 | |
| Operating loss | | | (6,623 | ) | | | (17,524 | ) |
| Other income (expense): | | | | | | | | |
| Interest expense, net | | | (510 | ) | | | (356 | ) |
| Loss on contribution of net assets of wholly-owned subsidiary | | | (10,119 | ) | | | - | |
| Equity in net loss of joint venture | | | (254 | ) | | | - | |
| Other income, net | | | 266 | | | | 73 | |
| Total other expense | | | (10,617 | ) | | | (283 | ) |
| Loss before income taxes | | | (17,240 | ) | | | (17,807 | ) |
| Income tax (expense) benefit | | | (175 | ) | | | 1,026 | |
| Net loss | | $ | (17,415 | ) | | $ | (16,781 | ) |
| | | | | | | | | |
| Net loss per share, basic and diluted | | $ | (0.09 | ) | | $ | (0.09 | ) |
Weighted-average common shares outstanding, basic and diluted | | | 193,147 | | | | 179,430 | |
(a) Shares were stated at par value of $0.01 in error. The correct par value of $0.001 has been reclassified with offset to additional paid-in capital.
See accompanying notes toare an integral part of the consolidated financial statements.
Deep Down, Inc. | |
Consolidated Statements of Cash Flows | |
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
| | | Successor | | | Successor | | | Predecessor | |
| | | Company | | | Company | | | Company | |
| | | | | | | | | | |
| | | Year Ended December 31, 2007 | | | Period since inception, June 29, 2006 to December 31, 2006 | | | For the 324-Day Period from January 1, 2006 to November 20, 2006 | |
| Cash flows from operating activities: | | | | | | | | | |
| | | | | | | | | | |
| Net income (loss) | | $ | 952,509 | | | $ | (3,299,817 | ) | | $ | 857,019 | |
| Adjustments to reconcile net income to net cash used in | | | | | | | | | | | | |
| operating activities: | | | | | | | | | | | | |
| Gain on extinguishment of debt | | | (2,000,000 | ) | | | | | | | | |
| Non-cash amortization of debt discount | | | 1,780,922 | | | | 48,179 | | | | - | |
| Non-cash amortization of deferred financing costs | | | 54,016 | | | | - | | | | - | |
| Share-based compensation | | | 187,394 | | | | 3,340,792 | | | | - | |
| Allowance for doubtful accounts | | | 108,398 | | | | - | | | | 75,880 | |
| Depreciation and amortization | | | 426,964 | | | | 27,163 | | | | 139,307 | |
| Gain on disposal of equipment | | | 24,336 | | | | - | | | | - | |
| Changes in assets and liabilities: | | | | | | | | | | | | |
| Lease receivable | | | (863,000 | ) | | | - | | | | - | |
| Accounts receivable | | | (4,388,146 | ) | | | (251,001 | ) | | | (166,724 | ) |
| Prepaid expenses and other current assets | | | (54,310 | ) | | | 23,335 | | | | 34,469 | |
| Inventory | | | (502,253 | ) | | | - | | | | 238 | |
| Work in progress | | | 246,278 | | | | (90,326 | ) | | | (826,159 | ) |
| Accounts payable and accrued liabilities | | | 1,022,726 | | | | 145,433 | | | | 255,243 | |
| Deferred revenue | | | (1,970 | ) | | | - | | | | 190,000 | |
| Net cash used in operating activities | | $ | (3,006,136 | ) | | $ | (56,242 | ) | | $ | 559,273 | |
| Cash flows used in investing activities: | | | | | | | | | | | | |
| Cash acquired in acquisiion 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 | ) | | | - | | | | (360,978 | ) |
| Proceeds from sale of land and building | | | - | | | | - | | | | 78,419 | |
| Restricted cash | | | (375,000 | ) | | | - | | | | - | |
| Net cash used in investing activities | | $ | (1,358,429 | ) | | $ | 101,497 | | | $ | (282,559 | ) |
| Cash flows from financing activities: | | | | | | | | | | | | |
| Payment for cancellation of common stock | | | (250,000 | ) | | | - | | | | - | |
| Distributions of capital | | | - | | | | - | | | | (557,502 | ) |
| 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 | | | | - | | | | 512,212 | |
| Payments of long-term debt | | | (2,760,258 | ) | | | (32,893 | ) | | | (212,091 | ) |
| Borrowings on line of credit | | | - | | | | - | | | | 950,004 | |
| Payments on line of credit | | | - | | | | - | | | | (1,000,004 | ) |
| Deferred financing fees | | | (442,198 | ) | | | - | | | | - | |
| Prepaid points | | | (180,000 | ) | | | - | | | | - | |
| Net cash provided by financing activities | | $ | 6,558,323 | | | $ | (32,893 | ) | | $ | (307,381 | ) |
| Change in cash and equivalents | | | 2,193,758 | | | | 12,362 | | | | (30,667 | ) |
| Cash and cash equivalents, beginning of period | | | 12,462 | | | | 100 | | | | 132,264 | |
| Cash and cash equivalents, end of period | | $ | 2,206,220 | | | $ | 12,462 | | | $ | 101,597 | |
| | | Common Stock | | | | | | Accumulated | | | | |
| (In thousands) | | Shares (#) | | | Amount ($) | | | Capital | | | Deficit | | | Total | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Balance at December 31, 2008 | | | 177,351 | | | $ | 177 | | | $ | 60,328 | | | $ | (6,670 | ) | | $ | 53,835 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (16,781 | ) | | | (16,781 | ) |
| Restricted stock issued for service | | | 3,100 | | | | 3 | | | | (3 | ) | | | - | | | | - | |
| Share-based compensation | | | - | | | | - | | | | 836 | | | | - | | | | 836 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2009 | | | 180,451 | | | $ | 180 | | | $ | 61,161 | | | $ | (23,451 | ) | | $ | 37,890 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (17,415 | ) | | | (17,415 | ) |
| Issuance of common stock pursuant to a | | | | | | | | | | | | | | | | | | | | |
| private placement | | | 5,150 | | | | 5 | | | | 510 | | | | - | | | | 515 | |
| Issuance of restricted stock | | | 1,798 | | | | 2 | | | | (27 | ) | | | - | | | | (25 | ) |
| Stock issued | | | 20,000 | | | | 20 | | | | 1,380 | | | | - | | | | 1,400 | |
| Share-based compensation | | | - | | | | - | | | | 727 | | | | - | | | | 727 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2010 | | | 207,399 | | | $ | 207 | | | $ | 63,751 | | | $ | (40,866 | ) | | $ | 23,092 | |
SeeThe accompanying notes toare an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
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.
Inventory is stated at lower of cost (first-in, first out) or net realizable value. Inventory consists
Replacements and betterments are capitalized, while maintenance and repairs are expensed as incurred. It is Deep Down’sour policy to include amortizationdepreciation expense on assets acquired under capital leases with depreciation expense on owned assets. Additionally, we record depreciation expense related to revenue-generating assets as Cost of Sales on the accompanying statements of operations.
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.